Mutual Fund Regulation in India

    Various investment mechanisms are available to investors, the mutual fund being one of them, is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities, subjected to the objectives mentioned in the offer document. It offers ample opportunities to an investor. Like any other type of investment, they are also associated with certain risks like poor planning of returns, underperformance, excessive diversification, etc. Also, because of the wide variety of mutual funds, they allow investors to participate in a wide variety of investment types.

    According to Securities Exchange Board of India (Mutual Fund) Regulations, 1996, “Mutual Fund means a fund established in the form of a trust to raise money through the sale of units to the public or a section of the public under one or more schemes for investing in securities including money market instruments or gold or gold-related instruments or real estate assets”.

    Furthermore, mutual funds usually launch different schemes having different objectives from time to time. In India, it is regulated by the Securities Exchange Board of India (Mutual fund) Regulations, 1996.

    History of Mutual Funds

    In India, the concept of mutual fund was introduced in 1963, when the Government of India and Reserve Bank of India (in brevity RBI) launched Unit Trust of India (in brevity UTI) under an Act of Parliament. UTI remained in monopoly for a long duration. In 1978, the Industrial Development Bank of India (in brevity IDBI) took regulatory and administrative control of UTI from RBI. The Unit Scheme was the first ever mutual fund scheme which was introduced by UTI in the year 1964. From the year 1987, the public and private sectors were allowed to invest in a mutual fund, which gave investors a wide choice of funds in the market. 

    Structure of a Mutual Fund

    A mutual fund is a form of trust which involves the participation of the sponsor, trustees, Asset Management Company (in brevity AMC), and a Custodian. The sponsor who is like a promoter of a company pools in money to form a mutual fund[1] for public trust, and to manage the same, an AMC is appointed. The AMC has professional people who have expertise in how the market and the money in the market works. And, trustees ensure that the interest of investors is protected by keeping a check on the activities of AMC. The custodian, registered with Securities Exchange Board of India holds the securities of schemes of the fund in its custody.

     

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    Mutual Fund regulation in India

    The Securities and Exchange Board of India (in brevity SEBI), is the apex regulator of the capital market in India and hence, regulates Mutual Funds. And in order to provide guaranteed return schemes, mutual funds are required to get approval from the RBI. The Ministry of Finance plays a supervisory role for RBI, SEBI, and appellate authority under SEBI regulations. In addition to that, to develop the mutual fund industry in India, The Association of Mutual Funds in India (AMFI) is established with the objective of protecting the interest of investors and to maintain ethical standards in the industry. Furthermore, certain steps were taken by SEBI for Regulation of Mutual Funds in India:

    • The formation of mutual funds has been made a tripartite process which includes the Trustees, AMCs, and the Mutual Fund shareholders. Although this is done to ensure the protection of investor’s rights there still exists an element of risk as the funds are managed by the AMCs but the custody of assets is with the trustees.
    • The AMCs are required to be set up with fifty percent independent directors; separate board of trustee companies having fifty percent of independent trustees; and independent custodians need to be appointed.
    •  Due to the changes made in SEBIs guidelines in 1993, mutual funds are mandatory to be registered to ensure the soundness of the transaction. 
    • The offer documents are to be in the format as prescribed by the SEBI.
    • The advertisement of mutual funds is required to be abiding by the code of advertising.
    • To ensure a healthy market and to provide authentic information of mutual fund schemes to the investors, SEBI has provided clear guidelines relating to Net Asset Values. 
    • In 1993, mutual funds were granted full-fledged voting rights as a shareholder in a company by the Department of Company affairs.

    SEBI and Mutual Funds

    SEBI is a body established to regulate the securities market and to ensure the protection of investors’ interest in securities. The SEBI (Mutual Funds) Regulations, 1996 which was notified on the 9th day of December 1996, provides for the guidelines which apply to mutual funds.

