Shruti RajanPartner
Khyati GoelSenior Associate
Rebecca CardosoAssociate
Key Developments
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Regulatory framework for Investment Advisers and Research Analysts relaxed to facilitate compliance and ease of doing business
On 16 December 2024, the Securities and Exchange Board of India (SEBI) made changes to the SEBI (Investment Advisers) Regulations, 2013 and SEBI (Research Analysts) Regulations, 2014 to strengthen both frameworks, facilitate compliance and enhance the ease of doing business.
The key changes to the frameworks are as follows:
- Simplified eligibility criteria: The educational qualifications for individual Investment Advisers (IA), individual Research Analysts (RA) and principal officers of non-individual IAs and RAs have been relaxed by removing the requirement for a post-graduate degree. Now, an undergraduate degree in finance, commerce, etc., will be sufficient. Likewise, the required qualification for persons associated with investment advice has been relaxed and the previous experience criterion has been removed.
- Elimination of the net-worth requirement: The earlier minimum net worth requirements for IAs and RAs have now been replaced with a deposit requirement. Now all IAs and RAs must maintain a deposit of the amount to be specified by SEBI periodically, with a scheduled bank marked as lien in favour of the Investment Adviser Administration and Supervisory Body or the Research Analyst Administration and Supervisory Body.
- Recognition of part-time categories: SEBI has recognised a new ‘part-time’ category for IAs and RAs. Part-time IAs or RAs cannot have more than 75 clients.
- Enhanced disclosure requirements: IAs and RAs must maintain a functional website to display the information suggested by SEBI from time to time. IAs and RAs are now also required to disclose the extent of their use of artificial intelligence.
- Relaxation of threshold for individual Investment Advisors: Individual IAs were earlier mandated to apply for in-principal registration as non-individual IAs if they onboarded 150 clients or more. This threshold has been relaxed to 300 clients or fee collection of INR 3 crore.
- Consideration for providing research services: SEBI recognised that the term ‘research analyst’ did not mention the aspect of payment of consideration for services provided by RAs. Therefore, the scope of research services remained open to arbitrary interpretation. The position has now been clarified by revising the definition of ‘research analyst’ to mean a person who provides research services for consideration.
These amendments are a response to the rising number of unregistered financial influencers. By relaxing the norms and allowing entities to register as part-time IAs or RAs, this move encourages more individuals to obtain SEBI licenses providing enhanced regulatory oversight and investor protection.
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Norms governing issuance of Offshore Derivative Instruments tightened
SEBI issued a circular on 17 December 2024 tightening the rules on issuance of offshore derivative instruments (ODI) by foreign portfolio investors (FPI).
FPIs are now permitted to issue ODIs only through a distinct and dedicated FPI registration that excludes proprietary investments. A dedicated registration is not required for ODIs referencing government securities. Further, ODIs cannot use derivatives as underlying and must be fully hedged with the same securities on a one-to-one basis throughout their tenure.
For smooth operationalisation, the following ‘transitory measures’ have been outlined by SEBI:
- Existing ODIs with derivatives as underlying can be redeemed within one year but not renewed.
- Existing ODIs hedged with derivatives can be redeemed or hedged with the same securities as underlying within one year.
- Existing ODIs issuing FPIs have one year to obtain separate dedicated registration, if required.
Another key change is the introduction of mandatory disclosure requirements for ODI subscribers. Earlier, SEBI had mandated certain FPIs (having equity investments meeting an objective threshold) to make additional disclosure requirements (to read our detailed update on that circular, click here). A similar framework has now been implemented for ODI subscribers meeting the following criteria:
- ODI subscriber having more than 50% of its equity ODI positions through the ODI issuing FPI in ODIs referenced to securities of a single Indian corporate group; and
- ODI subscriber having equity positions worth more than INR 25,000 crore in the Indian markets.
