TaxTMI 
TaxTMI 
Risk Management Framework (RMF) for Mutual Funds
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....ng in the area of product innovation, investment in newer asset classes, distribution landscape, technological evolution, investor penetration and awareness, increase in risk elements, etc. Accordingly, it has been decided to review the extant Risk Management Framework for Mutual Funds. The matter was deliberated in the Mutual Funds Advisory Committee (MFAC) based on the inputs received from the mutual fund industry. The recommendations of MFAC have been suitably incorporated in the Risk Management Framework for mutual funds. 3. With the overall objective of management of key risks involved in mutual fund operation, the revised Risk Management Framework (RMF) shall provide a set of principles or standards, which inter alia comprise the policies, procedures, risk management functions and roles & responsibilities of the management, the Board of AMC and the Board of Trustees. 4. The detailed RMF for mutual funds are placed at Annexure-A. 5. The elements of RMF, wherever applicable, have been segregated into 'mandatory elements' which should be implemented by the AMCs and 'recommendatory elements' which address other leading industry practices that can be considered fo....
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....mework must communicate and consult with stakeholders throughout. f. Protect reputation. ii. The objectives of RMF should assist the management and the Board of Directors of both AMC and Trustees in: a. Demonstrating high standards of due diligence in daily management. b. Promoting proactive management and early identification of risk. c. Assigning and increasing accountability and responsibility in the organization. d. Managing risk within the tolerance limits defined in the RMF. iii. The RMF of mutual funds shall comprise the following components: a. Governance and Organization. b. Identification of Risks. c. Measurement and Management of Risks. d. Reporting of Risks and related Information. 1.1 Governance and Organization i. Risk Management shall be an independent and specific function of the AMC. ii. There should be at least one CXO level officer identified to be responsible for the risk management of specific functions of the AMC/Mutual Fund. For instance, there should be dedicated risk officers for various key risks such as Investment Risk (by Chief Investment Officer),....
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....heme and the AMC level and assist the board of AMCs and trustees in discharging their duties in this regard. 1.1.1 Risk Management Policy The risk management policy can be a macro level description of risk management governance (including roles and responsibilities of the Board of AMC and the three lines of defense - Management, Risk Management Team and Internal Auditor), the organization's risk appetite and key elements of its risk management process. The policy on the RMF shall be approved by the board of AMC and trustees. The mandatory and recommendatory elements for inclusion in the risk management policy, approved by the board of AMC and trustees, are outlined below: 1.1.1.1 Mandatory Elements i. There shall be an approved policy on the RMF both at AMC and scheme level. ii. A risk appetite framework should be in place at both AMC and scheme level. Quantification of the framework in the form of a metric for key risks shall include but not limiting to credit risk, market risk and liquidity risk, etc. and targeted path of improvement. The metric, wherever applicable, should incorporate an appropriate benchmark vis-à-vis which the measurements....
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....ramework. iii. Periodic monitoring of risk appetite versus actual risk at scheme level. iv. Event based monitoring of Risk appetite versus actual risk at scheme level. v. Define specific responsibility of the management, including CEO vi. Approval for policy for risk based KRAs and KRAs at level of CEO and up to one level below CEO. Suggest modifications in KRA outcomes and link compensation to those KRAs. vii. Review of actions taken by Board of AMC and management in respect of risk management. viii. Reporting of material risk related observations to SEBI on periodic basis. ix. Setting up of the risk management function and developing appropriate structures and procedures to ensure that it can function independently. x. Approving a methodology for Board Evaluation of the RMF (either through outsourced or self-assessment) on an annual basis. xi. Annual review of effectiveness of the AMC and/or management's risk management function and policies including risk metrics to address the risk outcomes. xii. Trustee may recommend reduction/ change in the risk level of the schemes within the Potential ....
