Securities and Exchange Board of India
Monday 30th September 2024– SEBI Board Meeting
Sub: Amendments to the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 for introduction of a Mutual Funds Lite (MF Lite) framework for passively managed schemes of Mutual Funds
1. Objective:
1.1. This Board Memorandum proposes to introduce a relaxed regulatory framework in the Mutual Funds (MF) segment viz. “the MF Lite framework” for the passively managed MF schemes. Considering the lesser risk inherent in managing passively managed MF schemes, the proposed framework intends to reduce the compliance requirement, foster innovation, encourage competition and promote ease of entry for the MFs interested in launching only passive schemes.
2. Background:
2.1. The SEBI (Mutual Funds) Regulations, 1996 (“MF Regulations”) and the current regulatory framework inter alia provide for regulation of MFs and the schemes managed thereunder. While both active and passive MF schemes (i.e, Exchange Traded Funds (ETFs) and Index Funds) are covered under the purview of the extant MF Regulations, the provisions thereunder have been envisaged, primarily keeping in mind the actively managed schemes and the risks and complexities associated therewith.
2.2. While a large portion of the MF industry in India is actively managed MF schemes, the significance of passive schemes has increased in the MF industry. In terms of Asset under Management (AUM) of MFs in India, the total AUM of passive schemes (Index Funds and Exchange Traded Funds (ETFs)) is INR 10.95 lakh crore constituting 16.4 % of the total industry AUM of INR 66.7 lakh crore as on August 31, 2024.
2.3. The management of active MF schemes inter alia requires a team with expert fund managers who are responsible for defining investment philosophy and objective, security level analysis and selection, analysis of investment risks at security and portfolio level, ensuring appropriate portfolio diversification etc. The passively managed MF schemes on the other hand replicate an underlying index, wherein the portfolios of ETFs/Index Funds can be easily tracked as the underlying index compositions are available in public domain. Thus, the risks associated with passive MF schemes can be stated to be lower as compared to active MF schemes.
2.4. Hence, as various provisions of the existing regulatory framework may not be relevant for passively managed schemes, a relaxed framework with light-touch regulations can be explored as “MF Lite framework” for passive MF schemes, inter alia, with an intent to promote ease of entry, encourage new players, reduce compliance requirements, increase penetration, facilitate investment diversification, increase market liquidity and foster innovation.
2.5. Under this framework, MFs desirous of managing only passive schemes are proposed to be covered. However, there may be MFs existing as on date, who may opt for management of both active and passive schemes under their existing registration. Hence, to ensure uniform applicability of proposed relaxations and to provide a level playing field across all passive MF schemes, a three pronged approach has been adopted i.e.,
➣ Ease of entry and relaxed provisions for new MFs intending to launch only passive schemes under MF Lite framework. (Section 1)
➣Ease of compliance, relaxed disclosures and other regulatory requirements for the passive schemes based on indices that would be covered under the MF Lite framework (Section 2). If passive schemes based on these aforesaid indices are already launched by the existing AMCs, the proposals under this section shall also be applicable to those passive schemes.
➣ Section 3 includes proposals that may be applicable for all debt passive schemes irrespective of whether such debt passive schemes are covered under MF Lite.
3. Public consultation and proposals pursuant to consultation paper
3.1. SEBI had constituted a Working Group (WG) comprising of various stakeholders including MF industry participants, to study and recommend a relaxed regime for passively managed MF schemes. The recommendations of the WG were placed before the Mutual Funds Advisory Committee (‘MFAC’).
3.2. Based on the recommendations of the WG, views of MFAC and internal deliberations, a consultation paper on “Introduction of Mutual Funds Lite (MF LITE) Regulations for passively managed Mutual Fund Schemes” was issued on July 01, 2024, seeking public comments on the proposals made therein (Annexure A).
3.3. In response, more than fifteen comments were received from public including various stakeholders such as Association of Mutual Funds in India (AMFI), Asset Management Companies (AMCs), law firms, intermediaries, individual investors etc. The details of public comments received as on August 01, 2024, are placed at Annexure B.
3.4. The proposals, after taking in to account the views of all stakeholders involved, are presented in following 2 parts, under each of the aforesaid sections as mentioned at paragraph 2.4 above.
