Insights

INTRODUCTION

In an effort to lessen compliance requirements, market authority Securities and Exchange Board of India on July 01, 2024 has recommended a lenient regulatory framework for passively managed Mutual Fund (MF) schemes. The proposed schemes named as MF Lite aims to lower the compliance requirement, promote simplicity of entry for MFs interested in launching exclusively passive schemes, develop innovation, boost competition, and take advantage of the lower risk associated with administering passively managed MF schemes.

BACKGROUND

Through the SEBI (Mutual Funds) Regulations, 1996 (“MF Regulations”) and the present regulatory framework for MFs the schemes are administered. The current Mutual Fund Regulations apply to both active and passive mutual funds (MF) schemes, including Exchange Traded Funds (ETFs) and Index funds. However, the provisions of the regulations are primarily framed to address the risks and complexities associated with actively managed MF schemes.

A team of knowledgeable fund managers is necessary for the management of active mutual fund schemes. They are in charge of defining investment philosophy and objectives, selecting and analysing security levels, analysing investment risks at the security and portfolio levels, and making sure that the portfolio is appropriately diversified, among other things. Conversely, the passively managed mutual fund schemes mimic an underlying index, making it simple to follow the portfolios of exchange-traded funds (ETFs) and index funds because the components of the underlying index are publicly available. As a result, as compared to active MF schemes, the risks connected with passive MF schemes are lower.

And with that being laid a more relaxed framework with light-touch restrictions is also proposed as the MF Lite restrictions for passive MF schemes, as certain of the provisions of the current regulatory framework may not apply to passively managed schemes.

FEATURES OF THE SCHEME RELEASED

1. Framework for Passive-Only Mutual Funds
Only passively focused mutual funds will be subject to the MF Lite Regulations. At the moment, Navi Mutual Fund is the sole fund institution that carries this out. It will be prohibited for these firms to carry out any commercial activity other than overseeing passive mutual fund schemes.

2. Proposed Relaxed Requirements
Under MF Lite, SEBI has suggested lowering the net worth and profitability requirements for sponsors and asset management firms (AMCs). In addition to having a minimum net profit of ₹5 crore in three of the previous five years, the sponsor must have a positive net worth for the preceding five years. Currently, sponsors need to demonstrate a five-year net profit of ₹10 crore.
The minimum net worth criterion for AMCs would drop from ₹50 crore to ₹35 crore, and if they continue to turn a profit for five years in a row, they may be eligible for a further decrease to ₹25 crore. In the event that the sponsor chooses the alternate eligibility option, the AMC’s net worth is required to remain at least ₹75 crore, instead of the previous minimum of ₹150 crore.

3. Reduction in Management Experience
The combined experience requirement for senior executives will be reduced from 30 years to 20 years under the new regulations.

4. Launch of Hybrid Passive Investments 
The establishment of hybrid passive funds, which may mimic a composite index of debt and equity, is what SEBI suggests. At first, there will be three categories that may be chosen from: Balanced (Equity: Debt – 50:50), Debt-oriented (Equity: Debt – 25:75), and Equity-oriented (Equity: Debt 75-25). For each hybrid category, a fund may introduce a single strategy.

5. Information Document for Simplified Scheme 
Under MF Lite, the regulator proposes making the expeditious processing of Scheme Information Documents (SIDs) for passive schemes mandatory. Investment plan and benchmark performance are examples of irrelevant elements that will be eliminated for passive schemes. Rather, the SID will concentrate on key performance indicators such as tracking difference, tracking error, and certain characteristics of target maturity debt passive schemes.

ANALYSIS

MF schemes that are passively managed mimic an underlying index, such index funds and exchange-traded funds (ETFs), allowing for easy portfolio tracking. Expert fund managers who choose securities and outline their investing philosophies are necessary for active fund schemes. However, the current framework for MFs is universally applicable to all MF schemes and does not distinguish between them in terms of the applicability of provisions.

The current framework for MF regulations, however, applies to all MF schemes in the same way and does not make any distinctions in terms of the provisions pertaining to entry barriers, such as net worth, track record, and profitability, as well as other compliance requirements, for entities that may choose to launch only passive funds. Therefore, some of the current regulatory framework’s rules might not apply to passively managed schemes. As a result, the MF Lite Regulations, a more lenient framework with few restrictions, have been suggested. 

According to the proposed framework, the MF Lite Regulations should apply to MFs that want to manage exclusively passive schemes, such index funds and exchange-traded funds.
Mutual funds that are still in existence, however, could choose to administer both active and passive schemes under their current registration. Therefore, a two-pronged strategy has been taken in this consultation paper to guarantee consistent applicability of proposed relaxations and to offer a fair playing field across all passive MF schemes.

Easy compliance, loosened disclosure requirements, and other regulatory criteria for passive schemes under current MFs as well as schemes that aim to launch purely passive schemes under MF Lite registration have all been advocated by SEBI is the main objective of the proposed scheme.