Certain entities are exempt from these requirements, e.g., subscribers who are government/government-related investors, public retail funds, university funds, etc. Compliance with the mandatory disclosure requirements must be ensured within five months from the date of the circular.
The intent behind the circular is to introduce stricter reporting requirements to improve transparency in the capital markets. By collecting detailed ownership information, SEBI aims to prevent the misuse of ODIs for indirect control of Indian companies or to bypass regulations. This measure will also help identify potential risks and ensure compliance with investment rules, promoting a more secure investment environment.
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Introduction of Mutual Funds Lite framework for passive funds and Specialised Investment Funds
On 16 December 2024, SEBI introduced a new framework, Mutual Funds Lite (MF Lite), for passive funds. This framework, governed by a dedicated chapter in the SEBI (Mutual Funds) Regulations, 2016 (MF Regulations), allows for the establishment of streamlined mutual funds that primarily invest in index funds, exchange traded funds, or other passive schemes as specified by SEBI.
Sponsors seeking to establish an MF Lite must meet the following eligibility criteria:
- robust track record,
- deemed a ‘fit and proper person’,
- operate as a trust,
- contribute significantly to the Asset Management Company’s (AMC) net worth, and
- no history of fraud or economic offences.
The MF Lite’s AMC also has specific net worth requirements and detailed obligations concerning operations, compliance, investor protection, and the launching of MF Lite schemes, which require board approval and the filing of an offer document with SEBI. Further, trustees of MF Lites must adhere to independence requirements, meet eligibility criteria, and fulfil specific obligations related to investment management, investor protection, and conflict of interest management.
Existing mutual funds (MF) can transition to MF Lite if they plan to launch only MF Lite schemes. This will require relinquishing their existing registrations and following the transition procedure to be outlined by SEBI. The benefits of MF Lite schemes over regular MF schemes are easier entry, reduced costs, and streamlined regulations.
SEBI has also introduced a new category of mutual funds called Specialised Investment Funds (SIF). The minimum investment amount for SIFs is INR 10 lakh (not applicable for accredited investors). SIFs are designed to cater to the needs of high-net-worth investors with greater risk-taking potential by offering flexibility in portfolio construction and larger ticket sizes.
These amendments to the MF Regulations are expected to encourage AMCs to introduce new investment strategies under a more flexible regulatory framework, particularly benefiting those looking to enter the passive fund management space.
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Clarification of framework for investments in overseas mutual funds/unit trusts by Indian mutual funds
SEBI has clarified the framework for Indian mutual funds investing in overseas MFs and unit trusts (UT) and stipulated that the total exposure to Indian securities by such overseas MFs and UTs cannot exceed 25% of their assets. In case the exposure exceeds 25%, a six-month observation period kicks in. During this period, the Indian MF must not make any fresh investments in such overseas MFs/UTs. If the portfolio of the underlying overseas MF/UT is not rebalanced within the observation period, the Indian MF must liquidate its investments within the next six months. While investing, the Indian MF must also ensure compliance with the following conditions:
- all investor contributions must be pooled into a single investment vehicle;
- the corpus must be structured as a blind pool, with all investors having pari-passu and pro-rata rights;
- the overseas MF or UT must be managed by an independent investment manager or fund manager actively involved in all investment decisions;
- the overseas MF or UT must disclose its portfolios quarterly; and
- no advisory agreements must exist between Indian MFs and the underlying overseas MF or UT.
This initiative expands the permissible overseas investments for Indian MFs, reflecting SEBI’s efforts to facilitate easier investment in overseas MFs and UTs while enabling MFs to diversify their international portfolio in a transparent manner.
