SEBI Releases Circular Related To TER & Performance Disclosure

SEBI, the domestic Mutual Fund regulator, seems to be in the mood to shake up the industry this year! Post its September circular that severely curtailed Total Expense Ratios (TER’s) for Mutual Fund schemes, it released a second circular yesterday with the declared intent of ‘bringing transparency in expenses, as well as reducing portfolio churning and mis-selling in mutual fund (MF) schemes’.

The first clause of the circular, related to ‘transparency in TER’s’, stipulates that going forward, “all scheme related expenses shall necessarily be paid from the scheme only within the regulatory limits and not from the books of the Asset Management Companies (AMC), its associate, sponsor, trustee or any other entity through any route”. This is an important move; as it will effectively clamp down on the new breed of “pseudo-direct plan” distributors who, prima facie, distribute direct plans of Mutual Funds - but also collect moneys on the side by way of purported “investor awareness” activities. These businesses will now struggle to make ends meet. According to SEBI regulations, RIA’s (Registered Investment Advisors) are not allowed to earn commissions from their recommended products, but there has been a grey area that has been exploited thus far – but not anymore.

The second important clause does away with upfronting of commissions altogether, thereby moving all regular-plan distributors to an “all trail” model; after the barring of entry loads back in 2009, this is the second move on the regulator’s behalf to disincentivize fruitless “churning” of Mutual Fund investments from one fund to another.

So as to not stem the impressive (and strategically important) growth of the burgeoning industry SIP (Systematic Investment Plan) book, the regulator has allowed upfronting to continue for SIP investments, but with a strict set of checks and balances as well as caps. Eventually, it appears from the circular that SIP upfronting would only be allowed for “new to Mutual Fund” investors as identified by their PAN numbers. However, since this benefit will not extend to direct plans, new age direct plan players who are sourcing new SIP’s by the thousands every month, will not stand to benefit. It has also been specified that the upfronted commissions will be recoverable from the distributor, should the SIP be terminated before three years. In a sense, this aligned investors and distributors to stay invested in a fund for a long period of time, as well as ensure the continuity of their SIP’s. The domestic Mutual Fund SIP book is fast nearing the Rs. 8,000 Crore/month mark.

Besides the above, the circular also bans the practice of “passing back” of commissions by distributors to investors, and makes an incremental 30 basis point (0.3%) room for assets sourced from B-30 (Beyond the Top 30) cities. It has also been mentioned that the landmark TER reductions will be implemented once the amendments to the SEBI – Mutual Funds Regulators (1996) act are completed; although it’s unclear how long this would exactly take, industry participants are expecting a kick in to take place before the new fiscal year commences.

All things considered, SEBI’s recent moves are bound to create ripples in the industry. Direct Plan distributors need to find a way to actually “earn” fees from clients - or prepare for an extended phase of cash burn. Regular Plan distributors need to adjust to the new reality that is 30% lower commissions, by getting leaner and more efficient. And yes, everyone needs to buckle down and do what’s good for clients – sell appropriate products, counsel them against behavioural pitfalls, and keep their SIP’s running despite the vicissitudes of the markets. An interesting year lies ahead of us.