Mumbai: The capital market regulator may review its March order barring mutual funds (MFs) from using their unit premium reserve for distributing dividends in the face of concerns among asset managers that dividend schemes may collapse if the order is enforced. Such schemes account for a quarter of the assets managed by the MF industry.
The industry lobby, Association of Mutual Funds of India (Amfi), has taken up the matter with the Securities and Exchange Board of India (Sebi).
A senior Amfi official said it was an accounting issue and auditors were looking into the validity of Sebi’s order. Amfi is also consulting the Institute of Chartered Accountants of India (Icai) on the matter.
Mint learns that the market regulator is now considering reviewing the order.
Typically, MFs are supposed to pay dividends out of their profits, or realized gains. For instance, if an investor were to enter a fund at a net asset value (NAV) of Rs12, Rs10 would go to an account called unit capital, assuming the fund’s face value is Rs10. The balance of Rs2 (Rs12 less Rs10) would go into a separate account called unit premium reserve. If this Rs12 goes up to Rs13, the fund can declare a dividend of Re1—its gain.
In issuing the March order, Sebi noted that some fund houses were paying dividends from their unit premium reserve instead of the realized gains.
The market regulator has an accounting standards committee, led by chartered accountant Y.H. Malegam, but apparently the panel was not consulted while issuing the directive.
Sebi declined to comment on the issue, but a person close to the development who didn’t want to be named said the regulator had taken into account the views of five leading audit firms before issuing the order.
Wooing customers through high-dividend yield schemes under their monthly income plans (MIPs), daily dividend plans, and equity-linked savings schemes over years, the industry has mopped up at least Rs2 trillion, or one-fourth of the total assets managed by the Indian MF industry.
A majority of the fund houses have been paying high dividends from the money collected from investors, and not from the actual appreciation of investments. There are around 270 schemes that offer dividend plans for attracting customers and at times dividends paid are as high as 400% of the face value of a scheme.
Sebi has warned asset management companies (AMCs) not to pay dividends from their unit premium reserve, but the MFs are finding it difficult to comply with the new norms, citing accounting implications.
According to Sebi, the treatment of unit premium should be akin to that of share premium of companies and cannot be utilized for dividend distribution purposes.
But H.N. Sinor, chief executive of Amfi, has a different point of view. “A mutual fund is not a company and the units are not shares. This is a pass-through business. In a pass-through process, whatever is realized in cash can be distributed.”
This is the stated position of the MF industry, which has been distributing dividends out of the premium received for over a decade now.
Sebi, however, had its own logic while passing this directive: Since Indian funds have a concept of face value, not followed in other geographies, whatever money is received over and above this is considered a premium. So the fund houses must stop the practice of distributing dividends out of the unit premium collected from customers and should only use the gains from the actual appreciation of unit investments.
“We are unable to convince them and they are also unable to convince us. It is a serious issue and we are looking to resolve it soon,” Sinor said.
According to him, there can be no half measures. “Sebi should either reverse it or mutual funds should fall in line. There is no middle ground,” Sinor said.
Vivek Prasad, a partner at audit and consulting firm PricewaterhouseCoopers, said the matter should be discussed between the three parties involved—AMCs, Sebi and Icai —and resolved.
“The issue is slightly different from the share premium in the context of companies. While the Companies Act has clearly stipulated what the share premium can be used for, there was no such mention or prohibition for mutual funds until the Sebi circular of 15 March,” said Prasad.
According to him, unit premium reserve is not a realized gain and if it is kept in the scheme for good, then there is no utilization. “The mutual fund unit premium balance keeps changing everyday and there should be some clear specification as to what you can use it for. Otherwise, the funds may end up with unrealized gains higher than realized gains,” he added.
Uttam Agarwal, former Icai president, does not find anything wrong with the Sebi move. “Sebi should go ahead and stipulate strict penalties for violations to ensure that this practice of mutual funds declaring dividends out of capital” is stopped, he said.
While Sebi’s move will deal a blow to MIPs and daily dividend schemes, the existing schemes with high NAVs will still be able to declare moderately high dividends as they have already accumulated money in their schemes due to the appreciation of their investments.