AMFI puts in place SOPs to curb front-running at mutual funds

The Association of Mutual Funds in India (AMFI) has unveiled standards for institutional mechanisms for the identification and deterrence of market abuse including front-running and fraudulent transactions in securities at asset management companies (AMCs).

Market regulator Securities and Exchange Board of India (SEBI) earlier this month announced that effective November 1, mutual funds will come under the ambit of the SEBI (Prohibition of Insider Trading) Regulations, 2015, popularly called PIT Regulations.

AMFI has now mandated stricter surveillance to curb front-running—a kind of insider trading where assets are bought and sold ahead of a large transaction in the asset—in mutual fund trades.

Roadmap

The institutional mechanism will be applicable in phases starting with equity mutual funds. By November 2, all trades in equity securities (excluding overseas equities) in mutual fund schemes with total assets under management (AUM) of more than Rs 10,000 crore would come under the ambit of institutional mechanism for identification and deterrence of market abuse including front-running and fraudulent transactions in securities.

For equity schemes with assets less than Rs 10,000 crore, the standards would be implemented by February 2, 2025.

Further, trades of passive schemes, arbitrage schemes and overseas securities across all schemes need to follow the new standards by May 2, 2025, irrespective of the AUM. Lastly, debt securities and all other securities such as commodities, real estate investment trusts and infrastructure investment trusts, etc, would be covered by August 2, 2025.

Key measures

As per the standards, the chief executive officer or managing director or persons of equivalent or analogous rank and chief compliance officer need to put in place an institutional mechanism to ensure compliance with the standards.

AMCs have to develop adequate systems or processes to generate alerts as per the new framework, including for alert generation, processing, examination, escalation and review of the alerts.

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AMCs need to generate the alerts at least on a weekly basis and inform its board of directors and trustees of such alerts and of the results of the examination conducted.

Action against brokers

If the suspicious alerts indicate instances of market abuse by a broker, the fund house needs to take suitable action against such an entity. AMCs needs to provide a report on such instances to the trustees and SEBI on a quarterly basis.

For this purpose, AMCs will have to include an enabling clause in the broker empanelment forms/agreements for any action that may be needed to be initiated/taken against any such broker, including termination without cause.

Personal transactions

As per SEBI, specified employees will include chief investment officers, fund managers, dealers and any other personnel as identified by the AMCs' boards or trustees.

AMCs will now have to formulate written policies and procedures for conducting examination and taking action in case of potential market abuse including front-running and fraudulent transactions in securities by its employees and connected entities.

For all specified employees linked or suspected to be linked with the suspicious alerts, AMCs will review personal transactions in the securities markets executed by these employees and their immediate relatives.

For this, AMCs can seek trade-related data from exchanges and depositories on the basis of the PAN (Permanent Account Number) of the specified employees and their immediate relatives.

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To avoid suppressing any fraudulent activities, AMCs will also have to ensure that the fund managers and dealers go on mandatory leave of at least 10 business days in a financial or calendar year, with not less than five business days' leave at a stretch.

Fund houses will also have to review and update their employees’ guidelines/rules or employment/contract agreements with their employees to incorporate clauses that actions that may be taken in case they are found to be involved in potential market abuse.

Sharing of resources

Further, in order to keep the costs low, mutual fund houses may share know-how related to enhanced surveillance systems, internal control procedures and escalation processes with other AMCs.

This has been a concern for many investors when in some recent cases it was observed that when some mutual fund schemes’ net asset values fell sharply or suffered due to bad decisions by fund managers, the investors got stuck with the aftermath but some senior officials were later found to have withdrawn their own personal units in advance, sensing problems ahead.

Credit - Money Control