Mutual fund (MF) agents did not look pleased while going through the five-page questionnaire that HDFC Asset Management Co. Ltd sent to all its distributors late last week.

Illustration by Shyamal Banerjee/Mint

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Mint’s mutual funds editor Kayezad Adajania says Sebi’s rule on due diligence by mutual funds houses has left distributors deeply unhappy

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Reliance Capital Asset Management Ltd, JM Financial Asset Management Pvt. Ltd and Franklin Templeton Asset Management (India) Pvt. Ltd have already emailed their distributors asking them to keep their records ready and to expect a questionnaire from it soon. Mint has reviewed a copy of HDFC AMC’s questionnaire as well as communications sent by various fund houses. This comes just days after their annual commissions earned from selling MFs have been publicly disclosed. Indian firms are not new to the concept of auditing and due diligence but the distributor due diligence exercise that Sebi has advocated seems to be a mess. Here’s why.

To standardize...

The circular started the much-awaited distributor regulation, but puts the onus on fund houses as a first step towards regulating distributors. It said that fund houses will need to evaluate distributors on parameters mentioned earlier in the story. Fund houses have been told to conduct this due diligence when empanelling distributors and then subsequently once every year.

Last month, the Association of Mutual Funds of India (Amfi), Indian MF industry’s trade body, started to firm up plans to outsource the task of scrutinizing agents to audit and consultancy firms. Amfi had plans to appoint three-four such firms to avoid monopoly and fund houses would then be free to choose either one of these firms to do the due diligence on its behalf.

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 100 crore across all MFs and/or received commission above 1 crore across industry and/ or received commissions over 50 lakh from a single MF will come under the ambit of due diligence.

…or take responsibility?

However, about 10 days back, Sebi wrote to fund houses individually making it clear that it was the latter’s responsibility to do the distributor diligence. “The tone of the letter suggested that fund houses would need to do the due diligence work internally rather than getting anyone else to do it," said an industry official who did not want to be named.

Distributors aren’t convinced. “If I have to start filling so many forms for as many fund houses that send them to me, when will I have the time to do my business and address my clients’ needs?" said another Mumbai-based distributor, who also did not want to be named. He adds that if individual fund houses start sending such “lengthy forms", many distributors will start to disempanel themselves from smaller fund houses. Disempanel means to withdraw a licence to sell a particular fund house’s schemes. In that case, it would not be necessary for distributors to submit documents and participate in that AMC’s due diligence process.

Industry sources say that at the heart of the matter is Sebi’s fear about Amfi’s role in distributor evaluation and whether individual fund houses are serious enough to take up this responsibility. “Sebi’s 22 August circular also says very clearly that individual AMCs should put in place a due diligence process and that is where Amfi’s involvement may have ticked off Sebi," said a chief executive of a fund house who too did not want to be named.

But diluting the AMC’s responsibility, Amfi says, was never the intention. It believes that it’s perhaps a “miscommunication and hopes to sort it out soon". V. Ramesh, deputy chief executive officer, Amfi, says that even in the outsourcing plan, the responsibility will rest solely with the fund houses. “Outside firms will be brought in to only provide some sort of a common platform and standardization to do due diligence. There is not going to be any dilution in the AMC’s role or responsibility; a common platform is just a facilitator to reduce paperwork and cost. Besides, smaller AMCs have various distributors who sell schemes infrequently and it may not be cost-effective for them to individually do a due diligence of all such distributors. Additionally, fund houses will also be free to either ask for additional data over and above what the common platform prescribes or they may be free to do the entire due diligence on their own," he says. An email sent to HDFC AMC did not elicit any response. An official of Reliance Capital AMC replied: “Industry has been working together to develop a common template and standardize questionnaire for distributor due diligence for convenience of the distributors. However, the onus will be on AMCs to ensure compliance."

Harshendu Bindal, president, Franklin Templeton Investments (India), says: “Our understanding is that appointment of few common external auditors has been accepted. The other aspects of distributor due diligence are still being discussed and we are confident that a practical model taking into consideration all factors will evolve from these discussions."

“The effort to regulate distributors is in line with global best practices that look to distinguish between different types of distribution models. At the same time, we need to adopt a principle-based regulatory policy that acknowledges the existence of these different distribution models."

Classifying client’s transactions

The other part of this sordid saga is customer classification. Soon, every time you buy an MF scheme, the distributor will have to classify the transaction as either of the two: “advisory" or “execution only". In other words, most probably, you will need to file a declaration at the time of investing in an MF whether you understood what your agent is selling to you and what you are buying or whether your MF distributor has studied your needs well enough and has recommended you the fund that is best suited to you. Last month, Sebi also floated a concept paper on investment adviser guidelines on its website and invited public feedback wherein it advocates that all distributors should either act as “agent of the manufacture" or “adviser to investor". For now, Sebi has allowed MF distributors to be both; just that they will have to classify all their transactions accordingly.

Though the broad contours are still being worked out, distributors claim it’s tough to classify transaction. Says G.K. Balaji, head of investing business, Way2Wealth Brokers Pvt. Ltd, “My relationship managers who visit many clients on a daily basis will have to keep a very close track of which clients or transactions are to be recorded in what way. Customer support will then have to keep a track of such inputs too. It’s difficult for a human being to remember all this though especially when one is always on the move and ends up giving advice to all his clients." Many distributors see themselves moving to pure execution form. Says Surajit Misra, national head (mutual funds), Bajaj Capital Ltd: “We will eventually move into a ‘transaction only’ form of MF selling. Of course, we will do the basic due diligence of our customers. But since retail investors don’t tend to pay fees, it doesn’t make sense to adopt the ‘advisory’ model’."

Many also feel that it’s not easy to distinguish between an advice and information. “A bank’s relationship manager might feel that he is giving advice to customers, but in reality it might just be information," says the head of marketing of a fund house, who requested anonymity. There are logistical issues too. “We have 200,000 customers and that makes it practically very difficult to classify all our transactions. On a retail level, the average value of an MF transaction is about 30,000-50,000, it’s very difficult", says Rajender Rautela, director of retail and HNI (high networth individual) business, RR Investors Capital Pvt. Ltd, which is present in 21 cities across India. This is perhaps turning out to be as much of a game-changer as, if not bigger than, the abolition of entry loads that happened in August 2009. We’ll keep you posted.