Sebi board meeting may discuss contentious proposals such as TER, burden of proof

The draft regulation that challenges established principles of law—of innocent until proven guilty--is the one titled Sebi (Prohibition of Unexplained Suspicious Trading Activities in the Securities Market) Regulations, 2023

Today's Board meeting of the Securities and Exchange Board of India (Sebi) may have a lot of contentious proposals on its table.

Here are four of them. There is a proposal to regulate the total expense ratio (TER) charged by mutual fund houses, one seeking additional disclosures from foreign portfolio investors (FPIs) to ensure that companies do not violate the minimum public shareholding (MPS) requirement, a third one seeking to stop “suspicious trading activities” by putting the onus of proof on the person being investigated, and the fourth one to change the way unpublished price-sensitive information (UPSI) is defined to curb insider trading.

Also read: Credit-rating agencies asked to disclose entities not sharing information 

This is going by the consultation papers that have been released in the recent past and the date by which the public must send in their suggestions.

If the last date of submission falls before June 28, it is a fair assumption that the board may be deliberating on these regulations at this meeting.

Some proposals cover mutual fund (MF) houses, alternative investment fund managers, real-estate investment trusts (REITs) and infrastructure investment trusts (InvITs). Others relate to deepening the corporate bond market, and strengthening compliance requirements for companies.

TER: hotly debated proposal

Perhaps, the most discussed is the attempt to regulate the TER charged by MF  houses or asset management companies (AMCs).

The last date for submission of comments for this draft was June 8, 2023.

The market regulator has proposed that there should be uniformity in TER charged across MF schemes. Currently, fund houses are allowed to add four additional charges on top of the base TER, including brokerage and transaction fee (which is up to 0.12 percent of the trade value for cash market and 0.05 percent of the value in derivatives market).

They are also allowed additional expenses not exceeding 0.05 percent of daily net assets for schemes with exit loads, and goods and services tax on investment and advisory fee charged.

With the proposed change, the regulator wants the TER to be capped at the AMC level.

AMCs to take a hit

Brokerage Jefferies has estimated that this cap would cost the AMCs Rs 1,400 crore. In FY22, the AMCs made Rs 30,800 crore from the expenses collected. This will be capped at Rs 29,400 crore under the new proposal.

According to a report from Kotak Institutional Equities, fund houses will be able to pass on the impact to intermediaries such as distributors and brokers. The brokerage’s analysts cited the instance from 2019, when existing regulations on TER came into play and AMCs passed on 75-90 percent of the impact and largely to distributors.

FPIs under scanner

Another consultation which saw a lot of interest was the one that asked for more disclosures from FPIs, particularly from those with concentrated holdings in single group entities.

The regulator has proposed that, for now, high-risk FPIs, which hold more than 50 percent of their equity AUM in a single corporate group or with overall holding in the Indian equity market of over Rs 25,000 crore, would be required to comply with the requirements for additional disclosures as far as all natural persons and/or Public Retail Funds or large public listed entities are concerned.

The paper said that this was to prevent the violation of minimum public sector shareholding rules and to guard against opportunistic takeover of Indian companies using the FPI route.

The regulator is looking to plug the gaps in the Prevention of Money Laundering Act and in FII regulations. In both, if an entity is not a beneficial owner, going by a materiality threshold —10 percent ownership to capital or rights for companies and 15 percent ownership of the same for partnership—the details of the entity does not have to be disclosed.

According to the Sebi paper, many beneficial owners, by this economic interest, are not disclosed because each investor entity in the FPI category is “generally found to be below the threshold prescribed under PML rules”.

But there is the possibility that a person might be holding economic control over the FPI through different investment entities, each of which are threshold for identification as beneficial ownership. The consultation paper seeks to correct this by saying that high-risk FPIs would be required to disclose ownership and control rights to the level of natural persons, public retail funds or large listed corporates.

These disclosures have to be made without applying any materiality threshold and despite “any secrecy laws that may be applicable in other jurisdictions of their domicile”.

Guilty until innocent

There is one draft regulation that challenges an established principle of law —of being innocent until proven guilty. It is titled Sebi (Prohibition of Unexplained Suspicious Trading Activities in the Securities Market) Regulations, 2023. This regulation proposes to presume guilt and let the accused prove their innocence.

It was proposed because the market regulator noticed that many frauds were being committed in the securities market that were difficult to prove. There were traces of the crime— with surveillance systems flagging insider trading and front-running— but proofs were being eliminated with the use of high-end tech.

“The solution that SEBI has suggested is fairly simple,” as Jayant Thakur, a chartered accountant, explained in a column in Moneycontrol.

“Reverse the onus of proof. Presume such persons as guilty and let them prove their innocence. In other words, if serious transactions cross the prescribed bar of suspicion, then that person needs to explain and justify them as not being insider trading, front-running, etc.”

As Thakur pointed out, it runs the risk of putting a huge burden on small players such as mules (whose trading accounts can be used for various malpractices such as front-running) and name lenders. They may have played a small part but the market regulator may often hold them liable to the same extent as the bigger, ring leaders.

They may not be able to afford the legal defence real perpetrators can, and, therefore, end up being punished disproportionately.

Also read: Eros Intl allegedly used non-existent films to siphon funds

Catch- 22 situation

The regulatory change that compliance officers would be tracking from the meeting is the one on UPSI.

On May 18, the market regulator proposed to amend the definition of UPSI under the Prohibition of Insider Trading Regulations to include disclosures required under Regulation 30 of the Listing Obligations and Disclosure Requirements (LODR).

This would leave compliance officers to decide which events should be considered a ‘material event’ and therefore trigger a UPSI event. They are worried that they may be caught in a Catch-22 situation—call ‘UPSI’ too many times and the company’s management won’t be happy with the interruption in trading or call ‘UPSI’ too few times and earn the regulator’s wrath.

Mixed fare for REITs and InvITs

REIT and InvIT managers may see a mixed day.

While the bigger REIT players may be looking for some good news on the fractional ownership platforms (FOPs) front, believing that regulatory oversight will weed out the bad actors, they may be worried about what they call a “killer provision”.

The market regulator has been considering how to include FOPs under a framework for micro, small and medium REITs and InvITs. But the worrying inclusion in this framework is the requirement that sponsors of such REITs hold a minimum of 15 percent of MSM REITs units for three years from the date of listing. The FOPs that otherwise welcome the proposed regulation said that this requirement may make their business unviable.

Good news for retail investors

Besides, there might be reasons for retail investors to cheer. The board meeting is likely to take a call on a quicker, online investor grievance redressal mechanism. This could make it easier for investors to not just register their complaints but also see it to its end, including a review of action taken by the first-level regulator or trade bodies and an online dispute resolution mechanism instituted by Sebi.