As a welcome step, SEBI released a circular for AMCs requesting them to regulate distributors. This is the first time distributors of mutual funds in India will function in a regulated environment within a structured framework. In this circular, SEBI separates out two functions that can be played by the distributor, as an advisor and as an executor. By separating these functions, SEBI has empowered the customers to select distributors based on either their advisory expertise or their capacity to execute transactions or both. Both services have separate charges that need to be paid by the customer and advisory charges can be rejected by the customer. Transaction charges paid for execution services to the distributor are indirect charges to the customer as they are paid by AMCs from subscription money.
SEBI further keeps customer interests in mind while levying INR 100 transaction charges for only transactions above INR 10,000. This is to attract small and medium investors and encourage them to invest in mutual funds. SEBI also pays attention to improving the quality of originators as they ask Asset Management Companies (AMCs) to conduct thorough Due Diligence for distributors.
These guidelines seem well aligned with customer interests but if viewed from a distributor’s lens may seem to distort incentives and leave grey areas for AMCs. Some of the guidelines addressed by SEBI in the circular are analysed below:
1. Guidelines regarding transaction charges:
The new pricing structure introduced seems inflexible and charges all customers investing more than INR 10,000 a fee of INR 100. Even though this is less than a 1% fee, it may incentivise distributors to ignore small investors since the distributors will earn only if small investors are investing for the first time in mutual funds. Hence a more dynamic price structure needs to be introduced which keeps both, distributor incentives and customer interests in mind.
We feel that a more flexible pricing structure, like ad valorem fees with a cap of INR 100, may be better suited for the Indian mutual fund industry.
2. Due Diligence process conducted by the AMC
The introduction of due diligence checks before appointing distributors is a positive step. It will help maintain reports on quality checks and maintain updated audit reports. It will also help AMC’s monitor the distributors and ensure that they are abiding by regulations and are keeping customer interests in mind. The only concern that arises here is whether all AMCs have the expertise to carry out such checks. AMCs may have to invest in establishing due-diligence and monitoring processes.
The next steps for SEBI should be to publish a comprehensive check list and a unified format for building reports. Themes covered in the check list should be debated and discussed and must eventually align distributors to cater to customer needs through customer awareness programs, product innovation and capable advisory services.
3. Customer Relationship and Transactions shall be categorized as “Advisory” and as “execution only”
This is a great distinction to put in place since the distributor now has an incentive to build expertise in advisory services and the customer has the right to choose and pay for advisory services best suited to his needs. Each time a customer declines advice from a distributor and accepts only its execution services, a distributor will be encouraged to fine tune its advisory expertise. This will create healthy competition amongst distributors and benefit customers over a period of time.
The SEBI circular is definitely a step forward in encouraging presence of high quality distributors that are well aligned with customer interests. However, over a period of time these guidelines will require refinement and more detail to help deepen retail investor base beyond Tier 1 and Tier 2 cities. Important steps forward would be to introduce nationwide awareness campaigns that are conducted by SEBI, more flexible price structures that enable product innovation and increasing presence of distributors even beyond Tier 2 and Tier 3 cities.