Now, index funds and ETFs will be truer to label

SEBI has asked mutual fund houses to set up systems to catch front-running

The restriction on passive funds like index funds and Exchange Traded Funds (ETF) to invest up to 25 percent of their corpuses in securities of group companies of their sponsors have been removed. In a bid to harmonise the way passive funds invest in securities, the capital market regulator, Securities and Exchange Board of India (SEBI) has now allowed passive funds to invest up to 35 percent of their corpuses in group companies of the sponsor. These were some of the big decisions that SEBI took at the board meeting held on April 30.

To be sure, mutual fund schemes cannot invest arbitrarily, as much as they want to, in underlying shares and bonds of companies. For instance, no scheme can invest in shares of any single scrip over 10 percent of its Net Asset Value (NAV). The total exposure of the scheme to listed equity shares of group companies of the sponsor must not exceed 25 percent of its net assets. However, as per SEBI rules for index funds and ETFs, a single company is allowed to have a maximum of 35 percent weight in a sector / thematic benchmark index. To make life easier for passive funds to mimic their benchmark indices easier and more closely, SEBI has now relaxed the 25 percent upper cap restriction for such funds.

Also read: Can you build an entire portfolio just out of index and exchange-traded funds? Check out out passives basket in MC30

This move will help passive funds like index funds and ETFs to better mimic their benchmark indices. SEBI said that it would soon specify the indices and only funds based on these indices would benefit from the 25 percent rule relaxation.

Catch the front-runners

SEBI has also asked mutual fund houses to set up an institutional mechanism to catch market abusing practices like front-running and fraudulent transactions. “The mechanism shall consist of enhanced surveillance systems, internal control procedures and escalation processes to identify, monitor and address specific types of misconduct including front running, insider trading, misuse of sensitive information, etc,” according to the press release from the markets regulator.

The regulator has also asked fund houses to set up a sound whistle-blower policy to make sure that those who report such instances are properly heard and aren’t victimized.

In recent times, SEBI has caught instances of front – running in some fund houses in the Rs 40-trillion India mutual funds (MF) industry. In February 2023, it barred a former chief dealer and 19 others in a front – running case that was caught at Axis MF. In October 2022, SEBI had issued an order wherein it found that the fund manager of the erstwhile Deutsche Mutual Fund and his parents had employed a scheme to 'front run' the orders of the fund house.

Now typically, front-running and insider trading frauds are detected by stock market exchanges that use their surveillance systems in conjunction with SEBI. But with the proliferation of fund houses and brokerage houses over the years, this puts pressure on SEBI as well as the exchanges to constantly monitor and fish out culprits. By putting onus on the fund houses to put in place such systems, it wants fund houses to be more proactive.