SEBI

SEBI May Allow PE Firms to Set Up their own AMCs

The regulator of capital markets in India, i.e., SEBI may soon enable private equity firms to own asset management companies or AMCs. Private equity firms could then be seen either establishing their own AMCs or acquiring existing ones.

What’s the prospect for PE firms regarding the acquisition of AMCs?

Mutual fund sponsors can currently only be banks, non-bank lenders or NBFCs, or those with more than five years of experience in running & administering a public pool of funds. But due to the difficulty of their primary businesses to generate adequate funds in the aftermath of the epidemic, many existing sponsors and trustees are suffering a cash crunch.

Hence, to overcome this crisis, private equity (PE) firms may soon be seen to have more freedom to acquire or create asset management companies (AMCs). The Securities and Exchange Board of India (SEBI), India’s market regulator, is expected to relax mutual fund (MF) ownership rules even more. At its next board meeting, the subject will be discussed. This step will allow these PE firms to tap into the growing mutual fund industry in India.

The proposed regulations of the Securities and Exchange Board of India (SEBI) will grant conditional licenses to PE funds seeking to buy a majority share in AMCs. PE firms will be required to meet specified net-worth criteria, size, experience, and lock-in norms in order to be sponsors or buy ownership of any AMC under the new rules.

Furthermore, if a private equity firm wants to be a mutual fund sponsor, SEBI may require them to commit capital worth more than Rs 100 crore if they intend to be the sponsor or the owner in charge of the mutual fund business. In addition, the PE fund must establish a completely separate and independent AMC subsidiary, as well as a trustee to serve as the sponsor or owner in control of a mutual fund house.

Also, the private equity firm may be required to follow different regulations when launching open-ended and closed-ended equity-oriented schemes.

The board is also expected to relax the rules governing superior voting rights (SR shares) in order to provide new-age companies more freedom in raising capital before going public. In addition, SEBI could also put the structure in place to allow the establishment of gold spot markets and social stock markets.

What do PE firms do?

PE firms raise money from institutional investors and high-net-worth individuals to invest in a variety of assets. It is a type of private finance in which investors make direct investments in private companies. PEs buy distressed assets, undertake leveraged buyouts, and buy holdings in companies before they go public or launch IPOs. PE firms typically have a three to five years investment horizon. They want to invest in companies with the intention of increasing their value over time and then selling them for a profit.

What is the current scenario – Can PE firms own AMCs?

At the moment, PE firms are not prohibited from serving as MF sponsors. The requirements, however, make it very difficult for them to buy or administer a fund house.

According to the current legislation, a sponsor must meet the ‘fit and proper standards,’ which require a corporation to have a ‘sound track record’ and a general reputation for fairness and integrity in all of its commercial dealings and business transactions. A sponsor must have run a financial services business for at least five years and should have a positive net worth in the last five years in order to achieve the ‘sound track record’ criteria. In addition, the sponsor must own at least 40% of the stake of the AMC.

According to industry participants, many of the current requirements deter PEs from sponsoring MFs.

Moreover, attempts by private equity firms to bid for domestic mutual funds, either alone or in collaboration with SEBI-regulated businesses, have had mixed outcomes.

In the past, SEBI has preferred AMCs with permanent capital. It has only dealt with strategic players who are properly regulated, either in India or in their home country, and who have experience in retail fund management or are “carrying on the business in financial services.” As a result, SEBI has often been seen to turn down petitions from PE firms to take a controlling/sponsorship share in AMCs.

How will SEBI help?

SEBI’s mission is to protect the interests of investors in securities, as well as to promote the development and regulation of the securities market. As far as mutual funds are concerned, SEBI develops policies/procedures, regulates, directs, and supervises mutual funds in order to protect the interests of investors.

As indicated above, there are several rules that currently act as a deterrent for private equity firms to own or acquire AMCs. A mutual fund’s sponsor must have been in the financial services industry^[1] for at least five years and have a positive net worth in the previous five years. Furthermore, the sponsor must own at least 40% of the AMC.

In the light of such restrictions, several of these rules will be relaxed by the regulator (SEBI) in order to encourage innovation and increase the reach of MF products. The decision may also increase competition in the Rs. 36-trillion mutual fund market.

Moreover, you will find that investors must be given an exit option if a sponsor changes, according to the MF rules and guidelines. A private equity fund has a life cycle and may need to exit after a few years. In fact, many PE funds have a shorter life cycle than other types of funds. This means that such firms cannot meet the mandatory criteria. As a result, giving an exit option to investors on a regular basis is not conducive to business in general. Therefore, the regulator may consider relaxing this restriction provided if the private equity firms do not exit the business before 5 to 7 years.

The SEBI board is also considering loosening the eligibility requirements for superior voting rights. SEBI may allow founders to issue SR shares if they are part of a promoter with a collective net worth of Rs 500 crore. Furthermore, SEBI may permit these shares to be issued by corporate structures and trusts.

Why is SEBI wanting PE firms to start AMCs?

SEBI is supporting innovation in the mutual fund sector in order to improve mutual fund penetration in India. Private equity firms have the potential to drive this innovation and increase competition in India’s Rs. 36 trillion mutual fund market.

The increased involvement of private equity firms in the AMC business will improve mutual fund governance. Furthermore, numerous fintech firms are looking to grow into the mutual fund industry.

Private equity firms are interested in becoming mutual fund sponsors. Fintech companies are also interested in entering the mutual fund business. As new mutual fund products are introduced in a short period of time, it may lead to innovation. In a nutshell, private equity firms entering the mutual fund market can be beneficial to the industry.

The new guidelines could make it easier for global private equity firms like Blackstone to buy L&T Investment Management Ltd. The two corporations have been attempting to reach an agreement in which Blackstone will purchase L&T’s entire mutual fund division for around 3,200 crores.

Conclusion

Several entities have been looking to sell their mutual fund business in the context of a prolonged liquidity crisis in the NBFC space since the collapse of Infrastructure Leasing and Financial Services Ltd in 2018, as well as a cash crunch in the manufacturing sector companies with AMC businesses. Because of this, the market regulator in India is making potential efforts to bring in new rules for PE firms in order to grow the mutual fund industry. Such new rules by SEBI are likely to boost the mutual fund industry and clear the way for private equity firms to participate with their stake in this business.

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