In what could be one of its most radical decisions since it set up mutual fund guidelines in 1996, the capital market regulator, Securities and Exchange Board of India (SEBI) has proposed to change the role of a mutual fund's sponsor.
On January 13, SEBI floated a consultation paper seeking public opinion on broadly four big items: Whether private equity funds can be allowed become sponsors; whether the existing criteria to set up sponsors should be strengthened; whether new type of sponsors- albeit those that don’t have the traditional net-worth or profitability requirement- can be allowed; and whether sponsors are required at all, for well-established and long-running asset management companies.
A new class of sponsors
SEBI feels that it’s time for Private Equity (PE) funds to enter the Rs 40 trillion Indian Mutual Funds (MF) industry. “The Working Group noted that PE with significant capital can invest in technology, bring in strategic guidance and good talent to fuel growth and innovation and expand the presence of mutual funds including driving inclusive growth. PE may also provide constructive competition to the current entities in the Mutual Fund industry and improve value to investors,” says SEBI in its consultation paper.
This comes a year after Blackstone, a major PE giant was said to have evinced interest, as per numerous media reports, in acquitting the erstwhile IDFC AMC. Eventually, Bandhan Bank acquired IDFC MF, worth Rs 1.20 trillion in assets under management (AUM) in April 2022, a deal that got completed in around December 2022.
But to ensure that investors interested are protected in a PE-owned fund house, SEBI has proposed several safeguards. The market regulator has proposed that the PE-owned fund should have an experience in managing funds and experience of investing in the financial sector for a period of at least five years; and it has to have a capital of Rs 5,000 crore.
As per SEBI's proposal, schemes of a PE-owned fund house must maintain the same rigors and limits when it comes to investing in companies where the sponsor PE fund holds more than a 10 percent stake. Any such company headed for an Initial Public Offering (IPO) must also be avoided by the MF schemes.
Fostering innovation through a new breed
In addition to contemplating allowing private equity funds to become MF sponsors, SEBI also wants to reimagine the role of a sponsor.
As opposed to its current guidelines, where sponsors must have a business in financial services (like banking, stock broking, housing finance company and so on) for a period of at least five years, and have a profitability track record, and so on, SEBI has proposed that sponsors who don’t meet these criteria, and yet wish to set up an AMC, may also be allowed. This new breed of sponsors must have deeper pockets, though.
For instance, SEBI has proposed that if sponsors don’t have a profitability track record or the required experience in the financial services space, its AMCs must have a net-worth of at least Rs 150 core. At present, SEBI guidelines mandate a minimum net-worth of an AMC to be Rs 50 crore, if the sponsor has a profitability track and Rs 100 crore in the absence of this track record. The extra Rs 50 crore requirement in the AMC’s net-worth (with new type of sponsors) has been arrived at by calculating how much it takes to run its operations in a year (Rs 10 crore a year; for a period of five years).
Sponsors might also be required to hold a minimum stake of 40 percent in their AMCs for five years. The combined experience of its chief executive officer and chiefs of fund management, compliance, regulatory and operations must be at least 30 years.
SEBI has proposed strengthening the existing sponsor rules. It says that sponsors must have a net profit in each of the immediately preceding five years and the average should be at least Rs 10 crore. At present, sponsors must have profits in three out of the immediate, preceding five years, including the 5th year.
Changing times
SEBI’s move comes at a time when the Indian mutual funds (MF) industry is worth Rs 40 trillion at present, and not the same nascent industry it was, in the years following the setting up of the SEBI MF regulations in 1996. In those days, a strong sponsor was required to lend a brand name to the newly set up fund house.
For instance, an HDFC Mutual fund might have been a new fund house in 2000 when it was set up, but Housing Development Finance Corporation Ltd and Standard Life Investments Limited, its co-sponsors, were household names in their sectors.
In the late 90s, some fund houses used to offer guaranteed return schemes. The sponsor was required to make good this guarantee. Over time, SEBI banned guaranteed schemes.
SEBI has now proposed the idea of doing away with sponsors, altogether. It has proposed that a sponsor might be allowed to reduce its stake to 26 percent or 10 percent. Such a self-sponsored AMC can become one after it has had a full-fledged sponsor for full five years, and the AMC must be a profitable one; net profits in each of the preceding five years and an average of Rs 10 net profit in that period.
While acknowledging the positive role a sponsor plays in the lifecycle of an asset management company or a mutual fund, SEBI also lists out several ways in which a sponsor can exhort its influence on the mutual fund that might lead the latter to take bad decisions. For instance, a MF scheme investing in debt instruments of a bank or company which in turn lends to the sponsor, or MF schemes taking brokerage or distribution support from the sponsor-affiliated company at a higher cost. In light of all this, SEBI feels that it’s time for fund houses to be independent of a sponsor.
Public comments on this consultation pager are called for, by January 29, 2023.
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