India - Regulation

India - Regulation

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In India, collective investment schemes are regulated by the Securities and Exchange Board of India (SEBI). SEBI regulates these schemes through specific regulations, guidelines, and circulars issued by it in this respect.

1.1 Types of funds

Collective investment schemes in India can be classified, according to the type of investments to be made:

  • mutual funds, where the fund/scheme is established in the form of a trust to raise monies through the sale of units to the public, under one or more schemes for investing in securities, including money market instruments or gold or gold related instruments
  • collective investment schemes other than mutual funds for investing in property of any description.

Mutual funds

Under the SEBI (mutual funds) Regulations, 1996 (“SEBI (MF) Regulations” or “the Regulations”), mutual fund means a fund established in the form of a trust to raise monies 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.

A scheme of mutual fund can be set up either as an open-ended scheme, that is, a scheme, which does not specify any duration for redemption, or as a close-ended scheme, that is, a scheme in which the period of maturity of the scheme is specified or as an interval scheme, that is, a scheme in which subscription to the scheme can be made during a specific period (known as specified transaction period) and the repurchase of units is permitted on all business days subject to applicable loads (except for redemption during specified transaction period when no load is charged). No scheme shall provide guaranteed or assured returns except guaranteed by sponsor or asset management company (AMC).

Gold exchange traded fund schemes

Gold exchange traded fund scheme is a mutual fund scheme that invests primarily in gold or gold related instruments. Gold related instrument means an instrument having gold as underlying, as may be specified by SEBI from time to time.

Real estate mutual fund scheme

Real estate mutual fund scheme means a mutual fund scheme that invests directly or indirectly in real estate assets or other permissible assets in accordance with the SEBI (MF) regulations.

Capital protection oriented scheme

Capital protection oriented scheme means a mutual fund scheme which is designated as such and which endeavors to protect the capital invested therein through suitable orientation of its portfolio structure.

The scheme may be launched subject to the following conditions:

  • the scheme should be rated by a registered credit rating agency
  • the scheme should be close-ended
  • it should comply with such other requirements as may be specified by SEBI.

The AMC shall not repurchase units of this scheme before the end of the maturity period.

Close-ended scheme

A mutual fund can repurchase units in a close-ended scheme provided the initial issue expenses in respect of the scheme launched after the commencement of the SEBI (mutual funds)(second amendment) Regulations, 2006 have been charged or are proposed to be charged to the mutual fund. The mutual fund shall deduct an amount representing proportionate initial issue expenses or part thereof remaining unamortized, from the repurchase proceeds. The amount recovered will be credited to the unamortized initial issue expenses of the scheme.

The units of a close-ended scheme may be converted into open-ended scheme:

  • if the offer document of such scheme discloses the option and the period of such conversion or
  • the unitholders are provided with an option to redeem their units in full
  • the initial issue expenses of the scheme have been amortized fully.

All closed-ended schemes (except equity linked savings schemes) launched after 12 December 2008 should get their units listed as mandatory on stock exchanges.

Index fund scheme

Index fund scheme means a mutual fund scheme that invests in securities in the same proportion as an index of securities.

Fund of fund scheme

Fund of fund scheme means a mutual fund scheme that invests primarily in other schemes of same mutual fund or other mutual funds.

Infrastructure debt schemes

SEBI has amended the Regulations to provide regulatory framework for setting up of Infrastructure Debt Funds (IDFs) by inserting Chapter VI-B to the Regulations.

Salient features of Regulatory Framework for IDF Scheme.

  • The IDFs could be set up by any existing mutual fund. Applications from companies which have been carrying on activities or business in infrastructure financing sector for a period of not less than five years and fulfill the eligibility criteria provided in Regulation 7 of Mutual Fund Regulations will also be considered for setting up Mutual Funds exclusively for the purpose of launching IDF Scheme.
  • The IDF would invest 90 per cent of its assets in the debt securities of infrastructure companies or SPVs across all infrastructure sectors. Minimum investment by IDF would be Rs 1 crore with Rs 10 lakh as minimum size of the unit. The credit risks associated with underlying securities will be borne by the investors.
  • An infrastructure debt fund scheme shall be launched either as close-ended scheme maturing after more than five years or Interval scheme with lock-in of five years.
  • Units of infrastructure debt fund schemes shall be listed on a recognized stock exchange.
  • An Infrastructure debt fund shall have minimum 5 investors and no single investor shall hold more than 50 percent of net assets of the scheme.