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.... to him on a monthly basis b. define specific responsibility of CIO and CXO regarding risk management c. define a risk appetite framework for schemes and AMC. d. define appropriate risk metric for respective CXO, CIO, fund manager, etc. e. ensure adherence to the guidelines pertinent to SEBI in respect of RMF and relevant principles thereunder including risk identification, risk management, risk reporting (both periodic and escalation of material incident) and corrective actions taken, if any. f. The CEO shall approve the corrective action on various findings and report to the board of AMC and trustee regarding the same and also escalate to board of AMCs and trustees, if required, any major findings being reported. 1.1.2.2.2 Risk Management - Role of Chief Risk Officer (CRO) i. The CRO shall be responsible for ensuring that there is an effective governance framework and reporting framework of risk management in line with the regulatory requirements. ii. The risk management roles of the CRO are as under: a. Implementation of Risk management framework across the organization. b. Review specific respon....
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....ions taken, if any, to the CEO and the CRO. 1.1.2.2.4 Risk Management - Role of other CXOs i. The CXOs shall be responsible for the governance of the respective risk types. ii. In respect of respective risk type, CXO should ensure: a. Adherence to the guidelines pertinent to SEBI in respect of RMF and relevant principles thereunder including risk identification, risk management, risk reporting (both periodic and escalation of material incident) and corrective actions taken. b. Defining specific responsibility regarding risk management of key personnel reporting to them. c. Maintaining risk level as per the risk metric. iii. The CXOs shall take immediate corrective action for non-compliance or major finding post approval from CEO as per DoP and shall report to CRO regarding the risk reports. iv. The CXO shall escalate to CEO and the CRO any major findings reported by respective risk management function. 1.1.2.2.5 Risk Management - Role of Fund Manager (FM) i. The FM shall be responsible for daily management of investment risk of managed scheme(s) such as market Risk, liquidity Risk, credit risk and other s....
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....tsourced activities) both at the scheme and AMC level. 1.3 Measurement and Management of Risks 1.3.1 AMC should have approved internal policy for measurement of various scheme specific risks (such as governance risk, investment risk, liquidity risk, credit risk) through appropriate risk metrics. 1.3.1.1 It should reflect the Risk-O-Meter and the PRC of the scheme vis-a-vis the scheme benchmark. 1.3.1.2 The policy should have the defined guidelines regarding the appropriate risk metric with role clarity depending on the responsibility of each person. 1.3.2 AMCs should have approved internal policy for measurement of organization wide risk like operational risk, technology risk, legal risk, talent risk, outsourcing risk, etc. 1.3.3 Having identified and documented the applicable risks, the risk management function should develop process/tools to measure and manage those risks. For this purpose, the following needs to be considered for each risk category: i. Ascertaining the measurement criteria for each risk category (qualitative and quantitative criteria). ii. Documentation of measurement tool(s) for each risk category, i.e. Risk and Control Self-....
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....representation of the internal audit report. This number shall be generated considering all key risk types. f. Further, this number shall be compared in subsequent internal audits to analyze the improvement in minimizing the non-compliance level at the AMC. This shall reflect the degree of rectification of non-compliance as done at the level of AMC. Therefore, this number may be represented in the form of a "Rectification Index" in the internal audit report. iii. There shall be an RCSA process with defined frequency. iv. There shall be an established mechanism for reporting to the CRO, management and the Board of AMC and Trustees. v. Periodic review of policy frameworks shall be done to ensure that the said policies are up-to-date responding to new strategic priorities and risks and the monitoring mechanisms are working to ensure compliance with the updated policies. vi. Mechanisms are established for management to make use of early warning indicators to identify, evaluate, and respond to changes quickly. vii. Periodic stress tests are performed on critical risks and the impact of risks are assessed based on acceptable tole....
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..... It should provide information on existing as well as new risks including a statement on severity (e.g. low, medium, high) and its evolution over time, and the measures to mitigate existing risks where possible. iv. The Risk management function shall ensure that any significant emerging risk issues that are not adequately addressed by the responsible functional department are promptly reported to the management or the risk management team and to the Board of AMC. 2.0 Managing Key Risks a. SEBI (Mutual Funds) Regulations, 1996 vide various circulars has prescribed certain norms which would cover many aspects of risk management such as, stress testing, internal credit risk assessment, cyber security and system audit, liquidity buffer, creation of segregated portfolio, investment restrictions, investment due diligence, etc. that are to be adhered to by the mutual funds. The following sections incorporate comprehensive guidelines for management of various key risks by the AMCs, elements of which may overlap with the above mentioned norms and in such cases, the detailed norms specified in the relevant circular must be strictly followed. b. These key r....
