Sebi Proposes Significant Changes to Mutual Fund Regulations for Enhanced Transparency and Investor Protection

On October 30th, most capital market stocks, including those of listed asset management and stockbroking firms, remained under pressure. This followed the release of a consultation paper by the Securities and Exchange Board of India (Sebi) aimed at introducing changes in the mutual fund sector. Sebi is currently seeking public feedback and suggestions on these proposed changes.

When the consultation paper was unveiled on October 28th, capital market stocks experienced declines ranging from 1% to nearly 9% during trading on October 29th. Although the situation slightly improved on October 30th, many stocks continued to trade cautiously or were down. Stocks such as Edelweiss Financial, IIFL Capital Services, Indian Energy Exchange, HDFC AMC, Nuvama Wealth Management, and UTI AMC saw declines between 1% and 3.5% on Thursday. Meanwhile, stocks like 360 One WAM, Angel One, CDSL, Geojit Financial Services, One97 Communications, and Prudent Advisory Corporate experienced marginal decreases.

Conversely, some stocks showed positive movement. Anand Rathi Wealth, CAMS, ICICI Securities, Motilal Oswal, and NSDL traded higher by 1% to 3%. BSE and Nippon Life India AMC also saw slight gains. The proposed changes by Sebi are aimed at simplifying mutual fund regulations while addressing specific aspects of asset management companies' (AMCs) financials.

According to analysts at Kotak Institutional Equities, the primary goal is to streamline regulations for mutual funds. Key proposals include removing a 5 basis point exit load from the total expense ratio (TER) and adjusting expense ratio slabs to exclude statutory levies like STT, GST, and stamp duty. Other suggestions involve increased disclosure of TER components such as brokerage and regulatory fees and allowing differential expense ratios based on fund performance.

One significant change involves revising brokerage and transaction charges beyond the TER limit. Sebi aims to enhance transparency and protect investors with these adjustments. The removal of a 5 basis point additional charge on mutual fund scheme exits is among the proposed changes. Historically, AMCs used exit load charges for distributor commissions and marketing expenses until 2012 when they were credited back to schemes.

Sebi now proposes eliminating this additional charge entirely. To mitigate the impact on AMCs' operations, the first two slabs of open-ended active schemes' expense ratios will be increased by 5 basis points. Analysts at Kotak noted that a 5-basis point reduction in equity regular TER could result in a 3% impact on the value chain. If AMCs absorb this impact entirely, revenues could decrease by approximately 5%, affecting core profit before tax by around 10%.

Impact on Statutory Levies

Sebi also suggests excluding all statutory levies from expense ratio limits while maintaining permissible expenses for brokerage and regulatory fees within these limits. Currently, GST on management fees is allowed above the TER limit; however, other statutory charges are included within it.

Brokerage charges are another focus area for Sebi's proposals. Presently, mutual funds charge brokerage up to 0.12% for cash market transactions and up to 0.05% for derivatives transactions. Sebi observed that arbitrage fund brokerages were lower than those for equities during April 2023 to March 2024.

Brokerage Charges Adjustment

As a result, Sebi plans to reduce brokerage charges to 2 basis points from 12 basis points for cash market transactions and to 1 basis point from 5 basis points for derivatives transactions. All other transaction execution costs may be charged based on actual expenses incurred.

Analysts have expressed concerns about how these changes might affect large players in particular since distribution commissions could be lower for some large funds. They also highlighted that statutory levies like STT/CTT/GST/stamp duty incurred during trade execution may exceed the new brokerage cost limits.

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