Balancing Flexibility and Investor Protection: A Critical Review of SEBI’s Proposed Reforms for Asset Management Companies
I. Introduction
Mutual Funds have been one of the most optimal and accessible investment instruments for retail investors for the last few decades in India, offering the benefit of professional fund management and diversification of risks. Under the current SEBI (Mutual Funds) Regulations, Asset Management Companies (‘AMCs) that operate mutual funds (‘broad-based funds’) are restricted from providing any services to funds with less than 20 investors (‘non-broad-based funds’) in order to ensure investor protection. To reconsider these restrictions on Asset Management Companies, SEBI released a consultation paper titled ‘Consultation Paper on Review of Regulatory Framework on Permissible Business Activities for Asset Management Companies (AMCs) Under Regulation 24 of The SEBI (Mutual Funds) Regulations, 1996’ on 7th July, 2025 (‘Consultation Paper;). The primary objective of the Consultation Paper is to allow AMCs to widen their businesses by providing these services to non-broad-based funds as well, while trying to ensure the retail investor’s interest and ensure systemic integrity.
This piece aims to critically engage with the proposals of the consultation paper and constructively review the same. While the authors appreciate SEBI’s approach of liberalising financial institutions for promoting ease of doing business, it is equally important to ensure that such liberalisation does not undermine investor protection or create market asymmetries. The Consultation Paper has mentioned a number of proposals, and in order to limit the scope of the discussion, the authors will deal with four key proposals: the role of the Unit Holder Protection Committee (‘UHPC’), the 70% portfolio replication requirement, the prohibition on inter-business security transfers, and the proposed fee cap structure. In the opinion of the authors, each of these areas exposes potential lacunae that deserve a closer examination.
II. Background of the problem
Regulation 24(b) of the SEBI (Mutual Funds) Regulations, 1996, restricts AMCs from ‘undertaking any business activity other than in the nature of management and advisory services provided to pooled assets’. These are funds with at least twenty investors and no single investor holding more than 25% corpus in the fund. The framework was initially introduced in 2011 with the objective of preventing any conflict of interest due to differential fee structures and protecting retail investors from bearing the costs of the non-broad-based funds, where the clients are High Net Worth Individuals (‘HNIs’).
Over the years, AMCs and the Association of Mutual Funds in India (‘AMFI’) have vouched to liberalise these restrictions on AMCs. They argue that the broad-based requirement makes it costly and tough for non-broad funds to leverage their fund from the management expertise of the AMCs providing services to the broad-based funds.
III. Overview of the Consultation Paper
In response to these concerns, SEBI’s consultation paper proposes overhauling Regulation 24(b) to allow AMCs to provide their services even to the non-broad-based funds directly, subject to several restrictions. The consultation paper aims to find a middle ground to protect investors and promote ease of doing business, especially with the extraordinary growth of the Indian Financial Market.
SEBI acknowledged the critical concerns that could arise regarding the safeguarding of retail investors in case AMCs are allowed to manage both mutual fund schemes and pooled non-broad-based funds. These include resource diversion, where fund managers may be diverted from mutual funds to non-broad funds in the pursuit of getting higher fees, leading to suboptimal returns for retail investors.
SEBI also raised its concerns regarding market abuses, such as front-running, insider trading, and contrary trade positions. In order to address these challenges, SEBI proposed several suggestions to create an optimal market for both retail investors as well as HNIs. Among the various suggestions, four proposals merit special attention due to their importance in the creation of a free and fair market while safeguarding investors’ interests.
Firstly, a portfolio replication requirement is mandated by SEBI in the scenario where the same manager is proposed to provide services to both broad-based as well as non-broad-based funds. A common manager can only be allowed if at least 70% of the portfolio value is replicated across the funds with similar investment objectives.
Secondly, the paper places a cap on the fee differentials for such AMCs along with absolute restriction on performance-linked fees. SEBI provided two approaches: either a cap and floor on the absolute fees chargeable to pooled non-broad-based funds, or a cap on the difference in fees compared to similar mutual fund schemes.
