How MF Lite gives a fillip to passive funds

 How MF Lite gives a fillip to passive funds

The markets regulator has introduced the Mutual Funds Lite (MF Lite) framework to simplify the regulatory compliance for passively managed mutual funds.

What is Sebi’s liberalized MF Lite framework

The MF Lite framework is a simplified regulatory system for passively managed mutual fund schemes such as exchange traded funds (ETFs) and index funds, aimed at encouraging more players to enter the mutual fund market by easing entry barriers. Since passive funds follow a rule-based strategy and there is negligible discretion with asset management companies (AMCs) regarding asset allocation compared to actively managed ones, light-touch regulations are sufficient. By streamlining the approval process and reducing the need for exhaustive disclosures, MF Lite aims to make it quicker and less costly for entities launching only passive mutual funds to enter the industry. The approval process for introducing new passive funds is expected to be quicker and less cumbersome, savings AMCs time and resources. An increase in competition in the industry with the entry of new players is expected to boost innovation, provide more investment options for retail investors, and improve liquidity in the market.

Lower barriers for new entrants

Need to meet strict criteria regarding net worth, track record, and profitability. With MF Lite, these requirements are relaxed for companies interested in offering only passive fund schemes. The MF Lite rules lower the minimum net worth for an AMC to Rs 35 crore from Rs 50 crore, in the main eligibility route. In the alternate route where the sponsor of the mutual fund does not meet the main route eligibility criteria, the net worth requirement is Rs 50 crore against Rs 75 crore earlier. The usual five-year financial experience requirement for AMCs may not be necessary under the main route. Sebi has also suggested a mandatory three-years lock-in period, down from five years, for the sponsor’s initial shareholding. This opens the door for new market entrants, especially fintech firms or smaller financial institutions, to launch passive investment products.

 

Will it impact existing AMCs?

An existing AMC handling both active and passive funds will now have the option to separate its passive schemes into a new entity under a common sponsor, which will be governed by the MF Lite regulations. A sponsor can obtain up to two registrations – on for active and another for lite mutual funds. This enables it to operate under the relaxed regulatory framework while keeping its active funds under the traditional, slightly tighter norms. Alternatively, it can continue managing both types of funds within its current structure and still benefit from the relaxed disclosures and other regulatory requirements for its passive offerings under the MF Lite framework. This flexibility will help AMCs optimize their operations while taking advantage of a more streamlined regulatory process for passive schemes, which can lower costs and improve efficiency.

 

Reduced burden on trustees

The new framework will streamline the compliance and disclosure process for trustees, by reducing the number of disclosures and documentation needed to launch and manage passive mutual fund schemes. Sebi has allowed the appointment of a debenture trustee as trustee of more than one MF registered under the MF Lite rules, at nay given time. A fund’s trustee, which oversees the assets of a mutual fund on behalf of unitholders, is also responsible for ensuring that mutual funds comply with regulations and act in the best interests of investors. By simplifying these administrative tasks, Sebi aims to encourage the creation of more passive funds, which are less complex and require less active oversight. However, it will still oversee critical areas such as related party transactions, conflicts of interest, undue influence by sponsors and market abuse.

 

Why Sebi is pushing for passive funds

The new rules will help expand the range of low-cost and low-maintenance investment options available for retail investors, whose numbers are growing, allowing for greater diversification in portfolios. Passive mutual fund schemes offer a low-cost option to investors as the expense ratio is generally lower than active mutual funds. Since such funds track a benchmark index and aim to deliver returns in tandem with the benchmark, these are more conducive for first-time investors. As more entities enter the market following Sebi’s green signal, competition may drive innovation, leading to the creation of new passive products tailored to different investment needs. This would also drive up the interest of retail investors towards passive funds. This framework will also help new players such as Jio Financial Services-Blackrock and Zerodha which are expected to enter the space. Increased market participation by new players is expected to boost liquidity, potentially marking it easier for investors to enter and exit positions in passive funds. In the long term, this move could help deepen the mutual fund market by bringing in more players and investors, increasing overall asset flows into the passive investment segment, and fostering a more competitive landscape for both traditional and passive mutual funds.

 

 

For More Details: Pooja Manoj Gupta, visit www.giia26.com

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