Bridge between investment funds and PMS

SEBI’s New Asset Class Proposal: An Interpretive Study of Market Conventions and Regulatory Framework

On 16 July 2024, the Securities and Exchange Board of India (SEBI) published a consultation paper outlining a new asset class aimed at bridging the gap between mutual funds and portfolio management services ( PMS). This comprehensive research investigates the legal structure, regulatory consequences and potential market influence of this creative financial product.

Legislative structure and regulatory framework

Under Section 11 of the Securities and Exchange Board of India Act, 1992, which gives the regulator the authority to uphold the interests of investors and advance market growth, SEBI’s statutory authorities aim at a new asset class. Reiterated by the Supreme Court in Sahara India Real Estate Corporation Ltd. v. SEBI (2012), this approach is in line with SEBI’s Section 11(2)(b) obligation to register and monitor the operation of collective investment schemes.

Based on the current systems laid down in the SEBI (Mutual Funds), 1996 and SEBI (Portfolio Managers) Rules, 2020, the regulatory framework comes to a moderate ground with a minimum investment level of 10,000,000 INR. This position captures SEBI’s sophisticated approach to market segmentation as previously endorsed by the Supreme Court in SEBI v. Rakesh Agrawal (2004), where the Court highlighted the regulator’s power to establish unique market categories.

Operational requirements and eligibility criteria

The eligibility of asset management companies

• The consultation paper sets out the dual-track eligibility system for asset management companies (AMCs):

History Standards:

• Minimum three years of operational experience
• Assets under management (AUM) of Rs 10,000 crore
• Clear regulatory records under certain sections of the SEBI Act, 1992.

Control criteria:

• Appointment of the Chief Investment Officer (CIO).
• Additional fund manager with significant AUM management background
• This structure links with the eligibility criteria set out in SEBI v. Kishor R. Ajmera (2016), where the Supreme Court upheld SEBI’s ability to enforce strict qualification conditions for market intermediaries.

Structural framework and investment guidelines

Liquidity management and investment strategy

The suggested architecture uses adjustable exchange frequencies in accordance with the SEBI (Listing Obligations and Disclosure Requirements) guidelines, 2015. Emphasizing the combination of market efficiency and investor protection, this approach represents the regulatory attitude expressed in SEBI v. Pan Asia Advisors Ltd. (2015). ).

Exchange List Policies

Following the precedent of Exchange Traded Funds (ETFs) set by SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2019/011, the mandatory listing requirement of investment strategy units improves liquidity and ‘accessibility to the market. This need is in line with the 2012 Supreme Court endorsement of market opening as seen in Sahara India Real Estate Corporation Ltd . v. SEBI.

Legal framework and risk management Exposure to the derivatives market

Control values ​​for regulation

Unlike conventional mutual fund rules, the consultation paper suggests a complex strategy for exposure to the derivatives market. The construction consists of:

Exposure limitations:

• Maximum gross exposure limited to one hundred percent of net asset value
• Exposure to individual share derivatives limited to 10% of net assets
• Limit aggregate exposure to derivatives to half of net assets.

Prohibited activities:

• expressly prohibited to use
• Restrictions on speculative trading
• These restrictions follow the regulatory ideas developed in SEBI v. Kishore R. Ajmera (2016), where the Court emphasized the need for risk control in derivatives trading.

ETF inverse issues

The research addresses the complexity of ETF inverse investing and points to the compounding effects capable of producing different returns. This study complements global regulatory policies, including the US Securities and Exchange Commission’s advisory on leveraged and inverse ETFs (Release No. 34-89372).

Risk control and investor protection

Consent-based framework

Like the PMS framework under Regulation 23 of the SEBI (Portfolio Managers) Regulations, 2020, the proposal calls for a consent-based approach to derivative investments. The Court emphasized in SEBI v. Cabot International Capital Corporation (2015) the need for investor informed consent in sophisticated financial products, thus validating this approach.

Minimum risk aversion standard

The minimum risk aversion criteria established through investment limits and exposure limits reflect the regulatory ideas expressed in the SEBI (Mutual Funds) Regulations, 1996 and subsequent amendments. These criteria are in line with the Supreme Court’s views on the need for robust risk management systems in SEBI v. Pan Asia Advisors Ltd. (2015).

Openness and transparency guidelines

Marketing and correspondence

To establish the new asset class apart from conventional mutual funds, the consultation paper stresses the need for strong branding. This strategy supports the judicial precedents in SEBI v. Sahara India Real Estate Corporation Ltd. (2012) in accordance with the disclosure rules laid down in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

Disclosure requirements for portfolios

The requirements for monthly portfolio disclosure enhance openness and follow best global standards. While the operational difficulties and expenses associated with periodic disclosure are appreciated, these criteria are based on the current disclosure systems set out by SEBI Circular CIR/IMD/DF/21/2012.

Regulatory authority and compliance

Approval prerequisites

SEBI’s approval before implementing new investment plans ensures regulatory control in line with the values ​​laid down in SEBI v. Kishore R. Ajmera (2016). As the Supreme Court has emphasized in several decisions, this strategy combines creativity and investor protection.

Requirements relating to constitutional documents

The required public availability of constitutional documents enhances openness and conforms to market integrity values ​​outlined in the SEBI (Listing Obligations and Disclosure Requirements), 2015 regulations.

Market influence and future consequences

market segmentation

The launch of this new asset class marks a major shift in market segmentation and could spawn a new category of informed retail investors. This is in line with Section 11(1) of the SEBI Act, 1992, which confers the statutory responsibility on SEBI to create and monitor stock markets.

Innovation and Competence

Two-way eligibility rules maintain high standards of fund management while promoting market competitiveness. This strategy ensures the safety of investors and reflects the regulatory attitude expressed in SEBI v. Rakesh Agrawal (2004), thus encouraging market development.

• Advice on the application
• Development of uniform risk assessment techniques: Framework for Risk
• Following frequent stress test criteria
• Development of explicit risk communication strategies

Operating instructions:

• Comprehensive rules for the calculation of exposure to derivatives
• Explicit protocols for investor permission documents
• Particular criteria for risk disclosure statements

Examination and supervision:

• Agreements for periodic information on derivative exposures
• Periodic evaluation of risk management systems
• Well-defined guidelines for regulatory intervention

Finally

The new asset class suggested by SEBI marks a major change in the regulation of the stock market in India. Supported by accepted legal norms and regulatory precedents, the framework strikes a deliberate balance between innovation and investor protection. The success of this program will depend on the efficient application of the suggested safeguards and continued market observation.

The emphasis of the consultation paper on risk management, openness and investor protection in line with SEBI’s statutory mandate and international best practices is, however, the success of these steps will depend on a careful review of feedback of the market and of possible improvements to the suggested structure.

This new asset class could be very important in meeting the needs of sophisticated retail investors as the Indian stock market develops, thereby preserving the stability and integrity of the market. The success of this program will depend on SEBI’s ability to maintain efficient control while providing enough freedom for innovation and market growth.