The market regulator is wielding an unprecedented level of control over how mutual funds operate, delaying new launches and dictating investment strategy, frustrated insiders in the embattled industry say.
SEBI's tighter scrutiny adds to the challenges for the two-decade old mutual fund industry that has endured a steady stream of redemptions from equity funds in recent years.
Even as stocks hit record highs, most of India's 47 asset management firms are unprofitable and have underperformed the broader index so far this year.
"SEBI is trying to tell us what to do from an investment perspective, which we don't necessarily agree with," said Vivek Kudva, who heads India, Central Europe, the Middle East and Africa for the Franklin Templeton Investments unit of U.S.-based Franklin Resources Inc (BEN.N).
After months of back and forth with the regulator early this year, the proposed fund was eventually shelved.
"If they don't approve it, we are stuck," Kudva said.
Equity fund assets under management have fallen from a peak of $30.8 billion in December 2007 to $24 billion last month, after net outflows in four of the last five years.
SEBI's hands-on approach under its chairman, U.K. Sinha, who took the top job in 2011 after running India's oldest mutual fund firm, government-backed UTI Asset Management, marks a break from past practice at the agency.
Sinha has publicly railed against underperforming fund houses and the asset management sector's failure to lure more investors into stocks.
Partly as a result of that, new open-ended fund launches are down sharply, to 48 from the beginning of 2012 through October 2013, from 105 during the two-year period ending in 2011, industry and regulatory data shows.
During the same periods, 129 and 140 applications, respectively, were filed.
"We end up spending time and resources coming up with strategies our investors want, only for it to be modified beyond recognition or delayed to the point of no return," said the chief executive of a mid-sized asset management company who declined to be identified.
"(It) is killing us," the manager said.
SEBI officials acknowledged that they have become tougher on fund launches.
"I think it's a good thing that launches have come down. The regulator doesn't want a repeat of 2008," Sinha recently said on the sidelines of an industry event.
In 2008, many small fund investors lost money when the market collapsed amid the global crisis, and the industry has been accused by the regulator of rampant mis-selling and failure to provide adequate disclosures about market risks.
"SEBI has made it very clear we don't want new funds unless they have a separate (different) style of investment," Sinha said.
Under Sinha, SEBI also has enacted new rules aimed at curbing improper selling by distributors.
In 2009,it banned fund houses from sales charges or entry loads for new investors and put curbs on how much exit load could be levied on early redemptions.
Last year under Sinha, the agency said it would not allow asset managers to launch new funds if their existing portfolio includes a fund with the same or similar strategy.
Some industry insiders say there is ambiguity around what qualifies as a similar strategy, and that the initiative stifles innovation.
"The biggest problem is that there is no case for precedent," said the head of a big fund house, also declining to be identified.
"If SEBI has approved one investment strategy for one fund house there is no guarantee that a similar strategy at my firm will get the green light."
Earlier this year, SEBI turned down an HSBC Asset Management (India) Pvt. Ltd feeder fund that would have primarily invested in Russia, because the Russian markets had been underperforming those in India, according to a company executive and SEBI officials, all of whom declined to be identified.
When Axis Asset Management, part of Axis Bank, filed a draft prospectus earlier this year seeking to launch a fund that would switch allocation between equity and equity derivatives in an equal measure to manage risk, it was told to lower the derivatives exposure if it wanted approval, according to a fund manager involved in the matter.
Prudential Financial Inc's Pramerica Asset Management started the year in hopes of beefing up its funds portfolio. It has filed applications for seven open-ended funds this year, according to data from SEBI. Only one has thus far been approved, a Pramerica official said.
SEBI officials say it is up to fund managers to provide complete details in their applications, and to demonstrate that the product is indeed unique from existing funds. The track record of a fund house's existing products is also a factor.
"What happens in certain cases is that we literally have to hand-hold them when it comes to disclosures in the offer documents. They would leave out important details which only delays the process further," said a senior official with the regulator, declining to be identified.
Added another senior SEBI official: "It's not that we are going beyond the rule book. We are enforcing the existing rules strongly now and they have a problem with that."