Sebi’s anti-competition hike
It looks like a situation where market access is being denied to smaller players for no reason
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In what can only be termed as an anti-competition decision, the board of the Securities and Exchange Board of India (Sebi) on 13 February made it difficult for small mutual funds (MFs) to do business in India. Some of the best innovations in the MF industry have come from the smaller funds, but that seems to not matter to the regulator. The Sebi press release couches the decision as follows: “In the long run, the objective is to ensure that mutual funds achieve reasonable size and play an important role in the objective of financial inclusion while further enhancing transparency so that investors can take informed decisions.” Eight points have been listed to meet these goals. Of the eight, five decisions are within Sebi’s powers, and the remaining three proposals are for the government and the banks. One of the five decisions aimed at increasing financial inclusion and transparency is raising the minimum net worth of an asset management company (AMC) from the current Rs.10 crore to Rs.50 crore. How a larger net worth of a fund house will lead to either financial inclusion or more transparency has not been made clear.
There can be six logical arguments in favour of a hike in the net worth of an AMC. One, the current limit of Rs.10 crore was fixed long ago and needs to be inflation-indexed. Two, globally firms are getting better capitalized after the financial crisis. Three, there should be money available with the AMC in case of large penalties imposed by the regulator. Four, a higher net worth will encourage AMCs to push business beyond the top 15 cities. Five, investors who face the impact cost risk must have a capital buffer in case of an adverse market event or in the event of a scheme wind-up. (Impact cost represents the cost of executing a transaction in a given stock for a specific predefined order size, at any given point of time.) Six, all consumer-facing financial firms must display seriousness of intent by putting capital on the table.
If we agree with the argument that the net worth be inflation-indexed, then we are opening the doors for doing so for other parts of the capital market as well, including brokers on the stock exchanges, where we have seen the net worth criterion going down due to competition. The National Stock Exchange’s Rs.1 crore threshold for brokers has remained constant since the exchange started operations. Two, globally, the net worth requirement for asset management has been low and constant. In fact, post the 2008 crisis, the net worth requirement is linked to the level of ownership of client cash by the fund manager. The higher the ownership, the higher the capital need. For a pure pass-through business where the fund manager does not “own” the money, the net worth threshold is low. It has remained $100,000 in the US since 1940 and the net worth requirement for a pure pass-through has been reduced in the European Union, from €125,000 to €50,000. Indian funds are pure pass-through vehicles.
Three, if the higher net worth requirement is aimed at having a fund to dip into in case of big-ticket penalties by the regulator, then a sum of Rs.50 crore may not be enough. Given the structure of MFs in India, investor money will be at risk if there is a diversion of money or false disclosure leading to losses to investors that are not linked to market or fund manager performance. In such deliberate cases of fraud, even Rs.100 crore capital would not mean much for a large fund house managing thousands of crores of investor assets. This can be better dealt with through tightening the supervision function and identification and disgorgement from individuals who cause the fraud. It can be better dealt with by strengthening the role of the trustees who sit at the heart of the MF fund structure in India. Surely, it is the trustees who are responsible for not detecting fraud and misappropriation of money in the AMCs they have hired to manage investor money.
Four, we need to examine if there is a link between higher net worth and market expansion. Given that the regulatory threshold of the net worth requirement cannot be used, unless loans are taken against it, for either paying for office infrastructure, salaries or incentives to distributors, how will a higher net worth requirement make for spending on expansion? Anything additional to the minimum net worth requirement can be spent by the sponsors without regulatory intervention. The regulatory requirement for net worth should be distinct from the net worth a company chooses to maintain to grow. It may be a better idea to use financial incentives to achieve the target of better market coverage. Sebi had already done that in 2012, giving the fund houses an extra 30 basis points in expense ratio for the so-called B15 push to encourage them to go beyond the top 15 cities in selling their products. Shouldn’t we wait for two to three years for the effects of this step to play out before we do more for geographical reach?
Five, the higher net worth will be a buffer against the liquidity risk of a scheme faced by investors in products that either hold non-mark-to-market assets, offer higher risk due to their complexity or offer products that guarantee returns. If Sebi is planning a greater handshake with the Reserve Bank of India (RBI) in terms of the money market mutual funds (MMMFs) being a viable option to the savings deposit (access MMMF through a bank cheque book, for instance), then there may be a case for a higher net worth in fund houses with such products. Or, if Sebi has plans to allow MFs to introduce capital guaranteed funds in the future, then there is a case for higher net worth. However, that need for net worth can be product-specific and be taken care of by a “seed capital” requirement rather than an across-the-board increase in net worth for the whole MF industry.
Six, to deal with firms that manage investor money, instead of tinkering with the net worth criterion, the AMCs may be put through a stress test across a few market scenarios to see stress to the assets. In addition to this, retail seriousness of an AMC can be judged by looking at the ratio of equity to total assets. Given that equity assets are purely retail and a bulk of the debt portfolio of MFs is institutional money, the retail focus of a fund house will be obvious on the basis of this data.
Unless there is something that I am missing, where’s the case for a hike in the net worth? This does look like a situation where market access is being denied to smaller players for no apparent reason.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at firstname.lastname@example.org