MThe Association of Mutual Funds in India (AMFI) has put out minimum standards to prevent front running and market abuse by asset management companies (AMCs).

Earlier this month, SEBI had come out with a circular asking AMCs to put in place an institutional mechanism to deter such activities.

The standards will be implemented phase-wise beginning November for equity schemes with assets of over ₹10,000 crore and from February for schemes with a lower AUM. Rules for passive, arbitrage and overseas schemes will become applicable from May while that for debt and other schemes will get effected from August next year.

3-tier alerts

AMCs have to generate 3-tier level alerts on suspicious trading activity every week and create standard operating procedures to review these. The first set of alerts will be based on participation volume and volume weighted average price of large caps, mid-caps and small-caps. Next, price movements during deal execution and block trades as well as scrip volumes traded one hour before the AMC’s trade will be taken into account. Alerts identified as suspicious will then be probed further.

AMCs will review all recorded communication of key employees, entry logs of AMC premises and CCTV footages to examine suspicious alerts. Biometric access to dealing rooms will be mandatory.

While mutual fund employees do take prior approval from their compliance teams before placing trades, AMCs can review their transactions and that of their immediate relatives if linked to suspicious alerts and access trade related data from exchanges and depositories basis their PAN.

AMCs can also initiate action against brokers linked to suspicious alerts. To that end, broker empanelment agreements will now include a clause to allow for actions against front-running, including abrupt termination of services.

“How much time did it take to execute the AMC’s trade? If the share price was ‘X’ when the instructions for the trade was given and rose to ‘Y’ at the time of execution, one has to examine the reasons for the same. This is complex data as a number of factors could have led to the price increase and the AMC has to differentiate between suspicious and non-suspicious trades,” said an industry official.

The person added that the regulator was especially keen that the time lag between the instruction and execution be minimal, especially for large-cap stocks.

An email sent to AMFI did not get an immediate response.

Compliance cost

To be clear, SEBI will continue with its own surveillance on AMCs and their trading activity. The regulator had recently found irregularities in the management and investment practices of Quant MF.

“The new norms will raise compliance cost and put additional obligations on AMCs. The software to track some of the data is expensive and the industry is trying to get it directly from exchanges for level two alerts,” the official said.

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