SEBI regulates the mutual fund sector in India. However, RBI, as regulator of banks, would need to authorize the commencement of mutual fund operations by a banking entity. Further, since it is the regulator of money supply in the economy, it has control over the money market and foreign exchange market. Measures that it announces for the money market and foreign exchange market could impact mutual fund operations. Besides such areas of overlap with other regulators, all regulation of mutual funds is by SEBI.
The guidelines applicable to mutual funds are set out in the SEBI (Mutual Funds) Regulations, 1996 (“the regulations”). SEBI has prescribed a legal structure with inbuilt checks and balances in the form of independent agencies for the various critical roles, namely trusteeship, asset management and custody of investments.
1. Sponsor (Promoter of a Mutual Fund)
Every project needs a promoter, a prime mover who has overall responsibility for the project. The promoter of a mutual fund is referred to as “Spnsor” As per the regulations, a sponsor means, “any person who, acting alone or in combination with another body corporate, establishes a mutual fund.”
A sponsor has to meet the following qualifications prescribed by SEBI:
(i) Sponsor should have a sound track record and general reputation of fairness and integrity in all business transactions.
Sound track record means:
> Carrying on business in financial services for a period of not less than five years.
> Having a profit, after providing for depreciation, interest and tax, in three out of the immediately preceding five years, including in the latest year.
> Having a positive net worth in all the immediately preceding five years. (Net worth = paid up capital plus free reserves, minus miscellaneous expenditure not written off, minus deferred revenue expenditure, minus intangible assets, minus accumulated losses).
> In the immediately preceding year, having a net worth that is more than the capital contribution of the sponsor in the AMC.
(ii) The sponsor has to contribute at least 40 % to the net worth of the AMC. Further, any person who holds 40 % or more of the net worth of an AMC is deemed to be a sponsor and should, therefore, meet all the qualifications prescribed for a sponsor.
(iii) Sponsor should be a fit and proper person.
(iv) Sponsor, or any of its directors, or the principal officer to be employed by the mutual fund should not be guilty of fraud or convicted of an offence involving moral turpitude or found guilty of any economic offence.
While meeting the prescribed qualifications makes a person eligible to promote a mutual fund, the venture cannot be promoted unless SEBI permits it.
2. Trusteeship of Mutual Funds
(1) Trust Deed
A mutual fund has to be constituted in the form of a trust, created through a trust deed.
The trust deed:
> Has to contain certain clauses prescribed by SEBI;
> Can not contain any clause that:
– limits or extinguishes the obligations and liabilities of the trust with respect to the mutual fund or its investors; and
– indemnifies the trustees or the AMC for loss or damage caused to the unit holders on account of negligence or acts of commission or omission;
> Has to be duly registered under the provisions of the Indian Registration Act, 1908; and
> Has to be executed by the sponsor in favour of the trustees named in the deed.
Indian companies are governed by the Companies Act, 2013. Limited Liability Partnerships (LLPs) in India are governed by the LLP Act, 2008. Other Indian partnership firms are governed by the Indian Partnerships Act, 1932. Similarly, mutual fund trusts in India are governed by Indian Trusts Act, 1882.
Companies are real entities that are eligible to contract in their own name. Trusts, on the other hand, are notional entities that are not eligible to contract in their own name. Trusts, therefore, need to enter into contracts in the name of the trustees.
The Indian Trusts Act, 1881 gives two options for the constitution of trustees:
> An individual can be appointed as trustee. When more than one trustee is appointed, they would together constitute the Board of Trustees.
> A company can be appointed as trustee. Such a trustee company, like any company under the Companies Act, 2013, would have a Board of Directors.
Every trust has beneficiaries, namely the persons for whose benefit the trust has been created — and trustees, namely the persons who are responsible for protecting the interest of beneficiaries.
When a trust is created for mutual fund operations, the beneficiaries are the investors who invest in the various schemes promoted by the mutual fund.
(3) Disqualifications for Trustees
Given the critical role of trustees, the regulations provide stringent disqualifications. A person cannot be appointed trustee unless she:
> is a person of ability, integrity and standing;
> has not been found guilty of moral turpitude; and
> has not been convicted for any economic offence or violation of any securities laws.
A person who does not suffer from these disqualifications is eligible to become a trustee in a mutual fund. But she can be appointed as a trustee only after the prior approval of SEBI.
In order to strengthen the trusteeship and avoid potential conflicts of interest, it is provided that:
> Any mutual fund will have a minimum of four trustees.
