REGULATORY FRAMEWORK FOR WORKING OF MUTUAL FUNDS

REGULATORY FRAMEWORK FOR WORKING OF MUTUAL FUNDS

Every action of the mutual fund is governed by the various regulations laid down by SEBI and there is a need for mutual funds to follow these guidelines so that investors get the best services along with a fair treatment with respect to their investments. All of the regulations are not relevant for the lay investor and here we shall look at some of them that would be relevant and useful for them in their daily investment process. It is also to be noted that these can change anytime and one has to be alert for some of the changes are taking place on a regular basis.

FORMATION

One of the main regulations relate to the formation of a mutual fund. There are three entities present as far as the functioning of the mutual fund is concerned. The first link in the entire mutual fund setup is the presence of a sponsor. The sponsor is expected to have a sound track record along with a general reputation of fairness and integrity in all business transactions. This includes the requirement of carrying on business in financial services for a specified period of time. In addition there are also financial parameters relating to the net worth of the sponsor and its profits that are calculated after various adjustments as suggested by the guidelines. The whole idea behind the entire exercise both in terms of business reputation as well as financial parameters is that the sponsor should be sound enough so the mutual fund is backed by the right kind of people.

As one goes down to the other conditions of the setting up of the mutual fund there is the actual mutual fund, which has to be in the form of a trust with a trust deed. Thus there has to be a board of trustees who will acts as trustees of the mutual fund. The instrument of trust shall be in the form of a trust deed, duly registered under the provisions of the Indian Registration Act.

The trustees who have been appointed for the mutual fund have to be people of standing, ability as well as integrity. Similarly there is a condition that an asset management company or its officers or employees will not be eligible to act as the trustees of the mutual fund. There is also a requirement for certain proportion of the trustees to be independent persons and who are not associated with the sponsors in many manner. The reason behind such a move is to ensure that there is a clear separation between the management and the administration of the mutual fund.

After this is the process of management of the funds and for this there will be an asset management company and the trustees and the asset management company will enter into an investment management agreement. The asset management company has to manage the mutual fund schemes independently and take several other steps to ensure that the interest of the investors of one of the scheme is not being compromised in any manner whatsoever. It is the responsibility of the trustees to keep a check on the various activities of the asset management company and to see that everything is in order and is being carried out in accordance with the guidelines for mutual funds.

The asset management companies too have the requirement of having a sound track record, general reputation and fairness in transactions along with right qualities for the directors and key personnel of the company

EXPENSE LIMITS

There is also the issue of recurring expenses of a mutual fund. The limits that are prescribed for the fund to charge various expenses state that for the first Rs 100 crore of the average weekly net assets the expense is 2.5%, for the next Rs 300 crore it is 2.25%, for the next Rs 300 crore it is 2% and for the figure over that amount (Rs 700 crore) it is 1.75%. In case of a scheme investing in bonds the limit shall be lesser by at least 0.25% of the weekly average net assets. Any expense over and above the prescribed ceiling will be borne by the asset management company.

CHANGE IN FEATURES

There is also a condition that no change in the fundamental attributes of any scheme or the trust or even fees and expenses or some other change which would modify the scheme and affects the interest of unit holders will be carried out without a written communication being sent to each unit holder. In addition an advertisement has to be given in one English daily newspaper having nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated. The unit holders also have to be given an option to exit the scheme at this stage without paying any exit load.

INVESTOR SERVICES

Whenever there is an application by an investor for units in a mutual fund scheme then the asset management company shall issue to the applicant unit certificates or a statement of accounts specifying the number of units allotted to the applicant as soon as possible but this cannot be later than six weeks from the date of closure of the initial subscription list or the date of receipt of the request from an investor in an open ended scheme.

While calculating the prices of the units the mutual fund shall ensure that the repurchase price is not lower than 93% of the net asset value and the sale price is not higher than 107% of the net asset value. However the total difference between the repurchase price and the sale price of the units shall not exceed 7% calculated on the sale price. In case of a close ended scheme the repurchase price cannot be lower than 95% of the net asset value.

There has to be a dispatch to the unitholders of the dividend warrants within 30 days of the declaration of dividend in the scheme. In case of redemption proceeds this has to be within 10 working days from the date of redemption or repurchase.

INVESTMENTS

In terms of investments no mutual fund shall invest more than 10% of its NAV in the equity shares or equity related instruments of any company. This limit of 10% will not be applicable for index funds and sector or industry specific schemes. A mutual fund shall also not invest more than 5% of the NAV in the unlisted equity shares of an open ended scheme and 10% of its NAV in case of a close ended scheme. No mutual fund shall under all its schemes own more than 10% of any company’s paid up capital carrying voting rights.

A mutual fund shall not invest more than 15% of its NAV in debt instruments issued by a single issuer, which are rated not below investment grade by a credit rating agency. This can be extended to 20% with the prior approval of the Board of Trustees and the board of the asset management company. These limits are not applicable to government securities and money market instruments. A mutual fund shall not invest more than 10% of its NAV in unrated debt instruments issued by a single issuer and the total investments in such instruments should not exceed 25% of the NAV of the scheme. All such investments have to be made with the prior approval of the Board of Trustees and the board of the asset management company.

In case a company has invested more than 5 % of the net asset value of a scheme, the investment made by that scheme or any other scheme of the mutual fund in that company or its subsidiaries shall be brought to the notice of the trustees by the asset management company and disclosed in the half yearly and annual accounts of the scheme with justification for such investments.