SECURITIES AND EXCHANGE BOARD OF INDIA
CHIEF GENERAL MANAGER
MUTUAL FUNDS DEPARTMENT
September 30, 2002
All Mutual Funds Registered with SEBI
Unit Trust of India
Association of Mutual Funds in India
Risk Management System
As you are aware, SEBI (Mutual Funds) Regulations, 1996 prescribe the duties and obligations of asset management companies (AMCs) and trustees. The code of conduct prescribed under the Regulations requires that mutual funds should render at all times high standards of service and exercise due diligence and ensure proper care in their operations.
In furtherance of the above objectives and to protect the interests of investors, certain systems, procedures and practices must be followed by all the mutual funds.
You may recall that vide our letter dated March 29, 2001, all the mutual funds were advised to inform us on the adequacy of their risk management systems. Subsequently, on our advice, AMFI in association with Pricewaterhouse Coopers as a part of Indo-US Financial Institutions Reforms and Expansion Project, has undertaken a detailed study on risk management practices followed by all the mutual funds. They have made certain recommendations to ensure a minimum standard of due diligence or risk management system for all the mutual funds in various areas of their operations like fund management, operations, customer service, marketing and distribution, disaster recovery and business contingency, etc.
Operating Manual for Risk Management System
AMFI and Pricewaterhouse Coopers have prepared an operating manual for risk management system for the mutual funds. A copy of the operating manual has been sent to you by e-mail and is also available on SEBI website under the Mutual Funds Section.
The risk management practices in various areas of operations of mutual funds are covered in the operating manual under three categories: (i) Existing industry practices (ii) Practices to be followed on mandatory basis, and (iii) Best Practices to be followed by all mutual funds. Details are given below:
(i) Existing Industry Practices:
Under each head of risk area, the manual covers the exemplary practices followed by some / most of mutual funds in India. It may be mentioned that though there are exemplary practices covered in this category, the extent and degree of observance of these practices differ among the mutual funds. Therefore, it is desirable that all mutual funds should develop their systems and follow these practices, if not being done at present.
(ii) Practices to be followed on Mandatory BasisAll mutual funds shall follow the practices which have been indicated as mandatory in the operating manual. These are – (i) risk management function should be assigned to compliance officer or internal risk management committee or to an external agency (ii) disaster recovery and business contingency plans, and (iii) mutual funds should take insurance cover against certain risks.
(iii) Best Practices to be followed by Mutual Funds These are the practices which must be adopted by the mutual funds as a part of their due diligence exercise after considering the size of their operations.How to Implement the Risk Management SystemThe mutual funds are advised to follow the following step-by-step approach to implement the risk management system:Identification of observance of each recommendation
The mutual funds shall identify areas of current adherence as well as non-adherence of various risk management practices under each of the aforesaid three categories. They shall examine the areas where development or improvement of systems is required.
After identifying the same, the mutual funds shall review the progress made on implementation of the systems on a monthly basis and place the progress report in periodical meetings of Boards of AMCs and trustees. The mutual funds shall ensure full compliance of all the risk management practices within a period of six months.
Review of Progress of implementation:
Boards of AMCs and trustee companies shall review the progress made by their mutual funds with regard to risk management practices and the same shall be reported to SEBI at the time of sending quarterly compliance test reports and half-yearly trustee reports.
For the first two quarters – December 2002 and March 2003 – all mutual funds shall send a detailed report informing how each recommendation in each of three categories has been implemented and whether Boards of AMCs and trustees are satisfied. Review by Internal Auditors After full implementation of the risk management system, it shall be made a part of internal audit from April 1, 2003 onwards and the auditors shall check on a constant basis about the adequacy of risk management systems. Their reports shall be placed before the Boards of AMCs and trustees who shall make comments on the adequacy of systems in the quarterly and half-yearly compliance reports filed with SEBI.These guidelines are being issued in accordance with the provisions of Regulation 77 of the SEBI (Mutual Funds) Regulations, 1996.