Comprehensive Guide to the Legal Structure of Mutual Funds in India

The legal framework of mutual funds in India is designed to ensure transparency, investor protection, and professional management. Governed primarily by the SEBI (Mutual Fund) Regulations, 1996, a mutual fund is defined as a trust established to raise money through the sale of units to the public for investing in a variety of assets, including securities, gold, silver, and real estate.

3.1 Structure of Mutual Funds in India

In India, mutual funds follow a three-tier structure to ensure a clear separation between the ownership of assets and their management. This structure consists of the Sponsor, the Trustee, and the Asset Management Company (AMC).

• The Trust: The mutual fund is established as a trust under the Indian Registration Act, 1908.
• Separation of Roles: While the AMC handles the day-to-day management and investment of the funds, the Custodian holds the actual assets (securities, gold, etc.) to ensure they are not misused.
• Regulatory Oversight: The Asset Management Company must be a separate legal entity from the trust to operate the mutual fund business.

3.2 Key Constituents of a Mutual Fund

The integrity of a mutual fund relies on its core constituents, each having specific legal and operational responsibilities mandated by SEBI.

3.2.1 Sponsors

The Sponsor is the primary entity that applies to SEBI for the registration of a mutual fund. They are essentially the "promoters" of the fund.

• Track Record: Must have at least 5 years of experience in financial services.
• Integrity: Must have a sound reputation and be a "fit and proper" person.
• Financial Health: The Sponsor must have shown a positive net worth for all five immediately preceding years.
• Contribution: The Sponsor invests in the initial capital of the Asset Management Company.

3.2.2 Board of Trustees

Trustees act as the "guardians" of the unit-holders’ interests. They ensure the AMC and the fund comply with all SEBI regulations.

• Composition: A Sponsor must appoint at least 4 trustees. If a trustee company is formed, it must have at least 4 directors on its board.
• Independence: At least two-thirds of the trustees must be independent (not associated with the sponsor).
• Eligibility: No person convicted of economic offences or violation of securities laws can be a trustee. Employees or directors of the AMC are also ineligible.
• Core Responsibilities:
  • Enter into an Investment Management Agreement with the AMC.
  • Ensure all systems and key personnel (fund managers, compliance officers) are in place before a scheme launch.
  • Review all AMC transactions quarterly to prevent conflicts of interest.
  • Address investor complaints and ensure the protection of trust property.
  • Ensure fairness of fees charged by the AMC.

3.2.3 Asset Management Company (AMC)

The AMC is the operational arm that manages the money mobilized from investors.

• Appointment: Appointed by the Sponsor or Trustees with SEBI's approval.
• Expertise: Directors must have adequate professional experience in finance.
• Due Diligence: The AMC must ensure that investment decisions are not contrary to the trust deed or SEBI regulations.
• Termination: The appointment can be terminated by a majority of trustees or by 75% of unit-holders.

3.2.4 Custodian

The Custodian has the physical custody of the scheme’s assets, such as securities and gold.

• Role: Settles all purchase and sale transactions on behalf of the fund and tracks corporate actions like dividends and bonuses.
• Independence: To ensure safety, the custodian is generally independent of the sponsor to prevent undue influence.

3.2.5 Unit Holder Protection Committee (UHPC)

As per SEBI mandates, every AMC must constitute a UHPC to safeguard investor interests.

• Mandate: Review compliance issues, ensure sound market practices (preventing mis-selling), and oversee investor education.

3.3 Organizational Structure of an Asset Management Company

Individual AMCs may vary, but they generally follow a standardized functional structure to manage investments and serve customers.

3.3.1 Key Departments

3.4 Role and Support Function of Service Providers

AMCs utilize various specialized service providers to maintain high standards of service and accuracy.

• Fund Accountant: Calculates the daily Net Asset Value (NAV) by tracking the scheme’s assets and liabilities.
• Registrars and Transfer Agents (RTA): Maintain investor records, process transactions (purchase/redemption), and issue account statements.
• Auditors: Must maintain independence; the scheme auditor (appointed by Trustees) must be different from the AMC auditor (appointed by AMC).
• Distributors: Sell suitable schemes to investors. They must pass NISM certification and register with AMFI.
• KYC Registration Agencies (KRA): Centralized agencies that handle "Know Your Customer" (KYC) documentation to avoid repetitive processes for investors.
• Valuation Agencies: AMFI-appointed agencies (like CRISIL and ICRA) that provide fair valuation matrices for debt securities.
• Credit Rating Agencies: Provide ratings for debt instruments, which fund managers use as an initial input for investment decisions.
• Depositories: Hold securities in electronic (dematerialized) form. India has two: NSDL and CDSL.
• Stock Exchanges: Provide platforms (like BSE-Star MF and NSE NMF-II) for transacting in mutual fund units.

3.5 Role and Function of AMFI

The Association of Mutual Funds in India (AMFI) is the industry body representing all registered Asset Management Companies.

• Professional Standards: Defines and maintains high ethical and professional standards for the industry.
• Code of Conduct: Recommends best business practices for members and intermediaries.
• Intermediary Regulation: Allots the AMFI Registration Number (ARN) to distributors and can take disciplinary action for violations of the Code of Conduct.
• Investor Awareness: Undertakes nationwide programmes to promote the understanding of mutual funds.
• Representation: Acts as the collective voice of the industry when interacting with SEBI, the Government, and the RBI.

Note: AMFI is an industry association and is neither a regulatory body nor a Self-Regulatory Organisation (SRO).

Key Takeaways

• Mutual funds in India are structured as Trusts to ensure a separation of ownership and management.
• The Board of Trustees holds the AMC accountable and protects unitholder interests.
• SEBI is the primary regulator, while AMFI serves as the industry association.
• A wide range of service providers, from RTAs to KRAs, ensure smooth operations and regulatory compliance.

Important Terms

• Sponsor: The promoter of the mutual fund.
• Trustee: The guardian of the investors’ money.
• AMC: The company that manages the fund’s investments.
• NAV (Net Asset Value): The value per unit of a scheme.
• ARN: The registration number required by all mutual fund distributors.