Mutual funds seek a middle ground with Sebi on brokerage fee cap

“Mutual funds told Sebi that a reduction from 12 basis points (bps) to 2 bps is too sharp and that they should make it more practical and meet us halfway. They seemed open and receptive to our suggestions," said an executive from an asset management company (AMC).

The chief executive officers of AMCs met the market regulator on Monday for an hour-long meeting to discuss the proposed caps on brokerage fees of mutual funds. Last month, Sebi proposed a sweeping overhaul of mutual fund regulations, which created widespread concern in the industry regarding margins and top-line.

Fund houses expect Sebi to bring the cap on brokerage costs to about 6 bps instead of the proposed 2 bps but nothing was finalized in the meeting.

An emailed query to Sebi didn't elicit any response.

Sebi has proposed capping brokerage and transaction costs that mutual funds currently charge, in addition to the total expense ratio (TER). It represents the maximum annual fee a fund can charge investors, covering management charges, administrative expenses, brokerage and other operating costs.

To curb excessive trading costs, Sebi has recommended reducing brokerage limits from 0.12% (12 bps) to 0.02% (2bps) for cash market transactions and from 0.05% to 0.01% for derivatives, ensuring that investors are not charged multiple times for the same expense.

The regulator said that brokerage fees are often inflated because they include additional services such as research, which is a cost an investor already bears through a fund’s management fee.

Retail investors may benefit

The recommendations are expected to be good for retail investors but not for the mutual fund industry. If Sebi’s proposals are adopted, AMCs would need to bear their own research expenses instead of passing them on to investors. This could increase operating costs and compress profit margins in the short term. Institutional equity platforms that earn from both execution and research may also face reduced revenue as AMCs scale back on paid research.

“If implemented, we expect the impact on AMCs to be 1-8% of core revenues," said an October report by JM Financials.

Representatives from top asset managers, including HDFC Mutual Fund, Kotak Mutual Fund, Capitalmind Mutual Fund, Tata Mutual Fund, and Jio Blackrock Mutual Fund, were present at the meeting.

Smaller AMCs told Sebi they may no longer be able to afford research if the proposals are implemented, creating an information gap, as they also don't have internal research teams, said another person aware of the discussions. Fund houses also warned they could lose block deals to players who can pay brokers higher commissions, the person said.

Other issues discussed included relaxing the examination norms for Specialized Investment Fund (SIF) exams, which are compulsory for SIF distributors.

Sebi is not expected to meet mutual funds again to discuss the proposals. The recommendations are likely to go to the regulator’s board now, said the AMC executive quoted earlier.

“The MF industry has sent data on the implications of what will happen if there is a reduction in TER, but nothing substantial was discussed on it. Nothing is decided as of yet," said the second person quoted earlier.

Mint reported last week that the Association of Mutual Funds in India (Amfi) has asked fund houses to submit data on turnover for equities and derivatives trades, which will help them determine transaction and brokerage costs incurred while executing trades. The compiled data will be shared with Sebi, which aims to assess the actual weight of brokerage costs for mutual funds before finalizing the proposed caps.

The market watchdog also met sell-side brokers separately last week. Sell-side brokers provide research services to AMCs and are expected to also be hit by the proposals.

“We presented our case to Sebi and highlighted concerns on the impact of the suggestions on our business and the market. Sebi was receptive and heard us out," said a broker on the condition of anonymity.