Sebi's MF Lite plank for passive funds seen boosting India ETF landscape

Industry experts say it could help attract global players

SEBI, SECURITIES AND EXCHANGES BOARD OF INDIA

4 min read Last Updated : Apr 04 2023 | 11:10 PM IST

The Securities and Exchange Board of India (Sebi) plans to introduce the Mutual Fund (MF) Lite regulations for asset management companies (AMCs) offering passive-only products in the current financial year.

The proposed framework aims to reduce the compliance burden by 90 per cent and remove limitations on networth and experience for those offering exchange-traded funds (ETFs) and index funds—where investment decisions are not discretionary, but tied to changes in the underlying benchmark index.

The move is seen as a game changer for the passive funds industry, which currently accounts for less than a fifth of the MF industry’s Rs 40-trillion assets under management (AUM), or Rs 6.7 trillion.

“If MF regulations are 100 pages today, the target of the Sebi team is to bring it down to just 10 pages… and that’s going to come for passive funds,” explained Sebi Chairperson Madhabi Puri Buch after the regulator’s board meeting last week.

She said current MF regulations were built around active fund management and there was no reason for someone who wanted to only offer passive funds to comply with all the norms.

Industry players feel MF Lite could foster innovation and encourage global ETF majors like Vanguard and State Street to set up shop in India. The proposed framework for passive fund managers comes close on the heels of Sebi allowing private equity (PE) players to act as MF sponsors.

“Though more clarity is awaited, we can expect some reviews and relaxations on networth, profitability norms, and eligibility criteria which could give space to fintech, discount broking platforms, and other such PE-backed players in the passive category. As the AMC would still be managing public money, there will be no chance of dilution of responsibilities towards investors,” said Anil Ghelani, head of passive investments at DSP Mutual Fund.

ETFs and index funds have seen a 3.4x jump in AUM over the last three years, underpinned by low costs and underperformance of actively-managed schemes. According to the data shared by the Association of Mutual Funds in India (Amfi), the AUM of index funds is about Rs 6.72 trillion, up from Rs 2 trillion in February 2020. Despite the rapid growth, the absolute size of India’s ETF industry is miniscule compared with global standards.

“This significant reduction in regulations is expected to speed up innovation in the industry, specifically related to the basket of index related funds. The expansion could be something that we have seen in the US. However, as it is already a very competitive market, the differentiation may come up in service rather than at product level,” said Pratik Oswal, head of passive funds at Motilal Oswal AMC.

The variety of offerings in the passive category has also expanded beyond equity indices to debt, silver ETFs, gold ETFs, and overseas fund of funds.

Experts say MF Lite regulations could increase competition in this segment. However, it is unclear how many existing players would make the switch from active to passive given the low profitability and spreads offered by the latter.

Typically, passive funds have a very low total expense ratio (TER). In most cases, it is less than 20 basis points (bps), while active schemes charge upwards of 100 bps.

“The regulator has already liberalised the approval mechanism for standard index funds. Further, trustee responsibilities, fund manager’s experience requirements, among others may be relaxed. Whether having only passive funds will be a good business model or not is to be considered as the passive category is all about scale. Only in case of a large asset size can one keep low costs and keep a check on tracking error,” said Jimeet Modi, group CEO of Samco.