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....ns and concentrations. These limits should include the investment restrictions mentioned in the fund's SID as well as any limits and restrictions imposed by the risk management function within the regulatory limits. Risk control activities may include reviewing portfolio concentrations and adjusting portfolio holdings accordingly; evaluating and reviewing new and/or complex instruments, such as derivatives, and imposing conditions and limits on their use; monitoring and limiting credit exposure from issuers of portfolio securities and from counterparties; and ensuring that a fund is managed in compliance with the SID and the regulatory investment restrictions. 2.1.5 The mandatory and recommendatory elements for managing investment risk, are outlined below: 2.1.5.1 Mandatory Elements i. The AMC should have the following policies / process: a. An investment universe to be updated periodically and responsibility for the same should be clearly defined. b. An investment policy for investment in various asset classes/ securities as permitted by SEBI from time to time and policy on hedging of interest rate risk, foreign exchange risk, price risk, etc. ....
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....adequate information to identify those allocations that are out of line with the normal percentage allocation across funds. i. Quantitative risk analysis using metrics such as VaR, Sharpe Ratio, Treynor Ratio, Information Ratio, etc. j. Prepare and maintain management reports on topics discussed and conclusions made at investment committee meetings (including interest rate prospects, risk-taking and hedging policy, etc.) k. Distributor concentration analysis. v. Further, it should be ensured that: a. Actual risk measures and reports are adapted to the risk characteristics of the individual asset classes, and capture dependencies between risks (e.g. market risk and liquidity risk). b. Actual risk measures address risks in normal and stressed market conditions. c. Actual risk measures cover all risk types in the portfolio, including counterparty credit and liquidity risks (assets, investors). d. Appropriate tools are adopted for measurement of market and credit risks on different types of investment products. e. Adequate processes and controls are in place to ensure that risk reporting is complete, accur....
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....rts generated, the AMCs shall take appropriate measures and report the same to trustees. e. Concentration limits (counterparty wise, group wise, industry or sector wise, geography wise) monitoring. f. Stress testing for credit risk - applying shocks based on rating downgrades, negative outlook on specific industries and the consequent impact on credit exposures. 2.2.2.2 Recommendatory Elements i. Over a period of time and having regard to the size, scale and complexity of the fixed income portfolio, AMCs may consider developing sector level standards for implementing internal credit assessment based models to measure credit risk in line with the prevailing global best practices. 2.3 Liquidity Risk 2.3.1 Thinly traded securities carry the danger of not being easily saleable at or near their real values. Further, all securities run the risk of not being saleable in tight market conditions at or near their real values. Measuring and monitoring liquidity risk is an important aspect of risk management. 2.3.2 The mandatory and recommendatory elements for managing liquidity risk, are outlined below: 2.3.2.1 Mandatory Elements i. Liquidity Risk ....
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....s as per point-(a) above. c. The policy shall include monthly reporting to Board of AMC and Trustees and on quarterly basis to SEBI in a standard format (to be prescribed by AMFI in consultation with SEBI). d. The report shall include the details of alerts generated by the system regarding asset liability mis-match in excess of the defined threshold and subsequent actions taken to address the same. The scheme wise mis-match limits shall be put in the system and all alerts shall be managed effectively. iii. Stress testing should be mandatorily conducted for all schemes (excluding close ended and interval schemes) appropriately atleast on monthly basis. The results of the stress testing may be placed before trustees in every quarter. Trustees may forward the results along with their comments and steps taken, if any, to SEBI in the half-yearly trustee reports. With respect to stress testing of open ended debt schemes, norms have been provided vide SEBI circular No. CIR/IMD/DF/03/2015 dated April 30, 2015 and SEBI circular No. SEBI/HO/IMD/DF3/CIR/P/2020/229 dated November 6, 2020 and the same must be adhered to and any future guidelines issued by SEBI in this....
