Legal Structure of Mutual Funds in India

Legal Structure of Mutual Funds in India (Part 1)

Definition: A mutual fund is defined as 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, money market instruments, gold or gold-related instruments, silver or silver-related instruments, real estate assets, and such other assets and instruments as specified by SEBI from time to time.
Key Features:
- Established as a trust
- Raises money through the sale of units to the public or a section of the public
- Units are sold under one or more schemes
- Schemes invest in securities (including money market instruments) or gold or gold-related instruments or silver or silver-related instruments or real estate assets

Key Constituents of a Mutual Fund

Sponsors: The main people behind the mutual fund operation, responsible for making the application to SEBI for registration of a mutual fund and investing in the capital of the Asset Management Company (AMC).
Eligibility Criteria for Sponsors:
- Sound track record and general reputation of fairness and integrity in all business transactions
- Carrying on business in financial services for not less than 5 years
- Positive net worth in all the immediately preceding 5 years
- Net profit after providing for depreciation, interest, and tax in each of the immediately preceding five years
- Average net annual profits after depreciation, interest, and tax during the immediately preceding five years of at least rupees 10 crore
Board of Trustees:
- Critical role in ensuring that the mutual fund complies with all the regulations and protects the interests of the unit-holders
- Must be a person of ability, integrity, and standing
- Cannot be a person who is guilty of moral turpitude or convicted of any economic offence or violation of any securities law
- Cannot be an employee of the AMC
Trustees' Responsibilities:
- Enter into an Investment Management Agreement with the AMC
- Seek any information required from the AMC to facilitate meeting their responsibilities as trustees
- Periodically review service contracts relating to custody arrangements
- Ensure that all transactions entered into by the AMC are in compliance with the regulations and the scheme
Asset Management Company (AMC):
- Handles the day-to-day operations of a mutual fund
- Appointed by the sponsor or the trustees with the approval of SEBI
- Requires a net worth of not less than rupees fifty crore deployed in assets as may be specified by the Board to be effective from January 01, 2024
- Directors of the AMC need to be persons having adequate professional experience in the finance and financial services related field
- At least 50 percent of the directors should be independent directors i.e., not associated with the sponsor or any of its subsidiaries or the trustees

Legal Structure of Mutual Funds in India (Part 2)

Asset Management Company (AMC): The AMC is responsible for conducting the activities of the mutual fund, including arranging offices and infrastructure, engaging employees, and interacting with regulators and service providers.
Net Worth: The net worth of the AMC must be maintained on a continuous basis, and any change in control of the AMC requires prior approval from the trustees and SEBI.
Custodian: The custodian has custody of the assets of the fund and is responsible for settling transactions on behalf of the mutual fund schemes.
Registration: All custodians must register with SEBI under the SEBI (Custodian) Regulations 1996.

Key Functions of an Asset Management Company

Compliance Function: The Compliance Officer ensures all legal compliances and signs a due-diligence certificate for new issues.
Fund Management: The fund management team invests the investors' money in line with the stated objective of the scheme and manages it effectively.
Operations and Customer Services Team: This team attends to customer queries, resolves issues, and maintains investor records.
Sales and Marketing Team: This team reaches out to investors through mass media, marketing campaigns, and distribution channels.

Service Providers

Fund Accountant: Calculates the Net Asset Value (NAV) of each scheme.
Registrars and Transfer Agents (RTAs): Maintain investor records, process transactions, and update unit capital.
Auditors: Responsible for auditing the accounts of the mutual fund schemes.
Distributors: Sell mutual fund schemes to clients/investors and must pass the NISM Certification Examination and register with AMFI.
Collecting Bankers/Payment Aggregators: Enable the collection and payment of funds for the schemes.

Legal Structure of Mutual Funds in India (Part 3)

Introduction to New Players: New categories of players, such as payment aggregators, payment gateway providers, digital wallets, and payment banks, have emerged to facilitate mutual fund transactions.
KYC Registration Agencies:
- Definition: KYC (Know Your Customer) compliance is mandatory for all investors in the securities market, including mutual fund investors, under the Prevention of Money Laundering Act.
- Details: SEBI introduced a common KYC for investors investing in securities markets through registered KYC Registration Agencies (KRAs), which process details and documents to establish the identity of the investor and assign a unique number.
Valuation Agencies:
- Definition: Valuation agencies provide a valuation matrix to help Asset Management Companies (AMCs) arrive at a fair valuation of debt securities that are non-traded or thinly traded.
- Details: SEBI has issued guidelines for valuation agencies, and AMFI has appointed CRISIL Ltd. and ICRA Ltd. for this purpose.
Credit Rating Agencies:
- Definition: Credit rating agencies rate debt securities issued by various issuers, which helps fund managers make investment decisions.
- Details: Credit rating agencies play a crucial role in debt mutual funds, and their ratings are used to define investment universes and restrictions for certain schemes.
Depositories and Depository Participants:
- Definition: A depository is an institution that holds securities in dematerialized or electronic form on behalf of investors.
- Details: Depositories, such as National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL), reach out to investors through depository participants, which act as intermediaries between the depository and the investor.
Stock Exchanges and Transaction Platforms:
- Definition: Investors can transact in mutual fund units through stock exchanges, which have special segments for mutual fund transactions.
- Details: Platforms like BSE-Star MF and NSE Mutual Fund II Platform (NMF-II), as well as MF Utilities India, allow investors to transact in mutual fund units, reducing paperwork and transaction-related errors.
Execution Only Platforms (EOPs):
- Definition: EOPs are digital or online platforms that facilitate transactions in direct plans of mutual fund schemes.
- Details: SEBI has defined two categories of EOPs, which must obtain registration from SEBI or AMFI to operate.
Role and Function of AMFI:
- Definition: Association of Mutual Funds in India (AMFI) is the association of all registered Asset Management Companies.
- Details: AMFI's objectives include defining and maintaining high professional and ethical standards, recommending best business practices, and interacting with SEBI and the government on matters concerning the mutual fund industry. AMFI also registers mutual fund distributors and issues circulars recommending best practices.