The Securities and Exchange Board of India (Sebi) has made it compulsory for mutual funds to buy insurance cover against third-party losses arising out of errors and omissions.
Sebi has issued detailed guidelines on the risk management norms to be followed by mutual funds.
Third-party liabilities refer to those arising out of financial losses to investors or any other third party, incurred due to errors and omissions of directors, officers, employees, trustees, registrar and transfer (R&T) agents, among others. Sebi has also said the R&T agent should be required to take separate cover for errors and omissions.
While the level and type of cover are to be decided by the trustees, it is subject to a minimum level of Rs 5 crore. However, mutual funds with assets of less than Rs 100 crore may take insurance cover for an amount of less than Rs 5 crore as determined by their trustees. The premium for this cover will be according to Sebi regulations.
Custodians are also required to buy separate insurance cover for errors and omissions. At present, some mutual funds purchase insurance to cover first-party losses. First-party losses are those which impact the insured and include asset-based losses as well as financial or data losses. They also include losses due to acts of infidelity by employees of the insured, and computer-based crimes such as hacking or virus attacks that may impact the data of the mutual fund.
Sebi has made it mandatory for funds to have a risk management function assigned to a compliance officer or an internal risk management committee or an external agency. It should also set up disaster recovery and business contingency plans.
The risks identified are those pertaining to fund management, operations, customer service, marketing and distribution and other business risks.
Fund management risks are those arising out of market volatility which affects the performance of the schemes, including portfolio concentration and investment strategies. Customer service risks include errors in deal processing and fraud.
According to Sebi, the risk management function should be separate from fund management and the management should report to the chief executive officer of the asset management company.
The compliance wing of the asset management company has to review all trading activities at frequent intervals. Operating procedures should lay down reconciliation activities and their frequency. At the end of the day, there must be broker confirmation of records of deals and reconciliation of positions with custodian data. At least once a week, there must be a complete reconciliation of fund accounting system records with custodian records, while the fund should have a daily reconciliation practice with banks and other counterparties.