3.4.1. Proposals that may be accepted without modifications (Part A)
3.4.2. Proposals that may be accepted with modifications (Part B)
3.5. While, the analysis and consideration of public comments received on the suggestions in the consultation paper and the detailed proposals regarding the same are placed at Annexure C, the gist of the proposals is placed hereunder.
Section 1
4. Section 1 of this Board Memorandum deals with the proposals pertaining to the entities intending to get registered under the MF Lite framework, to launch only passively managed schemes.
Part –A (Proposals as consulted that may be accepted without modifications)
4.1. Eligibility Criteria for Sponsor-
a. The eligibility requirement for sponsors intending to operate an MF under the MF Lite framework may be relaxed for both the main and alternate eligibility route, as compared to the requirement under the extant MF Regulations. The relaxations which include requirements pertaining to minimum net worth, financial experience, lock in period of shareholding etc. are detailed at Table-1 of Annexure C.
b,. Further, AMCs may be required to abide by the net worth (N/W) requirement as per the extant MF Regulations (i.e. as applicable for MFs with active schemes), as and when the total AUM of any AMC under the MF Lite framework exceeds INR 1 Lakh Cr.
c. In case of both the main and alternate eligibility routes, AMCs may appoint a separate Chief Risk Officer (CRO) on a voluntary basis, otherwise the Chief Compliance Officer (CCO) may also act as the CRO of the AMC, subject to his/her eligibility and experience in risk management.
4.2. Roles and responsibilities of trustees
a. The roles and responsibilities of trustees of an MF Lite may be relaxed vis-à-vis those of existing AMCs, except those relating to related party transactions, conflicts of interest, undue influence of sponsor, mis-selling, misconduct including market abuse/ misuse of information including front running etc. which may be retained as per the existing requirements.
b. The trustee of an MF Lite may be any entity registered under the SEBI (Debenture Trustees) Regulations, 1993 and satisfying the applicable fit and proper criteria.
c. At any given point of time, a debenture trustee may be appointed as trustee of more than one MF operating under the MF Lite framework. In such case, the debenture trustee acting as trustee of any MF Lite shall be an independent entity and not an associate of the sponsor(s) or manager of the concerned MF Lite.
d. However, in case, an existing sponsor hives off passive schemes from its existing AMC to a new AMC within the same group, the existing trustees may be appointed as trustees of the MF Lite also, if so desired by the MF Lite AMC.
e. In case an existing AMC doesn’t hive off its passive schemes and continues to manage the passive schemes under the current MF Regulations, the reduced roles and responsibilities of trustees as mentioned at paragraph 4.2 (a) shall also be applicable to the existing trustees of such AMC but only pertaining to the passive funds covered under the proposed MF Lite framework. The detailed proposals along with modalities are placed at Table-3 of Annexure C.
4.3. Roles and responsibilities of Board of AMCs
a. While trustees of MF Lite shall have overarching role of protection of the interest of investors, the Board of AMCs shall have the primary accountability for acting in the interests of the investors. Accordingly, the core responsibilities of (i) ensuring fairness of fees and expenses charged and (ii) maintaining the tracking error and tracking difference within the regulatory limit, which are presently required to be independently undertaken by the trustees for existing MFs, may be shifted to the Board of AMCs w.r.t MF Lite.
b. As regards, the other core responsibilities relating to misconduct including market abuse/ misuse by information including front running, conflict of interest, related party transaction, mis-selling etc., the Board of AMC of MF Lite may also be responsible along with the trustees.
c. Further, certain common responsibilities such as periodic reporting to SEBI, overall risk management of all scheme specific and AMC specific risks, appointment of key personnel etc., that are currently entrusted upon both trustees and AMCs under the extant MF Regulations, may be applicable only to the Board of AMCs of MF Lite.
d. Apart from the above, certain reporting presently required to be made to trustees by AMC, such as information w.r.t change in Total Expense Ratio (TER), submission of declaration on votes cast by AMC that votes are cast in best interest of investors etc., may continue for MF Lite also for information of the trustees. In case AMC fails to timely submit the same to trustee, the trustee shall intimate regarding the same to SEBI.
e. As regards the role of trustees pertaining to related party transactions, conflicts of interest, undue influence of sponsor, mis- selling, misconduct including market abuse/ misuse of information; including front running etc., which is proposed to be retained as per the extant framework, the trustees shall seek information from AMCs pertaining to the aforesaid issues. The detailed proposals along with modalities are placed at Table-4 of Annexure C.
