Unit6 - Subjective Questions

Association of Mutual Funds in India (AMFI)

AMFI was incorporated on August 22, 1995, as a non-profit organization. It is the nodal association of mutual funds across India.

Significance:

• Industry Representation: It represents the mutual fund industry to the government, SEBI, and other regulatory bodies.
• Standardization: It helps in establishing uniform and professional standards of practice across the industry.
• Investor Protection: AMFI plays a crucial role in safeguarding the interests of mutual fund investors through education and awareness programs.
• Self-Regulatory function: Although SEBI is the primary regulator, AMFI acts as a semi-regulatory body by enforcing the AMFI Code of Ethics (ACE) among its members.
• Intermediary Regulation: AMFI registers mutual fund distributors and assigns them an AMFI Registration Number (ARN).

The primary objectives of AMFI are:

1. Define and maintain professional standards: To promote the highest ethical standards and uniform operational practices in the mutual fund industry.
2. Interact with Regulators: To represent the industry before the Securities and Exchange Board of India (SEBI), the Ministry of Finance, and the RBI on matters relating to mutual fund regulations.
3. Protect Investor Interests: To act as a protective entity for investors by ensuring transparency and resolving industry-level grievances.
4. Distributor Regulation: To regulate mutual fund distributors by implementing a registration framework (ARN) and setting up a disciplinary mechanism for code violations.
5. Promote Awareness: To undertake nationwide investor awareness programs (e.g., "Mutual Funds Sahi Hai") to promote the concept of mutual funds.
6. Disseminate Information: To act as a central hub for industry data, NAV reports, and research publications.

According to the SEBI (Mutual Funds) Regulations, 1996, a mutual fund is structured as a trust and encompasses the following key entities:

1. The Sponsor: The promoter who establishes the mutual fund trust. The sponsor creates the trust deed and appoints the Board of Trustees. The sponsor must have a sound track record and contribute at least of the net worth of the AMC.
2. The Trust / Board of Trustees: The mutual fund is constituted as a trust. The Board of Trustees holds the fund's property for the benefit of the unitholders. They oversee the AMC and ensure compliance with SEBI guidelines.
3. Asset Management Company (AMC): Appointed by the sponsor (or trustees), the AMC is responsible for managing the funds, making investment decisions, and handling daily operations. The AMC must be approved by SEBI.
4. The Custodian: Appointed by the Board of Trustees, the custodian is responsible for the safekeeping of the mutual fund's securities and participating in the clearing system. The custodian must be legally independent of the sponsor.

For a mutual fund to be registered under the SEBI (Mutual Funds) Regulations, 1996, it must fulfill several conditions:

• Application Form: An application must be submitted in Form A to SEBI along with a non-refundable application fee.
• Sponsor Eligibility: The sponsor must have a sound financial track record and a reputation for fairness and integrity.
• Trust Deed: The mutual fund must be established as a trust under the Indian Trusts Act, 1882, and the trust deed must be approved by SEBI.
• AMC Appointment: An Asset Management Company (AMC) must be formulated to manage the funds.
• Custodian: A SEBI-registered custodian must be appointed to hold the securities.
• Net Worth Requirement: The AMC must have a minimum net worth of , out of which the sponsor must contribute at least .

According to SEBI regulations, an entity must satisfy the following criteria to qualify as a mutual fund sponsor:

• Track Record: The sponsor must have a sound track record in carrying on business in financial services for not less than years.
• Net Worth: The sponsor must have a positive net worth in all immediately preceding years.
• Profitability: It must have generated profit after providing for depreciation, interest, and tax in out of the last years, including the immediately preceding year.
• Capital Contribution: The sponsor must contribute at least to the net worth of the Asset Management Company (AMC).
• Integrity: The sponsor (and its directors) must not have been found guilty of fraud or previously convicted of an economic offense.

