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Sebi cracks down on sponsor bias: New rules for passive funds in India

New Delhi, July 9, 2024

Passive funds, except for ETFs and index funds, are now restricted from investing more than 25% of their net assets in listed securities of companies belonging to the sponsor group.

Market regulator Securities and Exchange Board of India (Sebi) has implemented stricter regulations on how passively managed mutual funds can invest in companies affiliated with their sponsors. This move aims to mitigate concentration risk and promote greater diversification within these funds.

Limit on sponsor investment: Passive mutual funds, except for equity-oriented Exchange Traded Funds (ETFs) and index funds, are now restricted from investing more than 25% of their net assets in listed securities of companies belonging to the sponsor group.

ETF and Index Fund Leeway: Equity-oriented ETFs and index funds have slightly more flexibility. They can invest in sponsor group companies based on the weightage of those companies within the underlying index, but this investment is capped at 35% of the fund's net asset value.

Reasoning for change: SEBI formed a working group to review the existing regulations for passive mutual funds. Following public consultations and discussions with the Mutual Funds Advisory Committee (MFAC), SEBI decided to streamline the rules and address potential conflicts of interest.

Transparency in Index Tracking: To ensure transparency and adherence to the intended market representation, Sebi has defined "widely tracked and non-bespoke indices." These are indices:

* With a collective Asset Under Management (AUM) of Rs 20,000 crore and above.

* Tracked by passive funds.

* Serving as primary benchmarks for actively managed funds.

List of Approved Indices: The Association of Mutual Funds in India (AMFI) will:

* Update and publish a list of such approved indices biannually, on April 15 and October 15.

* Base the list on AUM data as of March 31 and September 30, respectively.

* The first list, effective June 30, 2024, includes prominent indices like Nifty 50 and BSE Sensex.

Rebalancing for non- compliant funds: Passive schemes that are not currently aligned with these approved indices will be required to rebalance their portfolios within 30 business days from the date Sebi issued this circular.

Rebalancing Requirements and Consequences:

Justification and Potential Extension: If a fund cannot rebalance within the initial 30 days, the Asset Management Company (AMC) must provide written justification to their Investment Committee, detailing efforts made towards rebalancing.

Extension for rebalancing: The Investment Committee has the authority to extend the rebalancing timeline by up to an additional 60 business days.

Strict measures for non-compliance: If a fund fails to rebalance within the mandated timeframe (including any extension granted), Sebi will impose the following restrictions on the AMC:

Launch freeze: The AMC will be prohibited from launching any new schemes until the existing scheme is rebalanced.

Exit load restriction: The AMC cannot levy exit loads (fees charged when investors redeem their units) on existing investors in the non-compliant scheme.

These new regulations aim to ensure that passively managed funds prioritize diversification and invest based on market performance rather than preferential treatment towards sponsor-affiliated companies. This can potentially lead to a more balanced portfolio and reduced risk for investors.

[The Business Standard]

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