MF sector: Excessive regulation reduces returns, under regulation up risks

Economic historians are uncertain whether mutual funds (MFs) originated in Belgiumin 1822, or were first created by Dutch merchant Adriaan Van in 1774. The Massachusetts Investors Trust set up in 1924 started the first modern MF scheme.
 
In India, the concept of MF was introduced with the enactment of Unit Trust of India (UTI) Act in 1963. Subsequently, in 1987, public financial institutions, banks, Life Insurance Corporation and General Insurance Corporation were permitted to float MFs. In 1993, the private sector was allowed to join the industry. Kothari Pioneer was the first to float an MF scheme.
 
The superintendence of the industry began initially with the Reserve Bank of India’s regulatory and administrative control over UTI; then, it was passed on to IDBI in 1978. Even though the regulatory oversight transited to the Securities and Exchange Board of India on its establishment, currently the MF industry is subject to supervision of the RBI, Association of Mutual Funds in India, the income tax department and investors’ associations, in addition.

 
MFs are expected to provide cost-effective professional management and diversification of risks. Regulation is essential to eliminate investor (principal)-manager (agent) conflict. The opportunistic behaviour of the manager can compromise the interests of the investors and expose them to risks other than outlined in the offer document arising out of portfolio selection, excessive churning, self-dealing, etc. An orderly regulatory regime was created with the promulgation of Sebi (Mutual Funds) Regulation 1996 covering areas ranging from capital requirement, monitoring and audit to disclosures and setting up of minimum standards for the management.
 
The collapse of the stock market in 2001, following the scam, hurt  MF investors disproportionately. A variety of investigations in the aftermath of the collapse revealed inter alia promoter-broker-fund manager nexus. The regulations were comprehensively revised in 2003 with focus on governance, risk management, reward system, advertisements, disclosures and reporting. Since then, regulations have been revised periodically in tune with market developments. The underlying principles have been to correct market imperfections, minimise market failure, increase investors’ benefits and confidence, and enhance competition.

 
Regulation is a cost. Excessive regulation reduces returns and under regulation raises risks. A regulator is perennially challenged to find the ideal state. Growing competition, rising number of investors, increasing inflows and mounting assets under management, coupled with MFs withstanding the onslaught of 2008 global meltdown and meeting investors’ commitments fully can be considered as proxy of the efficacious regulatory regime. Yet, an evolutionary regulatory framework remains the only appropriate fit to meet ingenuity of the players and dynamics of the market.
The writer is former chairman, Sebi