Mumbai: The stock market regulator is planning to cap mutual fund distributor commissions in an attempt to check mis-selling, three people aware of the matter said.

Many distributors move their customers frequently from one scheme to another to keep commissions flowing, with little regard for their ability to handle risk.

The Securities and Exchange Board of India (Sebi) plans to cap lifetime distributor commissions for fixed-income schemes at 1.5-2% and equity-oriented mutual fund schemes at 4-5% so that upfront commissions too come down automatically, the people mentioned above said on condition of anonymity.

Currently, commissions paid upfront alone are as high as 6.5% at several fund houses, which are followed by trail commissions later.

Under existing Sebi norms, the total expense ratio (TER) of an equity scheme, excluding issue or redemption expenses but including the investment management and advisory fee (which includes commissions/ brokerages), is capped at 2.5% (2.25% for debt funds) on the first 100 crore of average weekly net assets, 2.25% on the next 300 crore and 2% on the next 300 crore. Beyond 700 crore, asset management companies (AMCs) can only charge a TER of 1.75%. However, AMCs often incentivize their distributors over these limits by paying them from their own wallets.

“Sebi has observed that such excessive commissions offered to distributors lead to migration of distributors from one AMC to another and compel them to sell MF schemes to customers merely with an intention to earn better commissions, without really assessing the customer’s risk appetite. The new rules will put a maximum cap on commissions and attempt to curb mis-selling," said the first of the three people cited earlier.

“The customer’s risk appetite is no longer a priority for the distributor when an AMC offers a significantly higher commission than another AMC," said the second person.

This is Sebi’s second major attempt to curb mis-selling in India’s 23.40 trillion asset management industry. In 2009, it had banned so-called entry loads charged by AMCs at the time of investment to meet distribution and marketing expenses.

An email sent to Sebi on Friday was not answered.

Sebi chairman Ajay Tyagi asked the heads of top 12 asset management companies at a meeting in June if the regulator should go ahead and frame rules on MF commissions, the people mentioned above said.

Following this, the board of Association of Mutual Funds in India (Amfi) met in the first and third weeks of July, and wrote to the regulator that the latter should frame norms in this respect. Since Amfi has no power to enforce rules, several AMCs have written to Amfi that they will not be obliged to follow its advice on upfront commissions, according to the first person cited earlier.

Commissions are part of the total expense ratio (TER) charged as a proportion of the scheme’s assets under management. A part of it is paid by the customer and a part of it is paid by the AMC to the distributor.

At present, in the equity (small cap) category, L&T Emerging Opportunities Fund – Series II (a three-year close-ended fund) offers an upfront commission of 5% to distributors, Sundaram Multi-cap Fund – Series I NFO (new fund offer) (a five-year close-ended fund) offers 6.50%.

In the equity (large and mid cap) category, Invesco India Growth Opportunities Fund pays 4.5% upfront and 1% trail commission (fourth year onwards), along with an additional 25 bps incentive to distributors. Tata Equity P/E Fund offers 3.4% upfront commission and 0.75% trail commission (third year onwards) to distributors. Axis Focused 25 Fund 3.1% upfront commissions. Edelweiss Large & Midcap Fund and UTI Equity Fund offer 3% upfront commission to their distributors. There are at least a dozen more schemes that pay at least 3% upfront commission to their distributors and up to 1.1% extra as trail commission.

Kaustubh Belapurkar, director of fund research at Morningstar Investment Adviser (India) said if upfront commissions are high or uncapped, there could be an incentive for distributors to churn investor portfolios to maximize their commissions.

“Sebi has been looking at adviser versus distributor regulations to remove potential sources of conflict of interest by separating the activities of advice and execution. Currently, Indian fund expense ratios are bundled (distributor commissions are embedded in the TER) and are amongst the highest in the world (especially for equity funds). The regulator could either look to reduce overall TERs (by reducing the max expense ratio by fund AUM slabs) or moving to a totally unbundled mode i.e direct plans only. While direct plans have existed for many years now, the uptake has been limited, which bring us to the question—has the industry been doing enough to promote direct plans?," said Belapurkar.

Sebi feels a wide difference in commissions also leads to a clear inequality in competition among AMCs, by attracting distributors only to certain set of AMCs.

According to Amfi and AMC websites, there were at least 980 MF distributors in the country during fiscal 2018. Of these, NJ Indiainvest Pvt. Ltd earned the highest commission at 786.77 crore, which was almost 78% higher than its commission of 442.68 crore during the previous fiscal. HDFC Bank Ltd’s commission earnings grew around 62% to 641.39 crore, while State Bank of India’s commission earnings grew by 212% to 558 crore and Axis Bank Ltd’s commission grew by 116.36% to 537.71 crore during fiscal 2018 as compared to fiscal 2017.

Commissions at ICICI Bank Ltd grew by 68% (₹470.28 crore), ICICI Securities Ltd by 83.4% (₹316.53 crore), Prudent Corporate Advisory Services Ltd by 120% (₹217.82 crore), IndusInd Bank Ltd by 139% (₹160.22 crore) during fiscal 2018.

Top commission earners included Citibank N.A, Standard Chartered Bank, IIFL Wealth Management Ltd, Hongkong & Shanghai Banking Corp Ltd, Bajaj Capital Ltd, Anand Rathi Wealth Services Ltd, Karvy Stock Broking Ltd, Julius Baer Wealth Advisors (India) Pvt Ltd, JM Financial Services Ltd, Deutsche Bank AG, HDFC Securities Ltd and L&T Capital Markets Ltd.

In April 2015, Amfi had urged 42 AMCs in India to cap the maximum upfront commissions at 1% and the total payout at 1.75% for every year during the life of a mutual fund scheme. While upfront commissions are paid by AMCs to agents on the sale of a product, trail commission is paid through the life of a scheme.

For banks acting as distributors, most of the commissions from MF sales came from their in-house AMCs during fiscal 2018, according to Amfi.

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