Securities and Exchange Board of India's (SEBI) Risk Management Framework enables the Mutual Fund(MF) industry in India to address risk professionally, comprehensively, and competently. If implemented effectively, this would make the Asset Management Companies (AMCs) not only agile and resilient but also help win investors' confidence. Though challenges remain a collaborative effort of AMCs, the Boards, and the industry nodal body—Association of Mutual Funds in India (AMFI), can help fulfill SEBI’s objective of fostering a risk-conscious culture in the MF business.
The growth of Mutual Funds in India in the recent past has indeed been impressive, both in terms of business and the number of investors. Asset Under Management (AUM) of the MF industry has grown to Rs 38.42 lakh crore by the end of September 2022, registering more than a two-fold increase in a span of five years, as per AMFI data.
However, during the past decade there have been significant developments in the MF industry in terms of product innovation, investment in newer asset classes, distribution landscape, technological evolution, investor penetration, awareness, increase in risk elements, etc.
Recognising these developments, SEBI has lately come out with a comprehensive guideline called Risk Management Framework (RMF) which basically aims to foster a risk-conscious culture in the MF ecosystem and has been made effective from 1 April 2022.
SEBI’s Regulatory Directives
With the overall objective of management of key risks involved in mutual fund operations, the RMF provides a set of principles or standards which inter alia comprises the policies, procedures, risk of management functions, its roles & responsibilities, the Board of AMC, and the Board of Trustees.
The objective is to assist the management and the Board of Directors of both AMC and Trustees in demonstrating high standards of due diligence in daily management, promoting proactive management and early risk detection, accountability in the organisation, and managing risk within the tolerance limits defined in the RMF.
Importantly, the elements of RMF have been segregated into ‘mandatory’ divisions which should be implemented by the AMCs, and ‘recommendatory elements' which address other leading industry practices that can be considered for implementation by the AMCs based on relevance.
Risk Management shall be an independent and specific function of the AMC. There should be at least one Chief Experience Officer (CXO) identified to be responsible for reducing risks of specific functions of the AMC/Mutual Fund.
Independent Bodies To Oversee Mutual Fund-Related Risks
The policy of an AMC on risk management of the MF should have clarity on the roles and responsibilities assigned to CXOs and the same needs to be disclosed on their website. Further, AMC should have a Chief Risk Officer (CRO), who would be responsible for the overall risk management of the mutual fund operation including the key risks.
However, for the overall risk management of the mutual fund along with the management, both boards of AMC and trustees should also be responsible. For this, both bodies should mandatorily have separate Risk Management Committees (RMCs). These committees shall undertake an annual review of RMF at both AMC and scheme levels. The CRO should be part of the RMCs.
Risk Control: A Key Criteria for Human Resource Upskil
RMF recognises the critical role of officials and the importance of their performance evaluation and up-skilling. It has stressed the need for the inclusion of risk management as a parameter for performance appraisal of all the officials of the AMC at the level of CEO and up to two levels below CEO.
It also prescribes establishing human resource practices pertaining to hiring, orientation, and training in order to send messages to employees regarding the organisation's expected standards on integrity, ethical behaviour, competence and risk management.
AMC’s Risk Management Function and Its Challenges
While the guidelines of RMF are exhaustive and purposeful, the AMCs are likely to face some challenges, particularly in the short term. Some of these are:
Operating Cost : The compliance cost and expenses for putting in place the required risk management processes, risk-resilient infrastructure, hiring of professionals, training etc. will increase the operating cost for AMCs. The small-sized AMCs may feel the pinch more. Yet, such costs and expenses to AMCs are like the expenses we incur on medicines for good health. AMCs should not see them as financial and compliance burdens but as strong antidotes to fraud, malfeasance, and defaults.
Absence of Risk Management tools: There is often a general indifference or unpreparedness with respect to matters of risk, on the part of the financial institutions, which has led to many scams and business failures. MFs are no exception. Now that RMF mandates the use of risk management tools like scenario analysis, stress testing etc. for risk analysis, quantification and monitoring, AMCs will need to quickly invest in capacity building and embrace appropriate statistical tools, models, and best practices.
Finding domain specialists and professionals: RMF has caught many AMCs unaware and has created an urgency to tap the right professionals and domain experts, particularly at senior levels, to comply with the SEBI guidelines. As most of the AMCs would be in this situation, finding right talent immediately may be a challenge.
Customisation of the risk-related policies: AMCs may have formulated the ‘mandatory’ policies in compliance with the framework with their own internal resources and expertise. The industry body AMFI is also lending a helping hand in crafting policies. Yet, the AMCs would need to ‘customise’ the policies in the light of their own risk assessment, challenges, experiences, learnings, and perceptions to make them really useful.
Need for intensive training: There is an immediate need for AMCs to impart training not only to employees but also to distributors and service providers to build a risk-sensitive ecosystem. Even AMC /Trustee Board members need to be alive, updated and upskilled on RMF-related issues.
If implemented effectively and wholeheartedly, the RMF would make the AMCs not only agile, strong, and resilient but also help win confidence and trust of investors.
(The writer is a Board Member of a finance company. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)