Sebi mulls bringing in new expense structure for mutual funds

The Securities and Exchange Board of India (Sebi) is discussing with mutual funds (MFs) a proposal on introducing new total expense ratio (TER) slabs linked to the total equity and debt assets by replacing the current ones that are linked to assets of an individual scheme.

Senior MF executives confirmed that Sebi had held discussions on this matter with AMCs.

Such a change is expected to lead to a lower TER cap for bigger asset management companies (AMCs).

TER is the expenses charged by AMCs for managing a scheme.

If the new model is implemented, fund houses will have to charge TERs based on the category of the scheme, which means all schemes of a fund house that come under a particular category, equity or debt, will have the same TER.

At present, schemes have different TERs based on their size.

The lower the assets under management (AUM) of a scheme the higher is the cap on TER under the current framework.

Addressing a press conference after Sebi’s board meeting on Wednesday, chairperson Madhabi Puri Buch cited two problems with the current structure.

“First, it gives incentives to AMCs for fragmentation of schemes. Second, it leads to a lot of mis-selling,” she said.

Besides, Sebi is believed to have learnt that MF distributors move investors’ money from existing schemes to new fund offerings to earn higher commissions, which is detrimental to investors’ interest.

Newly- launched schemes have a higher TER due to their small size and, hence, are able to pay more to distributors.

Making the case for an asset-linked TER structure, Buch said AMCs enjoy economies of scale and this is linked to asset class levels and not schemes.

“Economies of scale are not linked to the scheme level but the asset class level.

"While the size of the asset grows, the cost does not go up significantly,” the Sebi chief said.

The TER charged by MF schemes has been under scrutiny for other reasons as well.

Sebi wants the TER to be all inclusive and, hence, is considering bringing charges like goods and services tax (GST) on fund management fee and brokerage costs within the TER.

“When we say total expense ratio, it should be total without any ifs or buts,” Buch said.

Fund houses are allowed to charge 18 per cent GST on the fund management fee over and above the TER.

The cost incurred in buying and selling of securities is also charged outside of the TER.

Sebi feels that keeping brokerage out of the TER is problematic for two reasons.

First, it amounts to “double charging” of unit holders.

“If you are taking asset management fees to manage the assets, then why are you paying such large sums to the broker for the research that you were supposed to do,” Buch said.

“The other thing we found was the distinct possibility that the brokerage was being paid for reasons other than professional ones.

"This is not coming under anyone’s radar because the board of the AMCs are not looking at it.

"The minute you bring it under TER, automatically the board of the AMC will seek justification on such payments to brokers,” she added.

The regulator has already suspended small-town linked incentives (B-30 incentives) paid to MF distributors to curb its misuse. AMCs were allowed to charge investors an extra 30 basis points for payment of the incentive.

Sebi will review the suspension after the industry puts systems in place to curb the misuse of the incentive by the distributors.

The regulator noted that the incentive structure was exploited by splitting transactions, churning investments, manner of calculation of B-30 incentives, including switch transactions for calculating them, and charging the B-30 incentive only in specific schemes rather than across all schemes.

Sebi is also exploring a new incentive structure, which will reward distributors bringing new investors to the industry, irrespective of the location of the investor.