Explained: What new SEBI proposals for direct mutual fund platforms mean

The Securities and Exchange Board of India (SEBI) has proposed a new regulatory framework for execution-only platforms that allow transactions in direct plans of mutual funds without the help of distributors.

The capital markets regulator has also sought by August 12 public feedback on its proposals, which can potentially overhaul the fast-growing sector and affect not just new-age investment platforms but millions of MF investors.

Why is there a need for a new framework?

Over the past few years, direct plans of MFs have gained popularity as they are cheaper than regular plans, which include a commission paid to distributors. This has resulted in the emergence of several MF investment plans that allow an investor to invest in direct plans, thereby saving on the commission.

But there are no clearly defined regulations for execution-only platform (EOP) service providers. This has created a situation where there is no clarity on protecting the interests of investors who use such services.

“For the investors who are not clients in terms of investment advisory or stock broking or portfolio management regulations, the risk associated with such transactions cannot be overlooked as the non-clients do not have any recourse or protection available under any regulatory framework,” SEBI said in its consultation paper.

“Thus, there is a need to strike balance between the convenience and investor protection,” SEBI said.

So, what exactly is the new framework?

SEBI has suggested three approaches to bring EOP entities under the regulatory framework.

In the first approach, an EOP enrolls as an intermediary with SEBI and acts on behalf of investors by signing an agreement with each investor client.

In the second approach, an EOP enters into a contract with mutual fund houses through the Association of Mutual Funds in India (AMFI) and acts as their agent.

The third approach requires an EOP to acquire limited-purpose membership of the stock exchange and sign agreements with all investors to act as their agent.

What else does the new framework include?

The proposed norms include adopting cybersecurity practices and grievance redressal mechanisms on such platforms. There may also be net worth requirements and other compliance norms depending on which of the three approaches are chosen.

How will the proposed regulations impact investors and investment platforms?

At present, investors who transact on such platforms don’t have any legal recourse if things go wrong. The proposed regulations intend to make it safer for people to invest in mutual funds. “The regulatory framework is aimed at protecting investors’ interests,” according to Ganesh Ram, managing director of MF Utilities.

However, investment platforms may have to tweak their business models.

Ram said the proposed guidelines will ensure that only serious players offer execution-only services, according to a Moneycontrol report.

EOP service providers also smell an opportunity. They say the guidelines propose that they can charge a transaction-based fee for their services from the clients or transaction-based fees only from AMCs. This will provide them better visibility on their revenue.

To be sure, many of these new-age investment platforms don’t have established business models and have thus far been sustaining and growing their operations thanks to the influx of money from venture capital investors. The new regulations will force them to adapt and come up with a sustainable business model.