Sebi defers decision on overhaul in total expense ratio for mutual funds

SEBI chairperson Madhabi Puri Buch says that armed with more data, SEBI will now come out with a second consultation paper on TER soon

Capital market regulator Securities and Exchange Board of India (Sebi) has deferred its decision to rationalise the total expense ratio (TER), or the expenses that mutual fund (MF) schemes can charge their investors.

The Sebi chairperson said that the regulator will soon come up with a second consultation paper around rationalising the TER.

Sebi was expected to redefine the TER by bringing many charges- that sit outside the TER at the moment- within the limits of the TER. But in its Board meeting held on June 28, Sebi didn't take any decision on this.

Explaining the Board's decision to defer its decision, Sebi chairperson Madhabi Puri Buch explained that it got feedback from the MF industry and more granular data that demostarted that economies of scale has in fact been achieved  to quite an extent.

On May 18, Sebi had brought out a consultation paper asking for public’s opinion on some key proposals that Sebi had put forth to make TER more transparent. The aim of this exercise, which SEBI had announced it had started work on in December 2022, was to bring economies of scale. The consultation paper of May 18 had confirmed an exclusive by Moneycontrol on January 28 that gave a glimpse of Sebi’s plans to cut down expense ratios.

"The MF industry gave us data that over the last 5 years, economies of scale has been achieved. When we (Sebi) saw the granular data, we understand therefore that our proposals need to undergo a change," said Buch. She explained further that Sebi takes its decision based on hardcore numbers. The earlier proposals were based on an exercise SEBI had undertaken earlier this year.

Buch says that now that Sebi has more data, it will come out with a second consultation paper on TER soon. "The MF industry will be quite happy with our second set of proposals," hinting that Sebi's TER proposals would be less stringent than its earlier proposals. This also shows that Sebi doesn't appear to be as disturbed about the fees that fund houses charge, as it did before.

As per Sebi's May 18 consultation paper, it were to have brought in brokerage fees, and Goods & Services Tax (GST) of fund management fees within the ambit of the TER. Both these fees, currently, sit outside the TER. Sebi had said, in its consultation paper last month, that the TER should include brokerage expenses.

Fund houses are now allowed to charge brokerage and transaction costs of up to 0.12 percent of the trade value. Sebi found that fund houses were charging brokerage amounts that were higher than the amounts charged under TER, and in some cases even double the permissible TER. And investors had been paying that, assuming that they were just paying the TER, which was the only expense they had been told of.

Another important announcement missing from Sebi's decision was the change of commission structure in a scheme's NFO. To curb the menace of mutual fund houses and distributors from churning their investors from their existing schemes to new schemes being launched, Sebi was expected to announce steps that would have discouraged this practice. Its consultation paper had said that if distributors switch investors’ money from one scheme to another, he would earn the lower commission of the two schemes.

This decision also wasn't taken up today. But expect the second consultation paper in another 10 days or so. Sebi would mostly take its final decision in its September-end board meeting.