In a bid to enhance the replication of benchmark indices by index funds and exchange-traded funds (ETFs), the Securities and Exchange Board of India (SEBI) has recommended lifting the limitation on investing up to 25% of their net assets in group companies or sponsors for these funds.
SEBI’s proposal entails permitting index funds and ETFs to invest in shares of listed companies belonging to the group companies of the sponsor, in alignment with their benchmark indices. This proposal, put forth by SEBI in a discussion paper released on February 23, 2024, forms part of the regulatory body’s efforts to streamline operations for mutual funds and facilitate ease of doing business in the capital markets.
Presently, mutual fund schemes are subject to regulations that restrict arbitrary investments in underlying shares and bonds of companies. For instance, a mutual fund scheme cannot allocate more than 10% of its Net Asset Value (NAV) to shares of a single business entity. Additionally, the total exposure of the scheme to listed equity shares of group companies of the sponsor is capped at 25% of its net assets. However, SEBI rules permit a single company to have a maximum weightage of 35% in a sector or thematic benchmark index for index funds and ETFs.
To enable passive funds to closely mirror their benchmark indices, SEBI has proposed relaxing the 25% upper cap restriction for such funds. Another suggestion made by SEBI pertains to easing the requirement of appointing a separate and dedicated fund manager for schemes investing in commodities such as gold, silver, and foreign assets. The regulatory body believes that having dedicated managers for such schemes may incur additional costs, especially considering that AMCs or fund houses may already have research analysts tracking these asset classes.
Therefore, SEBI proposes that a dedicated fund manager may not be necessary for tracking commodities and foreign investments in such schemes. Furthermore, SEBI has recommended making nominations optional for jointly-held mutual fund folios. The regulatory body suggests that since the second holder legally takes precedence over a nominee as a legal heir, making nominations mandatory for jointly-held folios may not be necessary.
This change would also eliminate the requirement for obtaining consent from all joint holders to approve or change a nominee, which is currently deemed burdensome. SEBI has invited feedback and suggestions from various stakeholders on these proposals by March 15, 2024.
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