4.4. Investment Management Agreement
The details of the investment management agreement in respect of MF Lite framework, may be specified by AMFI, in consultation with SEBI. The detailed proposals along with modalities are placed at Table-6 of Annexure C.
4.5. Risk Management Committee (RMC) for oversight of risk at the AMC level The requirement of Audit Committee and RMC at the trustee level may not be applicable to MF Lite AMCs. Further the requirement of RMC at AMC level may be made optional and the Audit Committees of AMCs may undertake the additional role of RMCs in case of MF Lite. The detailed proposals along with modalities are placed at Table-8 of Annexure C.
Part –B (Proposals as consulted that may be accepted with modifications)
4.6. Shareholding and governance in Mutual Funds
a. It was proposed in the consultation paper that
i. New players desirous of launching only passive MF schemes may operate under the MF Lite framework.
ii. Existing MFs having both active and passive schemes, may also hive off respective passive schemes, if they so desire, to a different group entity, thereby resulting in management of active and passive schemes by separate AMCs but under a common sponsor subject to certain conditions such as segregation and ring fencing of resources.
iii. Therefore, in case of hiving off of passive schemes by existing players, the restriction regarding not having more than 10% shareholding in more than one AMC would be relaxed only to cover the said scenario.
b. The aforesaid proposals may be accepted with the following modifications based on public comments:
i. In case the existing MFs having both active and passive schemes decide to hive off respective passive schemes to a different group entity, thereby resulting in management of active and passive schemes by separate AMCs but under a common sponsor, the sponsor may be required to completely segregate and ring-fence its resources including infrastructure, technology and staff etc. for passive MF management from the active MF management. However, certain other support functions namely, sales and marketing, Human Resources (HR) and administration may be allowed to be outsourced by the MF Lite AMC from the existing AMC.
ii. An AMC registered under the current MF Regulations may also be provided an option to get itself registered under the MF Lite framework and surrender the license of the full- fledged AMC, subject to the condition that the said AMC only manages passive schemes based only on underlying indices that are proposed to be permitted under MF Lite framework.
c. The detailed proposals along with modalities are placed at Table-2 of Annexure C.
4.7. Restrictions on business activities of AMCs
a. While it was proposed in the consultation paper that the entities registered under MF Lite may not be allowed to do any business activity other than managing passive MF schemes, comments are received inter alia suggesting AMCs operating under the MF Lite framework be allowed to provide advisory to pooled assets for only passive investments.
b. In view of the above, it is proposed that AMCs managing only passive schemes may be permitted to provide advisory services to pooled vehicles, only in the context of passive investments, subject to specified conditions.
c. The detailed proposals along with modalities are placed at Table-5 of Annexure C.
4.8. Advertisement Code
a. It was proposed in the consultation paper that the advertisement code currently prescribed for all MFs may not be necessary for MF Lite AMCs and it may be sufficient to mandate that any advertisement of passive investment schemes shall not be misleading or lead to mis-selling of such schemes.
b. The public comments, which are not in favor of a lighter advertisement code, have stated that as passive schemes are also exposed to market and volatility risk and prone to the possibility of mis-selling, the existing Advertisement Code should apply to MF Lite schemes also, especially w.r.t. risks and scheme performance.
c. In view of the above, it is proposed that the advertisement code as per the extant MF Regulation may also be applicable to all passive schemes under the MF Lite framework.
d. The detailed proposals along with modalities are placed at Table-7 of Annexure C.
4.9. Transactions through associated broker
a. It was proposed in the consultation paper that the current limit of 5% at the AMC level for purchase or sale of securities through an associate broker may be extended to 10% in case of associated broker and to 25% in case of a non-associate broker, for all entities under the MF Lite framework. Some have suggested to enhance the relaxation even further and exclude market makers’ creation/redemption trades from the broker limit.
b. In view of the above, it is proposed that the current limit of 5% at the AMC level for purchase or sale of securities through an associate broker may be extended to 10% in case of associated broker and to 25% in case of a non-associate broker, for all entities under the MF Lite framework subject to market makers’ creation and redemption trades being excluded from computation of the proposed enhanced broker limits for MF Lite schemes.
c. The detailed proposals along with modalities are placed at Table-9 of Annexure C.
