New regulatory framework for sponsors of mutual funds

The Securities and Exchange Board of India (SEBI) has recently introduced a new regulatory framework for sponsors of mutual funds, aiming to enhance the industry’s penetration, encourage innovation and competition, and facilitate the entry of new players. These changes, outlined in the SEBI circular dated July 7, 2023, provide alternative eligibility criteria for mutual fund sponsors and address various aspects related to the deployment of net worth, acquisition of an asset management company (AMC), pooled investment vehicles as sponsors, reduction of stake, disassociation of sponsors, and re-association of sponsors.

Deployment of Liquid Net Worth by AMC

The circular stipulates that AMCs must deploy the minimum net worth required, either in cash, money market instruments, government securities, treasury bills, repo on government securities, or listed AAA rated debt securities. These investments must be unencumbered and without bespoke structures or features that increase liquidity risk.

Acquisition of an AMC

In the case of a change in control of an existing AMC due to the acquisition of shares, the sponsor must ensure that the positive liquid net worth of the sponsor or funds tied up by the sponsor is at least equal to the aggregate par value or market value of the shares proposed to be acquired. The cost of acquisition may be funded through borrowings, provided the sponsor has sufficient other assets to encumber for borrowings.

Pooled Investment Vehicle as Sponsor of Mutual Funds

The circular permits private equity funds (PEs) among pooled investment vehicles to act as sponsors of mutual funds. To qualify, the applicant PE or its manager must have a minimum of five years of experience as a fund/investment manager, managing committed and drawn-down capital of at least INR 5,000 Crore. Additional safeguards, including restrictions on off-market transactions and shareholding lock-in, are imposed on PEs acting as mutual fund sponsors.

Reduction of Stake and Disassociation of Sponsor

Recognizing the evolution of the mutual fund industry, sponsors are allowed to voluntarily reduce their stake in an AMC, subject to certain conditions. An AMC can become a “self-sponsored AMC” if it has been in the financial services business for at least five years, maintains positive net worth, and meets profitability criteria. The largest financial investor becomes the signatory to the trust deed upon disassociation of the sponsor.

Re-Association of the Sponsor(s)

If an AMC fails to meet the criteria for self-sponsored AMC, a disassociated sponsor or any new entity may become the sponsor of the concerned mutual fund. The proposed sponsor must meet all requirements and obligations specified in the MF Regulations and follow due process to obtain SEBI’s approval. Unitholders of existing schemes are provided with an exit option without any exit load in such cases.