1.2 Laws

A mutual fund has to be approved by, and be registered with, SEBI. The scheme/fund, the trustee company and the management company are organized and supervised in India principally under the following laws/regulations:

  • the SEBI (MF) Regulations 1996
  • the Indian Trusts Act, 1882.

1.3 Managers, trustees, and custodians

As stated above, the SEBI (MF) Regulations govern the operation of mutual funds. The regulations lay down detailed requirements as to the managers, trustees and custodians of the funds/schemes and as to their functioning.

Managers

Mutual funds

A mutual fund has to be managed by an AMC. An AMC has to be an Indian company incorporated under the Companies Act, 1956 and approved by SEBI to function as an AMC.

Some of the important regulations governing AMCs are as follows.

  • Any company, incorporated in India, wishing to act as an AMC should get the prior approval of SEBI.
  • Existing AMCs should have a sound track record as regards net worth and profitability.
  • An AMC must have a net worth of not less than INR100 million. The sponsor should contribute at least 40 percent of the net worth of the AMC.
  • At least half the directors on the board of directors of an AMC should be persons who are not associates of, or associated in any manner with, the sponsor or any of its subsidiaries or trustees. No director (other than an independent director) can become a director of another AMC.
  • The chairman of an AMC cannot be a trustee of any mutual fund.
  • An AMC cannot purchase or sell securities through any broker associated with the sponsor, the total value of which exceeds 5 percent of the average of the aggregate purchases and sales of securities made by the mutual fund in all its schemes in a block of any three months.
  • An AMC cannot purchase or sell securities through any broker the total value of which exceeds 5 percent of the average of the aggregate purchases and sales of securities made by the mutual fund in any block of any three months. The limit can be exceeded only after recording a written justification for exceeding it. Such excess investments must be reported to the trustees on a quarterly basis.
  • The chief executive officer of the AMC shall ensure that the mutual fund complies with all the provisions of the SEBI (MF) regulations and the guidelines or circulars issued in relation thereto from time to time and that the investments made by the fund managers are in the interest of the unitholders and shall also be responsible for the overall risk management function of the mutual fund.
  • The fund managers shall ensure that the funds of the schemes are invested to achieve the objectives of the scheme and in the interest of the unitholders.
  • The provisions of the SEBI (criteria for fit and proper person) Regulation, 2004, shall as far as apply to all applicants or the mutual funds under these regulations, be complied with.

Expense limits

The total expenses of the scheme excluding issue or redemption expenses, whether initially borne by the mutual fund or by the asset management company, but including the investment management and advisory fee shall be subject to the following limits.

In the case of a fund of funds scheme, the total expenses of the scheme including the management fees shall be either:

  • not exceeding 0.75 percent of the daily or weekly average net assets, depending upon whether the NAV of the scheme is calculated on daily or weekly basis or
  • it may consist of:
    • (A) management fees for the scheme not exceeding 0.75 percent of the daily or weekly average net assets depending upon whether the NAV of the scheme is calculated on daily or weekly basis
    • (B) other expenses relating to administration of the scheme
    • (C) charges levied by the underlying schemes.

Provided that the sum total of (A), (B) and the weighted average of the total expense ratio of the underlying schemes shall not exceed 2.5 percent of the daily or weekly average net assets (depending upon whether the NAV of the scheme is calculated on daily or weekly basis) of the scheme.

In the case of an index fund scheme or exchange traded fund, the total expenses of the scheme including the investment and advisory fees shall not exceed one and one half percent (1.5 percent) of the weekly average net assets.

In the case of any other scheme:

  • on the first Rs.100 crores of the daily or average weekly net assets 2.5 percent
  • on the next Rs.300 crores of the daily or average weekly net assets 2.25 percent
  • on the next Rs.300 crores of the daily or average weekly net assets 2 percent
  • on the balance of the assets 1.75 percent.

Provided that in respect of a scheme investing in bonds such recurring expenses shall be lesser by at least 0.25 percent of the daily or weekly average net assets outstanding in each financial year.