> Two-thirds of the trustees need to be independent trustees, namely persons, who are not associates of the sponsors, or associated with them in any manner whatsoever.
> If consequent to an independent trustee vacating office, the number of independent trustees falls below the prescribed minimum, another independent trustee has to be appointed to fill the gap within three months.
> Relatives (as defined in the Companies Act) of the sponsor, directors of the sponsor company, or relatives of associate directors of the AMCs and trustee companies are considered as “associate”.
> Similarly, nominees of companies who are stakeholders in the sponsor company or AMC are considered to be “associate”.
> Persons providing any type of professional service to the mutual fund, asset management company, trustee company and the sponsors are considered as associate directors.
> Also, persons having any material pecuniary relationship with these entities, which in the judgment of the trustees may affect independence of directors, are treated as associate directors.
> An asset management company, or any of its officers or employees, are not eligible to act as trustee of any mutual fund.
> No person who has been appointed as trustee of a mutual fund can be appointed as a trustee of any other mutual fund unless:
– the person is an independent trustee; and
– the mutual fund where she is already a trustee gives prior approval for the proposed appointment in the other mutual fund.
(If a company is appointed as a trustee, then its directors can act as trustees of any other trust provided that the object of the trust is not in conflict with the object of the mutual fund).
> A person who is an “associate” in accordance with definition in the Regulations cannot be appointed as independent director even after she ceases to be an “associate” unless a cooling off period of three years has elapsed from the date of her disassociation.
> The quorum for any meeting of the trustees shall be deemed not to have been reached, unless at least one independent trustee / director is present.
> The auditor for the mutual fund has to be different from the auditor of the AMC.
(5) Obligations of Trustees
Some key obligations of trustees are as follows:
> The trustees shall enter into an investment management agreement with the AMC.
> Before the launch of any scheme, they shall ensure that the AMC has:
– Systems in place for its back office, dealing room and accounting;
– Appointed all key personnel including fund managers;
– Appointed a compliance officer to comply with regulatory requirements and to redress investor grievances;
> Appointed auditors and made suitable arrangements to handle the function of registrars;
> Prepared a compliance manual and designed internal control mechanisms including internal audit; and
> Specified norms for empanelment of brokers and marketing agents.
> They shall be accountable for, and be custodian of, the funds and property of the respective schemes and shall hold the same in trust for the benefit of the unit holders.
> Trustees shall ensure that all activities of the AMC are in accordance with the provisions of the SEBI regulations.
> If they have reason to believe that the conduct of business of the mutual fund is not in accordance with the regulations or the offer document of the scheme, they shall take appropriate remedial steps and inform SEBI immediately.
> Each trustee shall file the details of her transactions in securities with the mutual fund on a quarterly basis.
> They shall meet at least once every two calendar months, and at least six such meetings shall be held every year.
> The trustees shall obtain the consent of the unit holders:
– Whenever SEBI asks for it;
– Whenever three-fourths of the unit holders of any scheme ask for it;
– When the majority of the trustees decide to wind up or prematurely redeem the units; and
– When there is a change in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change that would modify the scheme or affect the interest of the unit holders is proposed.
> They shall call for details of transactions in securities by the key personnel of the AMC.
> They shall review quarterly, all transactions between the mutual fund, AMC and its associates.
> They shall review quarterly, the net worth of the AMC and ensure that any shortfall is made up.
> They shall periodically review the investor complaints received and their redressal by the AMC.
> They shall abide by the prescribed code of conduct.
> While filing a new scheme offer document, the trustees need to confirm that the new scheme is a new product of the mutual fund, and not a minor modification of an existing scheme, fund or product. This is however not applicable to fixed maturity plans and closed-end schemes.
> Every half-year, the trustees shall furnish to SEBI:
– A report on the activities of the mutual fund;
– A certificate that they have satisfied themselves that there have been no instances of self-dealing (e.g., selling own securities to the fund or buying securities from the fund) or front running (e.g., buying or selling shares for self, prior to executing similar transaction on behalf of the fund) by any of the trustees, directors and key personnel of the AMC; and
– A certificate that the AMC has been managing the schemes independent of any other activities.
> The independent trustees shall give their comments on the report received from the AMC regarding investments by the mutual fund in the securities of group companies of the sponsor.
> The trustees shall be discerning in the appointment of directors on the board of the AMC.
(6) Rights of Trustees
> The trustees have the right to obtain from the AMC, such information as they consider necessary to fulfil their obligations.
> A majority of the trustees have the right to terminate the appointment of an AMC. Any change in the appointment of the AMC is, however, subject to prior approval of SEBI and the unit holders.
