The Association of Mutual Funds of India (Amfi); the Indian mutual funds (MF) trade body, has decided to outsource the task of doing the due diligence on distributors. The capital market regulator, the Securities and Exchange Board of India (Sebi), has assigned the job to fund houses.
“Broadly, Amfi is moving to a direction where the MF industry will outsource the work to outside firms that can specialize in such a task,” says V. Ramesh, deputy chief executive officer, Amfi.
As of now, it is not clear whom the task will be outsourced to. “Although it is too soon to say conclusively, we feel that audit and consulting firms are better placed to do this due diligence,” said a fund house’s official, who is close to the development, on condition of anonymity.
In a circular that Sebi issued on 22 August, it kick started the initiative of regulating distributors by laying down guidelines, which Sebi estimates will cover about 50% of the assets brought into the MF industry by distributors.
Regulating distributors have for long been a grey area. While Sebi regulates mutual funds, there isn’t a regulator that monitors the day to day functioning of distributors.
Though all distributors who wish to sell MFs are mandated to be Amfi-certified and must pass an examination, their operations do not fall under any regulatory scanner. Further, though errant distributors are pulled up by Amfi from time to time, that only happens in cases of fraud and also when the investor complains and investigations prove that the distributor has committed a crime, such as fraudulently effecting a client’s redemption and vanishing with the money.
But mis-selling—selling a MF scheme with the intention of pocketing high commission and ignoring the client’s (investor) needs—is something that goes unchecked; it’s also hard to prove. “We think that Sebi is not too keen on regulating distributors directly as of now, but it is definitely concerned. Hence, to begin with, it wants us to regulate them,” said a fund house’s managing director, who did not want to be named.
Which distributors are under regulatory ambit? Sebi has laid out four broad parameters to identify distributors who will be covered by this due diligence. A distributor who is present across 20 locations and/or has raised assets under management over Rs 100 crore across all MFs and/or commission received above Rs 1 crore across industry and/ or commissions received over Rs 50 lakh from a single mutual fund, will come under the ambit of due diligence.
But there is a problem in leaving the job to the fund houses. Industry sources say that if left to individual fund houses to do due diligence, it could stir a hornets’ nest. “In order to please agents, fund houses may trip over one another in making exceptions in doing due diligence in terms of being lenient,” said the second official we spoke to.
Sebi has laid down a detailed roadmap as to what elements of MF agents would need to be accounted for. For instance, fund houses have to ensure that distributors earmark themselves as being in either an “advisory” or “transaction only” mode. Further, the “execution only” distributors will need to give a written communication to their investors if they believe that the transaction is not appropriate; for instance, if the MF scheme does not suit the client.
Seeking professional help
After fund houses independently draw a list of agents selling their schemes that fit any of the four-point criteria and pass them over to Amfi, the latter will look at outside firms who can then carry out much of the due diligence.
“We plan to appoint more than one firm to avoid monopoly. All such firms, though will adopt a common minimum procedure. Fund houses will then have the freedom to choose any one of these two, three or four firms assigned for the task,” said a foreign fund house’s chief executive officer, who is close to these developments.
Consulting firms such as KPMG and PricewaterhouseCoopers Ltd are expected to be approached by the MF industry but that is just an indication we got from our interactions with the MF industry as these are still early days. These firms will then prepare questionnaires, approach distributors and do the due diligence.
Although the discussions are in their initial stages, sources close to the development feel that not everything may be outsourced. “Despite engaging outside firms, the responsibility for due diligence will still be that of the fund house. Hence, not everything may be outsourced. Fund houses may still want to do a part of this themselves. All this is in the discussion stage,” said one of the officials quoted above.
Says Vivek Prasad, partner, PricewaterhouseCoopers Ltd, “It lends more credibility to the process if such due diligence is done through an external agency. Besides, it also saves on duplication such as the know-your-customer norms process that was outsourced to CDSL Ventures Ltd (a division of Central Depository Services (India) Ltd.”
Adds Abizer Diwanji, head (financial services), KPMG, “Even at present, some firms do background checks of potential distributors for fund houses to check the former’s credibility. If Amfi decides to go ahead with the due diligence, such checks will become standardized.”
Though these are early days, fund houses are optimistic that by the end of this year, the MF industry will iron out the wrinkles and begin the due diligence as required by Sebi.