An order passed by the Securities and Exchange Board of India (SEBI) on Friday regarding a mutual fund run by HSBC in India provides a fascinating example of the advantages of principles based regulation.
Indian regulations require that before a mutual fund makes a “change in any fundamental attribute” of any mutual fund scheme it should not only inform all unit holders but also give them a costless exit option (Regulation 18(15A) of the Mutual Funds Regulations). The regulations do not define what is a fundamental attribute so that absent any further “clarifications” by the regulator, we would have a very sensible principles based regulation.
In 2009, the HSBC Mutual Fund made the following changes in one of its mutual fund schemes, the “HSBC Gilts – Short Term Plan.”
- It changed the name of the scheme to “HSBC Gilt Fund”
- It changed the ceiling on the modified duration of the fund from 5 years to 15 years
- It changed the benchmark index from a sub index covering the 1-3 year maturity to a composite index covering all maturities.
Under a principles based regulation, there is no question that this would be a change in the fundamental attribute of the scheme. In fact, it changes the nature of the scheme so drastically that it is conceivable that many investors in the original scheme might not wish to remain invested in the changed scheme.
Unfortunately, the SEBI regulations were not truly principles based. Way back in 1998, it issued clarifications that replaced the nice principles based regulation with a set of bright red lines by giving a laundry list of things that are fundamental attributes. Neither the change of name, nor the change in the modified duration, nor the change in the benchmark index figured in this list.
The regulator was forced to accept that HSBC was technically correct in claiming that it had not changed any fundamental attribute of its scheme.
The moral of the story is that while principles based regulation is genuinely hard both for regulator and regulatees, rules based regulation is often a farce.