MFs seek urgent meet with Sebi on expense structure

The mutual fund (MF) industry has sought a meeting with the Securities and Exchange Board of India (Sebi) at the earliest, while seeking clarification on the market regulator’s diktat that all scheme-related expenses should be booked in respective schemes.

For liquid schemes that are under the regulator’s scrutiny, the MF industry has asked it to consider allowing redemption-related borrowings costs to be borne in asset management companies’ (AMCs’) books.

Liquid schemes are typically used by large corporates and banks to park their cash. As redemptions from these investors are also often large in size, fund houses at times need to borrow from banks to meet these redemptions.

The letter, reviewed by Business Standard, says, “We would request Sebi’s guidance and clarity with respect to borrowing costs, if it would be in order for AMCs to bear that portion of borrowing costs which exceeds the day’s yield to maturity of the scheme.”

According to industry sources, if these borrowing costs are adjusted in the liquid schemes, the net asset value of these schemes will get negatively affected, hurting existing investors.

However, sources also say booking these costs in AMCs’ books is a drag on their own profit margins.

Sebi is already mulling ways in which liquid schemes can be better equipped to deal with risks caused by volatile flows in tough market conditions. Reducing investor concentration and flow of less than sevenday money are some of the proposals being considered, as earlier reported.

The liquidity scare caused by the Infrastructure Leasing & Financial Services fallout has put the spotlight on liquid schemes. These schemes had to manage redemptions of ~2.1 trillion in September, when liquidity for even shortertenure debt instruments had dried up. With the view to bring transparency in expenses, the regulator, in its circular dated October 22, has stated that all scheme-related expenses must be booked in the respective schemes.

The MF industry has also sought clarification on passing non-cash benefits to distributors. In its letter, the industry has asked the regulator whether the loyalty programmes that reward distributors based on their contribution to an MF’s assets under management (AUM) will be construed as upfront payment and therefore, need to be discontinued. Certain MFs run contests where eligible distributors are rewarded with benefits such as international cruises or foreign trips. Sources add the regulator feels that such practices can prejudice a set of distributors in selling select schemes, hurting investors’ interests.

The Sebi in its circular has stated: “MFs shall adopt full trail model of commission in all schemes, without payment of any upfront commission or upfronting of any trail commission, directly or indirectly, in cash or kind, through sponsorships, or any other route.”

However, the regulator has allowed upfronting of trail commission on flows coming through new investors in the case of systematic investment plans (SIPs), with certain riders. The industry also wants to understand whether sending distributors to attend management programmes to build their knowledge base at leading institutes in India or abroad would amount to upfront payments. In some cases, the distributors can even take their spouses along for these trips. In its circular, the regulator has stated that as long as these training programmes are not misused to give non-cash rewards to distributors they can continue.

The industry has also requested Sebi to exempt MFs from disclosing scheme AUMs on a daily basis, citing risks of unhealthy competition and unwarranted media scrutiny or hype.

“Clause D5 of the circular requires disclosure of scheme AUM on a daily basis along with the scheme performance. In our view, it is not desirable to publish daily absolute AUM, as it could trigger unhealthy competition and also unwarranted media scrutiny or media hype. It may be noted that all AUM disclosures, presently, on Association of Mutual Funds of India website are based on average,” the letter read.

With respect to SIPs, the industry in its letter has pointed out that many MFs had brokerage structures which had a component of upfront commission paid for every SIP instalment. So, payment of upfront commission be allowed to continue for SIPs registered prior to the date of the circular, which had these structures. Further, the industry has requested the regulator to issue a list of expenses that could be classified as schemerelated expenses; as the list was last updated in 2009. The industry also submitted its own recommendations as to which expenses should be booked under the schemes and which expenses may need to be borne in AMCs’ books.