Fintech: Cleaning in Progress

SEBI looking to plug regulatory gaps in execution-only platforms for Direct MF investing

Overlooking the enormous investment rush in the Mutual Fund Industry, the regulators are spying on some loopholes between execution-only and advisory services for direct plans. Until now, SEBI has taken various initiatives to promote the adoption of new technology to ease the Mutual Fund Industry business. As a result, the Asset Under Management (AUM) of the Indian Mutual Fund industry stands at INR 38.04 lakh crores as of April 30, 2022. And over the years, it aspires to strengthen it by bringing in regular amendments and frameworks to enhance transparency and protect investors’ interests.

Recently, SEBI argued that the Execution-only providers (EOPs) need to maintain an arm’s length distance between their services as EOPs and other services. The proposal also included that entities desirous of providing execution-only services need to be mandatorily registered with AMFI (Association of Mutual Funds of India) or with the Stock exchange as a limited-purpose membership.

But why only direct plans?

Direct plans are investments that are not routed through any distributors. Investors investing via direct plans invest at their own discretion i.e without any agent or Mutual fund distributor (MDs). And certainly, since there’s no intermediary involved, its expense ratio differs from that of a Regular plan which includes a distribution cost. Owing to the ease in transacting into Direct plans, its AUM stands at INR 16.94 lakhs belonging to 45% of the total AUM of Mutual funds, the rest belongs to the Regular Plans of Mutual Fund Schemes.

But since these direct plan investors are not protected under any regulatory framework, SEBI welcomes comments on its proposed approaches to protect the retail investor’s interest.

Here’s what the paper says…

Securities and Exchange Board of India (SEBI) issues a consultation paper with respect to the Execution-Only Providers (EOPs) who are neither Mutual Fund Distributors nor Advisors.

According to the paper, there is no specific framework available at present for technology or digital platforms to provide execution-only services in direct plans of the Mutual Funds Scheme and obtain data feeds with respect to such transactions.

To simplify, the ‘digital platforms’ here refers to Investment apps such as Groww, Upstox, Kuvera, Paytm Money, and Zerodha.

The need for such a regulation can be traced back to its origin which is the gap that exists between the companies that are either registered investment advisors (RIAs) or stock brokers (SB). However, it’s been highly observed that the investors who use such applications or digital platforms to invest, transact on their own. To put it simply, they do not intend to avail any of the broking or advisory services provided by the respective platform.

What’s important to consider here is that despite not availing any advisory services, such IAs/SBs use their respective IA/SB registration codes for executing such non-advisory transactions through their digital platform which doesn’t seem relevant to SEBI. Further, it’s more concerned about the protection of such non-clients as they do not have any recourse or protection available under any regulatory framework.

Hence, the SEBI is aimed at regulating such execution-only platforms by three approaches:

     1. EOPs to get registered with SEBI and acts on behalf of the investors. For this, it may charge transaction fees from the clients as it’s acting on their behalf. But the question arises as to will the clients pay for this?

     2. Secondly, such platforms can link up with AMFI (Association of Mutual Fund of India) and act as their distributor. In this case, such platforms might get paid for acting as an intermediary.

     3. The third approach is that such platforms acquire limited-purpose membership in the Stock exchanges. In a way, it’ll act as an agent of the investors and charge fees.

To sum it all up, SEBI wants such online platforms to either become an agent of the AMCs and charge commissions or become an agent of the clients and charge them fees.

Along with these regulatory proposals, SEBI also laid stress on the cybersecurity norms of such platforms in addition to their redressal mechanism norms.

Let’s talk about the impact.

Acceptance of any of the 3 above-mentioned approaches will impact highly to both parties. Investors transacting through such online platforms will be more secure due to regulatory frameworks sliding in. Whereas, such online platforms such as Groww, Upstox, and Zerodha will look for ways to shift their business models to get least affected by the legal frameworks.

But SEBI on other hand will introduce net worth limits for EOPs to ensure seriousness about the frameworks. Similarly, the investor’s data should be well protected through robust cyber security norms to ensure safety and cater to requires criteria to get the EOP license.

Yet to be addressed?

Greater clarity on fees that these EOPs can charge either from investors or mutual funds, could also open up new monetisation opportunities for fintech players. However, will mutual funds be ready to pay these EOPs especially when these platforms may not prefer schemes of a particular MF?

But what matters at the end..

Through the proposed regulatory framework, SEBI intends to plug all the regularly gaps and strike a balance between convenience and investor protection. We await more clarity on what could be the final shape of these regulations, how this model will evolve, and concerns of various shareholders get ironed out. We are however certain that in the end investors are sure to benefit from a secured platform where they can invest in a mutual fund of their choice.