Capital market regulator SEBI plans to increase investor participation in mutual fund schemes to protect retail investors from the impact of selloffs by large investors and corporates. Sebi is likely to increase the minimum number of investors required in a mutual fund scheme from 20 at present and bring down the maximum holding by a single investor from the current level of 25%, said a person familiar with the matter.

It will discuss the proposed changes with industry officials and other stock holders soon, he said, requesting anonymity. The regulator also plans to widen the scope of such rules to the schemes plan and sub-plan levels, he said.

At present, Sebi rules require a MF scheme to have a minimum of 20 investors, with a single investor not owning more than 25% of assets. The rule popularly known as 20-25 rule in MF industry circles is applicable only at the scheme level and not at the plan or sub-plan levels. Typically, a scheme offers different plans that promise faster growth, higher dividends and bonuses. The 20-25 rule is unique to India.

The trigger for the proposed changes is the last years events that saw the mutual fund industry being rocked by sudden withdrawals by large institutional investors, especially in debt schemes, due to a liquidity crunch. Sebi is keen to ensure that redemptions by a few investors do not destabilise the schemes and create a run on the fund, impacting retail investors for whom MFs were designed. Industry officials say corporates own more than 50% of the total assets under management of MFs.

Action of some investors should not be allowed to hurt the interest of other investors who stay invested in a scheme, said a person familiar with the thinking at the regulatory body. Sebi officials feel that last years events could be repeated in the future. Hence, the existing rules need to be modified to address the systemic
imbalance in the structure.

Fund managers come under pressure when large unitholders suddenly press the exit button, as they have to sell a sizable part of their portfolio on short notice. In some cases, they sell some of their prized assets at a discount, hurting genuine investors. According to Sebi, such happenings can upset even the best fund management strategies.

A top fund manager said some fund houses have been getting around the 20-25 rule and have been accommodating corporates to boost their corpus. The 
deal is designed in such a fashion where a corporate routes its money through different investment companies. Greater transparency in terms of disclosures with regard to third-party funds and group firms investment would help investors at large, he said, requesting anonymity.

There should be periodic disclosures on investors and holding patterns. Fund houses must disclose to the public the total number of investors and also details about investors holding more than 5% in a fund, he said. This is the second time that Sebi is revisiting the rules. In 2003, Sebi had framed the 20-25 guidelines both at the scheme and plan levels.

However, the regulator faced opposition from fund houses, with their industry body AMFI requesting the regulator to implement the rule only at the scheme level. The 2008 events have now forced Sebi to cover the loopholes in the system. Last years developments had prompted RBI to open a special facility to banks to onlend to cash-strapped fund houses to meet the redemption needs. On its part, Sebi mandated the listing of close-ended schemes.