Bridging the gap between mutual funds and PMS

SEBI’s New Asset Class Proposal: An Interpretive Study of Market Conventions and Regulatory Framework

On July 16, 2024, the Securities and Exchange Board of India (SEBI) released a consultation paper outlining a new asset class intended to bridge the gap between mutual funds and portfolio management services (PMS) . The legal structure, regulatory consequences and possible market influence of this creative financial product are studied in this in-depth investigation.

Legislative structure and regulatory framework

Under Section 11 of the Securities and Exchange Board of India Act, 1992, which empowers the regulator to protect the interests of investors and promote market growth, the statutory authorities of SEBI designate a new class of assets. Reiterated by the Supreme Court in Sahara India Real Estate Corporation Ltd. c. SEBI (2012), this approach is consistent with Section 11(2)(b) of SEBI’s obligation to register and monitor the functioning of collective investment schemes.

Building on the current systems laid down under the SEBI (Mutual Funds) Regulations, 1996 and SEBI (Portfolio Managers) Regulations, 2020, the regulatory framework hits moderate ground with a minimum investment level of 10,00,000 INR. This positioning reflects SEBI’s sophisticated approach to market segmentation, as previously endorsed by the Supreme Court in SEBI v. Rakesh Agrawal (2004), where the Court highlighted the power of the regulator to establish single market categories.

Operational requirements and eligibility criteria

Eligibility of portfolio management companies

• The consultation document defines a dual eligibility system for asset management companies (AMCs):

Background Standards:

• Minimum three years of operating experience
• Minimum Assets Under Management (AUM) of INR 10,000 Crores
• Clean up regulatory records under certain sections of the SEBI Act, 1992.

Control criteria:

• Appointment of Chief Investment Officer (CIO)
• Additional fund manager with significant experience managing assets under management
• This structure establishes links with the eligibility criteria defined in SEBI v. Kishor R. Ajmera (2016), in which the Supreme Court upheld SEBI’s ability to impose strict qualification conditions on market intermediaries.

Structural framework and investment guidelines

Liquidity management and investment strategy

The suggested architecture uses adjustable redemption frequencies as per the SEBI (Listing Obligations and Disclosure Requirements) guidelines, 2015. Emphasizing the combination of market efficiency and investor protection, this approach represents the attitude regulatory expressed in SEBI v. Pan Asia Advisors Ltd. (2015). ).

Stock Exchange Listing Policies

Following the precedent of Exchange Traded Funds (ETFs) set by SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2019/011, the mandatory listing requirement for investment strategy units improves liquidity and market accessibility. This necessity corresponds to the Supreme Court’s approval in 2012 of the opening of the market, as shown in the Sahara India Real Estate Corporation Ltd case. c. SEBI.

Legal and risk management framework Exposure to the derivatives market

Control values ​​for regulation

Different from conventional rules on mutual funds, the consultation paper suggests a complex strategy for exposure to derivatives markets. The construction site includes:

Exposure limits:

• Maximum gross exposure limited to one hundred percent of net asset value
• Exposure limited to single equity derivatives to 10% of net assets
• Limit overall exposure to derivatives to half of net assets.

Prohibited activities:

• specifically prohibited from using
• Restrictions on speculative trading
• These restrictions follow the regulatory ideas developed in SEBI v. Kishore R. Ajmera (2016), where the Court highlighted the need for risk control in derivatives trading.

Issues with Inverse ETFs

The research addresses the complexity of inverse ETF investing and notes the cumulative effects capable of producing different returns. This study complements global regulatory policies, including the U.S. Securities and Exchange Commission’s Guidance on Leveraged and Inverse ETFs (Version No. 34-89372).

Risk control and investor protection

Consent-based framework

Like the PMS framework provided under Regulation 23 of the SEBI (Portfolio Managers) Regulations, 2020, the proposal calls for a consent-based approach for derivative investments. The Court pointed out in the case of SEBI v. Cabot International Capital Corporation (2015) the need for informed consent of investors in sophisticated financial products, thus validating this approach.

Minimum risk aversion standard

The minimum risk aversion criteria established through investment limits and exposure limits reflect the regulatory ideas expressed in the SEBI (Mutual Funds) Regulations, 1996, and subsequent amendments. These criteria coincide with the Supreme Court’s views on the need for robust risk management systems in SEBI v. Pan Asia Advisors Ltd. (2015).

Guidelines on openness and transparency

Marketing and correspondence

To establish the new asset class outside of conventional mutual funds, the consultation paper highlights the need for strong branding. This strategy supports the legal precedent in SEBI v. Sahara India Real Estate Corporation Ltd. (2012), in accordance with the disclosure rules laid down in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

Disclosure requirements for portfolios

Monthly portfolio disclosure requirements improve openness and meet best-in-class global standards. While appreciating the operational difficulties and expenses associated with regular disclosures, these criteria are based on the current disclosure systems defined in SEBI Circular CIR/IMD/DF/21/2012.

Regulatory authority and compliance

Prerequisites for approval

SEBI approval before implementation of new investment plans ensures regulatory oversight consistent with the values ​​laid down in SEBI c. Kishore R. Ajmera (2016). As the Supreme Court has emphasized in several decisions, this strategy oscillates between creativity and investor protection.

Requirements for constitutional documents

The required public availability of constitutional documents enhances openness and is consistent with the market integrity values ​​outlined in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

Market influence and future consequences

market segmentation

The launch of this new asset class marks a major shift in market segmentation and could generate a new category of savvy retail investors. This is in accordance with Section 11(1) of the SEBI Act, 1992, which vests legal responsibility on SEBI to create and control securities markets.

Innovation and competence

Two-track eligibility rules preserve high standards of fund management while promoting market competitiveness. This strategy ensures security for investors and reflects the regulatory attitude expressed in SEBI v. Rakesh Agrawal (2004), thereby encouraging market development.

• Advice on applying
• Development of uniform risk assessment techniques: Risk framework
• Following frequent stress testing criteria
• Development of explicit risk communication strategies

Instructions for use:

• Complete rules for derivatives exposure calculations
• Explicit protocols for investor authorization documents
• Specific criteria for risk disclosure statements

Examine and supervise:

• Conventions for regular reporting of derivatives exposures
• Regular assessment of risk management systems
• Well-defined guidelines for regulatory intervention

Finally

The new asset class suggested by SEBI marks a major shift in the control of the securities market in India. Supported by accepted legal rules and regulatory precedents, the framework demonstrates a deliberate balance between innovation and investor protection. The success of this program will depend on effective enforcement of suggested protections and continued market monitoring.

The consultation paper’s focus on risk management, openness and investor protection is in line with SEBI’s statutory mandate and international best practices. But the success of these steps will depend on careful consideration of market feedback and possible improvements to the suggested structure.

This new asset class could be very important in satisfying the needs of sophisticated retail investors as the Indian securities market develops, thereby preserving the stability and integrity of the market. The success of this program will depend on SEBI’s ability to maintain effective oversight while allowing sufficient freedom for innovation and market growth.