> The trustees shall not be held liable for acts done in good faith if they have exercised adequate due diligence honestly.
3. Asset Management Company (AMC)
(1) Appointment and Termination
It is obligatory for every mutual fund to have an AMC to manage the mutual fund and operate its schemes. The actual appointment could be made either by the sponsor or, if so authorized by the trust deed, the trustees.
The appointment can be terminated by a majority of the trustees or by 75 % of the unit holders. Any change in the appointment of the AMC is, however, subject to prior approval of SEBI and the unit holders.
(2) Business Activities for AMC
An AMC shall not:
> Act as a trustee of any mutual fund.
> Undertake any other business activities except portfolio management services and advisory services to offshore funds, pension funds, provident funds, venture capital funds, management of insurance funds, financial consultancy and exchange of research on commercial basis (“other activities”). This would again be subject to:
– the other activities not conflicting with the activities of the mutual fund;
– SEBI being satisfied that the key personnel, systems, back office, bank and securities accounts of the other activities are segregated from the mutual fund activities; and
– the AMC meeting the capital adequacy requirements, if any, of each such activity.
> Invest in any of its schemes unless full disclosure of the intention to invest has been made in the offer documents (The AMC cannot charge management fee on its investment in the scheme).
(3) Qualifications for AMC
AMCs need to fulfil the following conditions:
> Existing AMCs should have a sound track record (net worth and profitability), and general reputation for fairness and integrity in transactions;
> The AMC has to be a fit and proper person;
> Key personnel of the AMC should not have been found guilty of moral turpitude or convicted of economic offence or violation of any securities laws nor should they have worked for any AMC or mutual fund or any intermediary during the period when its registration has been suspended or cancelled at any time by SEBI; and
> The AMC should have a net worth of not less than 50 crore if it wants to manage mutual fund schemes. The requirement is Rs. 10 crore if the AMC wants to only manage infrastructure debt funds.
(4) Corporate Governance
> The directors of the AMC need to be persons having adequate professional experience in finance and financial services related fields and shall not have been found guilty of moral turpitude or convicted of economic offence or violation of any securities laws.
> At least 50 % of the directors on the AMC’s board shall not be associate of, or be associated in any manner with, the sponsor or any of its subsidiaries or the trustees (these are referred to as “independent directors”; other directors are “associate directors”).
> If, consequent to an independent director vacating office, the number of independent directors falls below the prescribed minimum, another independent director has to be appointed to fill the gap within three months.
> The provisions regarding “associate”, mentioned in the section on trustees, are also applicable for associate directors in AMCs.
> The chairman of the AMC shall not be a trustee of any mutual fund.
> No appointment of a director of an AMC shall be made without prior approval of the trustees.
> No person who has been appointed as director of an AMC can be appointed as a director of any other AMC unless:
– the person is an independent director, and
– the AMC where she is already a director approves the proposed appointment in the other AMC.
> Broking limits:
– An AMC cannot, through any broker associated with the sponsor (related broker), purchase or sell securities worth 5% or more of the aggregate purchases and sales of securities made by the mutual fund in all its
schemes (the 5% limit is applicable for a block of any three months and excludes the sale and distribution of units issued by the mutual fund).
– An AMC shall not through any broker (other than a related broker) purchase or sell securities worth 5% or more of the aggregate purchases and sales of securities made by the mutual fund in all its schemes unless it justifies the same in writing and reports all such investments to the trustees on a quarterly basis (the 5% limit is applicable for a block of three months).
> An AMC shall not utilize the services of the sponsor or any of its associates, employees or their relatives for any securities transaction and distribution and sale of securities unless it is disclosed to the unit holders and the brokerage or commission paid is disclosed in the half-yearly and annual accounts of the mutual fund.
> If the AMC enters into any securities transactions with any of its associates, a report to that effect shall be sent to the trustees at its next meeting.
> In case any company has invested more than 5 % of the net asset value of a scheme, the investment by that scheme or by another scheme of the same mutual fund in that company or its subsidiaries has to be brought to the notice of the trustees by the AMC and also disclosed in the half-yearly and annual accounts along with justification for such investment. The disclosure is to be made if the latter investment has been made within one year of the date of the former investment calculated on either side.
For instance, if Company A holds more than 5% of the units of a scheme floated by Mutual Fund XYZ, then investments by all schemes of Mutual Fund XYZ in Company A or its associates are to be disclosed. Such disclosure is to be made if the subsequent investment has been made within 1 year of the first investment.
