Part 1: Mutual Fund Regulations 1996 | CSL Module 7

1.1 SEBI MF Regulations - Overview

The SEBI (Mutual Funds) Regulations, 1996 form the cornerstone of mutual fund regulation in India. These regulations establish the comprehensive framework for establishment, registration, and operation of mutual funds, replacing the earlier UTI-centric regime.

Historical Evolution

The mutual fund industry in India evolved through distinct phases:

1963-1987: UTI monopoly era - Unit Trust of India was the sole mutual fund
1987-1993: Public sector entry - Banks and LIC/GIC established mutual funds
1993: Private sector entry permitted under SEBI MF Regulations, 1993
1996: Comprehensive SEBI MF Regulations, 1996 enacted
2003: UTI bifurcation - brought under SEBI regulation

Key Regulatory Framework

The SEBI (Mutual Funds) Regulations, 1996 read with various SEBI circulars and master circulars govern the entire mutual fund ecosystem. The regulations are structured around three key entities: Sponsor, Trustee, and AMC - forming the tripartite structure of every mutual fund.

Structure of the Regulations

The SEBI MF Regulations, 1996 are organized into the following chapters:

Chapter	Subject Matter	Key Provisions
Chapter II	Registration of Mutual Fund	Regulations 4-9
Chapter III	Constitution and Management	Regulations 10-25
Chapter IV	Schemes of Mutual Fund	Regulations 26-36
Chapter V	Investment Valuation Norms	Regulations 37-49
Chapter VI	General Obligations	Regulations 50-68
Chapter VII	Inspection and Audit	Regulations 69-73
Chapter VIII	Procedure for Action	Regulations 74-78

Mutual Fund [Regulation 2(q)]

"Mutual fund" means a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities including money market instruments or gold or gold related instruments or real estate assets.

1.2 Registration of Mutual Funds

No mutual fund can be set up in India without registration from SEBI. Regulation 4 mandates that no person shall carry on any activity as a mutual fund unless registered with SEBI.

Application for Registration [Regulation 5]

An application for registration must be made to SEBI in Form A of the First Schedule, accompanied by:

Non-refundable application fee of Rs. 1,00,000
Trust deed in the prescribed format
Details of sponsors including net worth certificate
Draft investment management agreement with proposed AMC
Draft custody agreement with proposed custodian

Eligibility Criteria [Regulation 6]

SEBI shall consider the following factors before granting registration:

Sound track record: Sponsor must have a track record of integrity and fairness in all business transactions
Financial soundness: Sponsor must be carrying on business in financial services for at least 5 years
Positive net worth: Sponsor must have positive net worth in immediately preceding five years
Profitability: Net worth in the immediately preceding year is more than the capital contribution in the AMC
Sponsor contribution: Sponsor must contribute at least 40% to the net worth of the AMC

Practice Tip

When advising a client on setting up a mutual fund, conduct thorough due diligence on sponsor eligibility. Focus on the 5-year track record requirement and ensure net worth certificates are from a qualified Chartered Accountant within 6 months of application.

Grant of Certificate [Regulation 7-9]

Upon satisfaction with the application, SEBI grants a certificate of registration in Form B. The registration is subject to:

Payment of registration fee of Rs. 25,00,000
Compliance with conditions specified by SEBI
Annual fee of Rs. 2,50,000 payable by April 30 each year

Important

Failure to pay annual fees may result in suspension of certificate. SEBI has issued show cause notices to several AMCs for non-payment of annual fees within prescribed timelines.

1.3 Sponsor Requirements

The Sponsor is the entity that establishes the mutual fund and gets it registered with SEBI. The Sponsor is akin to the promoter of a company and bears significant regulatory responsibilities.

Definition and Role

Sponsor [Regulation 2(x)]

"Sponsor" means any person who, acting alone or in combination with another body corporate, establishes a mutual fund.

Eligibility Requirements

A sponsor must satisfy the following criteria under Regulation 7:

Requirement	Specification	Purpose
Business Experience	5 years in financial services	Ensures industry knowledge
Net Worth	Positive in all preceding 5 years	Financial stability
Net Worth vs Contribution	Latest NW > AMC capital contribution	Adequacy of resources
Profitability	Profit after tax in 3 of preceding 5 years	Business viability
Track Record	No regulatory action for unfair practices	Integrity and fairness
AMC Contribution	Minimum 40% of AMC net worth	Skin in the game

Sponsor Obligations

Establishment of Trust: Create the mutual fund as a trust under the Indian Trusts Act, 1882
Appointment of Trustees: Appoint the Board of Trustees or Trustee Company
Formation of AMC: Set up the Asset Management Company
Capital Contribution: Maintain at least 40% of the net worth of the AMC
Ongoing Support: Provide necessary support for fund operations

Change of Sponsor

Change of control of a mutual fund through acquisition or change of sponsor requires prior approval of SEBI and majority consent of unitholders. This ensures continuity of fund management and protects investor interests. Key cases include the HDFC-Zurich, IDFC-IDFC First, and Franklin Templeton reorganizations.