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Comprehensive review of the Merchant Banker Regulations
In its board meeting held on 18 December 2024, SEBI approved several comprehensive amendments to the SEBI (Merchant Banker) Regulations, 1992. The key changes are as follows:
- Permitted activities: Merchant bankers (MB), excluding banks, public financial institutions, and their subsidiaries, will be permitted to carry out only specified activities relating to the securities market that come under SEBI’s jurisdiction. These include managing public issues, acquisitions, buybacks, delisting, scheme arrangements, underwriting, private placements of listed or to-be-listed securities, international offerings, filing placement memorandums for alternative investment funds, and issuing fairness opinions. Other regulated activities must be conducted only if a separate certificate of registration for such necessary activity is obtained through a separate entity or business unit and compliance will have to be ensured within two years.
- Valuation activities: Currently, MBs are permitted to undertake valuation activities under certain SEBI regulations and other regulatory framework such as the Income Tax Rules, Foreign Exchange Management (Non Debt-Instruments) Rules, 2019 (NDI Rules), and IRDAI (Registration of Indian Insurance Companies) Regulations, 2022. MBs will now be prohibited from conducting valuation activities unless registered with the relevant regulator. Existing valuation assignments will be allowed to be completed within nine months.
- Introduction of categorisation basis net worth: At present, all MBs must maintain a minimum net worth of INR 5 crore. SEBI proposes to categorise MBs into 2 buckets based on net worth. Category 1 will include those with a minimum net worth of INR 50 crore. Such MBs will be permitted to undertake all activities. Category 2 will include those with a minimum net worth of INR 10 crore. Such MBs will be permitted to undertake all activities except public issues of equity shares on the main board. Existing MBs will have a two-year glide path to meet the increased net worth requirements.
- Minimum liquid net worth requirements: MBs will have to maintain liquid net worth of at least 25% of the minimum net worth requirement. This requirement is being introduced to ensure that MBs have readily available funds to meet underwriting obligations and navigate unforeseen market uncertainties. A two-year transition period will be provided for this compliance.
The minutes of the SEBI board meeting also address the legal structures eligible for registration, permissibility of having multiple registrations within a group, underwriting obligations and thresholds, conflicts of interest provisions, qualifications of a compliance officer and designation of a principal officer.
MBs play an important role in the capital market and the amendments proposed by SEBI aim to strengthen the framework by introducing more stringent operational and financial requirements. However, existing MBs will have to adjust to the increased compliance requirements, and those desirous of availing registration may face higher entry barriers.
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Issuance of framework for reclassification of foreign portfolio investment to foreign direct investment
The NDI Rules mandate that the investment made by FPIs (along with their investor groups) in an Indian listed company cannot exceed 10% of the total paid-up equity capital on a fully diluted basis. FPIs in breach have the option to divest their holding or to reclassify them to foreign direct investment (FDI) within five trading days of the breach. In consultation with the Government of India and SEBI, the Reserve Bank of India issued the operational framework for such reclassification of foreign portfolio investment to FDI in a circular dated 11 November 2024.
The key requirements of the operational framework to reclassify investments are as follows:
- FPIs must obtain necessary approvals from the government and consent of the concerned Indian investee company.
- FPIs must ensure that the reclassification adheres to entry routes, sectoral caps, investment limits, pricing guidelines and other conditions for FDI under NDI Rules. Reclassification will not be permitted in sectors prohibited for FDI.
- FPIs must show their intent to reclassify and provide a copy of all necessary approvals to its custodian. Subsequently, the custodian will freeze purchase transactions by such FPIs in equity instruments of the investee company until reclassification.
- The entire investment held by the FPI will be reported in a manner prescribed by the circular.
- Post reclassification of FPI to FDI, the FPI’s entire investment in the Indian company will be deemed as FDI, even if the holding subsequently falls below 10%.
Earlier, FPIs in breach of the 10% threshold had to mandatorily divest their holdings, which often resulted in a loss. This regulatory framework enables FPIs exceeding the prescribed ownership thresholds to reclassify their holdings in accordance with a streamlined framework, reducing inefficiencies. This aligns with India’s broader initiative to streamline regulatory compliance and foster sustained foreign capital inflows.
