Regulator’s Skin-in-the-game rule is good in spirit, but needs simplification

Skin in the game is a good thing in any business, especially in the one of managing money. In spirit, the principle of having senior management and fund managers invest in the funds they manage and sell adds further accountability on their shoulders. Most sophisticated investors, especially globally, also demand this from asset managers, because it builds confidence. In that sense, the recent Securities and Exchange Board of India (Sebi) circular is good in spirit, but unfortunately, the devil is in the details, and those details pose a few significant challenges.

The first is that the circular, in the name of key personnel, covers too many people. Skin in the game when applicable to a chief executive officer (CEO), senior fund managers, chief investment officers (CIOs) and risk and compliance heads is very valuable, because they play a role in the investment decision-making and oversight process. However, this circular covers even research analysts and dealing staff as well as all heads of departments. A head of sales, head of human resources (HR) or head of tech play no role in investment decisions.

Coupled with the fact that the circular insists that 20% of an individual’s total compensation (net of tax) must be in their own scheme, this poses a problem. The reality is that people such as dealers or heads of support functions do not earn very large salaries unlike CEOs and CIOs. The new rule regulates how much money they save. For someone earning ₹15-20 lakh of net income, to save 20% in a city like Mumbai, which is mandatorily locked in for three years, between EMIs or rent and other responsibilities, is extremely onerous. Financial needs and circumstances differ from person to person, and can change dynamically.

The third problem is the mandate on where the money will be invested. A fund manager managing equities is forced to invest in only equities, and while I may be managing a mid-cap fund, I may not have a risk appetite for 100% equities. A liquid fund manager is forced to hold 50% of his money in liquid funds for three years, which is a bad allocation of capital. And everyone who doesn’t manage dedicated schemes has to hold all schemes of the asset management company (AMC) in assets under management (AUM)-weighted proportion. We at Edelweiss don’t even have that many schemes, but that is about 20 funds for each of us, which is definitely not optimal. Not to mention, if your AMC has an 80:20 debt-equity AUM, this automatically becomes your asset allocation. The AMC’s business model cannot decide the asset allocation of the head of HR.

A more simple solution that achieves the same objective is to say that employees earning above a certain threshold (maybe ₹50 lakh) invest a percentage (30-50%) of their total investments in schemes of their own AMC, as per their asset allocation choices. For fund managers, a certain percentage can be in their own schemes and a balance can be in schemes of another AMC. Another alternative is to restrict this to the percentage of bonus compensation for senior people.

In the current form, there are problematic implications ahead. AMCs, like any business, have to manage cost structures and this may lead to a natural hike in cost structures, especially for junior staff. It may also draw talent away from AMCs—a young analyst may well work for an alternative investment fund with none of these restrictions, and talent in HR, tech and marketing has many more unrestrictive options.

The irony is that in most AMCs, all fund managers and senior management already do invest a large part of their money in their own schemes. I have 70% of my money in my own funds, and all my senior management has large chunks too. We did not need any internal guidelines or regulatory push to do this. We did it because we understand our schemes the best, like the products we run and trust our people’s abilities to run them.

Like many other businesses, AMC senior management also have significant compensation from AMC ESOPs, and from what I have seen of this industry, if you want your business to grow, it will grow on the back of good and performing products. We already have a lot of skin in the game through bonuses, ESOPs and most importantly our names and reputations that headline our funds (in the case of fund managers). A regulation that is simple, focuses on the spirit and doesn’t impact junior people adversely in the organization is a welcome addition to supplement our own efforts.

Radhika Gupta is MD & CEO, Edelweiss Mutual Fund.