Regulatory mechanism of Mutual Funds

Mutual funds are considered as the best avenue for multiplying the wealth by diversifying the risk amongst different asset classes. In this article, we will read about the regulatory mechanism of Mutual funds in India. To understand the regulatory mechanism, let us first have a look on the history of mutual funds in India.

The concept of mutual fund was introduced in the year 1963 when Unit Trust of India established its Mutual Fund in association with the Government and RBI. As people become aware of the investment in mutual funds, State Bank of India came up with its own mutual fund in 1987. It has been observed that mutual fund markets were largely dominated by the Government sector. Private companies showed interest to open their mutual funds and in 1993 many private players entered the mutual fund market. The Securities and Exchange Board of India (SEBI) started its operation as the regulator of capital market in 1996 but SEBI Act was passed in 1992. SEBI made it mandatory to get the certificates from Association of Mutual funds in India which was established in 1995. Mutual funds companies have grown exponentially in India.

Having looked at the brief history of Mutual Funds in India, let us now read about the regulatory mechanism of Mutual funds.

As per the SEBI regulation 1996, Mutual Funds in India have a three-tier structure as mentioned below:
1. Sponsor
2. Public trust
3. Asset Management Company (AMC)

Sponsor

The sponsor is simply the promoter of the mutual fund. The sponsor is entrusted with the responsibility of bringing in capital and make a mutual fund trust by setting up the AMC. The sponsor seeks approval from SEBI by making the application to register as a mutual fund. A sponsor is liable to contribute at least 40% of the net worth of the AMC. In simple words, a sponsor is the first pillar in formation of Mutual fund company. It is required that a sponsor should also have a 5-year experience in the financial services business and should be profitable for at least 3 out of the 5 years. A Bank, a corporate or a financial institution can be the sponsors for a Mutual fund company.

Public Trust

Sponsor creates a public trust after getting registered with SEBI. The Public trust is made as per the Indian Trust Act 1882. However, it should get registered with SEBI first. Public trust, alone, has no legal identity in India as it is barred from entering into any contract by itself. Public trust has trustees who act on behalf of the trust. The sponsor and trustees sign a trust deed as per the Indian Regulation Act. The trust works like an internal regulator of the mutual fund and keeps a check on objectives mentioned in the deed.

Asset Management Company

Asset Management Company is the third pillar in the structure of a mutual fund. The trustees appoint Asset Management Company which pools money from investors and then manages it with the help of in house appointed mutual fund experts. The boards of directors of AMC works as per the rules laid down by SEBI and directions given by Trustees. An AMC floats variety of mutual fund schemes as per the requirement of markets. The AMC works as an investment manager for the trust. AMC charges small fees from its investors for managing their portfolio. It coordinates with brokers, auditors, bankers, registrars, lawyers, etc. by getting into an agreement with them.

Who is the top authority for Mutual Funds in India?

Sponsors, Public trusts, and Asset Management Companies are all regulated by Mutual Funds Regulations 1996 formulated by SEBI. SEBI is the authority for capital market and capital market intermediaries. Mutual funds are also regulated by RBI, company Act, stock exchange, Indian Trust Act and Ministry of finance as and when required. RBI acts as a regulator of Sponsors of bank-sponsored mutual funds, especially in the case of funds offering guaranteed returns.

Vigilance

SEBI keeps a close watch on the performance of a sponsor so that integrity in business transactions is maintained and financial soundness is not compromised. SEBI follows a strict process when it comes to granting various permissions to float new schemes. The code of conduct laid down by SEBI is strictly adhered by Mutual funds at the time of advertisement of new schemes.

Coordination

The mutual funds are required to set up AMC which has 50% independent directors, a separate board of trustees and independent custodians. This structure is suggested to ensure a synchronization between trustees, fund managers and custodians. AMC manages the funds while trustees are the custodian of assets which implies that they both are accountable to each other.

Minimum capital requirements

As per the SEBI guidelines, mutual funds are required to have a minimum of INR 50 crore for an open-ended scheme while INR 20 crore corpus for the close ended scheme. A mutual fund is allowed to invest up to 25% in money market instruments in the first six months after closure of the fund and up to 15% of the corpus after six months to meet short-term working capital requirements. Additionally, whatever money is raised by the mutual fund must be invested within 9 months. These guidelines are framed to ensure that interest of mutual fund companies is protected. SEBI ensures that mutual funds follow these norms by inspecting regularly on an annual basis.

Conclusion

The structure of mutual fund includes Sponsors, Public Trust and Asset Management Company and all of these play a crucial role in the fund management. There is a clear line of responsibility and accountability while ensuring a healthy coordination amongst them. The three-tier structure of the mutual funds resembles fiduciary nature of an organization. SEBI ensures that each participant works with full integrity and efficiency. As per Morningstar biannual Global Investor Experience report on disclosure, India mutual funds along with US mutual fund industry received “top” grades due to their investor friendly and transparent disclosure practices. India earns a top grade for its portfolio management, simplified prospectus, and monthly disclosure of portfolios. Indian mutual fund industry is also working to improve the level of details required by the investors with regards to risk and returns.

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