Trustees bear the primary fiduciary responsibility towards mutual fund investors. Their roles and responsibilities include:

• Oversight: Ensuring that the AMC operations comply with the trust deed and SEBI guidelines.
• Approvals: Approving major decisions of the AMC, including the appointment of Key Management Personnel (KMP) like the compliance officer.
• Review Systems: Ensuring that systems are in place for the AMC to prevent the abuse of unitholders' interests.
• Grievance Redressal: Overseeing the mechanism for resolving investor complaints and grievances.
• Reporting: Filing bi-monthly and half-yearly reports to SEBI regarding the functioning of the mutual fund.
• Independence: At least of the trustees must be independent (not associated with the sponsor).

The Asset Management Company (AMC) is the operational arm of the mutual fund. Under SEBI regulations, its duties include:

• Investment Management: Making informed investment decisions on behalf of the mutual fund schemes in accordance with the Scheme Information Document (SID).
• Regulatory Compliance: Adhering strictly to SEBI (Mutual Funds) Regulations, 1996, and guidelines issued by AMFI.
• Operations: Handling day-to-day operations like issuing and redeeming units, calculating Net Asset Value (NAV), and maintaining accounting records.
• Disclosure: Preparing and dispatching SID, Statement of Additional Information (SAI), periodic portfolio disclosures, and annual reports to investors.
• Fiduciary Duty: Acting with due diligence and avoiding conflicts of interest. The AMC cannot deal with related parties under unfair terms.
• Board Composition: At least of the AMC's directors must be independent.

Product Labelling in mutual funds refers to the standardized visual representation of the degree of risk associated with a particular mutual fund scheme.

Significance:

• Risk Assessment: It provides investors with an immediate visual cue regarding the risk embedded in a mutual fund, allowing them to assess if it aligns with their personal risk appetite.
• Mitigating Mis-Selling: By explicitly stating the risk level, product labelling prevents distributors from making false claims about the safety of high-risk products.
• Comparability: It creates uniformity across the mutual fund industry, making it easier for investors to compare different schemes from various AMCs.
• Informed Decision Making: Clear labels help retail investors make educated investment choices rather than relying solely on broker recommendations.

The Risk-o-meter is a visual semi-circular dial used in product labelling that indicates the level of risk in a mutual fund scheme. SEBI has mandated that all mutual funds must use this tool in their Scheme Information Documents (SIDs) and promotional materials.

The dial is divided into six distinct risk categories:

1. Low Risk: Indicates that the risk of capital loss is minimal (typically overnight funds or liquid funds).
2. Low to Moderate Risk: Represents a marginally higher risk than low-risk funds.
3. Moderate Risk: Suggests a balanced risk profile (e.g., short duration debt funds).
4. Moderately High Risk: Indicates considerable risk of principal loss, usually associated with balanced or conservative equity funds.
5. High Risk: Points to substantial risk, typical for pure equity funds.
6. Very High Risk: The highest risk tier, introduced by SEBI for highly volatile funds like sectoral, thematic equity funds, or small-cap funds.

SEBI (Securities and Exchange Board of India):

• Nature: It is the statutory, principal regulatory authority for the entire securities market in India.
• Power: SEBI has the legal authority to enact laws (such as Regulations, 1996), impose financial penalties, suspend or close down mutual fund operations, and protect investor interests by law.
• Scope: Regulates Sponsors, Trustees, AMCs, Custodians, and all forms of market intermediaries.

AMFI (Association of Mutual Funds in India):

• Nature: It is an industry association acting as a Self-Regulatory Organization (SRO) or a quasi-regulator primarily for its members (AMCs) and distributors.
• Power: AMFI cannot enforce laws. It works by setting voluntary guidelines and codes of conduct (like the AMFI Code of Ethics). It can suspend or cancel an AMFI Registration Number (ARN) of a distributor but cannot penalize an AMC financially or criminally.
• Scope: Focuses greatly on standardizing industry practices, lobbying with SEBI/Govt., and investor advocacy.