4.10. Simplified Scheme Information Document (Simplified SID) and Submission of trustee report to SEBI
a. A modified format of SID for MF Lite schemes was proposed in the consultation paper. Further, it was proposed the fast track approval of SIDs (currently optional) may be made mandatory for passive schemes floated by AMCs under the MF Lite framework. The requirement of separate filing of the Key Information Memorandum (KIM) may be done away with. Further, it was proposed that the requirement of submission of trustee report to SEBI may be discontinued considering the limited role of trustees in case of MF Lite. As the Board of AMC shall have the primary accountability of acting in the interests of the investors, the Board of AMC may be required to submit yearly AMC Report (YAR) in case of MF Lite.
b. While majority of comments received are in agreement with the proposals, some have suggested that the modified SID should be applicable to any passive scheme irrespective of MF lite registration.
c. The aforesaid proposals may be accepted with the following modifications based on public comments.
The simplified SID may be made applicable for all passive funds based on underlying indices, whether for an MF under the MF Lite framework or for a full-fledged MF, that would be permitted under MF Lite framework.
d. The detailed proposals along with modalities are placed at Table-10 and Table-11 of Annexure C.
Section 2
5. Section 2 of this Board Memorandum deals with the proposals pertaining to ease of compliance, relaxed disclosures and other regulatory requirements for the passive schemes based on indices that would be covered under the MF Lite framework. If passive schemes based on these aforesaid indices are already launched by the existing AMCs, the proposals under this section shall also be applicable to those passive schemes.
Part –A (Proposals as consulted that may be accepted without modifications)
5.1. Investment and trading in securities by the employees of the AMC(s) and Trustee(s)
Considering negligible scope for active management of funds in passive schemes, prior approval of employees’ transactions may be replaced with prior intimation. Thus, w.r.t MF Lite, prior intimation of at least 3 working days before the date of transaction may be mandated and the requirement for reporting of employees’ transactions within 7 working days may be retained. The detailed proposals along with modalities are placed at Table-14 of Annexure C.
5.2. Compliance and disclosure
The frequency for updation of SIDs for the passive schemes, based on indices that would be permitted under MF Lite framework, may be reduced from half yearly basis to yearly basis. The frequency w.r.t disclosure of portfolio for the aforesaid schemes may be reduced to monthly disclosures for debt oriented schemes and quarterly disclosures for equity oriented schemes and the requirement for publishing unaudited half yearly financials may be discontinued. The detailed proposals along with modalities are placed at Table-15 of Annexure C.
Part –B (Proposals as consulted that may be accepted with modifications)
5.3. Investor education and awareness
a. It was proposed in the consultation paper that the requirement w.r.t allocating funds towards investor education and awareness initiatives for passive schemes may be relaxed. Further, out of the total amount transferred to AMFI for investor awareness by AMCs, a minimum specified percentage may be allocated towards promoting passive funds.
b. While majority of the comments are in favour of the proposal, there are some suggestions inter alia proposing a higher threshold of AUM below which the requirement of allocating funds towards investor education and awareness wouldn’t apply. With respect to the aforementioned threshold of AUM, it was internally deliberated that considering various relaxations including sharing of resources (in case of hive off), it may not be appropriate to completely do away with the requirement of contribution towards investor education and awareness even for schemes with lower AUM.
c. In view of the above, it is proposed that
i. The AMCs may allocate funds towards investor education and awareness initiatives for passive schemes and Fund of Funds, as under:
➣ Fund of Funds (investing more than 80% of its NAV in the underlying domestic passive fund – Nil
➣ ETFs/Index Funds/Overseas Fund of Funds (FoFs) investing in underlying ETFs: 5% of total TER charged to direct plans, subject to maximum of 0.5 bps of AUM.
ii. Out of the total amount transferred to AMFI for investor awareness by AMCs, AMFI may be mandated to allocate a minimum of 5 percent for focused investor education and awareness towards promoting passive funds, distinct from AMFI’s general investor education initiatives.
d. The detailed proposals along with modalities are placed at Table-12 of Annexure C.
