The Securities and Exchange Board of India notified the SEBI (Mutual Funds) (Amendment) Regulations, 2024 on 2 July 2024, introducing a targeted modification to the investment restriction framework governing mutual fund schemes. The amendment creates an exemption to the existing 25 per cent cap on investments in listed securities of sponsor group companies, allowing equity-oriented exchange-traded funds and index funds to exceed this threshold subject to conditions specified by the Board.
Background
Under the Seventh Schedule of the SEBI (Mutual Funds) Regulations, 1996, Clause 9(c) previously stipulated that no mutual fund scheme shall make any investment in the listed securities of group companies of the sponsor which is in excess of 25 per cent of the net assets of the scheme. This restriction was designed to prevent concentration risk and potential conflicts of interest arising from a mutual fund investing disproportionately in securities of entities related to its own sponsor.
However, the growth of passive investment products in India, particularly equity-oriented ETFs and index funds that track benchmark indices such as the Nifty 50 or Sensex, created a structural tension with this restriction. Where a sponsor group company holds a significant weight in the tracked index, the 25 per cent cap could compel the fund to deviate from the index composition, resulting in tracking error that undermines the fundamental objective of passive investment strategies.
Key Provisions
The amendment modifies Clause 9 of the Seventh Schedule with the following operative changes:
Exemption for passive funds: Equity-oriented exchange-traded funds and index funds are now permitted to hold investments in listed securities of sponsor group companies in excess of the 25 per cent net asset cap, provided that such excess investment is undertaken in accordance with conditions specified by the Board.
Conditional relaxation: The exemption is not unconditional. The Board retains the authority to prescribe specific conditions under which the excess investment may be held, ensuring that the relaxation operates within a regulated framework rather than as an open-ended permission.
Limited scope: The amendment applies specifically to equity-oriented ETFs and index funds. Actively managed mutual fund schemes continue to be bound by the 25 per cent group company investment restriction without exception.
Effective date: The amendment came into force on 2 July 2024, the date of its notification in the Official Gazette.
Implications for Practitioners
This amendment resolves a long-standing operational challenge for asset management companies that manage passive products benchmarked to indices where sponsor group companies carry substantial weightage. Fund managers of affected schemes can now replicate index compositions more faithfully, reducing tracking error and improving investment outcomes for unitholders.
For compliance teams at AMCs, the practical impact requires careful attention to the specific conditions that SEBI prescribes for the exercise of this exemption. The conditional nature of the relaxation means that AMCs must establish internal monitoring frameworks to ensure that any investment exceeding the 25 per cent threshold in sponsor group securities is compliant with the applicable conditions.
Legal advisors should note that this amendment does not alter the underlying conflict-of-interest rationale that informed the original restriction. The exemption is narrowly tailored to address a specific structural problem with passive investment products and should not be read as signalling a broader relaxation of concentration limits for actively managed schemes.