SEBI has prescribed a dynamic approach to maintain the accuracy of the Risk-o-meter. The key guidelines are:

• Periodic Evaluation: The AMC must evaluate the risk of every scheme on a monthly basis.
• Calculation: The risk must be calculated based on the actual portfolio held as of the last day of the given month, using specific risk metrics (e.g., Macaulay Duration, credit risk value, and liquidity risk value for debt).
• Communication: If the risk category changes, the AMC must immediately inform investors through a Notice cum Addendum via email or SMS.
• Platform Updates: The revised Risk-o-meter must be updated on the AMC's website and the AMFI website within days from the close of each month.
• Annual Disclosure: The AMC must publish an annual history of all changes made to the Risk-o-meter for each scheme over the course of the financial year.

The SEBI (Mutual Funds) Regulations, 1996, established stringent investment valuation norms to ensure that a mutual fund's Net Asset Value (NAV) represents the true realizable value of its portfolio.

Key Principles:

• Mark to Market (MTM): All investments must be valued on a 'mark to market' basis to capture their current market value, not their historical cost.
• Traded Securities: Equities and debt instruments traded on exchanges are valued at their last quoted closing price.
• Non-Traded/Thinly Traded Securities: If a security is not actively traded, it is valued based on guidelines provided by independent valuation agencies like CRISIL and ICRA, using yield matrices and intrinsic value models.
• Consistency: The valuation methods must be applied consistently across all schemes. Any deviation must be justified, documented, and reported to the Trustees.

The SEBI Code of Conduct for AMCs acts as a constitutional guide for asset managers. The broad principles include:

• Integrity and Fairness: Conduct business with the highest standards of integrity, fairness, and transparency.
• Fiduciary Duty: Place the interest of the unitholders well above the commercial interests of the AMC or the sponsor.
• Due Diligence: Ensure proper care and independent professional judgment are exercised in all investment and corporate operations.
• Conflict of Interest: Clearly identify and mitigate any conflicts of interest. The AMC should not use its position for personal gains or the gain of related parties.
• Marketing Guidelines: Mutual funds should not publish misleading advertisements. Sales practices and product labelling must strictly align with the actual risk and historical performance of the scheme.

Role of a Custodian:

• Safekeeping: Holding physical and dematerialized securities of the mutual fund.
• Clearing and Settlement: Acting as an agent to settle trades executed by the AMC.
• Corporate Actions: Tracking and collecting dividends, bonus shares, and interest payments on behalf of the fund.

Regulatory Restrictions:

• Registration: The custodian must be registered with SEBI under the SEBI (Custodian of Securities) Regulations, 1996.
• Independence: To prevent conflicts of interest, a sponsor or its associate cannot act as a custodian for the mutual fund unless specific strict criteria are met.
• Exemption clause: An associate can be a custodian only if at least of the custodian's directors are independent of the sponsor, and its systems and personnel are completely segregated from the sponsor.

These are essential disclosure documents mandated by SEBI to ensure transparency:

1. Scheme Information Document (SID):

   • Contains scheme-specific details such as investment objectives, asset allocation patterns, risks involved, benchmark indices, and fee structures.
   • Helps investors understand the exact nature of the specific fund they are investing in.

2. Statement of Additional Information (SAI):

   • Contains statutory and operational information about the entire mutual fund house (AMC, Trust, Sponsor, Key Personnel, and financial data).
   • Since this information is common across all schemes of an AMC, it is grouped in the SAI.

3. Key Information Memorandum (KIM):

   • A concise summary of the SID and SAI.
   • SEBI mandates that every application form must be accompanied by the KIM. It ensures that an investor reads the vital points (like Risk-o-meter, minimum investment, and past performance) before signing the application.

