For the second time in as many months, SEBI tightened the regulation of mutual funds during the last week. There are two major announcements made by SEBI with respect to mutual fund regulation. Here are the highlights of the SEBI announcement.

· In a major move towards transparency, SEBI only wants mutual funds to invested paper; both debt and equity. This is aimed at discouraging mutual funds from investing in opaque companies. Any investment in unlisted company equity or in debt that is in the form of private debt is not permitted any longer. In the last few months, large mutual funds had to freeze redemptions on their fixed maturity plans (FMPs) due to investments in illiquid paper where the issuer was on the verge of default. Listed debt paper has to be automatically rated by a rating agency. So, now cases like Zee, Dewan Housing and Jet where promoters struck private deals with fund managers, will not be possible any longer. This will help protect the interests of the investors.

· SEBI also wants the debt funds to reduce their exposure to unrated debt; albeit in a phased manner. All debt funds holding unrated paper in their portfolios will have to reduce their exposure to such unrated paper from the current 25% to 5% in a phased manner. A lot of such privately agreed debt (where promoter funding was structured as bonds) will have to be wound up. While that could create short term pain in markets, the regulator is of the view that it would clean up the system once and for all.

On the positive side, the regulator has also permitted mutual funds to collect upfront fees but such fees will have to be fully disclosed and will have to adhere to the standard guidelines laid down by the regulator. The stringent MF norms may appear to be tough on the funds but it could be the right step from the perspective of investors. At Rs.25 trillion, Indian MFs are too big to be left with such minimal regulation. When they manage such a huge corpus, checks and balances are a must.