> The AMC has to give a quarterly report to the trustees giving details and adequate justification about the purchase and sale of the securities of the group companies of the sponsor or the AMC.
> Every quarter, the AMC has to give the trustees, a statement of securities transactions of the directors of the AMC. For this purpose, security transactions below 100,000 in value may be ignored.
> The mutual fund shall disclose, at the time of declaring half-yearly and yearly results:
– Underwriting obligations undertaken by the schemes of the mutual fund with respect to issues of securities by associate companies;
– Subscription by schemes in issues lead managed by associate companies; and
– Subscription to any issue of equity or debt on private placement basis where the sponsor or its associate companies have acted as arranger or manager.
(5) Other Obligations of an AMC
> The AMC will float schemes for the mutual fund only after the trustees approve them.
> It shall issue or publish offer document of a scheme, key information memorandum, abridged half-yearly results and annual results only after prior written approval of the trustees.
> The AMC shall take all reasonable steps and exercise due diligence to ensure that the investment of funds pertaining to any scheme is not contrary to the provisions of the regulations and the trust deed.
> The sponsor or AMC need to invest at least 1 % of the amount raised in NFOs of open-end schemes. The investment, subject to a cap of Rs. 50 Iakh, is to be made in the growth option of the scheme, and cannot be redeemed until the scheme is wound up.
> It shall not carry out its operations including trading desk, unit holder servicing and investment operations outside the territory of India.
> It shall exercise due diligence and care in all its investment decisions as would be exercised by other persons engaged in the same business.
> The AMC shall maintain proper books of accounts, records and documents for each scheme. It shall maintain and preserve these for a period of eight years.
> The AMC shall be responsible for the acts of commission or omission of its employees and its other service providers.
> The AMC shall submit to the trustees, quarterly reports on its activities and the compliance with the regulations.
> The AMC shall file with the trustees, details of transactions in securities by key personnel of the AMC.
> The AMC shall appoint RTA who are registered with SEBI, unless the activity is to be handled in-house.
> Any change in the controlling interest of the AMC shall be only with the prior approval of the trustees, SEBI and the unit holders.
> The AMC shall furnish such information and documents to the trustees as and when required by them.
4. Maintenance of Investor Records
The AMC can either handle the RTA work in-house, or it can appoint a SEBI approved RTA.
If handled in-house, the AMC can charge the schemes competitive market rates for the service. If the AMC proposes to charge higher than the competitive market rates, then prior approval of the trustees is to be obtained and reasons for such higher rates has to be disclosed in the annual accounts.
5. Unique Client Code
Mutual funds need to obtain a unique client code for each of their schemes and plans. This is to be conveyed only to the member-broker through whom the fund transacts in the market. It may also be shared with unit holders to enable them to claim the tax benefits associated with payment of STT.
6. Custody of Investments
The mutual fund shall appoint a custodian to carry out the custodial services for the schemes of the fund and inform SEBI about the appointment within 15 days.
The mutual fund shall enter into a custodian agreement with the custodian. The agreement, the service contract, terms and appointment of the custodian shall be after prior approval of the trustees.
If the sponsor or its associates hold 50% or more of the voting rights of the share capital of the custodian, or where 50% or more of the directors of the custodian represent the interest of the sponsor or its associates, then such custodian will not be appointed for a mutual fund constituted by the same sponsor or any of its associate or subsidiary company. This limitation is not applicable if:
– The sponsor has a net worth of at least 20,000 crore at all times;
– 50% or more of the directors of the custodian are those who do not represent the interests of the sponsor or its associates;
– The custodian and AMC are not subsidiaries of each other;
– No person is a director of both custodian and AMC; and
– The custodian and AMC give an undertaking to operate independent of each other.
7. Setting up a Mutual Fund Operation
First, the sponsor needs to apply to SEBI in Form A prescribed under Schedule I of SEBI (Mutual Funds) Regulations 1996 along with the requisite application fees. While applying, it is to be ensured that the main objects of the memorandum of the sponsor company permit it to carry on mutual fund activities. An applicant should also submit the following documents, and wherever relevant, additional information for the sponsor as well as for the other shareholders in the proposed asset management company:
> Draft Trust Deed.
> Draft Investment Management Agreement.
> Draft Custodian Agreement.
> List of group / associate companies and their registrations with SEBI, RBI or regulatory agencies abroad.
> Details of listing of the sponsor, or its group I associate companies in any stock exchange(s).
> Penalties, details of suspension / cancellation of registrations.
SEBI may conduct an on-site due-diligence of the existing businesses of the sponsor to study the following:
> Existing infrastructure for client servicing, complaints handling;
> Track record of complaint / grievance handling; and
> Compliance philosophy and practice.
