Reforms by SEBI to revive ailing MF industry

The Securities and Exchange Board of India (SEBI) at its board meeting on 16th August announced a number of measures to boost the ailing mutual fund industry. These steps are also aimed at increasing the penetration of mutual funds, improving its reach in semi-urban and rural areas, and strengthening the regulatory framework.

A number of measures that were announced at the meet were not surprising to say the least as the market was largely anticipating them. However, the new rules will be effective after SEBI comes out with details pertaining to the guidelines. SEBI has now decided that there will be fungibility of the Total Expense Ratio (TER). Earlier while charging TER the slab was 2.5%. It included management charges, custodian charges and distribution charges. With the new regulation coming in, slabs will be removed and it will be up to the fund house to decide the charges. This regulation comes as a relief to fund houses as they can pay higher commission to distributors from the expense ratio.

Since the past few months there has been a steady decline in distributors selling mutual funds. Hence to bring back some lost glory, SEBI has decided to simplify the distributors' registration process and increase the base of mutual fund distributors by including postal agents, retired officials from government, banks and retired teachers to help distribute simple mutual fund products. "Introduce varied levels of certification and registration depending on products and services offered and reduce the fees for NISM certification and AMFI registration," said SEBI in its release. In order to tackle the issue of mis-selling, SEBI has decided to create a system of identification of actual sales personnel of distributors, evolve a system of 'product labelling' and inclusion of mis-selling as a 'fraudulent and unfair trade practice' in SEBI regulations.

Apart from fungibility of TER, the market regulator also allowed asset management companies (AMC) to charge an additional TER, up to 30 basis points, depending upon the extent of new inflows from locations beyond top 15 cities. SEBI said, "AMCs will be able to charge 30 basis points if the new inflows from these cities/towns are a minimum of 30% of the total inflows.

In case of lesser inflows, the proportionate amount will be allowed as additional TER." In other words, fund houses will be able to charge extra 30 bps from investors if they are beyond top 15 cities, provided they get at least 30% of inflows from beyond top 15 cities. SEBI also directed fund houses to make complete disclosures of the efforts taken by them to increase penetration of mutual funds in their half yearly reports. They also sought details of the opening up of new branches, especially those beyond top 15 cities. Some market participants feel that this move will increase the cost for investors, but fund houses will be able to bring in more money.

To further align the interest of investors, distributors as well as fund houses, SEBI has decided to subject all new investors to a single expense structure under a single plan. Currently, there are different expense structures for retail as well as institutional investors.

SEBI also said that there should be a different plan for direct investments with a lower expense ratio. This move by the market regulator is likely to encourage informed investors to directly go to fund houses and apply for units instead of going through a broker or a distributor. Further, to get more number of investors to mutual funds, especially those who are not tax payers and do not have a Permanent Account Number (PAN) or bank accounts, such as farmers, traders, businessmen and workers, the SEBI has decided to allow cash transactions to the extent of Rs 20,000, subject to compliance with the Prevention of Money Laundering Act, 2002 (PMLA). Earlier it was necessary for investors to have PAN to get into mutual funds.

By introducing these measures, SEBI has surely brought cheer to investors. However, it also announced that service tax will have to be borne by investors and not fund houses as was the case earlier, to be in line with other industries. To further strengthen the regulatory framework of fund houses, SEBI has decided that AMCs should disclose half yearly financial results of mutual funds on their websites and publish an advertisement in this regard in at least one national and one regional newspaper. A Self-Regulatory Organization (SRO) will also be set up to regulate distributors, said SEBI. "To provide fair treatment to existing investors of mutual fund schemes, it has decided to harmonize applicability of net asset value (NAV) across various schemes based on the day on which the funds are available for utilization, for an amount equal to or more than Rs 2 lakh," stated SEBI. In other words, the same NAV will be applicable to the investor who invests more than Rs 2 lakh on the day it is available for utilization.

Currently, several corporate investors make payments through cheques, which takes at least one or two days to clear. However, units are allotted at the day of the request, which allows them an extra day's benefit, at the cost of existing investors. Also, to reduce churn and align the interests of fund houses as well as distributors with that of investors, SEBI said that the entire exit load should be credited to the mutual fund scheme, while the AMCs will be able to charge an additional TER to the extent of 20 bps. Currently, exit loads are taken away from the fund houses. "This will not result in any additional cost to the investors. Claw back of additional TER (in the case of inflows from cities beyond top 15 cities) would be provided to the extent the investments are redeemed within a period of one year," stated SEBI. The Board welcomed the government's recent announcement of a new scheme called Rajiv Gandhi Equity Savings Scheme (RGESS) and decided that SEBI should make a recommendation to the government suggesting that RGESS may also provide for investments in equity schemes of mutual funds, which have the securities allowed under RGESS as the underlying. In the last Union Budget, the then Financial Minister Pranab Mukherjee had announced RGESS to bring retail money into the Indian equity markets.

Finally, it was decided that to attract long-term money there is a need to develop a policy for mutual funds by taking into account its importance in mobilizing domestic savings for the growth of the economy. "The policy would include all aspects, including enhancing the reach and promoting financial inclusion, tax treatment and obligation of various stakeholders, among others.  The Mutual Fund Advisory Committee of SEBI would recommend long-term policy measures after wider consultation with all the stakeholders in a reasonable time frame," mentioned SEBI in the release.

Experts believe that in the next six months we may see some action regarding certain regulations which seek to attract long-term money into mutual funds. The big bang reforms that were expected by SEBI have been finally announced. While some of these reforms are likely to bring in more money, others could slightly increase the cost for investors. But overall measures will bring in more clarity not only for fund houses and distributors but also for retail investors. SEBI has laid a right plan to bring more money into mutual funds. It all depends on how fund houses cash into the opportunity and start earning profits for themselves.