    The key provisions of the SEBI Regulations, 1996 are as follows:

    • whenever a scheme is launched by the AMC, it is required to be approved by the Board of Trustees, and the copies of offer documents are also required to be filed with SEBI.
    • For an investor to make an informed decision, such a document must contain all the necessary disclosure.
    • Close-ended schemes must be listed on a recognized stock market within six-months from the closure of the subscription. However, such listing is not required in the below-mentioned cases, if the scheme:
    1. Discloses details of repurchase in the offer document;
    2. Provides monthly income or caters to senior citizens, women, children, and physically disabled;
    3. Is capital protection oriented;
    4. Opens for repurchase within six-months of the closure of subscription.
    • If the minimum and maximum amount related to sale, redemption, and periodicity are disclosed in the offer document, then units of close-ended scheme can be opened for sale or redemption (at a predetermined fixed interval).
    • With the consent of majority unit-holders, a close-ended scheme can be converted into an open-ended scheme; and such disclosure is required to be made in the offer letter.
    • By the majority of the shareholders, a resolution can be passed to roll over the units of the close-ended scheme.
    • No scheme, except the equity-linked saving scheme, can be opened for subscription for more than fifteen-days 
    • The extent of minimum and maximum subscription, intended to be retained must be disclosed on the offer letter. In addition to that, if there is a case of oversubscription, the applicants applying up to five-thousand units must be given full allotment.
    • If the minimum subscription is not received, AMC is required to refund the application money, and also the excess oversubscription within five working days of closure of subscription.
    • The close-ended scheme must wound up on the redemption date, except:
    1. in the case where it is rolled over; or
    2. if unit holders with the majority seventy-five percent pass a resolution for winding up of the scheme;
    3. If trustees are in need of winding up of the scheme due to happening of an event;
    4. If SEBI directs to do so.

    In addition to that, due to the measures that SEBI took and the guidelines it issued, mutual funds were allowed to invest in government as well as foreign debt securities in other countries having full convertible currency. Moreover, guidelines were also issued for the valuation of unlisted equity shares for bringing uniformity in calculating the Net Asset Value of mutual fund schemes.

    Furthermore, SEBI also amended its regulation in 2006[2], to allow mutual funds to invest in both gold and gold-related instruments by introducing Gold Exchange Traded Fund (GETF) schemes, which are subjected to few investment restrictions.

    Recent changes made in Mutual Fund Regulation by SEBI

    To encourage investors in investing mutual funds, SEBI has made certain changes[3] in mutual fund regulation, viz.,

    • Large, mid, and small-cap mutual funds are now defined more clearly. 
    • Investors will now be required to invest a minimum of 65 % of the corpus in equity according to the Flexi-cap category. And there is no such requirement for investing in Large, mid, and small-cap socks.
    • mutual funds to be categorized into five groups: equity, debt, balanced/ hybrid, solution-oriented, and others. In addition to that, only one scheme is permitted in each category except Sectoral Funds, and Index Funds.
    • The foreign investment limit has been changed from USD 300 million to USD 600 million. Also, the Overseas Exchange Fund is permitted a maximum of USD 200 million per mutual fund.
    • Open-ended debt mutual funds, except liquid and overnight funds, to hold a minimum of 10 % corpus in liquid assets.

     

    Cryptocurrency and Mutual Funds

    A cryptocurrency is a form of digital currency that is monitored by a decentralized system (cryptography) rather than any central authority. The risk associated with a cryptocurrency investment is that it is not backed by the government and has no legal sanction. Furthermore, it is considered as a commodity as inferred from the judgment in Tata Consultancy Services v. State of Andhra Pradesh[4], and allowing such trading by the mutual fund would mean to legalize commodity trading. Also, trading in cryptocurrency violates the existing foreign exchange norms of the country. It is also associated with the risk of hacking and the sale of cryptocurrency is unidentified, thus, it may result in an illegal transaction. Along with the risks associated, cryptocurrency also has its benefits. It promotes immediate settlement and requires fewer efforts.

    Conclusion

    As the mutual fund is a source for additional income, it is preferred more and more these days. There are various risks associated with such investment but the guidelines set up by SEBI have made it easy to deal with such issues. Also, the categorization is made in such a way that it will help the investors by reducing the number of schemes, merging schemes with other schemes, which will further make it easy for the investors to choose from the various schemes. SEBI guidelines are investor-friendly and with recent changes made in its regulation, things have become more clear to understand.

    Endnotes

    1. The Indian Trust Act, 1882 (Act 2 of 1882).
    2. The Securities and Exchange Board of India (Mutual Funds) (Amendment) Regulation, 2006.
    3. The Securities and Exchange Board of India (Mutual Funds) (Second Amendment) Regulation, 2020.
    4. AIR 2005 SC 371.

    BY RICHA GUNAWAT | SYMBIOSIS LAW SCHOOL, PUNE

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