SEBI may seek further information, which would need to be provided within 30 days of the request. After examining the application against its eligibility criteria, SEBI conveys its decision on the eligibility status.
If found eligible, the following critical preliminaries would need to be done within 12 months of SEBI’s communication:
> The sponsor would set up the trust through the trust deed. If the sponsor has opted for the trustee company route — as distinct from board of trustees — then this company would need to be incorporated.
> Executed trust deed has to be submitted to SEBI.
> If not already in existence, the sponsor would promote the AMC. Two copies of the memorandum and articles are to be submitted to SEBI for forwarding to the Registrar of Companies.
> A chartered accountants’ certificate would have to be submitted to SEBI to show that net worth of the AMC is at least 50 crore, and more than 40% of the equity is held by the Sponsor(s).
> Either the sponsor or (if permitted by the trust deed) the trustees will appoint the AMC for the mutual fund. Investment Management Agreement would be executed between the trustees and the AMC, and submitted to SEBI.
> he mutual fund will enter into a custodial agreement with the custodian for handling the securities in which its schemes would invest.
> If the AMC chooses to perform the RTA activity in-house, then appropriate arrangements would need to be put in place. Alternatively, the AMC can appoint a SEBI-registered RTA for the purpose.
> A note would have to be submitted to SEBI indicating the infrastructural arrangements and other progress made. This would include office premises, organization chart, profile of key personnel (including fund managers and equity research personnel), hardware, software, investor servicing arrangements and internal control systems and procedures.
SEBI will, after a review of the above factors, and receipt of requisite fees, grant a Certificate of Registration for the mutual fund and approve the AMC.
Once the Certificate of Registration is granted:
> The trustees would appoint the statutory auditor for the mutual fund, who would audit the various schemes to be promoted by the mutual fund.
> The AMC would appoint statutory auditors who would audit the accounts of the company, as distinct from the schemes. The auditor of the AMC, as seen earlier, would need to be different from the auditor of the mutual fund.
> The AMC will put in place guidelines for empanelment of brokers for purchase and sale of securities by the mutual fund schemes, and distributors who would distribute the schemes of the mutual fund.
> The AMC will appoint other key personnel and set up systems for investment management, accounting, internal audit, etc.
> The AMC will draft the first schemes of the mutual fund.
> The AMC will prepare the offer document, which has to contain adequate disclosures to enable investors to make an informed investment decision. This needs to be filed with SEBI, which has a period of 21 working days to stipulate modifications.
> SEBI’s observations would need to be incorporated in the Offer Document.
> The scheme’s offer document, key information memorandum, etc., would need to be approved by the trustees in writing.
> Once all the above are in place, the trustees will authorize the AMC to launch the scheme’s New Fund Offer (NFO).
The NFO should be open for not more than 15 days (but this limitation is not applicable for Equity Linked Savings Schemes — ELSS).
In case no mutual fund scheme is launched within 12 months from the date of registration, the registration granted would be treated as cancelled.
> After approval of the trustees, the AMC can market the scheme. Advertisements would have to conform to the advertising code and submitted to SEBI within 7 days from the date of issue.
> Once subscriptions equivalent to the minimum amount specified in the offer document are received, the AMC can allot units to the subscribers on behalf of the mutual fund. There is no statutorily prescribed minimum unit capital, although offer documents mention a nominal minimum amount of 1 crore.
> The AMC has to allot units / refund money and send confirmation specifying the number of units allotted to the applicant by way of email and/or SMS’s to the applicant’s registered email address and/or mobile number as soon as possible but not later than five working days from the date of closure of the initial subscription list and/or from the date of receipt of the request from the unit holders. The new units shall be available for ongoing sale / re-purchase / trading within 5 business days of allotment (not applicable for ELSS).
Account statements are computer generated. They provide details of transactions under the schemes during the relevant period, and give the closing balance of units held in the investor’s name. An account statement is not construed as proof of title. Unit certificates are proof of title.
The general market practice is that open end schemes issue account statements (and not unit certificates), which are non-transferable. Closed-end schemes need to issue unit certificates (if not demat units), which are transferable. SEBI has stipulated that demat units (open-end as well as close end schemes) would be freely transferable.
The AMC can start investing the funds only on or after the closure of the NFO period. Post-allotment, the AMC is to invest in line with the investment objectives set out in the otter document. Pending such investment, the money may be invested in short-term deposits of scheduled commercial banks.