Investment advisory fees

An AMC can charge investment and advisory fees to a mutual fund. The fees have to be disclosed in the offer document and are subject to the following limits:

  • one and one-quarter percent of the weekly average net assets outstanding during an accounting year for the scheme concerned, as long as the net assets do not exceed INR1 billion
  • one percent of the excess amount over INR1 billion, where the net assets exceed INR1 billion.

In the case of an index fund scheme the total limit of the investment advisor fees is 0.75 percent of the weekly average net assets.

Load

No entry load shall be charged for direct applications received by the AMC that is, applications received through internet, submitted to AMC or collection center/investor service center that are not routed through any distributor/agent/broker.

The SEBI has mandated no entry load to be charged for the mutual fund schemes launched after 1 August 2009.

On 9 March 2011, The SEBI has has allowed the load balances to be used for marketing and selling expenses including distributor’s/agent’s commissions. The load balance needs to be segregated into two accounts in the books of accounts of the scheme - one to reflect the balance as on 31 July 2009 and the other to reflect accretions since 1 August 2009. Not more than one- third of load balance as on 31 July 2009 shall be used in any financial year including the financial year ending 31 March 2011. The unutilized balances can be carried forward, yet in no financial year the total spending can be more than one third of the load balances on 31 July 2009. The accretions to load balances after 31 July 2009 can be used by mutual funds for marketing and selling expenses including distributor’s/agent’s commissions without any restrictions.

Trustees

Mutual funds

Any person who is a person of ability, integrity and standing can be appointed as the trustee of a mutual fund with the prior approval of SEBI. Even a body corporate can be appointed as a trustee of a mutual fund. Also, there is no restriction on the appointment of non-residents as trustees of a mutual fund. There are no limits on foreign equity holding in a trustee company. The following restrictions apply.

  • An AMC and director (including independent director) or any of its officers or employees cannot act as trustee of a mutual fund.
  • No trustee can act as trustee of any other mutual fund.
  • Two-thirds of the total number of trustees should be independent persons and should not be associated with the sponsor.

Trustees are primarily required to ensure that the AMC has been managing the mutual fund schemes independently of other activities and has taken steps to ensure that the interests of the investors are not compromised. The Trustee will be required to give an undertaking for the new scheme offer document that the (name of the scheme/fund) approved by them is a new product offered by (name of the MF) and is not a minor modification of the existing scheme/fund/product. This undertaking shall not be applicable to fixed maturity plans and close-end schemes but shall be applicable to close-end schemes with a feature of conversion into open-ended on maturity.

Custodians

A mutual fund is required to appoint a custodian, registered with SEBI, to carry out the custodial services for the schemes of the fund and intimate SEBI within fifteen days of appointment. In the case of a gold exchange traded fund scheme, the assets of the scheme being gold or gold related instruments may be kept in custody of a bank which is registered as a custodian with SEBI. A custodian cannot act as the custodian of a mutual fund if:

  • the sponsor or its associates hold shares carrying 50 percent or more of the voting rights of the share capital of the custodian or
  • fifty percent or more of the directors of the custodian represent the interest of the sponsor or its associates.

There are no specific regulations for the appointment of custodian, to collective investment schemes.

1.4 Investment restrictions

Mutual funds

The moneys collected under any scheme of a mutual fund shall be invested only in securities, money market instruments, privately placed debentures, securitized debt instruments (asset backed securities or mortgaged backed Securities) or gold or gold related instruments.

A mutual fund can also engage in short selling and securities lending and borrowing as per framework specified by the SEBI.

The mutual fund may enter into derivatives transactions on a recognized stock exchange, subject to guidelines specified by SEBI.

The mutual funds can also make investments overseas in:

  • ADRs/GDRs issued by Indian or foreign companies
  • equity of overseas companies listed on recognized stock exchanges overseas
  • initial and follow on public offerings for listing at recognized stock exchanges overseas
  • foreign debt securities in the countries with fully convertible currencies, short-term as well as long-term debt instruments with highest rating
  • money market instruments rated not below investment grade
  • repos in the form of investment, where the counterparty is rated not below investment grade, repos should not however, involve any borrowing of funds by mutual funds
  • government securities where the countries are AAA rated
  • derivatives traded on recognized stock exchange overseas only for hedging and portfolio balancing with underlying as securities
  • short-term deposits with banks overseas where issuer is rated not below investment grade
  • units/securities issued by overseas mutual funds or unit trusts which invest in the aforesaid securities, real estate investment trusts listed in recognized stock exchange overseas, or unlisted overseas securities (not exceeding 10 percent of their net assets).

