Introduction
The Securities and Exchange Board of India (Mutual Funds) (Third Amendment) Regulations, 2024[i] (‘SEBI Regulation 2024’) introduced significant changes to the mutual funds ecosystem in India. With the inclusion of Specialized Investment Funds and Mutual Funds Lite, the amendment addresses the evolving investor and fund manager needs, fostering efficiency and flexibility in regulatory frameworks for conciseness.
The amendments, introduced under the powers conferred by s. 30 of the Securities Exchange Board of India Act, 1992 (‘SEBI Act’), focus on new categories of funds, shareholding norms, valuation standards, compliance obligations and investor protection mechanisms.
Key Highlights of the Amendments
1. Specialized Investment Funds (‘SIFs’)
SIFs are designed for institutional and sophisticated investors, focusing on tailored investment strategies.
Eligibility: Investors must contribute a minimum of Rs.10 across all investment strategies, except for accredited investors.
Investment Scope: SIFs can invest in Real Estate Investment Trusts (‘REITs’), Infrastructure Investment Trusts (‘InvITs’), and other securities, subject to specified limits.
Portfolio Restrictions:
A maximum of 20% of Net Asset Value (‘NAV’) can be invested in debt instruments of a single issuer (extendable to 25% with trustee approvals).
Total investments across schemes must not exceed 15% of a company’s paid-up capital carrying voting rights (inclusive of other mutual fund schemes.)
Investments in equity shares and equity-related instruments of a single company are capped at 10% of NAV.
REITs and InvITS:
Not more than 20% of NAV is in debt instruments of a single issuer in REITs and InvITs.
Maximum of 10% of NAV in units of a single REIT/InvIT issuer.
Government securities, treasury bills, and debt exchange-traded funds are exempt from these limits.
SIFs must comply with additional diversification and risk management norms.
2. Introduction of Mutual Funds Lite (‘MF Lite’)
MF Lite introduces a simplified compliance framework aimed at passive investment schemes like index funds and Exchange-Traded Funds (‘ETFs’).
Eligibility and Norms for Shareholding:
Sponsors may hold separate registrations for regular mutual funds and MF Lite.
Existing sponsors can transfer eligible passive schemes to a group entity registered as MF Lite.
Shareholders holding 10% or more holdings in Asset Management Companies (‘AMCs’) may hold equivalent stakes in MF Lite AMCs within the same group.
Existing MFs focusing solely on passive schemes may surrender their existing registrations and migrate as MF Lite.
Net Worth Requirements:
Minimum net worth of Rs. 35 crores for the AMC, reduced to Rs. 25 crores if the AMC reports profits for five consecutive years.
For sponsors not meeting eligibility criteria, a higher net worth of Rs. 50 crores are required, subject to the same reduction clause.
Operational Simplifications:
Mutual fund lite schemes must operate under a trust registered under the Registration Act, 1908.
Trustees can be debenture trustees provided they meet fit-and-proper criteria.
The AMCs must ensure distinct operational frameworks for passive funds.
3. Valuation and Compensation Mechanisms
Valuation: Investments must be valued and comply with regulations in the Eighth Schedule.
Compensation: AMCs and sponsors must compensate investors for losses arising from inappropriate valuations or unfair practices.
4. Compliance Obligations
Mutual Fund Lite Asset Management Company (‘MF Lite AMC’)
The MF Lite AMC is subject to stringent governance and compliance norms:
Governance Standards:
Directors must disclose personal securities transactions quarterly.
Key personnel found guilty of economic offences or securities law violations.
Registrars and share transfer agents must be SEBI-registered.
Operational Restrictions:
Operations, including trading desks and investment functions, must be within India.
Business activities beyond passive investments are limited to advisory services and must avoid conflicts of interest.
Investor Protection:
AMCs must establish a whistleblower policy and a Unit Holder Protection Committee.
Investors must be informed of any fundamental changes to schemes, with exit options provided without charges.
Risk Management:
AMCs must ensure systems for back-office operations, fund management, compliance, and investor grievance redressal.
Boards are responsible for reviewing the net worth of AMCs and the desirability of continuing operations in case of irregularities.
Due Diligence:
Regular review of broker empanelment, securities transactions, and investor complaints is mandatory.
Special attention must be given to potential conflicts of interest and ensuring the independence of fund management.
Disclosure Requirements:
Annual reports detailing activities, compliance status, and instances of self-dealing or front-running must be submitted to SEBI.
Restrictions on Business Activities
AMCs are prohibited from acting as trustees for any mutual fund lite and must avoid any material conflict of interest across activities. In case of unavoidable conflicts, transparent disclosures and independent fund management are required.
Scheme Launch and Operational Guidelines
MF Lite schemes can only be launched after obtaining board approval and filing an offer document with SEBI.
Trustees and directors must ensure compliance with SEBI regulations and take remedial actions in case of non-compliance.
Effective Dates
The amendments take effect immediately upon publication in the Official Gazette, with phased implementation for specific provisions:
Sub-regs. I, II, and VI of reg. 3 of SEBI Regulation 2024 apply after 90 days.
Sub-regs. IV and V of reg. 3 of SEBI Regulation 2024 are effective from 01.04.2025.
Our Analysis
SEBI aims to address the evolving needs of sophisticated and passive investors. SIFs enable institutional investors to pursue tailored investment strategies while adhering to stringent diversification and risk mitigation norms. MF Lite simplifies compliance requirements for passive schemes like ETFs and index funds, providing sponsors and AMCs greater operational flexibility. Additionally, governance, disclosure, and investor protection norms have been significantly enhanced. These include comprehensive due diligence requirements, whistleblower policies, mandatory risk management systems, and detailed reporting obligations to ensure transparency and accountability. The reforms emphasize fair valuation practices and conflict-of-interest management, safeguarding unitholder interests while fostering market trust. These amendments are a step forward in modernizing India’s mutual fund ecosystem, encouraging innovation and growth while maintaining a strong regulatory framework to protect investors.
End Note
[i] SEBI/LAD-NRO/GN/2024/221 dated 16.12.2024.
Authored by Onam Singhal, Chartered Accountant at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.