Co-Sponsors

Multiple entities can act as co-sponsors. In such cases:

Each sponsor must individually satisfy the eligibility criteria
Combined contribution must be at least 40% of AMC net worth
All sponsors are jointly and severally responsible for regulatory compliance

1.4 Trustee Obligations

The Trustee holds the property of the mutual fund in trust for the benefit of unitholders. Trustees act as the guardians of investor interests and exercise oversight over the AMC.

Forms of Trusteeship

A mutual fund can have trustees in two forms:

Board of Trustees: Individual trustees acting collectively as a board
Trustee Company: A company registered under the Companies Act acting as trustee

Trustee [Regulation 2(za)]

"Trustee" means the Board of Trustees or the Trustee Company who holds the property of the Mutual Fund in trust for the benefit of the unit holders.

Trustee Eligibility [Regulation 16]

Persons cannot be appointed as trustees if they:

Are guilty of moral turpitude
Have been convicted of any economic offence
Are associated with securities market violations
Have been found guilty of misfeasance by a court

Independence Requirements

At least two-thirds of trustees must be independent (not associated with sponsor)
In case of Trustee Company, two-thirds of directors must be independent
No trustee of one mutual fund can be trustee of another mutual fund

Rights and Obligations [Regulation 18]

Key trustee obligations include:

General Oversight: Ensure that AMC has proper systems and procedures
Investment Compliance: Ensure investments are made as per trust deed, regulations, and SID
NAV Calculation: Ensure proper calculation and publication of NAV
Unitholders Interest: Take all reasonable steps to protect unitholder interests
Quarterly Review: Review AMC activities at least once every quarter
Half-yearly Trustee Report: Furnish report to SEBI every six months

Best Practice

Trustees should maintain detailed minutes of all meetings, specifically recording their oversight of investment decisions, expense ratios, and investor grievance redressal. These records are crucial during SEBI inspections.

Trustee Liability

Trustees can be held liable for:

Failure to exercise proper oversight over AMC
Not taking action on known violations
Breach of fiduciary duty to unitholders
Non-compliance with SEBI directions

Case Study: Franklin Templeton

In the Franklin Templeton wound-up scheme matter (2020), SEBI examined trustee liability for failure to adequately oversee AMC decisions. Trustees must actively monitor portfolio concentration, liquidity risk, and compliance with scheme mandates.

1.5 AMC Requirements

The Asset Management Company (AMC) is the operational arm of the mutual fund, responsible for day-to-day management of the fund's assets. The AMC acts under the supervision of trustees and must comply with stringent regulatory requirements.

AMC Definition and Constitution

Asset Management Company [Regulation 2(d)]

"Asset Management Company" means a company formed and registered under the Companies Act, 1956 and approved as such by SEBI under sub-regulation (2) of regulation 21.

Eligibility Criteria [Regulation 21]

An AMC must satisfy the following requirements:

Requirement	Specification
Net Worth	Minimum Rs. 50 crore (including seed capital commitment)
Directors	At least 50% must be independent directors not associated with sponsor or associate companies
Key Personnel	At least 2 persons with at least 5 years experience in portfolio management or securities markets
Chief Compliance Officer	Dedicated CCO is mandatory
Principal Officer	Must be approved by SEBI

AMC Obligations [Regulation 25]

Key obligations of an AMC include:

Fiduciary Duty: Manage investments in the interest of unitholders
Due Diligence: Exercise proper care and diligence in investment decisions
Fair Dealing: Ensure fair treatment of all schemes and investors
Disclosure: Make proper disclosures to unitholders
Books and Records: Maintain proper books of account and records
Code of Conduct: Comply with the Code of Conduct for AMCs (Fifth Schedule)

Key Personnel Requirements

Chief Executive Officer/Managing Director: Overall responsibility for operations
Chief Investment Officer: Responsible for investment decisions
Chief Compliance Officer: Regulatory compliance oversight
Fund Manager: Day-to-day scheme management (minimum 5 years experience)
Chief Risk Officer: Risk management framework

Compliance Point

SEBI requires prior approval for appointment/change of Key Management Personnel. Ensure Form A (Third Schedule) is filed at least 15 days before proposed appointment. Track regulatory amendments on KMP requirements - SEBI has progressively tightened qualification and experience criteria.

Restrictions on AMC Activities

An AMC cannot:

Undertake any business activity other than portfolio management and advisory services without SEBI approval
Act as trustee of any mutual fund
Purchase or sell securities through any broker associated with the sponsor beyond 5% of aggregate business
Appoint any person as key personnel who is involved in any litigation connected with securities market

Investment Management Agreement

The relationship between Trustees and AMC is governed by the Investment Management Agreement (IMA), which must include:

Scope of AMC's authority
Investment restrictions
Fee structure and expense allocation
Reporting requirements
Termination provisions