8. Change in Fundamental Attributes
Consent of three-fourths of the unit holders is required for making a change in the fundamental attributes of any scheme, or the trust, or fees and expenses payable, or any other change which would modify the scheme or affect the interest of the unit holders.
The following are fundamental attributes:
Types of Scheme
a. (a) Open end / closed end / interval scheme.
b. (b) Sectoral fund / equity fund / balance fund / income fund / debt fund / index fund / Any other type of fund.
(a) Main Objective — growth / income / both.
(b) Investment pattern — The tentative equity / debt / money market portfolio break-up with minimum and maximum asset allocation, while retaining the option to alter the asset allocation for a short term period on defensive considerations.
Terms of Issue
(a) Liquidity provisions, such as listing, re-purchase, redemption.
(b) Aggregate fees and expenses charged to the scheme.
(c) Any safety net or guarantee provided.
Although the regulations refer to consent of “three-fourths of the unit holders”, in practice it is not the number of unit holders that is relevant but the unit holding they represent. If the unit holding of person A is twice that of person B, then A would have twice the number of votes that B has.
Apart from this requirement of approval of three-fourths of unit holders, those unit holders who do not give their consent need to be given the option of redeeming their holdings in the scheme.
The approval of unit holders is, however, not required in the case of open-end schemes if:
> The change in fundamental attribute is carried out after one year from allotment of units;
> Individual communication is given to unit holders about the proposed change;
> Advertisement is issued in an English daily newspaper having national circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated; and
> Unit holders are given an option to exit at the prevailing net asset value, without any exit load (“load”).
Further, minor changes in the scheme, e.g. change in registrar’s address, may be effected with the approval of trustees, without the requirement of unit holder approval.
9. Mergers and Acquisitions
The sponsor promotes the AMC which, in turn, manages the mutual fund operation under the supervision of the trustees. A change in control could happen due to a change in any of these instrumentalities of the fund, namely sponsor, AMC, trusteeship or the schemes.
The authorization for such inorganic changes in the structure of a mutual fund or its schemes is determined by the following broad principles:
As per SEBI regulations, any material change would require the consent of unit holders with at least 75 % voting rights, subject to the exceptions applicable to open-end schemes mentioned in the earlier section. Investors who do not agree have to be given the option to exit at the NAV applicable on the date of exit.
Regulator of mutual fund operations in the country, SEBI has to approve any change before it can be implemented. In the absence of clear provisions in the regulations, approval of such changes is influenced significantly by “precedence.” SEBI is, however, not bound by the precedence — it has the authority to set new precedents.
Companies Act 2013
Apart from SEBI’s approval, if the proposed change is with respect to a company (sponsoring company, asset management company, or trustee company) then the provisions of the Companies Act, 2013 would apply.
Under the companies act, approval of merger of two companies entails:
> Special resolution to be passed at a general meeting of each company. Special resolution means that the votes of members, present in person or proxy or voting by postal ballot, supporting the resolution is at least three times the votes of those opposing the resolution.
> Approval is also required from the National Company Law Tribunal. Simplified process is possible for “small” companies.
The Competition Act 2002
In certain cases of business combinations, permission of the Competition Commission of India is also required.
SEBI Takeover Code
If the proposed change involves a company that is listed, then the provisions of SEBI Takeover Code would also need to be complied with. The takeover code requires that if any one acquires more than 25 % of the share capital of a listed company, then an open offer would need to be made to acquire at least a further 26 % of the share capital from other shareholders.
In the light of these broad principles, let us evaluate each possible situation.
(1) Consolidation of Two Schemes
There are several such precedents in India, including by UTI Mutual Fund, Kotak Mutual Fund, JP Morgan Mutual Fund, JM Mutual Fund, etc.)
SEBI had stipulated that a consolidation would be viewed as a change in the fundamental attribute of the schemes. Permission of the boards of the AMC and Trustees is to be taken before approaching SEBI with the draft Offer Document of the new scheme.
The letter to the unit holders, giving them the option to exit at prevailing NAV without exit load, shall disclose all relevant information enabling them to take well informed decisions, including information on the following aspects:
> Information on the investment objective, asset allocation and the main features of the new consolidated scheme;
> Basis of allocation of new units by way of a numerical illustration;
> Percentage of total Non-Performing Assets (NPA5) and percentage of total illiquid assets to net assets of the individual schemes as well as in the consolidated scheme;
> Tax impact of the consolidation of schemes on the unit holders;
> Any other disclosures as specified by the trustees; and
> Any other disclosures as directed by SEBI.