5.4. Introduction of Hybrid ETFs/ Index Funds
a. It was proposed in the consultation paper that:
i. A new class of passive fund known as Hybrid passive funds may be introduced which shall replicate a composite index comprising fixed proportions of equity and debt and enable investors to invest in a single product having exposure to both equity and debt instruments.
b. While the comments are mostly in favour of the proposal, some modifications have been suggested w.r.t the indicative asset allocation, permitting more asset classes etc.
c. The aforesaid proposals may be accepted with the following modifications based on public comments.
i. To begin with, only debt and equity oriented indices may be included in case of hybrid passive schemes in the following 3 categories. Further, a range for indicative asset allocation may be provided instead of fixed allocation (as proposed at paragraph 5.4 (a) above) for each asset class in each category of hybrid funds.
➣ Balanced (Equity 40%-60% and Debt 40%-60%)
➣ Equity Oriented (Equity 65%-80% and Debt 20%-35%)
➣ Debt oriented (Debt 65%-80% and Equity 20%-35%)
However, AMCs may be required to fix the asset allocation mix of equity and debt within the defined range in each category of hybrid passive fund as given above, while filing the SID with SEBI.
ii. The TD for such funds may be as specified by SEBI, in consultation with stakeholders.
d. The detailed proposals along with modalities are placed at Table-13 of Annexure C.
5.5. Investments by passive schemes
a. It was proposed in the consultation paper that considering the simpler operations of passive schemes, underlying securities in which they invest may be equity, plain vanilla debt securities, physical commodities and exchange traded commodity derivatives or equity derivatives only for rebalancing.
b. While comments are majorly in favour of the proposal, some have suggested for greater flexibility regarding investment in equity derivatives of underlying securities.
c. In view of the above, the aforesaid proposals may be accepted with the following modification:
Investment in equity derivatives of underlying securities may be allowed in instances such as portfolio rebalancing, unavailability of the securities, in cases of events of corporate actions and scheme of arrangement etc. affecting the weightage of the stock.
d. The detailed proposals along with modalities are placed at Table-16 of Annexure C.
5.6. Tracking difference (TD) for equity oriented passive schemes
a. It was proposed in the consultation paper that
i. TD in case of equity passive schemes, may be targeted to be lower of 1.5 times of TER charged or 1.25%.
b. Some comments are received suggesting different methods for providing a threshold for calculating targeted TD, in view of the same, instead of prescribing a flat limit of TD, the TD may be linked with the actual TER charged by that scheme.
c. It is proposed that in case of equity oriented passive schemes, tracking difference may be targeted to be 50 bps (over and above actual TER charged).
d. The detailed proposals along with modalities are placed at Table-17 of Annexure C.
5.7. Uniform guidelines for launching equity passive schemes for overseas indices
a. It was proposed in the consultation paper that the indices, on which overseas passive schemes are to be launched, may be standardized across industry and broad based. The permissible overseas indices, under the proposed MF Lite framework shall be based on criteria as may be specified by SEBI.
b. Although the comments received in this regard are mixed in nature with few disagreement/ partial agreement, it is felt that as the regulatory requirements in the MF Lite framework are proposed to be relaxed, a limited set of overseas indices may be allowed in the first phase of implementation.
c. In view of the above, it is proposed that as the regulatory requirements in the MF Lite framework are proposed to be relaxed, a limited set of overseas indices whose quantitative threshold/ AUM exceeds a minimum threshold of $ 20 billion may be allowed in the first phase of implementation along with specifications of some standardization norms.
d. The detailed proposals along with modalities are placed at Table-18 of Annexure C.
5.8. Categories of schemes under MF Lite framework
a. Two approaches were suggested in the consultation paper w.r.t the permissible set of indices, passive schemes on which shall be covered under the MF Lite framework.
➣ Approach 1 shall be implemented in a phased manner. Under phase 1 of this approach, a list of indices, based on a quantitative threshold of AUM following them or some other criteria, shall be prescribed by SEBI to be covered under the MF Lite framework in the first phase of implementation.
