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In a landmark regulatory move, the Securities and Exchange Board of India (SEBI) has amended the Prohibition of Insider Trading (PIT) Regulations, expanding its ambit to include mutual fund units. Starting November 1, 2024, the amended regulations impose new compliance obligations on asset management companies (AMCs) to prevent insider trading in mutual fund units. This change, which has been in the works since July 2022, is part of SEBI’s continued effort to enhance transparency, market integrity, and investor protection.
This article delves into the detailed implications of SEBI’s PIT regulations on mutual fund units, the compliance requirements for AMCs, and the broader impact on the mutual fund industry.
The SEBI (Prohibition of Insider Trading) Regulations, 2015, were originally designed to curb insider trading in listed securities. However, mutual fund units, despite being market-linked securities, were not initially covered under these regulations. Over time, SEBI noticed potential loopholes where insiders with unpublished price-sensitive information (UPSI) could exploit mutual fund investors. In July 2022, SEBI released a consultation paper proposing amendments to the PIT regulations to cover mutual fund units. After thorough consultation with stakeholders, the final amendment was notified in July 2024, with the effective date set for November 1, 2024.
The amendments to the PIT regulations introduce several critical changes for AMCs. Some of the major changes include:
One of the most significant changes is the inclusion of mutual fund units under the definition of ‘insider.’ Previously, AMCs and their employees could trade in their own mutual fund units without restrictions on insider trading. Now, with the introduction of mutual fund units under PIT regulations, AMCs must ensure that their designated persons do not trade in mutual fund units while in possession of UPSI.
Definition of Insider: The definition of an insider now applies to mutual fund units. An insider is any person connected to the AMC who has access to UPSI. This could include directors, employees, immediate relatives, or any other individual who has access to material, non-public information regarding mutual fund schemes.
Unpublished Price-Sensitive Information (UPSI): UPSI in mutual funds refers to material events that could impact the Net Asset Value (NAV) or the interests of unitholders. This could include changes in liquidity, regulatory actions, significant market movements, or material observations or advisories.
To ensure compliance with insider trading regulations, AMCs must now maintain a Structured Digital Database (SDD). This database is essential for tracking the possession and sharing of UPSI both internally and externally. The SDD should record the details of all individuals who come into possession of UPSI and must be equipped with proper audit trails.
The SDD is a critical tool in preventing insider trading, as it allows AMCs to monitor the flow of sensitive information and ensure that no individual trades based on UPSI.
The regulations introduce stringent reporting obligations for AMCs. AMCs must now submit quarterly reports detailing the mutual fund holdings of their designated persons and immediate relatives. This report must be submitted to the stock exchanges using a dedicated platform created for this purpose.
Designated Persons: These are individuals identified by the AMC who, due to their role or position, are likely to come into contact with UPSI. This typically includes senior management, directors, and other key personnel.
The quarterly reporting requirement also extends to transactions conducted by designated persons and their immediate relatives. These transactions must be disclosed to the AMC’s compliance officer within two business days, and the compliance officer, in turn, must report them to the stock exchanges within two business days.
A new pre-clearance requirement has been introduced for trading in mutual fund units by designated persons. Designated persons will now need to obtain approval from the compliance officer before executing any trades in mutual fund units.
Exceptions: However, pre-clearance will not be required for certain types of mutual fund schemes, such as Overnight Schemes, Index Funds, and Exchange Traded Funds (ETFs).
This pre-clearance mechanism is similar to the one used for trading in listed securities and aims to prevent potential misuse of insider information in mutual fund transactions.
AMCs must now formulate and implement a comprehensive Code of Conduct in line with Schedule B1 of the amended PIT regulations. This code will govern trading restrictions, information sharing, and penalties for violations.
Key Components of the Code of Conduct:
AMCs must also establish an institutional mechanism to prevent insider trading. This includes formulating written policies and procedures for investigating any leak or suspected leak of UPSI and conducting an annual review of compliance with SEBI’s PIT regulations.
