The stock market regulator on Tuesday proposed sweeping changes to how mutual funds charge investors, as well as easing business restrictions on them. In a consultation paper, the Securities and Exchange Board of India (Sebi) outlined overhauling the total expense ratio (TER) structure, and increasing transparency in charges levied on investors.
Sebi suggested capping brokerage and transaction costs charged to investors, currently allowed over and above the TER limit. TER is the cap on the annual costs that a mutual fund can charge its investors, covering management fees, administrative expenses, brokerage, and other charges related to running the fund. It is deducted from the fund’s returns, which affects what customers actually earn.
Sebi proposed slashing the brokerage limit for cash market transactions from 0.12% (12 basis points) to just 0.02% (2 bps) and for derivatives from 0.05% (5 bps) to 0.01% (1 bps), so that “expenses are charged fairly only once to the investors.”
Transparency
The regulator said high brokerage charges often bundle in other services like research, which investors are already paying for through the fund’s management fee. The TER limits are currently based on the fund’s assets under management (AUM).
For transparency, Sebi has planned a more comprehensive disclosure of the TER itself. The proposed definition for TER would include all charges: the base expense ratio, brokerage and exchange fees, regulatory fees, and all statutory levies.
Jimmy Patel, MD at Quantum Mutual Fund, appreciated the move. “It is a good thing. Nowadays, GST keeps changing; now we can define TER more simply.”
AMCs will be required to disclose this all-inclusive TER with a clear breakdown of each component, giving investors a complete picture of the costs of their investments, Sebi proposed.
The Sebi paper suggested scrapping a transitory provision that allowed AMCs to charge an additional expense to schemes as distribution commission to the distributors and other marketing /selling expenses. This charge, initially set at 20 basis points in 2012 and later reduced to 5 bps in 2018, will be completely removed.
Open-ended schemes
To soften the blow, Sebi suggested a concurrent upward revision of 5 bps in the first two expense ratio slabs for open-ended active schemes. This means a slight increase of 5 bps in the base expense ratio limits for the smallest tiers of open-ended active mutual funds.
The regulator also proposed a structural change in how expense ratios are calculated. It said all statutory levies, including Securities Transaction Tax (STT), Goods and Services Tax (GST), and stamp duty, may be excluded from the main TER limit.
Currently, only GST on management fees is charged separately. This would mean any future changes in statutory taxes would be passed on directly to investors.
Business curbs
Sebi said it is also revisiting the rules restricting the business activities of AMCs under Regulation 24(b). In the meantime, it has proposed allowing AMCs to offer investment management and advisory services to non-pooled funds, which cater to large, non-retail investors.
This would be permitted under strict conditions, including the creation of a distinct business unit separated by ‘Chinese walls,’ segregation of key employees, and direct reporting by this unit’s head to the AMC’s CEO to prevent conflicts of interest.
D.P. Singh, deputy MD and jCEO of SBI Mutual Fund, welcomed Sebi’s move. “Amendment to Section 24(b) is the right thing to do. Globally, AMCs also work like distributors, advisors as well as manufacturers. This is not allowed in India, but this change being suggested for non-pooled schemes is a welcome step.”
He added, “Easing restrictions on AMCs managing non-broad-based funds will help them improve efficiencies and inclusiveness, as they will be able to garner larger investments.”
Differential ratio
The consultation paper, open for public comment until 17 November, also includes other proposals like:
* Giving a voluntary option to AMCs to introduce a differential expense ratio, where fees are linked to the performance of a scheme.
* Clarification that all expenses related to launching a New Fund Offer (NFO) up to the point of unit allotment must be paid by the AMC, not charged to the scheme.
* Defining what can be considered winding-up costs for a scheme, such as custodian and audit fees, while explicitly excluding investment and advisory fees.
* Reducing the mandatory frequency of trustee meetings from six to four times a year.
Sebi also called for suggestions and comments on the current three-tier structure of mutual funds i.e. the requirement of a sponsor, trustee and AMC.
“MFs need to look at corporate or LLP structures. If Sebi needs a third-party guardian, they should allow an independent trustee or assume the role themselves. If I am an expert in fund management, I should be allowed to manage all types of funds”, Patel of Quantum Mutual Fund said.
Singh also pointed out that the current three-tier structure can be overly complicated for smaller and new mutual funds. “For smaller and new MFs, this structure is sometimes very complex. It doesn’t exist globally. But the responsibility given to trustees by Sebi is important, they take care of the interests of investors,” he said.