➣ Under approach 2, there may not be a phased implementation and all ETFs, Index funds, domestic and overseas FoFs investing in a single ETF/Index fund may be included under MF Lite regime.
b. Although many comments received are in favor of proposed Approach 2 for implementation, however as the MF Lite regime is intended to be lighter than current regulatory framework for MFs, it is felt that the domain of passive schemes to be allowed under MF Lite framework needs to be carefully considered.
c. In view of the above, it is proposed that only a limited set of indices may be covered under phase 1 as proposed under the approach 1:
i. Accordingly, passive funds based on only domestic equity passive indices (broad indices tracked by passive funds or act as primary benchmark for actively managed funds), with collective AUM of INR 5,000 Cr. and above, may be covered under phase 1 of implementation of MF Lite.
ii. Domestic debt passive funds based on only such domestic debt indices with collective AUM, which exceeds a threshold as may be specified by SEBI, may be covered under phase 1 of implementation of MF Lite.
iii. In cases of overseas ETFs and FoFs having single underlying overseas passive fund, passive funds based on only such overseas indices, with collective AUM of $20 billion and above, may be covered under phase 1 of implementation of MF Lite.
iv. All FoFs investing only in single domestic/ overseas index, wherein the reference benchmarks of underlying passive funds are permitted under MF Lite framework, may be covered under the purview of MF Lite.
v. All FoFs investing in more than one index may not be covered under the MF Lite framework under its phase 1 of implementation.
d. The detailed proposals along with modalities are placed at Table-19 of Annexure C.
Section 3
6. Section 3 of this Board Memorandum includes proposals (i) the proposal w.r.t “Disclosure of Debt Index Replication Factor (DIRF)” for all debt passive schemes irrespective of such debt passive schemes are covered under MF Lite or not and (ii) the proposal relating to providing an option for “Introduction of Close ended passive funds” to all AMCs whether they are registered under MF Lite or the extant MF Regulations.
Part –A (Proposals as consulted that may be accepted without modifications)
6.1. Disclosure of “Debt Index Replication Factor (DIRF)” in debt oriented passive schemes and Introduction of close ended debt passive schemes
i. Debt oriented passive schemes may be mandated to disclose the “Debt Index Replication Factor (DIRF)” of the underlying index.
ii. In addition, an option for launching of close ended debt passive scheme may be enabled.
iii. The detailed proposals along with modalities are placed at Table-20 and Table-21 of Annexure C.
7. The other provisions of the MF Regulations not specifically covered in the proposals of this Board Memorandum shall be applicable for MF Lite framework also.
8. Proposals for consideration
The Board may consider and approve the proposals at paragraphs 4.1, 4.2, 4.3, 4.4, 4.5, 4.6 (b)&(c), 4.7(b)&(c), 4.8(c)&(d), 4.9(b)&(c), 4.10(c)&(d), 5.1, 5.2, 5.3(c)&(d), 5.4(c)&(d), 5.5(c)&(d), 5.6(c)&(d), 5.7(c)&(d), 5.8(c)&(d), 6.1 and 7 detailed at Annexure C. Draft amendments to the SEBI (Mutual Funds) Regulations, 1996, are placed at Annexure D.
8.2. The proposals at paragraphs 4.1, 4.2, 4.3, 4.6(b)&(c), 4.7(b)&(c), 4.8(c)&(d), 4.9(b)&(c), 4.10, 5.2, 7 may be enabled through amendments to SEBI (Mutual Funds) Regulations, 1996.
8.3. The operational modalities w.r.t proposals at paragraphs 4.1, 4.2, 4.3, 4.6(b)&(c), 4.10, 5.2 and other proposals at paragraph 8.1 above may be implemented through issuance of circular.
8.4. A reasonable time, in consultation with AMFI, may be provided for implementation to facilitate stakeholders to have required systems in place.
8.5. The Board may authorize the Chairperson to take steps to implement the proposal by amending the MF Regulations, with consequential and appropriate change, as may be required, and to notify the necessary regulations and/ or issue circular/(s) in this regard.
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Annexure A
This has been excised.
Annexure B
This has been excised.