The concept of Contra Trade is introduced for mutual fund units. A contra trade refers to any trade executed by a designated person that is opposite to a previous trade. For example, if a designated person buys mutual fund units, they cannot sell those units for a specified period.
Contra Trade Restrictions: For mutual fund units, the contra trade restriction has been set at two months. This means that once a designated person buys mutual fund units, they cannot sell them for at least two months. In contrast, the restriction for equity securities remains at six months.
The contra trade restriction aims to prevent short-term profiteering based on insider information.
AMCs must implement Closure Periods, during which trading in mutual fund units by designated persons will be prohibited. These periods will be imposed when designated persons are likely to have access to UPSI, such as before the announcement of significant events that could affect the NAV of mutual fund schemes.
During the closure period, AMCs can implement a PAN-level freeze on the designated person’s mutual fund accounts. This freeze ensures that no transactions can be processed during the closure period.
AMCs can work with Registrar and Transfer Agents (RTAs) to reject any transactions made by designated persons during the closure period, thus preventing insider trading during sensitive times.
The regulations require AMCs to establish a robust institutional mechanism to prevent insider trading. This includes formulating written policies and procedures for:
By instituting this mechanism, AMCs can ensure that they have a comprehensive framework for monitoring and preventing insider trading.
While the extension of insider trading regulations to mutual fund units is a welcome move to enhance transparency and protect investor interests, it also presents significant compliance challenges for AMCs.
The new regulations introduce a host of new compliance obligations for AMCs. From maintaining a structured digital database to implementing pre-clearance mechanisms and reporting quarterly to stock exchanges, AMCs must invest in the necessary infrastructure to meet these requirements.
In particular, the maintenance of a Structured Digital Database (SDD) will require significant investment in technology. AMCs will need to procure tools and software to track the possession and sharing of UPSI in real-time. Additionally, AMCs must enter into arrangements with RTAs, depositories, and stock exchanges to ensure that they can implement trading freezes and comply with reporting obligations.
AMCs that manage both equity securities and mutual funds will now need to adhere to two different sets of insider trading regulations. For example, the contra trade restriction for equity securities is six months, while for mutual fund units, it is two months. Similarly, the reporting requirements for mutual fund units differ from those for equity securities.
This dual compliance obligation will require AMCs to establish separate compliance frameworks for both equity and mutual fund transactions, increasing their operational complexity.
The new regulations could also have an unintended consequence of discouraging designated persons from investing in their own mutual fund units. Under the current framework, designated persons can freely invest in their own mutual fund units without approval. However, the new pre-clearance requirements and trading restrictions may dissuade them from doing so.
Designated persons may opt to invest in mutual funds managed by other AMCs to avoid the compliance burden associated with investing in their own AMC’s schemes.
On the positive side, the introduction of insider trading regulations for mutual fund units is likely to strengthen investor confidence in the mutual fund industry. By imposing strict controls on the trading of mutual fund units by insiders, SEBI is sending a clear message that it is committed to protecting the interests of retail investors and ensuring that all market participants operate on a level playing field.
The increased transparency and accountability brought about by these regulations will help enhance the reputation of the mutual fund industry as a safe and reliable investment option.
To ensure compliance with the new PIT regulations, AMCs must take several immediate actions. These include:
SEBI’s decision to bring mutual fund units under the ambit of insider trading regulations marks a significant step towards enhancing transparency and investor protection in the mutual fund industry. While the new regulations impose additional compliance obligations on AMCs, they are a necessary step to curb potential misuse of UPSI and protect the interests of retail investors.
As AMCs gear up for the November 1, 2024 deadline, they must ensure that they have the necessary infrastructure and processes in place to comply with the new regulations. By doing so, they can not only avoid regulatory penalties but also contribute to building a more transparent and fair mutual fund ecosystem.
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