On 23rd December, the Securities and Exchange Board of India put out a discussion paper proposing a halt in purchases and sales of mutual funds through pool or escrow accounts of brokers and online platforms. The move comes in the wake of the alleged misuse of the pooling system in the Karvy case, The regulator has proposed direct credit and debit of investor bank accounts for mutual fund transactions.
What SEBI has proposed
An intermediary can first aggregate the money of customers and then pass it on to AMCs (and vice versa for mutual fund redemptions). Such transactions are called pooled transactions. An example of this is purchase of mutual funds through a stock broker where the money is first collected in the broker’s pool account. Platforms such as Mutual Fund Utility (MFU) also use an escrow account to collect investor money before remitting it to AMCs, which is a pooled transaction.
Alternatively, money can flow to the AMC through a clearing corporation on a stock exchange. These transactions are called non pool transactions. For instance distributors and investment advisors conducting transactions through the BSE Star MF platform use the non-pool method. Such transactions involve collection of money through the clearing corporation and not the intermediary. In FY 18-19 the share of pool transactions was 51.5% and the share of non-pool transactions was 48.5%.
SEBI has proposed an end to pooled transactions. According to the regulator, AMCs and Registrar and Transfer Agents (RTAs) do not have visibility of funds and investor details when pooling is done. Further in case of purchase of mutual funds in demat accounts, the liability of AMCs is discharged when payment is made to the broker. As a result, investors are forced to use the Exchange’s grievance redressal system in case of non-credit of units or funds. “In the recent past, instances have come to light where client’s funds/securities were diverted or mis-utilized by trading member/ clearing member toward margin obligations or settlement obligations of itself or for some third party or for raising loan against shares on its own account," the discussion paper said.
Experts have highlighted problems with the implementation of the SEBI proposals. "Not all the exchanges currently have facilities for direct payment to customers from the exchange. Also brokers who charge fees for mutual fund purchases (mostly those offering direct plans) may face problems in the recovery of these charges. Finally, digital platforms that use pool accounts get some benefits because of the volume of money they handle. The new proposals can hit their business model in some way," said Deepak Jasani, Head of Retail Research, HDFC securities.
The Payment Gateway Conundrum
Most online platforms such as Paytm Money, Scripbox and Mobikwik use payment gateways. Whether these platforms can continue with payment gateways is not clear. Some platforms such as Kuvera have clarified that they use BSE Star MF, an exchange platform and will not be affected by the Sebi proposals. Senior Executives at some online platforms have announced their intention to seek clarification from SEBI on this matter. Payment Gateways pool money from end investors and transmit it to AMCs. This cycle can take up to 48 hours to go through. It is unclear whether online platforms will be able to continue using payment gateways. “The new regulations are a result of SEBI’s desire to implement PMLA norms, apart from the Karvy case," said a senior executive at an online platform who did not wish to be named. “For example, online platforms no longer accept debit cards because the investor details cannot be ascertained by the AMC in case of such payments," he added. “The solution is not to bypass the escrow/nodal account but to make it transparent. We should highlight that there is no misuse of the nodal/escrow account with a payment gateway licensed by the RBI," said Kunal Bajaj, Business Head, Online Wealth Management, Mobikwik. “SEBI needs to create parity between clearing corporations and payment gateways," he added.
The SEBI proposals will make mutual fund transactions safer and reduce the risk of fraud or default by intermediaries. However the regulator should urgently clarify its stance on payment gateways regulated by RBI. Disruption in this area could hurt the growth of online investing and mutual fund penetration overall.