The requirement to increase the networth requirement to Rs 50 crores is perplexing. It is contrary to logic as well as international requirements and practices.
SEBI has recently come out with its "Long Term Policy on Mutual Funds". A lot of positive statements have been made -- such as having higher tax exemption limits for investments in mutual fund schemes and allowing EPFO to invest in mutual funds and so on.
However, the implementation of these proposals is outside the remit of SEBI. We have seen a lot of such proposals in the past and the fate of such past proposals does not inspire too much confidence, especially since we will have a vote-on-account this year in February instead of a regular Budget.
What does fall under the purview of SEBI is the entry norms and capital requirements. These would come into effect without requiring Parliament approval.
There are two decisions. The first decision is to increase the net-worth requirement from Rs 10 crore to Rs 50 crore and the second decision is to require the asset management company/sponsor to have a seed capital in each open-ended scheme to the extent of Rs 50 lakh or 1 percent of AUM, whichever is higher.
In my view, one measure is excellent while the other is damaging to the sector.
I have no argument with the seed capital requirement. The investment managers should have their interests aligned with those of the unit holders. In case of a fall of NAV or in case of underperformance, the investment managers should feel the investor's pain. Nassim Taleb, the author of The Black Swan calls this having “skin in the game”.
The requirement to increase the networth requirement to Rs. 50 crore is however perplexing. It is contrary to logic as well as international requirements and practices.
An asset management company depends upon intellectual capital and investment management is a professional service like that of an accountant, lawyer or a doctor. Adherence to best practices, competence and professional accreditation is what matters rather than the net-worth or size of the service provider.
These are the only entry barriers mandated in such activities. Capital requirements in such activities are either not specified at all or kept to the bare minimum.
The minimum eligibility norms in some countries to set up a mutual fund (as listed in an earlier SEBI group report) are USD 100,000 (or Rs. 62,50,000) in the United States, EUR 125,000 (or Rs 1,06,75,000) in the UK or Euro, SGD 250,000 (or Rs. 1,23,35,000) in Singapore while there is no minimum capital requirement in Japan. (Exchange rates as on February 14, 2014)
In other words, with a total capital of Rs 3 crore, one can set up a mutual fund in the US, EU and UK, Singapore and Japan.
Apart from these markets for which the sub-group has listed the requirements, we tried to look for requirements in other countries. We are not experts in international regulations. However on doing a preliminary search on the internet, we could not find a net-worth requirement listed on the websites of regulators for many countries.
We were unable to locate minimum net-worth criteria in case of Brazil and China. In the case of Hong Kong there is a requirement of a minimum starting capitalization of HKD 1 million or Rs. 80.50 lakh. Ongoing requirement is just a positive net-worth.
In fact, SEBI has an advisory committee to recommend policy actions and many members of the committee were against raising the networth requirement. After much deliberation and heeding to the desire of SEBI, the committee agreed to increase the networth requirement to Rs 25 crore.
The recommendations of the committee have been completely ignored and finally the requirement has been raised to Rs 50 crore, which is twice the amount that the committee had recommended.
If we look at the arguments given for the increase, we repeatedly hear arguments such as a). Smaller AMCs have very low market share; b). by inference, they are “non-serious” players and c). an increase in networth requirements will bring in serious players and increase penetration.
Let us examine these arguments with the facts on the ground.
We have seen a lot of players exiting the mutual fund space. We have seen in a short span of time exits of financial groups like Fidelity, Daiwa and Morgan Stanley. None of these groups had any problem in meeting the networth requirement or of access to capital.
These players had networth in excess of what SEBI is now prescribing and despite that one cannot call them serious players in the mutual fund space.
On the other hand, we have had many smaller fund houses bring in innovation, cost efficiencies and best practices. We had the erstwhile Benchmark Mutual Fund bring in Exchange Traded Funds (ETFs), Quantum Mutual Fund bringing in direct plans with low costs to the investors and PPFAS Mutual Fund introducing the “skin in the game” approach.
In our fancy for size, we are creating too-big-to-fail institutions. We are ignoring the lessons taught by the financial crisis of 2008 and we still love larger players.
Let us look at the argument that in any case most of the assets -- about 94 percent -- are with the larger AMCs.
One approach would be to question as to why the concentration is happening and what can be done to reduce it rather than remove players having 6 percent market share and give 100 percent of the market to larger players.
There are numerous regulations and practices which favor the incumbent players and create hurdles for new entrants and addressing those would reduce the problems of concentration of assets with a few players.
Having few large players increases the market volatility and ultimately harms capital formation. If we look back to a time where UTI was the only mutual fund in India, we see that any buying by UTI would drive up the market and any selling would result in a market collapse. We would ideally want more number of players to impart depth and liquidity to the market rather than have a few players with undue powers.
One can only hope that there is a serious re-think on this measure.
(The writer is CEO, PPFAS Asset Management)