SEBI has provided that merger or consolidation shall not be seen as change in fundamental attribute of the surviving scheme if the following conditions are met:
> Fundamental attributes of the surviving scheme do not change. The “surviving scheme” means the scheme which remains in existence after the merger.
> Mutual funds are able to demonstrate that the circumstances merit merger or consolidation of schemes and the interest of the unit holders of surviving scheme is not adversely affected.
> After approval by the boards of AMCs and trustees, the mutual funds file such proposal with SEBI which would communicate its observations on the proposal within 21 working days.
> The letter to unit holders is issued only after the final observations communicated by SEBI have been incorporated and final copies of the same have been filed with SEBI.
(2) Conversion of Closed-end Schemes to Open-end
(Precedent in India — Mastershare of UTI)
Such conversion is possible if the unit holders are provided with an option to redeem their units in full.
Draft of the communication to unit holders that is to be submitted to SEBI for such cases shall include the following:
– The latest portfolio of the scheme in the format prescribed for half yearly disclosures.
– Details of financial performance of the scheme since inception in the manner prescribed under the Standard Offer Document along with comparison with appropriate benchmarks.
– Addendum to the offer document detailing the modifications (if any) made to the scheme.
Since the scheme would re-open for fresh subscriptions, the disclosures contained in the scheme information document of the scheme would have to be revised and updated. A copy of the draft scheme information document would also need to be filed with SEBI.
The letter to unit holders and scheme information document shall be issued only after SEBI’s final observations have been incorporated and its final copy filed with SEBI.
Further, unit holders shall be given a time period of at least 30 days for the purpose of exercising the exit option. Unit holders who opt to redeem their holdings in part or full during the prescribed period, shall be allowed to exit at the NAV applicable for the day on which such a request is received.
(3) Takeover of Schemes
(Precedent in India — Schemes of Apple Mutual Fund taken over by Birla AMC; schemes of IL&FS Mutual Fund taken over by UTI Mutual Fund; schemes of GIC Mutual Fund taken over by Canbank; schemes of Alliance Mutual Fund taken over by Birla Mutual Fund; schemes of Morgan Stanley Mutual Fund taken over by HDFC Mutual Fund; schemes of Pine Bridge Mutual Fund taken over by Kotak Mutual Fund.
This is the most popular form of consolidation among AMCs, because the acquirer gains control of the schemes, without having to worry about the divesting AMC’s financials, assets, employees and legal traps. Besides, the divesting AMC can continue with its non-mutual fund activities such as Portfolio Management Schemes.
In the Apple-Birla case, apart from 75 % unit-holder approval and exit option, SEBI insisted on a synchronization of trusteeship and asset management roles. Therefore, along with Birla AMC taking up the asset management responsibility for the transferred schemes, Birla trusteeship had also to be extended to these transferred schemes. SEBI was not comfortable with an arrangement where Birla AMC would manage two sets of schemes — one under the Birla trusteeship and another under Apple trusteeship.
(4) Merger of Two AMCs
(Precedent in India — HB and Taurus)
The legal requirements are:
– 75 % unit holder approval and exit option for dissenting investors in all the schemes managed by the two AMCs;
– Since it is a merger of two companies, special resolution of shareholders and permission of the respective high courts (now National Company Law Tribunal) is also required, unless they are “small companies”; and
– Revised trusteeship arrangements has to be conveyed to SEBI.
(5) Change of AMC
(Precedent in India — None)
Under SEBI’s regulations, an AMC can be changed by:
> Majority of trustees, but subject to approval of SEBI and 75 % of the unit holders of the scheme; or
> 75 % of the unit holders of the scheme, present and voting at a meeting called with the prior approval of SEBI.
(6) Change of Trusteeship
Precedent in India — Change in trustees comprising any Board of Trustees is a normal phenomenon. There is no precedent for a change of Trustee company in India, though the transfer of Apple schemes to Birla Mutual Fund (mentioned earlier) also entailed a change of trusteeship responsibility.
Under the regulations:
– The trust deed cannot be amended without SEBI’s approval. If the proposed amendment materially affects the unit holders, then even their permission would be required. Unit holder permission is, however, not required for conversion from a Board of Trustee format into a trustee company format.
– The sponsor may appoint and remove trustees as provided in the trust deed. But such appointment and removal is subject to prior SEBI approval.
– Investors do not have the right to remove the trustees.
