In this blog post, Tapas Patra, a Deputy Manager in the technical department of a State run energy company (CPSE), who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses how mutual funds are regulated in India.
A mutual fund is a trust made up of money collected from public or investors through the sale of units for investment in securities such as stocks, bonds, and money market instruments. Mutual Funds in India are governed by the Securities Exchange Board of India (Mutual Fund) Regulations 1996 with the exception of Unit Trust of India (UTI) as it was created by the UTI Act passed by the Parliament of India. All mutual funds must be registered with SEBI.
Structure of mutual fund in India
Mutual Funds in India primarily have a 3-tier structure i.e. Sponsor (1st tier), Public Trust (2nd tier) and Asset Management Company (3rd tier). Sponsor is any person who himself or in association with another corporate, establishes a mutual fund. The Sponsor seeks approval from the Securities & Exchange Board of India (SEBI). Once SEBI approves it, the sponsor creates the Public Trust as per the Indian Trusts Act, 1882. Since Trusts have no legal identity in India, the Trust itself cannot enter into contracts. Thus, Trustees are appointed who are authorized to act on behalf of the Trust. The instrument of trust must be in the form of a deed between the Sponsor and the trustees of the mutual fund registered under the provisions of the Indian Registration Act. The Trust is then registered with SEBI leading to formation of mutual fund. Henceforth, the Trust is known as mutual fund. Sponsor and the Trust are two separate entities.
The Trustee’s role is only to act as internal regulators of mutual fund where they see, whether the money is being managed as per the objectives. Trustees appoint the Asset Management Company (AMC), to manage money collected through sale of mutual fund’s units. The AMC’s Board of Directors have at least 50% of independent directors. The AMC is also approved by SEBI. The AMC functions under the supervision of its Board of Directors, the direction of the Trustees and SEBI. AMC in the name of the Trust floats new schemes and manage these schemes by buying and selling securities. In order to do this, the AMC needs to follow all rules and regulations prescribed by SEBI and as per the Investment Management Agreement it signs with the Trustees.
Regulation of mutual funds
Mutual funds are regulated primarily by Securities and Exchange Board of India (SEBI). In 1996, SEBI formulated the Mutual Fund Regulation. SEBI is also the apex regulator of capital markets and its intermediaries. Issuance and trading of capital market instruments also comes under the purview of SEBI. Along with SEBI, mutual funds are regulated by RBI, Companies Act, Stock exchange, Indian Trust Act and Ministry of Finance. RBI acts as a regulator of Sponsors of bank-sponsored mutual funds, especially in case of funds offering guaranteed returns. In order to provide a guaranteed returns scheme, mutual fund needs to take approval from RBI. The Ministry of Finance acts as supervisor of RBI and SEBI and appellate authority under SEBI regulations. Mutual funds can appeal to Ministry of finance on the SEBI rulings.
Some SEBI regulations for mutual funds
Mutual funds must set up AMC with 50% independent directors, a separate board of trustee companies with minimum 50% of independent trustees and independent custodians to ensure an arm’s length relationship between trustees, fund managers, and custodians. As the funds are managed by AMCs and the custody of assets are with trustees, a counter balancing of risks exists as both can keep tabs on each other.
SEBI takes care of the track record of a Sponsor, integrity in business transactions and financial soundness while granting permission. The particulars of schemes are required to be vetted by SEBI. Mutual funds must adhere to a code of advertisement.
As per the current SEBI guidelines, mutual funds must have a minimum of Rs. 50 crore for an open-ended scheme, and Rs. 20 crore corpus for the closed-ended scheme. Within nine months, mutual funds must invest money raised from the saving schemes. This protects the mutual funds from the disadvantage of investing funds in the bullish market and suffering from poor NAV after that. Mutual funds can invest a maximum of 25% in money market instruments in the first six months after closing the funds and a maximum of 15% of the corpus after six months to meet short-term liquidity requirements.
SEBI inspects mutual funds every year to ensure compliance with the regulations.
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