The AMFI Code of Ethics (ACE) is a supplementary framework established by AMFI to guide the operational behavior of AMCs beyond bare regulatory requirements. Its key tenets are:

• Integrity and High Standards: Promoting trust in the mutual fund sector by emphasizing ethical behavior by AMC personnel.
• Fair Dealing: Ensuring equal and fair treatment to all investors across different schemes.
• Confidentiality: Protecting the proprietary and personal data of investors.
• Responsible Distribution: Mandating that AMCs only deal with AMFI-registered distributors (with a valid ARN) who adhere to ethical selling guidelines.
• Corporate Governance: Elevating corporate governance standards within AMCs, minimizing market manipulation, front-running, and insider trading.

Mis-selling occurs when a distributor sells a mutual fund scheme that does not match the investor's risk tolerance, often by suppressing or hiding the product's actual risk.

Product labelling mitigates this by:

• Standardized Visualization: The Risk-o-meter provides a graphic summary of risk. Even a financially illiterate investor can see if a dial points to 'High Risk' or 'Low Risk'.
• Bypassing Verbal Claims: Investors no longer have to depend solely on verbal explanations from agents. The label acts as an objective, SEBI-endorsed truth.
• Alignment: It forces the distributor to map the internal risk profile of the client with the stated label of the product. Selling a 'Very High Risk' fund to a conservative retiree is easily flagged by the label.
• Mandatory Display: Since it is mandatory to display the Risk-o-meter on all application forms, marketing materials, and SIDs, the risk is 'front-and-center' in the transaction.

To ensure diversification and limit risk, SEBI has imposed several investment restrictions on mutual funds:

• Single Issuer Limit: A mutual fund scheme cannot invest more than of its NAV in debt instruments issued by a single issuer (with some exceptions like government securities).
• Unlisted Securities: Schemes cannot invest more than a specified limit (often zero for certain funds or a small percentage) in unlisted equity shares to avoid severe liquidity issues.
• Inter-scheme Transfers: Transfers of investments from one scheme to another within the same AMC are permitted only if done at prevailing market prices and if they match the investment objective of the receiving scheme.
• Borrowing Limit: A mutual fund cannot borrow money to invest. Borrowing is strictly permitted only to meet temporary liquidity needs for redemption distributions, capped at of the net assets, for a maximum duration of months.
• Sponsor Group Limits: Restrictions exist on investing heavily in securities issued by the sponsor or its associate companies.

AMFI takes a proactive role in educating the masses to widen the penetration of mutual funds in India. Its role includes:

• "Mutual Funds Sahi Hai" Campaign: AMFI launched this flagship media campaign spanning TV, print, and digital spaces. It uses relatable analogies to demystify mutual funds and highlight their long-term benefits.
• Funding Mechanism: SEBI mandates that AMCs set aside () of daily net assets specifically for investor education. A portion of this is pooled by AMFI to run industry-wide initiatives.
• Educational Resources: AMFI provides localized literature, brochures, and web resources that explain financial concepts like SIPs, compounding, and inflation.
• Seminars and Workshops: AMFI conducts regular outreach programs, tier-2/tier-3 city workshops, and college-level financial literacy programs to build grassroots awareness.

Winding up of a mutual fund scheme implies permanently shutting it down and returning the investors' money. According to SEBI regulations, a scheme may be wound up if:

1. Expiration: The period of the scheme ends (in the case of close-ended funds).
2. Trustees' Decision: The Trustees pass a resolution feeling it's in the best interests of the unitholders, or if unitholders holding at least of total voting rights pass a resolution to wind it up.
3. SEBI Directive: SEBI directly orders the fund to be wound up in the interest of investors.

Process:

• Notice: The trustees must immediately issue a notice to SEBI and publish it in two daily newspapers with nationwide circulation.
• Halt Operations: Once the notice is issued, the AMC must completely halt all business activities related to the scheme (no new creations, no cancellations, and no trading).
• Liquidation: The AMC proceeds to systematically liquidate the scheme's assets at market prices.
• Distribution: After clearing all liabilities, the remaining proceeds are distributed to the unitholders in proportion to their respective holdings (NAV-based).