Money collected under money market scheme of a mutual fund shall be invested only in money market instruments.

Money collected under gold exchange traded fund scheme shall be invested only in gold and gold related instruments.

Following are some of the significant investment restrictions laid down by the SEBI (MF) Regulations.

  • The funds of a mutual funds scheme shall not in any manner be used in carry forward transactions.
  • A mutual fund may enter into underwriting activities after registration with and approval from SEBI.
  • A mutual fund scheme is not permitted to invest more than 5 percent of its NAV in unlisted equity shares or equity related instruments in the case of an open-ended scheme and 10 percent of NAV in the case of a close-ended scheme.
  • A scheme may invest in another scheme under the same AMC or any other mutual fund without charging any fees provided that aggregate inter scheme investment made by all schemes under the same management or otherwise shall not exceed 5 percent of the NAV of the mutual fund. This clause shall not apply to any fund of funds scheme.
  • A mutual fund cannot advance any loans for any purpose.
  • Every mutual fund shall buy and sell securities on the basis of deliveries and shall in all cases of purchases, take delivery of relevant securities and in all cases of sale, deliver the securities. Provided that a mutual fund may engage in short selling of securities in accordance with the framework relating to short selling and securities lending and borrowing specified by the board. Provided further that a mutual fund may enter into derivatives transactions in a recognized stock exchange, subject to the framework specified by the board.
  • A mutual fund cannot, under all its schemes, own more than 10 percent of any company’s paid-up capital carrying voting rights. Furthermore, a mutual fund scheme cannot invest more than 10 percent of its NAV in the equity shares/equity-related instruments of any company except in the case of investments by an index fund or an industry-specific scheme.
  • A mutual fund scheme can invest up to 15 percent of its NAV in debt instruments issued by a single issuer, if they are rated at or above investment grade by a credit rating agency. The limit is increased to 20 percent if prior approval of the trustees and the AMC is obtained. This limit is reduced to 10 percent if the debt instruments issued by a single issuer are not rated and the total investments shall not exceed 25 percent of the NAV. Investments in un rated debt instruments require a prior approval of board of trustees and AMC.
  • No mutual fund scheme shall invest more than 30 percent of its net assets in money market instrument of an issuer (other than investment in goverment securities, treasury bills and CBLOs).
  • A mutual fund scheme cannot invest in any unlisted security of or in securities issued by way of private placement by an associate or group company of the sponsor or in listed securities of group companies of the sponsor, which is in excess of 25 percent of the net assets.
  • The mutual funds shall adhere to the specific guidelines for making overseas investments by the mutual fund schemes inter alia: appointment of dedicated fund manager; due diligence; disclosure requirements; reporting requirements to the Trustees, SEBI, prudential investment norms, etc.
  • Pending deployment of the funds of a scheme in securities in terms of investment objectives of the scheme, a mutual fund can invest the funds in short-term deposits of a scheduled bank. However, no mutual fund scheme shall park more than:
    1. fifteen percent of the net assets in short-term deposit(s) of all the scheduled commercial banks put together
      • It may be raised to 20 percent with prior approval of the trustees.
    2. twenty percent of total deployment by the mutual fund in short-term deposits of associate and sponsor scheduled commercial banks
    3. ten percent of the net assets in short-term deposit(s), with any one scheduled commercial bank including its subsidiaries.

No funds can be parked by a scheme in a bank which has invested in that scheme.

Further, the tenure of parking of funds in short-term deposits of a scheduled bank should not exceed 91 days. This limit has been raised to 182 days in the case the deposits are placed as margin for trading in derivatives.

No scheme of a mutual fund shall make any investment in any fund of funds scheme. A fund of funds scheme shall be subject to the following investment restrictions.

