MUTUAL FUND - STRUCTURE NOTE
I. INTRODUCTION
A. A mutual fund is constituted in the form of a trust, in accordance with the provisions of the Indian Trusts Act, 1882 and would be registered with the Securities Exchange Board of India (“SEBI”) under the SEBI (Mutual Fund) Regulations, 1996 (“MF Regulations”) (hereinafter referred to as the “Fund”).
The Fund would consist of entities including sponsor(s), trustees, asset management company (“AMC”) and a custodian. The constitutional document of the Fund would be in the form of a trust deed to be executed by the sponsor in favor of the trustees of the Fund, duly registered under the provisions of the Indian Registration Act, 1908. Further, such trust deed will be required to incorporate provisions as set out in Schedule IV of the MF Regulations.
B. At the time of the application for registration to SEBI, Zerodha will be the ‘sponsor’ as it meets the qualification requirements prescribed under the MF Regulations. Additionally, the Fund should be a fit and proper person and should be in compliance with the criteria specified in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 (“Intermediaries Regulations”).
C. The customary structure for the Fund is set out below:
In accordance with the above structure you may note:
• The trustees of the Fund would hold its property for the benefit of the unit-holders of the Fund. The trustees shall be responsible to oversee the AMC and exercise direction over the AMC and shall further monitor the performance of the Fund and its compliance with the MF Regulations.
• The AMC, approved by SEBI, would be responsible to manage the funds of the Fund and would make investments in various types of securities.
• The custodian, who is required to be registered with SEBI, would hold the securities of various schemes of the Fund in its custody.
Simplified diagram showing the inter-relationship between the entities:
- Board of directors of trustee and AMC have to be classified as independent (I) or associate (A).
- There can be no overlap between directors of Trust and that of the AMC
- Minimum 4 trustees have to be appointed with 2/3rd of them independent
- For AMC at least 50% have to be independent directors
D. In light of the foregoing, Part II of this Memorandum discusses certain functions of each of the entities, their responsibilities, eligibility and qualification requirements and restrictions as set out in the MF Regulations.
II. ROLE OF THE ENTITIES
(a) Sponsor
(i) Eligibility and Qualification Requirements:
• The sponsor is required, under the provisions of the MF Regulations, to have a “sound track record”, a reputation of fairness and integrity in all its business transactions.
• The Sponsor be a fit and proper person and should be in compliance with the criteria specified in Intermediaries Regulations.
• Additionally, the sponsor should contribute at least 40% to the net worth of the AMC. However, if any person holds 40% or more of the ‘net worth’ of an AMC shall be deemed to be a sponsor and will be required to fulfill the eligibility criteria specified in the MF Regulations.
Regulation 7 (a): Explanation of the MF Regulations state that, “sound track record” shall mean the sponsor should:
(i) be carrying on business in financial services for a period of not less than five years; and
(ii) the networth is positive in all the immediately preceding five years; and
(iii) the networth in the immediately preceding year is more than the capital contribution of the sponsor in the asset management company; and (iv) the sponsor has profits after providing for depreciation, interest and tax in three out of the immediately preceding five years, including the fifth year.”
Networth” means the aggregate of the paid up capital and free reserves of the asset management company after deducting there from miscellaneous expenditure to the extent not written off or adjusted or deferred revenue expenditure, intangible assets and accumulated losses.
(ii) Responsibilities:
• The Sponsor or the trustees would be responsible for the appointment of an AMC.
• The Sponsor must comply with the code of conduct as set out at Paragraph 11 of Schedule V of the MF Regulations i.e.:
• The sponsor shall not render, directly or indirectly any investment advice about any security in the publicly accessible media, whether real-time or non-real-time, unless a disclosure of his interest including long or short position in the said security has been made, while rendering such advice.
• In case an employee of the sponsor is rendering such advice, he shall also disclose the interest of his dependent family members and the employer including their long or short position in the said security, while rendering such advice.
(iii) Shareholding Norms:
No sponsor of the Fund, its associate or group company including the AMC of the Fund, through the schemes of the Fund or otherwise, individually or collectively, directly or indirectly, have –
• 10% or more of the share-holding or voting rights in the AMC or the trustee company of any other mutual fund; or
• Representation on the board of the AMC or the trustee company of any other mutual fund.
(iv) Restrictions:
• The sponsor or any of its directors or the principal officer employed by the Fund should not be guilty of fraud, not be convicted of an offence involving moral turpitude or should have not been found guilty of any economic offence.
• Two-thirds of the trustees shall be independent persons and shall not be associated with the sponsor or be associated with them in any manner whatsoever.
(b) Trustees
The trustees and the AMC shall, with the prior approval of the SEBI, enter into an investment management agreement having necessary provisions for making investments. Schedule V of the MF Regulations set out contents that must form part of the investment management agreement.
