Capital Markets: Challenges and Developments

Can domestic MFs invest in their overseas counterparts?

Explained | Economics | Mains Paper 3: Indian Economy
Note4Students

From UPSC perspective, the following things are important :

Prelims level: Function of SEBI

Mains level: Market Regulations in India;

Why in the news?

SEBI issued a consultation paper, proposing a framework to enable domestic Mutual Funds (MFs) to invest in their overseas counterparts or Unit Trusts (UTs) that allocate a portion of their assets to Indian securities.

About the Framework for Facilitating Investments by Domestic Mutual Funds (MFs)

  • Aim: To clarify the process and regulations surrounding such investments to encourage domestic MFs to diversify globally while maintaining limited exposure to Indian securities.

About the Proposals:

  • On Investment Cap: SEBI proposes that overseas instruments being considered for investment by domestic MFs must not have more than 20% exposure to Indian securities.
    • This cap is intended to balance facilitating global investments while preventing excessive exposure to Indian markets.
  • On Pooling of Contributions: Indian MFs must ensure that all investors of the overseas MF/UT pool their contributions into a single investment vehicle. This ensures fair distribution of gains among investors, proportional to their contributions, without any preferential treatment.
  • On Autonomous Management: Investments must be made autonomously by the manager of the overseas instrument, without influence from investors or undisclosed parties, to avoid conflicts of interest.
  • About Transparency and Disclosure: SEBI requires periodic public disclosures of the portfolios of such overseas MF/UTs for transparency.
  • No Advisory Agreements: SEBI warns against any advisory agreement between the Indian MF and the overseas MF/UT to prevent conflicts of interest and avoid undue advantage.
  • On Observance Period: If an overseas instrument breaches the 20% limit, the Indian MF scheme will enter a six-month observance period for rebalancing the portfolio.
    • Further investments will only be allowed when the exposure is below the limit. If not rebalanced within six months, the MF must liquidate its investment in the overseas instrument.

Impacts of the Regulation

  • Diversification of Opportunities: The framework provides a structured path for Indian MFs to invest in overseas instruments, enhancing diversification opportunities for Indian investors.
  • Market Transparency: The requirement for periodic public disclosures of portfolios will increase transparency and investor confidence in overseas investments.
  • Risk Management: The 20% exposure cap and autonomous management of investments help mitigate risks associated with excessive exposure to Indian securities and conflicts of interest.
  • Compliance Burden: The need to adhere to strict regulations and rebalance portfolios within specified periods may increase the compliance burden on domestic MFs.
  • Potential for Growth: By facilitating global investments, the framework can potentially attract more investors to Indian mutual funds, contributing to the growth of the mutual fund industry in India.

What are the concerns associated with this framework?

  • RBI’s Upper Limit: The Reserve Bank of India’s (RBI) upper limit for overseas investment by mutual funds poses a concern. RBI Governor Shaktikanta Das indicated there are no plans to increase this limit, which means the overall industry limit for overseas investments is already exhausted.
  • Practical Impact: As the industry limit for overseas investments is effectively exhausted, the changes to regulations may not have an immediate practical impact, limiting the diversification opportunities for Indian investors.
  • Implementation and Compliance: Ensuring compliance with the 20% exposure cap and other regulations may pose challenges for domestic MFs, requiring careful monitoring and management of their overseas investments.

Conclusion: Need to establish collaborations with global investment firms to gain insights and best practices in managing overseas investments. Learning from established global players can help Indian mutual funds navigate the complexities of international markets more effectively.

Mains PYQ:

Q The product diversification of financial institutions and insurance companies, resulting in overlapping of products and services strengthens the case for the merger of the two regulatory agencies, namely SEBI and IRDA. Justify. (UPSC IAS/2013)

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