28 July 2011

Here is the link to SEBI's press release : http://www.sebi.gov.in/cms/sebi_data/pdffiles/21119_t.pdf. The salient features and their implications are discussed below :

Distributor regulations

The text of the SEBI press release has this to say :

"As a first step towards regulating distributors of Mutual Funds, selected distributors will be regulated through Asset Management Companies (AMCs) by putting in place the due diligence process to be conducted by AMCs. The due diligence process may be initially applicable for those distributors satisfying one or more of the following criteria:

Multiple point presence in more than 20 locations

AUM raised over Rs.100 crore across industry in the non institutional category but including high networth individuals (HNIs)

Commission received of over Rs. 1 crore p.a. across industry

Commission received of over Rs. 50 lakh from a single mutual fund

It is estimated that this measure will cover distributors handling about half of the total AUM in the industry.

AMCs shall disclose the commissions paid to the distributors meeting one or more of the above criteria and AMFI will disclose the aggregate amount of commissions paid to such distributors by the MF industry."

SEBI is very clear that this is only the first step. One can reasonably surmise that these regulations will eventually cover every ARN holder. In phase one, it is not just banks and national distributors that will be covered. Any ARN holder who meets any one of the above criteria, will be covered. All large IFAs with either an AuM (non-institutional) of over Rs. 100 crores or an annual commission income (whether from institutional or non-institutional business) of over Rs. 1 crore will now fall under the ambit of the regulations within phase one itself. If large IFAs are in the ambit within phase one, it is very reasonable to presume that all IFAs will be eventually covered - perhaps sooner rather than later.

What is the due diligence that AMCs now have to perform for these large distributors? We had alerted you back in February 2011 to get ready for the new sales process regulations, in our Industry Trends article "Are you prepared for these sales process regulations?" (http://www.wealthforumezine.net/Industrytrends230211.html.) We sincerely hope that you did give this a thought and that you have begun putting in necessary processes to comply with the framework of what was covered in that article. It is quite possible that what is eventually announced will bear a close resemblance to what SEBI spelt out in Feb 2011 on this subject.

If compliance will now acquire a whole new dimension for you, so will disclosure. All the large distributors will now see their commission income disclosed in public by AMFI on a periodic basis.

Transaction fees of Rs.100 - Rs. 150

This is the text of SEBI's press release on this much debated topic

"In order to help Mutual Funds penetrate into retail segment in smaller towns, the distributor would be allowed to charge Rs. 100 as transaction charge per subscription. No charge can be made for investments below Rs. 10,000. An additional amount of Rs. 50 can be charged to first time Mutual Fund investor. However, there would be no transaction charge on (a) transactions other than purchases/ subscriptions relating to new inflows, and (b) direct transactions with the Mutual Fund. For SIPs, the transaction charges can be recovered in 3 or 4 instalments. The transaction charges are in addition to the existing eligible commissions permissible to the distributors."

We will have to await AMFI's implementation guidelines to get clarity on a few issues. For example, if an investor wishes to invest Rs. 50,000, will he now make out a cheque for Rs. 50,100, of which Rs. 100 comes to you as the distributor or will the AMC invest Rs. 49,900 in the chosen scheme and pay you Rs. 100? Then again, how does one decide who is a first time investor in mutual funds?

There is no doubt that this is welcome incremental revenue for retail distributors. On an investment of Rs.10,000, this works out to either 1% or 1.5% additional upfront commission - depending on whether the investor is an existing MF investor or a first time investor. If you are sourcing business from a first time investor, you stand to get 1.5% (on a transaction size of Rs. 10,000) in addition to the 0.5% upfront and another 0.5% first year trail that most AMCs give IFAs these days as commission. Your total 1st year commission to get a new investor into the industry works out to 2.5% - which is a very healthy and reasonable reward for your market development efforts on the retail side. Of course, this example works very well for a ticket size of Rs. 10,000 : anything lower will not be remunerative as the transaction fee vanishes and anything substantially higher than Rs. 10,000 won't look as attractive as the effective income percentage drops sharply because of the flat charge structure. Is this a good enough booster dose to get retail distributors to sell harder to small investors across the country? Well, the remuneration structure is surely very reasonable now. There is every good reason for you to bring back mutual funds into your product suite when talking to retail investors. Will this result in multiple applications of Rs. 10,000 each in order to maximise distributor revenues? There is a fair chance this will happen - but frankly, if that is the way in which money can start coming back into the industry, perhaps the cost of multiple applications is a small price to pay to generate sales momentum.

We will have to wait for the implementation process to gain clarity on one important aspect, which we have highlighted earlier : will this come in the way of fee-based advisors' efforts to collect an advisory fee? Since the text of SEBI's statement says "the distributor would be allowed to charge Rs. 100 as transaction charge per subscription", it perhaps implies that the discretion is available to the advisor whether to levy this charge or not. If that is the case, this would indeed be a wonderful situation. Fee based advisors will be able to charge what they currently are doing. Non fee based advisors have a facility to charge upto Rs. 100 or Rs. 150 as the case may be, to supplement their commission income. Now, the only question that remains is how investors will look at this structure. Would investors who were reluctantly agreeing to pay a fee now try and bargain the fee down to Rs. 100? Only time will tell. Keep your fingers crossed on this one.

Common account statement

SEBI has taken a very important and customer friendly decision - here is the text :

"One common account statement will be dispatched every month for investors who have transacted in any of his folios across the mutual funds. The statement shall also contain the disclosure related to the transaction charge paid to the distributor. One common account statement will be dispatched to the investor every half year for all nontransacted folios."

Single account statement is now officially a reality. This is no doubt a huge relief for investors who receive multiple statements from various AMCs and then depend on their distributor's software package to give them a consolidated statement. And, in case their distributor did not possess this software, they needed to do the consolidation themselves. A huge benefit for investors no doubt. But, as a distributor, you now need to ask yourself this : if a consolidated statement was one of your principal value adds, what will your principal value add now be? It should perhaps be advice and not your back office capabilities.

There are a number of other measures relating to returns disclosure, advertisement code, offshore trading desks, offshore advisory services etc which will perhaps be of greater interest to AMCs rather than distributors - all of these are available here :

http://www.sebi.gov.in/cms/sebi_data/pdffiles/21119_t.pdf.

The biggest announcement which never came was a move to tinker with the expense ratios. The MF industry was agog for weeks with a rumour that SEBI might decide to introduce a flat upper limit on expenses at 1.75% instead of the present tiered structure which starts from 2.5% and goes down to 1.75%. There was also talk of bringing in fungibility in the expense ratio sub-limits. Had SEBI gone ahead with this move, it would surely have been an unbearable burden for all the smaller AMCs - who would have seen 40 to 50 bps shaved off from their equity fund revenues. Mercifully, SEBI decided to leave things as they stand on this count. Clearly, SEBI seems firm about not doing any further damage to business viability and seems quite keen to find ways to spur industry growth.

What do you think of these SEBI decisions? How prepared are you to comply with the new sales process regulations? Are you now enthused to sell mutual funds to retail investors? Will you generate retail sales momentum now? Are these decisions a step forward or backward? Share your thoughts by posting your comments in the box below - its YOUR forum !