In a first-of-its-kind move aimed at investor protection, the Securities & Exchange Board of India (SEBI) has come out with a regulatory framework for execution-only platforms (EOPs) for mutual fund investing, making it mandatory for these entities to get registered and barring them from offering regular plans.
For the regulation purpose, SEBI has defined an EOP as a digital or online platform, which facilitates transactions such as subscription, redemption and switch transactions in direct plans of schemes of mutual funds.
We look at how these regulations will impact investors and companies and whether the norms will increase costs for investors.
What are the key points in the regulations?
The first category would need to be registered with the Association of Mutual Funds in India (AMFI), the mutual fund industry body. On the other hand, entities going for EOP 2 license would need to be registered as a stock broker with SEBI and can operate only through the platforms provided by stock exchanges.
Entities registered with AMFI would act as agents of asset management companies (AMCs) and integrate their systems with AMCs and/or Registrar and Transfer Agents (RTAs) to facilitate transactions in mutual funds.
In a key positive for EOPs, the regulator has allowed that both kinds of EOP platforms can sell other products other than mutual funds, after providing adequate disclosure to clients.
"Till now, these platforms had to follow Registered Investment Advisor (RIA) guidelines, which are proper advisory guidelines. As these entities had a huge client base, it was becoming difficult to follow the RIA guidelines for lakhs and lakhs of clients. Now with these guidelines, there is clarity that you can operate like an execution-only platform. Previously, as a full-fledged RIA, you were not allowed to cross-sell any product, which was giving in-built commissions. The norms have paved the way for a revenue model for these companies," said Mohit Gang, Co-founder and Chief Executive Officer at Moneyfront.
Depending on whether an entity chooses to be an EOP 1 or EOP 2, it stands to make some money either by charging clients or AMCs.
Will the costs increase for investors?
As per SEBI, the EOPs registered with AMFI can charge a flat transaction fee (not ad-valorem; meaning it can’t be based on transaction value), which would be borne by AMCs, within the upper limit as specified by AMFI.
Also, onboarding fees, if levied, would need to be borne by the AMCs.
On the other hand, the broker-based EOPs can levy a flat transaction fee (not ad-valorem), which would be borne by investors within the upper limit as specified by stock exchanges.
Further, onboarding fees by this category of EOPs would be borne by the AMCs and/or investors.
Additionally, AMCs cannot charge any fees/charges paid to the EOPs, or to the schemes of the mutual funds.
There are concerns that the new norms may result in higher costs for doing investments on these platforms.
Gaurav Rastogi, CEO and Founder at Kuvera, however, reiterated that direct plans will not become expensive for investors after the norms. Started in 2017, Kuvera has about 16 lakh users and around Rs 40,000 crore of assets are tracked on the platform.
As per Rastogi, direct platforms currently use BSE StarMF or MF Utilities India for transaction processing. Both these entities charge a transaction fee from AMCs, which is already included in AMC expenses.
"EOP 1 will be incentivised to create parallel infra to BSE and MFU to get a pie of existing AMC expenses. EOP2 continues to use exchange infrastructure and offer free service," he said.
"No change in status-quo for direct plan execution, thus no impact on direct plan costs for AMCs or investors. Also, competition for execution mandate leads to lower costs and better service," Rastogi added.
Also, according to experts, most direct platforms as of now are not charging clients for mutual transactions, which because of competition, will be motivated to continue going ahead as well.
“My sense is that costs will not increase for EOP 1 clients as the AMCs will bear the cost. Also, the transaction fee and onboarding fees cannot form a part of the Total Expense Ratio of AMCs, so, it will not impact the client under the overall expense ratio system,” said Gang.
Which category of EOP is better for entities?
SEBI has left it to the platforms to decide which category of EOP they would prefer to register under.
According to experts, the choice will depend on whether a platform is in a position to charge its clients for services.
If an entity wants to charge its clients, then it would be beneficial to register as a stockbroker under the EOP 2 category, where the flexibility is on the company to charge clients. But if an entity thinks that the client might not be paying, then they might want to be in the EOP 1 category, where AMCs will pay them some token amount on each transaction.
“However, charging a client can be a slightly better revenue proposition if you're able to do that. But none of the platforms have been successfully able to charge clients. Also, if an entity doesn’t have a broking setup already, then it is a very difficult proposition for someone to start a broking setup altogether and then start offering mutual funds through that,” said Gang.
Experts believe that barring EOPs from offering regular mutual plans would have a negative impact on players such as private wealth platforms.
Notably, major direct platforms such as Zerodha, Groww and Paytm Money do not offer regular plans to investors.
What are the ambiguities in the circular?
As per the circular, for Category 1 EOPs, the requirements with respect to the onboarding of investors would be as specified by AMFI.
Also, under this category, the charges in terms of transaction fees, which would be borne by AMCs, should be the upper limit as specified by AMFI.
The clarifications on these points are expected from AMFI in due course.
According to the SEBI circular, EOP 1 players will have to directly deal with AMCs or RTAs from now on, meaning it will be a big operational migration, which is expected to be extremely cumbersome on platforms.
“Today, most of the digital players use BSE or NSE infra to do transactions. Assuming they’ll want to move to EOP 1, some clarity is needed on whether these entities can continue with existing platforms for execution,” said Gang.