Thirdly, the paper suggests that the UHPC should have an enhanced role. The UHPC would be in charge of reviewing the fee differences between pooled non-broad-based funds and similar mutual fund schemes periodically. It will also review the decisions about the allocation of resources and ensure that all the changes are justified, documented and within SEBI’s limits. The AMC’s Board of Directors, trustees and SEBI shall get a report of UHPC’s filings.
Lastly, in order to avoid any conflicting interest, SEBI mentioned that any transfer of assets between mutual fund schemes and non-broad-based funds must be restricted to eliminate the risk of fraud, low liquidity or offloading illiquid assets from one business segment to another, especially at the cost of retail mutual fund investors.
IV. Analysis
In the view of the authors, some of SEBI’s suggestions suffer from significant practical limitations and structural flaws. Addressing the same is required to protect the retail investors and overall market functioning from the material risks. The authors have mentioned these practical limitations and provided recommendations for the same below. These recommendations will help policymakers to create a fairer market for retail investors.
A. 70% replication rule
As mentioned earlier, in order to avoid duplication of staff and additional cost associated with segregation of the fund managers, the SEBI proposes that the same fund managers may be allowed to manage both the funds, provided that both funds have the same investment objective and 70% of the portfolio is replicated across the funds. However, the term ‘same investment objective’ is prone to broad interpretation. For example, if the investment objective of the fund is to generate ‘long-term capital appreciation from a diversified equity instrument’, then this potentially could encompass both a low-risk Nifty 50 fund and a high tactical fund targeting special situations but falling under the broad objective. Despite similar stated objectives, the actual portfolio strategy may vary for both funds.
Further, the levy of 30% allows the fund managers to reserve their best ideas or early access opportunities for non-broad-based fund clients.. For example, fund managers may allocate high growth opportunities such as pre-IPO, exclusive block deals, or tactical early entries in small and mid-cap stocks early and disproportionately to non-broad-based funds. This is not a far-fetched concern, since pooled non-broad-based clients would typically be HNIs and Institutional investors with higher risk tolerance, managers would have a natural incentive to channel such trade into their portfolio, thereby, in a way, creating a two-tier structure of opportunity access. Logically, this means that the retail investors would remain invested in the safer basket; the upside potential of innovative trades is selectively reserved for non-broad-based clients. This creates room for preferential treatment of selective investors, which goes against the spirit of SEBI’s objective of equitable treatment.
Additionally, the protective cover extended to retail investors in the form of no directionally opposite trades also appears to be insufficient. While it prevents the most obvious conflicts, i.e. taking a long position in one fund short position in another, it does not address the other indirect mechanism of preferential treatment. For instance, a manager may execute a trade in the pooled fund before replicating it in the mutual fund, thus giving the former the advantage of better pricing. Similarly, when the price of stock starts degenerating, the manager would prioritise exiting the position in the pooled fund while leaving the mutual fund investors exposed for longer. Another possibility includes exclusive allocation of IPOs or QIPs to non-broad-based fund clients, depriving retail investors of equal access. These scenarios demonstrate that simply banning opposite trades does not eliminate the risk of indirect but significant biases in allocation and timing.
To effectively address this concern, it is suggested that SEBI may increase the replication threshold to 85% or 90% to reduce the performance disparity. A higher threshold reduces the discretion room for fund managers to divert their lucrative ideas to non-broad-based fund clients. For example, if two funds are required to be 90% identical in portfolio composition, the remaining 10% discretionary bucket is much smaller and less likely to generate materially different outcomes over time. Further, SEBI may adopt a standardised definition of investment objective for shared managers along with a mandatory external audit of trade allocation to prevent any vague equivalence, which will, in turn, enhance greater trust and accountability.
B. Differential fee justification and inadequate monitoring mechanism
SEBI proposes a cap and floor price on the fee structure and requires justification for any difference in fee based on complexity, customization, mandate, etc. However, these terms remain undefined and broadly worded, thereby allowing fee differences to be easily justified using internal documentation, which ultimately weakens the intended transparency. For example, a non-broad-based fund may be classified as ‘complex’ merely because it invests in unlisted debt and pre-IPO securities, even though the actual cost of research is similar to that of a mutual fund equity scheme. Likewise, ‘customisation’ may be cited as a reason for charging high fees, even though there are only minor tweaks in the portfolio composition. These kinds of justification allow fee differences to be inflated or deflated at will undermining the transparency SEBI seeks to achieve.
