Summary: SEBI’s recent amendment to the Prohibition of Insider Trading (PIT) Regulations, set to take effect on November 1, 2024, extends insider trading restrictions to mutual fund units. The regulations introduce several key compliance measures for asset management companies (AMCs). Mutual fund units will now fall under the definition of ‘insider,’ prohibiting trading when in possession of unpublished price-sensitive information (UPSI). UPSI can include liquidity changes, regulatory actions, or any material event affecting the net asset value (NAV) or unitholders. AMCs must now maintain a structured digital database (SDD) to track UPSI sharing and are required to report quarterly on the holdings of their designated persons and immediate relatives. Additionally, pre-clearance for trading in mutual fund units will be required, except for certain fund types like ETFs and overnight schemes. AMCs must implement a code of conduct, set trading restrictions during closure periods, and impose penalties for violations. These changes aim to enhance transparency and prevent insider trading but also require significant procedural updates for AMCs to ensure compliance.
In July 2022, the Securities and Exchange Board of India (SEBI) proposed significant changes to the SEBI (Prohibition of Insider Trading) Regulations, 2015, through a consultation paper specifically targeting the applicability of these regulations to ‘units of mutual funds’. After more than 2 years, in July 2024, SEBI notified the amendment regulations and set November 1, 2024 as the effective date for Chapter IIA and Schedule B1 of the PIT Regulations. This article delves into the implications of these changes on the compliance requirements for AMCs, offering insight into the upcoming shifts and their potential impact.
Summary of the Changes to be implemented from November 1, 2024.
1. Definition of ‘Insider’ now made applicable for mutual fund units and no insider shall trade in the units of mutual funds when he/she is in possession of an unpublished price sensitive information (‘UPSI’)1.
UPSI for the purpose of Mutual fund units can be defined as material changes in the Liquidity position of a Mutual Fund Scheme, Material Regulatory observations/advisories, or any other event that can have an impact on the NAV2 or the unitholders of the Mutual Fund Scheme, read more about the various kinds of UPSI pertaining to Mutual Fund Units in the footnote.
2. Maintenance of Structured Digital Database (SDD) shall now be required for mutual fund units as well, for efficiently tracking the Possesion and sharing of UPSI. UPSI might be shared internally or externally for various business reasons.
3. AMCs shall be required to report on a quarterly basis the aggregate holdings held by its Designated Person(s) and their Immediate Relative(s) in scheme(s) managed by it to the stock exchanges in the dedicated platform created for the purpose.
Any transactions done by the Designated Person(s) or their Immediate Relative(s) in the units of own mutual fund schemes shall be disclosed to the Compliance Officer of the AMC within 2 business days and the Compliance Officer shall in turn report the same on the dedicated platforms of the stock exchanges for this purpose within 2 business days of such intimation from Designated Person(s).
2. AMC shall have an institutional mechanism to prevent insider trading which includes formulating a written policy or procedure documents for investigating leak or suspected leak of UPSI and review of compliance with the provisions of SEBI PIT Regulations by the Audit Committee of the AMC atleast on an annual basis.
2. Code of Conduct shall be formulated in line with Schedule B1 of the PIT Regulations, which shall include norms such as trading window closure, Chinese wall procedures etc.
3. Compliance Officer of the AMC shall define the Closure period during which the Designated persons are expected to have access to UPSI and no trading shall be permitted in the units of concerned mutual fund scheme(s) during such Closure Period.
During the scenarios as listed down in the footnote, the Compliance Officer shall be required to impose a Closure Period and a PAN level freeze shall be implemented, so that no transactions are done by the Designated Person(s) during such Closure Period. Such PAN level freeze can be done with the help of RTAs3, who can reject processing of such transaction(s) if done by the Designated Person(s) during a Closure Period.
1. Trading of mutual fund units shall be subject to pre-clearance by Compliance Officer of the AMC, a threshold shall be prescribed for such trades by SEBI. However, requirement of pre-clearance will not be applicable for trading in Overnight Schemes, Index Funds and Exchange Traded Funds (ETFs)
2. Contra Trade4 restriction duration has been prescribed as two(2) months for mutual fund units.
3. Code of Conduct can prescribe Internal Sanctions and Disciplinary Actions including wage freeze, suspension and termination etc.
Potential Impact & Actionable
While implementing PIT Regulations for Mutual Fund units is a welcome move and will help prevent the insider trading that can happen in mutual fund units, at the same time this also calls for a robust and an improved mechanism within AMCs to meet the prescribed new reporting and compliance obligations.
