Legal structure of mutual funds in India

A mutual fund in India is not a company that owns your money. It is a trust, and understanding who holds what role is the difference between answering the structure questions in ten seconds and guessing. The exam asks for the numbers (net worth, percentages, independence ratios) and for the function of each constituent.

The three-tier structure

SEBI's Mutual Fund Regulations, 1996 require every mutual fund to be set up as a trust under the Indian Trusts Act, 1882. Three parties make that happen.

Sponsor

The sponsor is the promoter, the entity that sets up the mutual fund, like a promoter of a company. The sponsor applies to SEBI for registration, creates the trust by executing the trust deed in favour of the trustees, and sets up the AMC. SEBI's eligibility conditions for a sponsor include: a sound track record and reputation of fairness in business; at least 5 years of carrying on business in financial services; positive net worth in each of the immediately preceding 5 years; net worth in the latest year greater than the capital it contributes to the AMC; profits after tax in at least 3 of the 5 preceding years, including the latest; and holding at least 40% of the net worth of the AMC. The sponsor must be a fit and proper person. SEBI has since added an alternative route for sponsors such as private equity funds that do not meet the profit test but satisfy higher capital conditions, as notified.

Trust and trustees

The mutual fund itself is the trust. It holds the investors' money for their benefit. The trustees (a board of individual trustees or a trustee company) are the legal owners of the scheme assets, holding them in trust for unitholders. Their job is oversight: they appoint the AMC through an investment management agreement, approve every new scheme before it is filed with SEBI, ensure the AMC complies with regulations, review the AMC's systems and transactions, and report to SEBI half-yearly. At least two-thirds of the trustees must be independent of the sponsor, and a minimum of four trustees or directors of the trustee company is required. Trustees sign off on the scheme information document and have the power to dismiss the AMC with SEBI approval.

Asset management company

The AMC is the sponsor's company that actually manages the money: it designs schemes, invests, computes NAV, handles investor servicing and marketing, and is paid an investment management fee from the scheme. Key rules: a minimum net worth of ₹50 crore, at least 50% independent directors, SEBI's approval of its appointment, and it cannot act as a trustee of any mutual fund. An AMC may carry out only permitted activities such as portfolio management or advisory services, provided they do not conflict with fund management and are approved. The AMC's fees and all scheme expenses must sit within the total expense ratio limits.

The other constituents

The three-tier structure is supported by service providers appointed by the AMC or trustees.

• Custodian: keeps safe custody of the scheme's securities, settles trades, collects corporate actions such as dividends and bonus shares, and must be registered with SEBI. The custodian is appointed by the trustees. A sponsor or its associate cannot be the custodian unless the conditions in the regulations (on shareholding, control and independent directors) are met. Securities are held in the name of the mutual fund through the depositories, NSDL and CDSL.
• Registrar and transfer agent (RTA): maintains the register of unitholders, processes purchases, redemptions and switches, sends account statements and IDCW payouts, and handles investor queries. CAMS and KFin Technologies serve almost all Indian AMCs. An AMC may also do this work in-house.
• Fund accountant: computes NAV daily, either an in-house AMC team or an outsourced provider.
• Auditors: each scheme's accounts are audited by an auditor who must be different from the AMC's own auditor.
• Distributors: individuals and institutions with an AMFI Registration Number who bring investors to the fund.
• KYC registration agencies (KRAs) and the Central KYC Records Registry (CKYCR): hold investor KYC records so an investor does not repeat KYC with every intermediary.
• Collecting bankers and payment aggregators: receive investor money; depositories for units held in demat form; valuation agencies (CRISIL, ICRA) that supply prices for debt securities; and stock exchanges and MF Utilities as transaction platforms.

The sponsor is not responsible for any loss in a scheme beyond its initial contribution towards setting up the trust (generally ₹1 lakh). Scheme losses are borne by unitholders.

Following one transaction through the structure

An investor hands a cheque and application to a distributor. The distributor submits it to the AMC's branch, the RTA, or an online platform. The RTA time-stamps the application and the collecting bank credits the money. Units are allotted at the applicable NAV and the RTA sends an account statement. The AMC's fund manager deploys the money; the custodian takes delivery of the securities bought. The fund accountant marks the portfolio to market each evening and publishes the NAV. Trustees review the whole chain through periodic reports. When the investor redeems, the chain runs in reverse and the money reaches the registered bank account within the SEBI timeline.

Mergers, takeovers and change of control

Sponsors change. When an AMC is sold or two fund houses merge, SEBI's prior approval is needed. The change is treated as a change in a fundamental attribute of the schemes, so unitholders must be informed and given at least 30 days to exit without exit load. Scheme mergers within the same fund house follow the same notice and exit rules. The trustees must satisfy themselves that the interests of unitholders are protected throughout. Acquisition of 10% or more of an AMC's shareholding also needs SEBI's prior approval.

The fund house can also wind up a scheme: on maturity for close-ended schemes, by a 75% majority of unitholders, by the trustees if they believe it is in unitholders' interest, or at SEBI's direction. After winding up is announced, the scheme stops selling and redeeming units and the assets are liquidated and distributed.