This article is written by Alefiya Giletwala, pursuing Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho) and Smriti Katiyar (Associate, LawSikho).
Table of Contents
Mutual funds pool the resources from small and individual investors together and invest them in securities, bonds or other assets. Investing in Mutual funds has increased participation in the financial markets.
Mutual Funds in India are governed by the Securities and Exchange Board of India (SEBI) with the exception of Unit Trust of India (UTI). Its objective is to protect the interest of investors in securities and to promote the development of and regulate the securities market.
In pursuance of its objective, it issued a circular dated April 28, 2021, called ‘Alignment of interest of Key employees of Asset Management Companies (‘AMCs’) with the Unitholders of the Mutual Fund Schemes’ to align the interest of the investors with that of the asset management companies by mandating the fund houses to invest a fifth of fund managers and other senior officials’ salaries in their own schemes.
Meaning of mutual fund
A mutual fund is a company that pools money from many people and invests it in assets like bonds, securities, etc. It is a professionally managed investment program that is funded by shareholders trading in diversified holdings.
A mutual fund is an actual company that has a CEO, Board of Directors, fund managers, auditors, and other employees and is also an investment, where the mutual fund investors are the owner of both; the company and its assets. An average mutual fund holds many different securities which result in the mutual fund shareholders gaining important diversification at low prices.
A person who invests in shares of only one company is at risk of losing a lot of money as opposed to somebody who invests in a mutual fund. For instance, consider an investor who has bought only Hindustan Unilever stocks before the company went into loss, the probability of him losing a great deal of value is high because all of his money is attached to one company. A different investor who has bought shares in a mutual fund that happens to own only some of the Hindustan Unilever stock before the company has had a bad quarter, he would lose significantly less because Hindustan Unilever is just a small part of the fund’s portfolio.
Role of Securities And Exchange Board of India (SEBI) viz-a-viz mutual funds
Securities and Exchange Board of India (SEBI)
The Securities and Exchange Board of India Act was passed in the year 1992 aiming to provide for the establishment of a Board to protect the interest of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith. SEBI formulates policies and regulates mutual funds to protect the interest of investors. The Securities and Exchange Board of India first formulated the regulations for mutual funds in the year 1993 which resulted in the entry of mutual funds sponsored by private sector entities into the capital market. The SEBI (Mutual Funds) Regulations, 1993 was fully revised in the year 1996 and a new comprehensive SEBI (Mutual Funds) Regulations, 1996 came into being and have been amended thereafter from time to time. To protect the interest of investors, SEBI keeps issuing guidelines to the mutual funds whenever required.
SEBI (Mutual Funds) Regulations, 1996
SEBI formulated and issued SEBI (Mutual Funds) Regulations, 1996. All mutual funds whether sponsored by the public sector or private sector are governed by the same set of regulations.
The regulatory requirements are similar for all these mutual fund entities and all are subject to inspection and monitoring by SEBI.
SEBI (Mutual Funds) (Second Amendment) Regulations, 2021
The recent amendment to the regulations made the following changes:
- Insertion of sub-regulation (16A) after sub-regulation (16) of regulation 25
Sub-regulation (16A) provides that the asset management company (AMC) will mandatorily have to invest such amounts in such schemes, based on the risks associated with the schemes, as the Board may specify from time to time.
The addition of sub-regulation (16A) makes it compulsory for the fund houses to invest in their schemes.
- Deletion of sub-regulation (4) of regulation 28
- Substitution of regulation 76 (Action by Board)
Mutual funds compensation diluted by SEBI
Prior to the passing of the SEBI (Mutual Funds) (Second Amendment) Regulations, 2021, fund houses were not mandated by law to invest in their schemes. Sub-regulation (16A) of regulation 25 was added by this amendment which now makes it compulsory for fund houses to invest in their schemes.
The Securities and Exchange Board of India issued a circular on the 28th of April, 2021. This circular aims to align the interest of Asset Management Companies with that of the investors, that is, the unitholders. The rationale for issuing such a circular is evident. SEBI under its objective, is protecting the interest of the investors in securities and promoting the development of and regulating the securities market by mandating AMCs to invest in their schemes.
Alignment of interest of key employees of asset management companies (‘AMCS’) with the unitholders of the mutual fund schemes
The circular was issued by SEBI on April 28, 2021, to align the interest of the AMCs with that of the investors, therefore it is also called ‘alignment circular’. The AMCs and the key employees are responsible for the management of risk-return profiles of the schemes. The Circular provided for the following:
Manner of dilution of compensation
According to the circular, a part of the compensation of key employees of the AMCs shall be paid in the form of units of the scheme. Minimum of 20% of the salary/ bonus/ perks/ non-cash compensation (gross annual CTC) net of income tax and any statutory contributions like NPS and PF of the key employees shall be paid in the form of units in the mutual fund schemes in which they have a role or an oversight.