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....ong with having a direct impact on debt issuances. 2.4.2.1 Mandatory Elements a. The AMC shall have an approved policy to deal with governance risk of the investee companies. b. The policy shall incorporate measures such as assessment of whether there are enough system checks and balances in the governance structure of the issuer to prevent such wrong doing and also assessment of track record or history of the issuer to monitor the trend of their past behavior. c. The policy shall also include guidelines on how it identifies and monitors any conflicts of interest involving members of the Board/ KMPs of the investee company. d. The AMC shall adhere to the "Stewardship Code" prescribed by SEBI for mutual funds which inter alia includes continuous monitoring of the investee companies on various matters such as operational and financial performance, corporate governance, related party transactions, opportunities or risks including ESG risks, etc., bearing in mind the insider trading Regulation while seeking information from the investee company for the purpose of monitoring etc. 2.5 Operational Risk 2.5.1 Operational risk refers to the risk ....
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.... product approval' process to ensure that all functions have the systems, people, processes to support a new product 11. Recording and documentation. b. The Dealing room policy incorporating the non- usage of mobile, restricted internet access, dedicated recorded lines, handling of information, etc. In this regard, the detailed guidelines on this aspect as provided in SEBI circular SEBI/HO/IMD/DF2/CIR/P/2020/175 dated September 17, 2020 as well as in the part B of Fifth Schedule of SEBI (Mutual Funds) Regulations, 1996 or any further SEBI guidelines may be referred to. c. Roles and responsibilities are defined for the following: 1. Time stamping, application processing and confirmation, 2. Review of KYC and investor declarations as specified through various SEBI regulations, 3. Timely and accurate credit identification (for investor subscription) and bank reconciliations (banks/custody). 4. A system to track and report high value transactions (including bulk redemptions) to the Investment management function. 5. Control oversight on brokerage computation and payment, redemptions, inter-scheme switches, matu....
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....ave an integrated system (front-mid-back) to perform the following functions: 1. Order generation 2. Position-keeping (Positions on all supported products are updated in real time). Trades can be accounted for by an electronic feed. 3. Pre-trade compliance checks 4. Order execution 5. Deal booking 6. Straight-through processing to allow one-time capture of trade details. 7. System check on preset parameters and reporting of breaches e.g. whether investments made in permitted securities or limits on deal size, etc. have been adhered. 8. Automatic time-stamping of deals. 9. Maker-checker authorisations. 10. Exception reporting. 11. Generation of deal confirmations. 12. Monitoring of outstanding confirmations, settlements and payments. 13. Cash management. 14. Integrated reporting across the Mutual Fund. 15. The back office system should facilitate daily fund projections to ascertain liquidity and settlement requirements. h. The AMC should have documented procedures for the following: 1. Trade confirmations, settlements. 2. C....
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....an objective to catch early warning signs for fraud or any systemic issues. d. Related Party Transactions. e. Front running f. Conflict of Interest. g. Employee Trading (including issues related to Insider Trading). h. Code of Conducts. i. Commission and other sales & marketing costs. j. Commercial Bribes or Kickbacks. k. Fraud Risk Management l. Whistle Blowing m. Information Security and Data Privacy n. Gifts and Entertainment o. Record Retention p. Dealing Room Policy q. All disclosure requirements (including derivative transactions, off balance sheet items and contingent liabilities, etc.). ii. There should be defined responsibilities for: a. Filing of timely and accurate regulatory reports to the Regulator(s) and Board of AMC and Trustees as prescribed by the applicable laws and regulations. b. Pre-use review of AMC's marketing materials (collateral, brochures etc.), website uploads, digital advertising and performance advertising etc. c. Monitoring that all investments and holdings are consistent with disclosures mad....
