The story so far: The Securities and Exchange Board of India (SEBI) on September 30, introduced the liberalised Mutual Funds Lite (MF Lite) framework for passively managed schemes. The framework intends to promote the entry of new players into the MF ecosystem, present diversified investment opportunities for retail investors through less risky schemes and enhance market liquidity.
Why a separate framework?
Passively managed mutual fund schemes are generally considered less risky compared to their actively managed peers. They usually track a benchmark index, say BSE Sensex or Nifty50, and try to mimic their performance. In other words, these funds try and deliver returns in tandem with the benchmark they are following. Since the underlying constituents of the benchmark indices are publicly available, passively managed schemes can be easily tracked and therefore, the associated risks are lower in comparison to their active peers.
SEBI observed that passive funds’ investment strategy imbibes on mimicking instruments already bearing established rules. Asset management companies (AMCs) of the fund, thus have “negligible discretion” about asset allocation and the investment objective. Thus, the regulator held that the current framework, intended primarily for active mutual fund operators, may not be relevant for passively managed schemes. Thus, opting to introduce the “relaxed framework”. The light touch regulations would include relaxed requirements relating to eligibility criteria for sponsors (the ones who set up and register the mutual fund) including net worth, track record and profitability etc.
How does it help new players’ entry?
This would be encouraged by two measures — governance structures (and responsibilities) and requirements for net worth holdings. Net worth is the difference between the assets and liabilities of the fund. The framework deems a minimum net worth of ₹35 crore to be appropriate for AMCs operating a passive fund. Emphasising on the need for liquid money, the regulator observed that the fund may require to deploy the entire amount of the net worth in liquid assets on a perpetual basis. Thus, a lower minimum requirement could provide the “desired head start for a cost effective and competitive passive MF industry”. According to stockbroking firm AngelOne, the framework would likely attract both existing and new market players.
Further, with respect to governance, SEBI explored that in management of passive funds, the oversight role of trustees (tasked with protecting the investors’ interest) also gets considerably reduced. Thus, a case for relaxation. However, it stipulated that the role of trustees in averting conflict of interest and overseeing related party transactions, undue influence of sponsors, misconduct including market abuse and misuse of information including front running would still be relevant along with AMCs. Important to note here however, that certain oversight measures relating to daily operations would now be entirely with the board of the AMC, the paper held. For example, ensuring fairness in fees and expenses charged and more importantly, maintaining the tracking error and difference within the regulatory limit.
What about risks and disclosures?
The success of a passively managed scheme is subject to two factors, namely, TER (refers to the costs associated with running and managing a scheme) and tracking error. Thus, the latest framework moves away from metrics such as strategy and investment avenues, among other things. These would not form part of the scheme information document (SID) that contains all the relevant information for a prospective retail investor. SEBI however sought that the prospective investor be informed about the name of the underlying benchmark, among other things, in the SID. SEBI’s consultation paper had also concentrated focus on costs for compliance considering the lowered risks.
It provided that the responsibilities of the risk management committee(s), being limited in the paradigm, could be instead additionally carried out by the audit committee of the AMC.
Published - October 08, 2024 08:30 am IST
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