Mutual Fund Regulations

Before the establishment of the Securities Exchange Board of India (“SEBI”), Unit Trust of India was created in order to bring the savings from the household to industries and protect the interests of the investors. However, with the growth of industrialization, there was a need to amend the initial mutual fund regulations.  This eventually paved way for the establishment of SEBI. Although the mere establishment of SEBI was not going to complete the mutual fund regulations matrix. Because of the involvement of transactions, the regulations came under the purview of other regulatory authorities as well. Currently, all the mutual fund regulations are controlled by following entities:

• Securities Exchange Board of India
• Ministry of Finance
• Income Tax Regulations
• Reserve Bank of India
• Association of Mutual Funds of India
• Investors Associations

Securities Exchange Board of India (‘SEBI”)

To start with, no mutual fund can be launched unless the scheme is registered with SEBI. The Securities Exchange Board of India (Mutual Fund) Regulations 1996, is the Bible under which all the mutual funds are regulated. The mutual fund regulations are amended from time to time to bring in consonance with the ever-increasing needs of investors in light of their protection. Further, SEBI Regulations are universal in nature with an objective of bringing greater transparency, stability, and a common governing structure. The registration process involves numerous disclosures, to provide precise information about the facts of the mutual fund. A mutual fund scheme can be launched only when SEBI is satisfied with the parameters such as the integrity of the Asset Management Company (‘AMC’), infrastructure, net worth as specified under regulation etc. After reviewing all the filters, the mutual funds are registered under SEBI, thus minimizing the risk of fraud or misuse of funds.

Ministry of Finance (“MOF”)

Ministry of Finance is the body that helps both the SEBI and Reserve Bank of India (“RBI”) in formulating the policies for mutual fund regulations. SEBI and RBI – though quasi-legislative bodies (Quasi-meaning being partly or almost; Legislative meaning law enacting body) – have a limited lawmaking power. Hence, they both require the MOF to legislate on certain critical matters. Ministry of Finance through their notifications or circulars, regulate the mutual funds and aid in protecting the investors.

Income Tax Regulations

These mutual fund regulations deal with the income or liquidation of an investment in mutual fund units. As part of the source of revenue generation for the government, these regulations are very thorough and pinpoint in their application. Stuff like Securities Transaction Tax (“STT”) or Capital Gain Tax or Tax Deducted at Source (“TDS”) are a part of these regulations. These mutual fund regulations help investors in their tax planning regime, and since tax saving mutual funds have lock-in period, it eventually paves way for a longer investment period. The capital gain tax also deters investments of a shorter period, since it will not only attract heavy tax but also significantly reduce the actual profit. In addition to that, longer the mutual fund investments remain, the more stability it achieves.

Reserve Bank of India (“RBI”)

Although RBI is the apex body in banking governance, it has a major role in framing the mutual fund regulations. All the money market instruments such as treasury bills, certificate of deposits, call and notice money etc., are governed by the RBI. Therefore, any mutual fund scheme that invests in the money market instruments requires to be registered under the RBI. The Reserve Bank of India also plays a direct and vital role in foreign investment in India. For example, if an NRI wishes to regularly invest in mutual funds in India, then according to the RBI regulation, he/she must have a Non-Resident External Account. Another important mandate formulated by RBI is the Know Your Customer (‘KYC”) information. Without complying with the KYC norms, no investor can invest in mutual funds. The KYC norms are nothing but a deterrent to the money laundering or un-named/un-authorized transactions.

Association of Mutual Funds (“AMFI”):

It is basically a Non-Profit Organization, established with an objective of protecting the interests of investors creating more awareness about investment. Association of Mutual Fund of India is a collaboration of the Asset Management Companies registered under SEBI.  AMFI works to formulate mutual fund regulation policies and for maintaining ethical and healthy standards of operation of schemes. It acts as a link between the mutual fund industry (investor + scheme floater) and the regulators (SEBI, RBI, Income tax authorities).

Investor Association/ Self Regulatory Organization (“SRO”)

As the name suggests these entities can govern without any government regulations. The stock exchanges are a prime example of SRO. The stock exchange is governed by SEBI. However, they implement their own regulations in addition to the SEBI regulations, which the mutual fund schemes have to adhere. Depository Participants also play a part in SRO and govern the demat accounts.

Though the above list is not exhaustive, these are the main bodies that govern the mutual fund schemes. Now let us discuss the benefits of bringing regulations into mutual funds.

• Transparency:

Without transparency, it’s like investing blindly, without any idea about the returns. Transparency is the foundation of mutual funds regulations, as it involves strict adhering to the disclosure of various information. These disclosures include information such as the net worth of the scheme maker, profile of directors/ managers, previous track-record etc. Thus, transparency gives all the necessary information to the regulatory body, which in return decides the viability of the scheme and gives its consent.

• Confidence:

To put it simply, if there aren’t any regulators, there won’t be any investors. When we search the school for our kids, we make sure that our kids are safe; the same goes for our money. Regulators bring confidence in the minds of investors. This confidence is essential to attract investors not just domestically but across the globe.

• Stability:

Mutual fund regulations help in making informed decisions. Since investments always pertain to future cash-flows, planning is essential and this planning can only be successful if there is stability in the management of mutual funds. Mutual fund regulations ensure that the fund remains committed to offering maximum benefit to the investors.