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.... dependence on technology, any system failure could trigger a variety of risks, e.g. operational risk, compliance risk. etc. Technology Operations should support processing and storage of information, such that the required information is available in a timely, reliable, secure and resilient manner. 2.7.2 Increasing disclosure requirements on public portals by AMCs required a focused approach towards data management. Digitalization and online platforms have given rise to need for effectively mitigating information security and cyber risks. SEBI vide circulars, SEBI/HO/IMD/DF2/CIR/P/2019/12, SEBI/HO/IMD/DF2/CIR/P/2019/57, SEBI/HO/IMD/DF2/CIR/P/2019/58 dated January 10, 2019, April 11, 2019 and April 11, 2019 respectively has provided indicative guidelines encompassing cyber security and cyber resilience framework and audit framework encompassing systems and processes for Mutual Funds/AMCs. The systems and processes as elaborated in the aforementioned circulars must be in place and any future guidelines issued by SEBI in this regard may be suitably followed. 2.8 Reputation and Conduct Risks 2.8.1 The risk of damage to the firm's reputation that could lead to negative ....
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....duct risk indicators. c. Incorporating conduct performance as part of the AMCs' sales and marketing team metrics. 2.9 Outsourcing Risk 2.9.1 Inadequate management of outsourced processes lead to errors, frauds, Inefficiencies, poor quality investor services, breach of fiduciary duties data pilferages and long term impact on reputation and contractual obligations. 2.9.2 Asset management companies often rely on third parties including Custodians, Fund Administrators, R&T agents, and various types of outsourced service providers who perform operational, accounting, recordkeeping and other types of services. In utilizing the services of such third parties, it is important from a risk management perspective to keep in mind that asset managers have ongoing fiduciary obligations to their customers even though they have delegated certain of their roles to others. It is therefore critical to perform careful reviews of the capabilities of third parties at inception of relationships and on an ongoing basis, and to review information provided by third parties for completeness, balance and accuracy in order to be able to determine whether such third parties meet the risk manag....
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.... execution capabilities 4. A disaster recovery and business continuity plan exist with regard to the contracted services and products, and that the adequacy and effectiveness of the same is maintained and tested periodically by the service provider. c. Analysis of the benefits and risks of outsourcing the proposed activity as well as the service provider risk, and determination of the cost implications for establishing the outsourcing arrangement. v. After outsourcing any activity, the AMC shall ensure: a. Outsourcing vendors' process/people/systems are reviewed. b. A periodic internal review is done on the functioning of outsourced activities (like Fund Accounting and R&T agent functions) at least annually. c. An effective structured tool (IT / manual) is used to review/benchmark the performance of the third party service providers (Fund Administrators / Custodians / R&T agents) vis-a-vis the SLA. d. The result of the review documented and risks emanating from them are highlighted and remediation plans are monitored on an ongoing basis. e. Communication of its error tolerance, code of conduct and objective to ....
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....the portfolio of investors, analysis based on assessment of appropriateness to the investors, etc. As an example, a parameter to gauge mis-selling may be the analysis of whether growth in the AUM of a scheme is on account of performance or mainly due to higher commission paid to distributor. ii. The AMC shall also be responsible for the mis-selling done by the persons associated with selling of mutual funds including distributors. The performance disclosure to investors, if any, by the distributors should be true and fair. It should not be misleading to the investor by representing any selective time period representing the favorable return. iii. Detailed analysis should be done at the AMC level to verify mis-sellings, if any. iv. All the sales staff and distributers must be NISM certified with the required qualifications prescribed by SEBI/AMFI. v. The AMC must implement the following procedures relating to distributor commissions: a. Analytical tools/ audit procedures used to review trends/errors in brokerage/ commission disbursements. b. An approved methodology for determining commission structures applicable to distributors ....
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....y: i. A defective transaction. ii. A claim (including a defense to a claim or a counterclaim) being made or some other event occurring which results in a liability for the institution or other loss (for example, as a result of the termination of a contract). iii. Failing to take appropriate measures to protect assets (for example, intellectual property) owned by the institution. iv. Change in law v. Misinterpretation of statutes and regulations. vi. Failure to collect or pay appropriate taxes, or submit required returns or information. 2.12.2 The mandatory elements for managing legal and tax risk, are outlined below: 2.12.2.1 Mandatory Elements i. The AMC should have documented processes and defined responsibilities for: a. Calculation and deposit statutory levies applicable to Mutual Funds. b. Acceptance of applications from permitted jurisdictions. c. Monitoring of risks emanating from tax related aspects and their redressal. d. Implementation of new and amended statutory and regulatory requirements. ii. To mitigate legal risks, the AMC should have documented processe....