Further, as a safety measure, SEBI has suggested the requirement of a periodical review of fee differentials or resource allocation by the Unit Holder Protection Committee (‘UHPC’). However, the UHPC is composed of members appointed by the AMC Board itself, thus unlikely to act independently and take an adversarial stance.
Further, the UHPC only has the power to observe, suggest and recommend anything regarding the issues. It has no authority to block any investment or halt a fee schedule. Even if a conflict is flagged, the AMC Board retains the power to override its recommendations, reducing the UHPC to a mere reporting body without real enforcement capability.
In order to prevent this, it is suggested that SEBI may consider mandating external validation of fee justification. While the authors understand that such a measure could result in possible delays or administrative inefficiencies, it could be implemented in a calculated manner. For instance, third-party validation would only be mandated for a fee structure that diverges beyond the threshold (say, over 20% of the benchmark premium). This ensures that routine fee differentials are still reviewed internally, while only outlier or high-impact cases undergo third-party scrutiny. Additionally, mandatory disclosures by AMCs regarding resource allocation ratios and cost attribution across schemes can further enhance the transparency and avoid the risk of arbitrary fee differentials.
C. Asset transfer prohibition
SEBI has inter alia proposed that the transfer of securities between pooled non-broad-based funds and mutual fund schemes may not be allowed. Here, the intention of SEBI is to prevent any unfavourable transfer of bad or low-quality assets to mutual fund schemes. However, the SEBI here only bans the direct transfer of assets between schemes, leaving the way open for any indirect transfer via market-based mechanisms. For example, the AMC could sell the risky or illiquid bonds held in a pooled fund to a third-party broker and then, a few days later, repurchase the same by the mutual fund scheme of the same AMC, thereby resulting in a round-tripping of assets through market-based intermediaries.
To address this concern, the SEBI could implement cross-scheme tracking with a mandate of reporting any repurchase made by the mutual fund of the same AMC within a period of 15 days, with an adequate justification for such a repurchase. While such monitoring may strain SEBI’s supervisory resources, it can be effectively managed through a blended approach of self-reporting by AMCs, supplemented by SEBI’s selective audits. This ensures that the entire burden of monitoring does not fall solely on SEBI but is instead distributed under a compliance-first regime, where AMCs are required to self-report potential conflicts, subject to random audits or spot checks. Such a framework would enhance scrutiny while avoiding undue administrative inefficiency. This measure would also add a layer of transparency and accountability on AMCs regarding any transaction they execute.
V. Conclusion
Although the Consultation Paper of SEBI is a step forward in helping to increase operational flexibility of the AMCs, the suggested framework needs more enforcement to eliminate the risk of regulatory arbitrage and safeguard the retail investors. The analysis by the authors points at certain loopholes in the propositions of SEBI namely the 70% replication rule, the justification of varying fees and asset transfer bar that loopholes and enforcement shortcomings can erode the security of investors.
The paper adds to the existing literature by going beyond the descriptive analysis of the Consultation Paper of SEBI and giving a systematic review of how it was designed to work, govern and enforced. It facilitates the gap between the regulatory purpose and the ground-level realities of implementation, providing a useful perspective on the extent to which the protection of investors can co-exist with liberalisation.
Moving ahead, SEBI may consider carrying out pilot projects to see how the suggested reforms may be enacted and how to use the limited AMC to work under a dual-management system where they would be able to find the real issues in tracking the replication threshold, fees, as well as allocation of resources. The regulator can also constitute a permanent advisory panel whereby the representatives of the AMCs, investor associations, and independent experts will regularly analyze the effectiveness of these reforms and recommend the calibrations using market data. These measures would not only guarantee regulatory flexibility but would build an evidence-based framework on how to perfect AMC governance in India.
* Arihant Sethia is a 4th year BCom. LLB student at the Gujarat National Law University. Keshav Kulshrestha is a 5th year BA LLB student at the Institute of Law, Nirma University.