(i) Eligibility and Qualification Requirements:
• The Trustee (i) must be a person of ability, integrity and standing; (ii) should not have been found guilty of moral turpitude; and (iii) should not have been convicted of any economic offence or violation of any securities laws.
• The appointment of the trustee initially or any time thereafter shall require the prior approval of the SEBI.
• As mentioned in II (a) (ii) above, the Fund is required to have an independent board of trustees, i.e. two thirds of the trustees should be independent persons who are not associated with the sponsors in any manner whatsoever.
• An AMC or any of its officers or employees is not eligible to act as a trustee of the Fund.
• In case a company is appointed as a trustee, then its directors can act as trustees of any other trust provided that the object of such other trust is not in conflict with the object of the Fund.
• Additionally, no person who is appointed as a trustee of the Fund can be appointed as a trustee of any other mutual fund unless he is an independent trustee and prior approval of the Fund has been obtained for such an appointment.
(ii) Responsibilities:
• The trustees or the Sponsor(s) would be responsible for the appointment of an AMC to manage the assets of the Fund.
• As set out in Regulation 18 of the MF Regulations, the trustees would further be responsible for inter alia:
• Ensuring that the AMC has all its systems in place, all key personnel, auditors, registrars etc. have been appointed prior to the launch of any scheme;
• Ensuring that the AMC does not act in a manner that is favorable to its associates such that it has a detrimental impact on the unit holders, or that the management of one scheme by the AMC does not compromise the management of another scheme.
• Ensuring that the AMC has been diligent in empanelling and monitoring any securities transactions with brokers, so as to avoid any undue concentration of business with any broker.
• Preventing any conflicts of interest between the AMC and the unit holders in terms of deployment of net worth.
• Ensuring that there is no change carried out in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change that would modify the scheme and affect the interest of unit holders, unless each unit holder is provided with written communication thereof.
• Performing a quarterly review of all transactions carried out between the mutual funds, AMC and its associates.
• Approving the schemes of the Fund.
• The Trustee must comply with the code of conduct as set out at Schedule V of the MF Regulations.
(c) Asset Management Company
(i) Eligibility and Qualification Requirements:
The AMC must be registered with the SEBI under the MF Regulations and have the following eligibility criteria as set out in Regulation 21 of this MF Regulations including the following:
• The AMC must have a sound track record, general reputation and fairness in transactions. Sound track record here shall mean the networth and the profitability of the AMC;
• The AMC is a fit and proper person;
• The AMC must have a 40% stake of the sponsor in it;
• The directors of the AMC should be persons having adequate professional experience in finance and financial services related field and not found guilty of moral turpitude or convicted of any economic offence or violation of any securities laws;
• The key personnel of the AMC have not been found guilty of moral turpitude or convicted of economic offence or violation of securities laws;
• The AMC must at all times maintain, a minimum net worth of Rs. 50 Crores;
• The board of directors of such AMC must have at least 50% of the directors, who are not associate of, or associated in any manner with, the sponsor or any of its subsidiaries or the trustees;
• The Chairman of the AMC should not be a trustee of any other mutual fund.
(ii) Responsibilities:
• The AMC would primarily be responsible to manage the assets of the Fund.
• The Chief Executive Officer (whatever his designation may be) of the AMC shall ensure that:
• the Fund complies with the MF Regulations and the guidelines or circulars issued in relation thereto;
• the investments made by the Fund managers are in the interest of the unit holders
• the overall risk management function of the Fund.
• The AMC shall file with the trustees and the SEBI the following:
• detailed bio-data of all its directors along with their interest in other companies within 15 (fifteen) days of their appointment;
• any change in the interests of directors every 6 (six) months;
• a quarterly report to the trustees giving details and adequate justification about the purchase and sale of the securities of the group companies of the sponsor or the asset management company, as the case may be, by the Fund during the said quarter;
• details of transactions in securities by the key personnel of the AMC in their own name or on behalf of the AMC and shall also report to SEBI, as and when required by SEBI; and • in case the AMC enters into any securities transactions with any of its associates a report to that effect.
• Each director of the AMC shall file the details of his transactions of dealing in securities with the trustees, on a quarterly basis, in accordance with guidelines issued by SEBI.
(iii) Shareholding Norms:
In addition to II (a) (iii) as mentioned above, any shareholder holding 10% or more of the share-holding or voting rights in the asset management company or the trustee company of a mutual fund, shall not have, directly or indirectly, -
• 10% or more of the share-holding or voting rights in the AMC or the trustee company of any other mutual fund; or
• Representation on the board of the AMC or the trustee company of any other mutual fund.