  • A fund of funds scheme shall not invest in any other fund of funds scheme.
  • A fund of funds scheme shall not invest its assets other than in schemes of mutual funds, except to the extent of funds required for meeting the liquidity requirements for the purpose of repurchases or redemptions, as disclosed in the offer document of fund of funds scheme.

These restrictions shall not apply to gold exchange traded fund scheme. The funds of a gold exchange traded fund scheme shall be invested only in gold or gold related instruments except to the extent necessary to meet the liquidity requirements for honoring repurchases or redemptions. The mutual fund may invest such funds in short–term deposits of scheduled commercial banks.

1.5 Borrowing

A mutual fund cannot borrow except to meet temporary liquidity needs of the mutual fund for the purpose of repurchase, redemption of units or payment of interest or dividend to the unit-holders. The borrowing cannot exceed 20 percent of the net assets of the scheme and the duration of such borrowing cannot exceed six months.

1.6 Prospectus

Mutual funds

It is mandatory for a mutual fund to publish an offer document before launching a scheme. The scheme should be approved by the trustees and a copy of the offer document is required to be filed with the SEBI. In the case no modifications are suggested by SEBI within 21 days of filing, the AMC may issue the offer document.

1.7 Supervision

The principal supervising authority for mutual funds and collective investment schemes is the Securities and Exchange Board of India, Plot No.C4-A,'G' Block, Bandra Kurla Complex, Bandra (East), Mumbai 400051 India.

1.8 Fund ownership

Mutual funds

Each scheme and individual plan(s) under the schemes of a mutual fund should have a minimum of 20 investors and no single investor should account for more than 25 percent of the corpus of such scheme/plan(s). Generally, all Indian residents are permitted to invest in mutual funds. The following classes of non-residents are also permitted to invest in units of mutual funds:

  • non-resident Indians or individuals of Indian origin residing outside India, on a full repatriation basis or on a non-repatriation basis
  • foreign institutional investors (FIIs) registered with SEBI and the Reserve Bank of India (RBI – the central bank), on a full repatriation basis.

1.9 Fund structure

Umbrella funds are permitted in India. Hence, it is possible that a unitholder’s interest may be restricted to assets of a particular scheme under the mutual fund.

A scheme floated by a mutual fund is permitted to invest in another scheme under the same AMC or that of any other mutual fund, provided that the aggregate inter-scheme investments made by all the schemes of the mutual fund does not exceed 5 percent of the NAV of the mutual fund.

Mutual funds are not allowed to issue units in bearer form and any transfer of units is registered only upon the production of an instrument of transfer together with the relevant unit certificates. Units held in electronic form through a depository are transferable in accordance with SEBI regulations governing depositories.

1.10 Stock exchange

All closed-ended schemes and interval schemes (except equity linked savings schemes) launched after 12 December 2008 should get their units listed as mandatory on stock exchanges.

Foreign funds are not entitled to register on local stock exchanges.

1.11 Fund set-up

Every mutual fund is required to pay application fees of INR100,000 and registration fees of INR2.5 million to SEBI.

Annual fees payable by mutual funds are:

Net assets as at 31 March Annual fees payable
Up to INR0.5 billion INR0.25 million
INR5 billion and above to 10 billion INR0.35 million
INR10 billion and above to 30 billion INR0.45 million
INR30 billion and above to 50 billion INR0.55 million
INR50 billion and above to 100 billion INR0.65 million
Above to INR100 billion INR0.75 million
Filing fees for offer documents 0.002 percent of the amount raised in the new fund offer subject to minimum of INR0.01 million and maximum of INR0.5 million

The mutual fund shall pay the minimum filing fees while filing the offer document and balance fees at such time as specified by SEBI.

Further, the cost of forming and registering the trust, including professional fees, would vary from case-to-case depending upon the complexity of the trust provisions.

A fund can usually be established in India within a period of 15 to 18 months.

1.12 Use of the internet

The internet revolution has also affected the mutual funds sector and mutual funds/AMCs have their websites on which information on the mutual fund can be found. Contract notes with digital signature are valid subject to obtaining a certificate from the certifying authority under the Information Technology Act, 2000. Minimum requirements are prescribed for internet based purchase and sale of units by the SEBI.

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