• Industrialization:

Every industry, be it manufacturing or service, requires funds from an external source to grow. Mutual funds cater to a major part of such requirement. An economy flourishes when the household savings are injected into it. However, these household savings are mainly attracted towards bank fixed deposit and other secured assets thus, adjusting on minimal returns. Since the inception of mutual fund regulations, the trend has changed, and it has had a positive impact on the growth of economy and industrialization.

A game without rules is never a game. Rules make it complete and worth playing. Regulatory bodies enact these rules not just to make it complete, but to protect the money of innocent investors. The powers and duties of each regulatory body overlap within themselves; their function is what segregates their role.

Role of RBI and other regulatory bodies:

• The KYC norms of RBI are very strict. This indirectly helps in reduction of money laundering. It helps in identifying the true beneficial owner and thereby avoiding the insertion of black money transactions into the economy.
• The association of mutual funds plays a major role as the regulatory body in terms of generating investor awareness. This awareness helps educate investors to take more informed decisions to avoid loss of their funds.
• The Income tax department caters to the influx of funds by promoting investment in mutual funds and providing tax benefits to investors. They also help in increasing government revenue by imposing taxes on short-term investments. This regulatory body helps in tax and investment planning of the investors.
• The regulatory bodies and their regulations are the brains of the whole mutual fund system. Without these bodies, the industry will be ineffective and inadequate. However, this is just one side of the coin. The other side is significantly influenced by SEBI in formulating its regulations. SEBI plays the role of the apex body in the functioning of the mutual fund schemes.

Primary Role of SEBI as Regulatory Body

• Protect the financial interests of investors
• Examining the prospects of the asset management company and other players related to floating of Mutual fund
• Uninterrupted review of the functioning of mutual fund leading to minimization of fraud and loss of innocent investors.

This role of SEBI not only helps in the protection of investors but also in becoming a stable source of funds for the economy due to the rise in investor confidence. Some important steps of SEBI in mutual funds can be seen below:

1. Registration: Registration of mutual funds is mandatory, it helps the apex body to understand and study the situation of the sponsor, its track record and overall viability of the scheme.
2. Privatization: Until SEBI the investors did not have many options of investment, In February 1993, SEBI cleared six private sector mutual funds viz. 20th Century Finance Corporation, Industrial Credit & Investment Corporation of India, Tata Sons, Credit Capital Finance Corporation, Ceat Financial Services, and Apple Industries.
3. Advertisement: This is an important part as investors sometimes fail to understand the genuineness of the scheme or product. SEBI regulations prescribe a certain code while designing an advertisement, which is to be strictly adhered to.
4. Minimum amount to be collected: It is like a minimum subscription to mutual funds. SEBI states a minimum of 50 Cr for open-ended schemes and 20 Cr. for close-ended schemes, otherwise, the money is to be refunded. The objective behind this is that the risk is shared between small investors to large investors, if not large investors then underwriters.
5. Net Asset Value: It is essential for all mutual fund schemes to derive and state the true and easy to know net asset value to investors.

Now since the regulatory authorities are making it easier for the investors to invest, are there still any points for investors to look after? The answer is “YES”. Here are the guidelines for mutual fund investors, let us check out:

1. Chalking out Financial Goals: This is very important unless we understand the need for which we are saving, we cannot know how much will be sufficient? The objective is necessary because it will you help in choosing the right mutual fund scheme. For example, if the objective is to be achieved in short-term you can invest in a low-risk debt fund, but of the objective is child education, you have to consider equity backed mutual funds.
2. Past Performances: Always remember to check out the past performances of any mutual funds. It is a way you can understand its volatility, judge its future performances. The actual results may vary from the judgment but it will not be drastic.
3. Types of Return: The return in mutual funds can be of two types one in the form of capital appreciation and the other in the form of a dividend. Therefore, as per your requirement, one has to choose how the return they require and invest accordingly.
4. Tax Benefits: The investors must remember, Equity linked savings scheme are currently one of the best options in a mutual fund, which comes with a lock-in period. ELSS can be used as a great tax planning tool since it is combined with tax savings along with better returns compared to fixes deposit or public provident fund, however, the maximum tax benefit is limited to 1.5 lakhs under section 80C. Therefore if one has covered their tax planning, it would not be wise to block your money for three years without any returns.
5. SEBI Guidelines: SEBI guidelines has specifically categorized the mutual fund schemes into Equity, Debt, Hybrid and Solution oriented. In addition to that large cap (low risk), Midcap (medium risk), small-cap (high risk) have been defined to clearly.

The above list is not a complete guide; however, it can help investors in taking decisions. The guidelines can help the investors in comparing different investment avenues and on the basis of requirements they can decide the right alternative. It is the twenty-first century, where keeping the money under the bed or in biscuit tiffin will not help, it needs to be invested to tackle the growing inflation. Guidelines of mutual funds will make investors aware that their money is as safe as it was in the biscuit tiffin. Winning the confidence of investors is the main objective, and these guidelines will help in doing just that. It will also boost their confidence, help them guide and diversify their investment, and divide their risks and returns.