(iv) Restrictions:
The AMC is required to observe the following restrictions in its normal course of business:
• A prior approval of the trustees is required for the appointment of AMC;
• As per Regulation 22(a) of the MF Regulations, any director of the AMC should not hold office of a director in another AMC unless such person is an independent director and the approval of the board of the AMC of which such person is a director, has been obtained;
• The AMC shall not act as a trustee of any other mutual fund;
• The AMC cannot undertake any other business activities except activities in the nature of portfolio management services, management and advisory services to offshore funds, pension funds, provident funds, venture capital funds, management of insurance funds, financial consultancy and exchange of research on commercial basis, if any of such activities are not in conflict with the activities of the Fund. (However, the AMC may, itself or through its subsidiaries, undertake such activities if it satisfies the Board that the key personnel of the asset management company, the systems, back office, bank and securities accounts are segregated activity wise and there exist systems to prohibit access to inside information of various activities).
• The AMC shall not invest in any of its schemes unless full disclosure of its intention to invest has been made in the offer.
• As per Regulation 22 of the MF Regulations, no change in the controlling interest of the AMC shall be made unless:
• prior approval of the trustees and SEBI is obtained;
• a written communication about the proposed change is sent to each unitholder and an advertisement is given in one English daily newspaper having nationwide circulation and in a newspaper published in the language of the region where the head office of the Fund is situated; and
• the unitholders are given an option to exit on the prevailing net asset value without any exit load.
Note: To also be kept in mind while approaching SEBI to ensure that once the partly paid up shares become fully paid up, then such action of paying the pending amounts does not result in change in control.
○ The AMC is required to take all reasonable steps and exercise due diligence to ensure that the investment of funds pertaining to any scheme are not contrary to the provisions of the MF Regulations and the trust deed.
○ The AMC cannot, through any broker associated with the sponsor, purchase or sell securities, which is an average of 5% or more of the aggregate purchases and sale of securities made by the Fund in all its schemes. (However, the aggregate purchase and sale of securities excludes the sale and distribution of units issued by the Fund and the limit of 5% shall apply only for a block of any three months).
○ The AMC shall not utilise the services of the sponsor or any of its associates, employees or their relatives, for the purpose of any securities transaction and distribution and sale of securities. (However, the AMC may utilise such services if disclosure to that effect is made to the unitholders and the brokerage or commission paid is also disclosed in the half-yearly annual accounts of the Fund.)
(d) Custodian
The Fund is required to appoint a custodian to carry out the custodial services for the schemes of the Fund and send intimation of the same to the SEBI within 15 (fifteen) days of such appointment. The Fund shall enter into a custodian agreement with the custodian, having provisions necessary for the efficient and orderly conduct of the affairs of the custodian. Provided however, the terms and conditions of this custodian agreement (including the terms of appointment of the custodian) would require approval from the trustees.
(i) Eligibility and Qualification Requirements:
○ The custodian must be registered with SEBI under the SEBI (Custodian of Securities) Guidelines, 1996, and must fulfill the specified eligibility criteria there under;
○ The custodian must be totally delinked from the AMC;
○ As a general practice, SEBI approves only those institutions having substantial organizational strength, service capability in terms of computerization, and other infrastructure facilities are approved to act as custodians.
(ii) Restriction:
As per Regulation 26 of the MF Regulations, a custodian in which the sponsor or its associates holds 50% or more of the voting rights of the share capital of the custodian or where 50% or more of the directors of the custodian represent the interest of the sponsor or its associates cannot act as custodian for a mutual fund constituted by the same sponsor or any of its associate or subsidiary company.
Provided that where the sponsor or its associates hold 50% or more of the voting rights of the share capital of the custodian, such custodian may act as custodian for a mutual fund constituted by the same sponsor or any of its associates or subsidiary company if: (i) the sponsor has a net worth of at least 20,000 crore rupees at all points of time; (ii) 50% or more of the directors of the custodian are those who do not represent the interest of the sponsor or its associates; (iii) the custodian and the AMC of a mutual fund are not subsidiaries of each other; (iv) no person is a director of both the custodian and the AMC of a mutual fund; and (v) the custodian and the AMC of a mutual fund sign an undertaking that they will act independently of each other in their dealings with the scheme.
III. SCHEME GOVERNANCE
○ The sponsor or asset management company shall invest not less than one percent of the amount which would be raised in the new fund offer or fifty lakh rupees, whichever is less, in the growth option of the scheme and such investment shall not be redeemed unless the scheme is wound up: Provided that this sub-regulation shall not apply to close ended schemes.
○ The Scheme/Plan shall have:
○ A minimum of 20 investors and
○ No single investor shall account for more than 25% of the corpus of the Scheme/Plan(s).