(7) Change of Sponsor / Takeover of Mutual Fund Business
Precedent in India: (i) Zurich — 20th Century Finance; (i Zurich — ITC Threadneedle; (iii) Sun F&C; (iv) Sahara — First India; (v) Goldman Sachs — Benchmark; and (vi) Dewan Housing Finance Limited’s acquisition of 50% stake of Prudential Group (US) in Pramerica’s mutual fund business.
The regulations stipulate that SEBI’s permission is required in such cases. SEBI did not insist on permission of unit holders in the case of 20th Century Finance; but such permission was called for in the case of ITC Threadneedle.
The case of Sun F&C is significant because there was no change in the share holding within the Indian AMC. Foreign & Colonial (F&C) of Britain continued to hold a stake in the Sun F&C Asset Management India. Only the controlling interest in F&C, Britain changed hands from Germany’s Hypo vereins Bank to Eureko, the insurer. SEBI took the view that this is a material change, and therefore insisted on an exit option for investors.
It is important to recognize that when a sponsor changes, control over the AMC changes. After seeing several such changes, SEBI has drawn up the following detailed guidelines:
> The mutual fund handing over control would need to submit a draft letter that is to be sent to investors. This would include the following information:
– The activities of the new sponsor and its financial performance as prescribed in the standard offer document;
– In case of takeover of the schemes by an existing mutual fund registered with SEBI, the draft letter should also include the condensed financial information of all the schemes in the format prescribed in the standard offer document; and
– The amount of unclaimed redemption and dividend, and procedure for claiming such amount by the unit holders.
> If the applicant proposing to take control is not an existing mutual fund, then the applicant would need to apply to SEBI for registration as a mutual fund. Thus, the various requirements of sponsor would need to be complied with.
> Also, the party assuming control of the AMC would need to give the following undertakings:
– Take full responsibility of the management and the administration of the schemes including matters relating to the reconciliation of accounts (as if the schemes had been floated by the new trustees on the date of taking over).
– Assumption of trusteeship of the assets and liabilities of the schemes including unclaimed dividends and unclaimed redemptions.
– Assumption of all responsibilities and obligations relating to the investor grievances, if any, in respect of the schemes taken over, in accordance with and pursuant to the SEBI (Mutual Funds) Regulations.
> In cases such as indirect change in control over AMC, change in promoter of sponsor etc, full information is to be given to SEBI. Within 21 working days, SEBI will communicate any procedural requirements.
> SEBI insists on 30-days window for investors to exercise the exit option in such cases of change of control.
SEBI’s stipulation of higher net worth for AMCs is likely to lead to a consolidation in the industry. Some of the smaller AMCs may choose to sell their businesses to larger players.
(10) Categorisation and Rationalisation of Mutual Fund Schemes
SEBI expressed its concern several times over scheme proliferation. It wants the various schemes offered by a single mutual fund to be distinct in terms of asset allocation and investment strategy. Further, similar types of schemes should have uniform characteristics across mutual funds. This is essential to ensure that investors are not confused by the universe of mutual fund schemes.
In October 2017, SEBI took a decisive step in this direction for open-end schemes which comprise 91 % of the AUM in the industry. It classified mutual fund schemes into five groups, namely. Equity schemes, debt schemes, hybrid schemes, solution oriented schemes, and other schemes. Scheme categories have been defined under each of these groups.
There are two categories under ‘Other schemes’, namely.
Index funds / ETFs and Fund of Funds (Overseas / Domestic). For every category under each of these five groups, SEBI stipulated standard ‘metrics’.
SEBI has mandated that all existing schemes needed to revise their offer documents, advertisements, marketing material etc. to fall in line with the SEBI defined categories and type of scheme. This change alone do not make it a change of fundamental attribute. However, consequent to this change, investment objective, investment strategy and benchmark may need to be changed. These would qualify as change of fundamental attribute, calling for unit-holder approval, exit option at NAV, and other procedural requirements.
Any consequential portfolio was to be executed within one month of the change of scheme type.
SEBI allows any mutual fund to have only one open-end scheme in each of these categories. Three exceptions have been provided:
(i) The AMC can have multiple index I ETFs so long as they replicate or track different indices.
(ii) Similarly, the AMC can have multiple Fund of Funds, each having different underlying schemes.
(iii) The AMC can also have multiple sectoral / thematic funds, each investing in different sectors / themes.
Mutual funds were directed to map their current schemes to these SEBI mandated categories and develop a plan (winding up / merger / change of fundamental attribute) to ensure that they have only one open-end scheme in each category. They were mandated to implement this plan within three months of SEBI giving its observations on the plan.
Some in the mutual fund industry have viewed this move as a curb on innovation. However, it was a huge step in simplifying mutual fund investment in the country.