Such compensation has to be proportionate to that Asset Under Management (AUM) in which the employee has a role/ oversight. Exchange-Traded Funds (ETFs), Index Funds, Overnight Funds and existing close-ended schemes are therefore excluded.
The employee can withdraw its investment after a minimum period of 3 years from the date of the investment or the tenure of the scheme, whichever is less.
In the case, where the key employee manages only a single scheme or a single category of schemes, he will have a choice to invest 50% of the aforementioned compensation by way of units of those schemes whose risk value as per the risk-o-meter is equivalent or higher than the scheme managed by such employee and 50% by way of units of the scheme or category managed by him.
Redemption is not allowed before the lock-in period attaining the age of superannuation as defined in the AMC service rules. However, in case of employees facing emergencies or on humanitarian grounds, it can have a provision of borrowing from the AMCs against such units. The key employee shall be free to redeem the units in case of retirement on attaining the superannuation age except for the units in close-ended schemes. They shall remain in until the tenure of the scheme is over.
In the case where the key employee is found guilty of violating the Code of Conduct, fraud, gross negligence, such employee shall be subjected to clawback, meaning, the AMC shall retrieve the unit paid out to such key employee, thus the units will be redeemed and the amount shall be credited to the scheme.
The AMCs and Trustees are responsible for ensuring and monitoring respectively the compliance of the provisions of this circular. The quarterly CTR and half-yearly trustee report must mention any non-compliance in this regard.
On the website of the AMC, under the provisions of this Circular, the aggregate of the compensation paid in the form of units to the key employees shall be disclosed by every scheme.
Key Employees having role/ oversight only over Exchange-Traded Funds, Overnight Funds, Index Funds, and existing close-ended schemes shall be exempted from the provisions of this Circular.
This Alignment Circular was to be applicable with effect from July 01, 2021. However, the date of its implementation was extended to October 01, 2021, based on the feedback received from the representatives of the Mutual Fund industry and other stakeholders.
Clarifications with respect to the Circular dated April 28, 2021 (Alignment Circular)
SEBI issued on September 20, 2021 clarifications with respect to Circular dated April 28, 2021, on ‘Alignment of interest of Key Employees (‘Designated Employees’) of Asset Management Companies (AMCs) with the Unitholders of the Mutual Fund.
Following are the changes that the clarifications Circular dated September 20, 2021, with respect to the Alignment Circular as specified by SEBI:
- The nomenclature ‘Key Employees’ has been replaced with ‘Designated Employees’.
- ‘Paid in the form of units’ will be read as ‘mandatorily invested in units’. Such investments shall be made on the day of the payment of salary considering the previous month’s AUM for apportioning the investments across various schemes.
- An employee who is below the age of 35 years and who is not the CEO, Head of any Department or Fund Manager will be called ‘junior employee’. The implementation of the provision under para 2(i) of the Alignment Circular for junior employees will happen in a phased manner:
- 10% in the first year, that is, from October 01, 2021, to September 30, 2022.
- 15% in the second year, that is, from October 01, 2022, to September 30, 2023.
- 20% from the third year onwards, that is, from October 01, 2023.
Thus, all junior employees shall mandatorily have to invest 20% as specified under para 2(i) of the Alignment Circular from October 01, 2023, onwards.
This phased implementation will cease to apply from the date such an employee attains the age of 35 years.
- Designated employees other than junior employees will mandatorily have to invest 20% as specified in the Alignment Circular.
- CTC will not include superannuation benefits and gratuity paid at the time of death/retirement and the value of interest on loan availed of by the designated employees against the units from the AMC.
- It has also clarified that the designated employees will have the option to set off their existing investments, if any, as against the fresh investments as required in the same scheme. They may also set off their units for which the lock-in period has expired as against the fresh investments required to be made in the same scheme as provided by the Alignment Circular. Such units will be locked in for the further period of 3 years or tenure of the scheme, whichever is less.
- Only fund managers will be required to invest in the fund of fund schemes.
- In case of death of the Designated Employee, units allotted in pursuance of the Alignment Circular shall be released from the mandatory lock-in period.
- The modalities with respect to close-ended schemes mentioned in para 7 of the Alignment Circular is as follows: the required investment in close-ended schemes will be made in the units of open-ended schemes having risk value equivalent to or higher than mandated close-ended schemes.
A mutual fund like its name suggests is a financial vehicle that clubs funds from people and invests them in securities, bonds or other assets. Investing in mutual funds has significantly contributed to the development of the Indian economy.
SEBI is the regulatory body of mutual funds in India. Its objective is to protect the interest of investors in securities. In pursuance of its objective, it issued an Alignment Circular, mandating the fund houses to invest a fifth of their compensation in the form of units in the mutual fund schemes they have a role/ oversight.
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