MF Lite: Sebi proposes rules to make launching low-cost index funds easier

Markets watchdog Sebi has proposed a relaxed regulatory framework for the passively managed mutual fund (MF) schemes in a bid to reduce compliance requirements.

The financial regulator  is looking to make it simpler for companies to launch low-cost index funds and similar investment products. These funds, which track a specific market index, are generally considered less risky than actively managed funds.

Passively managed MF schemes replicate an underlying index such as ETFs and index funds where portfolios of index funds can be easily tracked. Active fund schemes requires expert fund managers who define investment philosophy and select securities.

Currently, all mutual funds have to follow the same rules, regardless of whether they are actively or passively managed. The present regulatory framework for MFs  does not differentiate regarding the applicability of provisions relating to entry barriers -- net worth, track record, profitability -- and other compliance requirements for entities who may want to launch only passive funds.

Accordingly, various provisions of the existing regulatory framework may not be relevant for passively managed schemes, a relaxed framework with light-touch regulations has been proposed as MF Lite Regulations for passive MF schemes.

Under the proposed framework, MFs desirous of managing only passive schemes (such as Exchange Traded Funds and Index funds) should be covered under the MF Lite Regulations.

Sebi is asking for public feedback on the proposal until July 22. Here are some of the key points:

• Easier to start a passive fund company: The new rules would make it cheaper for companies to start offering passive investment options.
• Simpler regulations: There would be less paperwork and fewer requirements for companies to comply with.
• More competition: By making it easier to enter the market, Sebi hopes to encourage more companies to offer low-cost index funds.
• More choices for investors: This could lead to a wider range of low-cost investment options for Indian investors.

However, there may be mutual funds existing as on date, who may opt for management of both active and passive schemes under their existing registration. Hence, to ensure uniform applicability of proposed relaxations and to provide a level playing field across all passive MF schemes, a two-pronged approach has been adopted in this consultation paper.

In its consultation paper, the regulator has also proposed the eligibility requirements for sponsors and AMCs under the main as well as alternative eligibility route, in the proposed MF Lite framework.

Main Eligibility Route:

• This is likely the simpler option.
• Sebi suggests a minimum net worth requirement of Rs 35 crore for Asset Management Companies (AMCs) wanting to launch MF Lite funds this way.
• Sebi proposes that the usual 5-year financial experience requirement for AMCs might not be necessary under this route.

Alternative Eligibility Route:

• This might be a route for new players or those without a long track record.
• Sebi proposes a higher minimum net worth of Rs 75 crore for AMCs opting for this route.
• To ensure serious players enter the market, Sebi also suggests a mandatory 3-year lock-in period where the sponsor (backer) of the AMC cannot sell their shares.

Additional Considerations:

The document also proposes outlining the roles and responsibilities of the trustee (who oversees the AMC's activities) and the AMC board under the new MF Lite rules.