Currently, AMCs maintain a restricted list, which comprises of all securities that are owned by the schemes of their mutual funds, and no Designated Person(s) is permitted to trade(buy/sell) in such securities, however such restrictions do not apply to trading in units of own Mutual Fund, a Designated Person(s) is currently allowed to trade in units of own mutual fund without obtaining an approval. This will change post November 1, 2024 where necessary systems would have to be built by the AMCs to facilitate the approval of trading in units of own Mutual Fund by Designated Person(s).
AMCs will now have to adhere to two different sets of regulations for reporting and compliance, one for equity securities and another for trading of units of own mutual fund, each with distinct compliance requirements. For example – Contra Trade restriction for an equity security would be 6 months, while the same for units of own mutual fund would be 2 months (presently 1 month).
In addition, the AMCs shall also be required to maintain a Structured Digital Database and actively track all the possession and sharing of UPSI within and outside of the organisation.
Actionable for AMCs
Modify the Code of Conduct to bring in the new changes pertaining to the below:
1. Definitions to reflect the applicability of PIT Regulations for Mutual Fund units.
2. Pre-clearance requirement for own Mutual Fund Units
3. Transaction Reporting and Quarterly Reporting requirements
4. Contra Trade Restrictions
5. UPSI disclosure and handling
6. Penal Provisions including disciplinary actions for violation of the Code of Conduct
7. Closure Period restrictions
8. AMCs shall implement necessary infrastructure to implement the above changes and enter into arrangements with RTAs, Depositories and Stock Exchange(s) wherever required.
9. AMCs shall write policy and procedures for investigating any leak or suspected leak of UPSI
10. AMCs shall procure necessary tools/software for maintenance of the SDD
In conclusion, while the new change regarding the investment in units of own Mutual Fund aims to enhance vigilance against insider trading in an AMC, it also necessitates the establishment of additional policies and mechanisms for effective implementation. This may lead to Designated Person(s) refraining from investing in their own mutual funds, except as mandated by SEBI for “Alignment of interest of Designated Employees of asset management companies with the Unit holders of the mutual fund schemes”, and opting to invest in schemes of other Mutual Fund Houses.
Footnotes
1. UPSI (Unpublished Price Sensitive Information) in perspective of mutual fund units can include the following scenarios:
1. Change in the accounting policy
2. Material change in the valuation of any asset or class of assets
3. Restrictions on redemptions of scheme(s)
4. Winding up of scheme, winding up of scheme(s)
5. Creation of a segregated portfolio
6. Triggering of the swing pricing framework and the applicability of the swing factor
7. Material change in the liquidity position of a MF Scheme(s)
8. Default in the underlying securities which is material to the MF Scheme(s)
9. Fundamental attributes change
10. Merger of schemes
12. Change in the personnel of the AMC, which is likely to materially affect the interest of the investors or materially affect the NAV
13. Change in Total Expense Ratio in such situations which are likely to materially affect the interest of the investors or materially affect the NAV
14. Trigger of business continuity plan in such situations which are likely to materially affect the interest of the investors or materially affect the NAV
15. Audit observations which are likely to materially affect the interest of the investors or materially affect the NAV.
16. Regulatory observations which are likely to materially affect the interest of the investors or materially affect the NAV
17. Major events in a material investee company.
18. Declaration of Dividend in a Scheme
19. Change in Fund Management Responsibilities
2. NAV (Net Asset Value) of a mutual fund is the total value of all the assets owned by the fund divided by the total number of outstanding shares. It represents the per-unit value of the fund’s investments.
3. RTA (Registrar and Transfer Agent) is a financial intermediary responsible for maintaining records of mutual fund shareholders, processing transactions like purchases, redemptions, and transfers, and ensuring compliance with regulatory requirements.
4. Contra Trade means a Trade or transaction which involves buying or selling any number of shares of a Company/units of mutual fund within 6 (six) months or 2(two) months (in case of units of mutual fund) of Trading or transacting in an opposite transaction involving selling or buying of the shares purchased or sold, as the case may be. Basically Contra Trade is an opposite transaction that is executed after a buy/sell transaction.
5. SEBI (Prohibition of Insider Trading) Regulations, 2015
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Disclaimers: The views expressed in this article are solely my own and done in personal capacity and do not necessarily reflect the opinions of any other individuals or organizations.
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