Capital market regulator Securities and Exchange Board of India’s (Sebi) consultation paper on rationalisation of total expense ratio (TER) has sent the Rs 40 lakh crore mutual fund (MF) industry to the drawing board to reassess the impact of the proposals on their business models.
Most fund houses Moneycontrol spoke to, ever since the paper came out on May 18, say that the proposals are on expected lines. However, some fund officials say that Sebi’s proposals to bring brokerage costs within the TER limit dent a fund house’s margins.
All officials Moneycontrol spoke with requested anonymity as they didn’t want to speak on regulatory matters. The Association of Mutual Funds of India (AMFI), the MF industry’s trade body, refused to comment.
“Thanks for reaching out. We don't have any comment as of now as these queries are already part of the consultation process,” said an AMFI spokesperson in an email.
On expected lines
Most industry officials say that Sebi’s proposals are on expected lines. Ever since the regulator put out a press note in late 2022 about setting up a committee to look into the expenses, the Sebi chairperson has publicly acknowledged the regulator’s rationale in having a re-look at expenses.
TER definition okay; charges perhaps not
Among the proposals, the more contentious appears to be the one in which Sebi says that a scheme’s TER must include brokerage costs. Earlier a few important costs, like goods and services tax (GST), brokerage and securities and transaction tax (STT), and beyond 30 incentives were paid over and above the base. Now, Sebi has proposed that all these charges must be included in a scheme’s TER.
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Though many batted for transparency in the TER, they ask for exclusion of statutory payments, such as GST and STT from TER.
“They are neither in our control nor in the control of Sebi. They may change any time,” says a senior fund official. Taxes paid should not be included in TER as the rate of tax can change or new taxes can be introduced. As a principle, it is better to keep these tax payments out of TER, officials say.
Brokerage or research fees: the dilemma
Sebi points out that fund houses have been seen as paying research fees to brokerage houses. This, it says, amounts to double-charging investors, as they pay management fees to the fund house.
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MF schemes transact in many securities through stockbrokers. They are paid remuneration by MFs for trade execution and allied services as well as research. Sebi’s consultation paper says that 42 MF houses paid out Rs 3,466 crore in FY2021-2022. MFs are allowed to pay up to 0.12 percent of trade value towards brokerage and transaction costs for the purpose of execution of trade in case of cash market transactions and 0.05 percent of trade value in case of derivatives transactions.
“Such a high payout towards brokerage can lead to corruption. For instance, too cozy a relationship between dealers and brokers can also lead to front-running,” says the first official quoted above.
“If the regulator asks to include brokerage costs in TER, the board members of the AMC will scrutinise the quantum of payment made to brokers for trade execution as the same will eat into the profits of the AMC,” says a second MF official.
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But not all are in favour of including brokerage in the TER. Some point out to the nuances of money management. “This is not a typical charge you can estimate for the entire year, saying we would incur 0.12 percent charge and then charge it to the scheme’s TER within the prescribed limits. Dynamic markets and a surge of inflows or outflows at any given time of the year can increase or decrease the brokerage cost drastically,” says a third MF official. For instance, there are often macro changes that impact sectors differently and fund managers will need to churn in the interest of the portfolio. These transactions will have brokerage costs, he adds.
A fourth MF official pointed that appointing a panel of stockbrokers is a global practice in money management business. “There are some sell-side analysts who can offer better insights on a business or an underlying security than the internal talent pool of an AMC. Brokerage costs factor in expenses incurred on such research,” he adds. Large AMCs, however, can consider taking limited purpose membership of stock exchanges to carry out their trades as envisaged in the consultation paper,” he added.
A uniform TER across all schemes
Some fund houses, especially small- and mid-sized ones, say that Sebi’s move to have a uniform TER among all schemes within a fund house is a good move. “Including all the expenses in TER is a good move as the customer comes to know what she is paying,” says the second fund official quoted above.
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“Uniform TER for all schemes in a category is a good move as it disincentivises floating new schemes with a sole objective of charging higher TER. The fund houses may continue to focus on existing schemes’ performance to attract more money,” says the fifth fund official.
Sebi has also proposed paying B30 incentives only in case of a new investor (new PAN-based) at the industry level. The commission payable may be fixed at 1 percent of the first application amount, or the SIP committed, subject to a cap of Rs 2,000, the paper added. Also, this incentive must be paid out of investor education and awareness expenses.
Earlier, MF houses used to charge 30 basis points, over and above TER, subject to conditions and pass it to the distributors.
The fourth MF official quoted above pointed out that a new investor typically starts with more than one scheme, spread across fund houses. There may be confusion about which fund house will pay the B30 incentive. Similar is the case for women investor incentives. “Also, investor education and awareness expenses should be used only for the purpose of investor education and not for rewarding distributors,” the fourth official added.
Most fund officials Moneycontrol spoke with are upbeat about the regulator’s stance of empowering smaller MF houses. Measures such as performance-based fee are being attempted through regulatory sandbox, which should show the way forward to this high-growth industry, they say.
They see the consultation paper effectively addressing three stakeholders – investors, AMCs, stockbrokers and distributors. “All in all, this consultation paper has shaken up the MF industry and will work for the greater good in the long term as the investor benefits from lower costs. However, the regulator should also need to pay heed to bringing down expenses incurred towards services rendered by the Registrar and transfer agents, banks and KYC by AMCs,” says the fourth official quoted above.
Mutual fund companies may jointly or individually approach Sebi before June 1, 2023, the deadline set by the regulator for feedback on the consultation paper.