Capital markets regulator SEBI has asked mutual fund companies to keep the small-town linked incentive structure in abeyance, citing the lack of a system-driven mechanism to check the misuse of this incentive structure.
To promote financial inclusion through increased penetration of mutual funds and in the interest of investors, SEBI had permitted fund houses an additional expense ratio of 30 basis points (bps) on new inflows (amounts up to Rs 2 lakh) from retail investors for incentivising mutual funds garnering funds from B-30 cities and to energise the distribution network.
T-30 refers to the top 30 geographical locations in India and B-30 refers to the locations beyond the top 30.
As per a SEBI letter dated February 24, which was forwarded to the fund houses by the Association of Mutual Funds in India (AMFI) on March 2, the regulator observed certain inconsistencies and deficiencies in the manner of implementation of charging an additional expense ratio of 30 bps on new inflows from B-30 locations.
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The inconsistencies and deficiencies were related to the splitting of transactions, churning of investments, and the manner in which B-30 incentives were calculated, including switch transactions for calculation of B-30 incentives and charging B-30 incentives only in specific schemes (rather than across all schemes).
“Further, the lack of system-driven mechanisms to check the misuse of incentives structure is a serious bottleneck in achieving the desired objective. Thus, it is desirable to keep the B-30 incentive structure in abeyance till AMCs put in place effective controls to address the concerns of SEBI as mentioned above to identify and take action against wrongdoing,” the regulator’s letter read.
Asset management companies (AMCs) have now been asked to ensure that they have a system-driven mechanism to detect and prevent splitting, the churning of investments and other misuse modalities so as to take action against wrongdoing, whether internal to the AMC or external in terms of mutual fund distributors (MFDs).
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Accordingly, AMFI has asked members to strengthen their processes regarding the B-30 incentive mechanism and put in place a system-driven mechanism as a top priority to detect and prevent splitting, the churning of investments and other misuse modalities, and confirm compliance with AMFI latest by March 24.
As per AMFI, AMCs may continue to make the payment of the B-30 incentive on inflows in B-30 cities already received prior to the date of the SEBI letter.
In its letter, SEBI observed that the splitting of transactions was carried out to maintain the same under Rs 2 lakhs, to earn higher B-30 incentives by MFDs.
Also, multiple transactions of the same investor were carried out on the same day in the same scheme by the same MFDs instead of a single transaction.
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SEBI's algorithms identified that during the financial year 2019-2022, 5,987 purchase transactions from B-30 cities for 1,049 investors amounting to Rs 91.71 crore were split and based on which B-30 incentives were determined. This was despite AMCs confirming that processes and systems for the identification of splitting of transactions are in place.
The regulator noted that no action was taken by AMCs against those responsible for the misuse.
On churning of investments, SEBI said that for FY2019-20, around 2,000 instances of churning were identified by SEBI's algorithms across 19 mutual funds involving an amount of Rs 3.32 crore where mutual fund units from B-30 cities were held for more than one year and then redeemed and re-invested in the same schemes within five days of redemption.
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“This indicates that the same was done with the intent to earn higher B-30 incentives. Thus, it is observed that the AMCs do not have processes and systems in place to detect churning of investment of unitholders and do not take action against those responsible for the misuse,” the letter noted.
It was also observed that B-30 incentives were made applicable by AMCs at their discretion for specific schemes and not for other schemes despite B-30 inflows in such schemes.
As per SEBI, some of the AMCs were found not charging the same for a particular period of time. This practice is arbitrary in nature and may lead to anti-competitive practices through cross-subsidising of the TER across schemes.
According to the SEBI letter, the purpose of financial inclusion is adversely impacted due to the misuse and lack of uniformity in the practice of B-30 incentives.
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