SEBI Proposes Changes in Mutual Fund Expense Structure

The Securities and Exchange Board of India (SEBI) has introduced reforms in the Total Expense Ratio (TER) and brokerage fee structure for mutual funds. These changes aim to enhance transparency, reduce costs for investors, and simplify regulatory compliance. The reforms are expected to impact asset management companies (AMCs), brokers, and ultimately benefit investors through lower charges.

Background of TER and Exit Load Charges

Before 2012, mutual funds charged exit loads which were used by AMCs to pay distributor commissions and marketing expenses. Post-2012, SEBI mandated that exit loads must be credited back to the schemes. To compensate, AMCs were allowed to charge an additional 20 basis points (bps) under TER, which was later reduced to 5 bps in 2018. This 5 bps provision was temporary and now SEBI plans to remove it.

Revised TER Structure

SEBI has increased the TER by 5 bps for the first two slabs of open-ended equity schemes to ease the transition. For assets under management (AUM) up to ₹500 crore, active funds can charge 2.5% and passive funds 2%. For AUM between ₹500 crore and ₹700 crore, the TER is fixed at 2% for active and 1.75% for passive funds. TER decreases progressively for higher AUM slabs. This move is expected to impact larger fund houses more than smaller ones.

Changes in Brokerage and Transaction Charges

Currently, AMCs can charge brokerage up to 0.12% for cash market trades and 0.05% for derivatives. SEBI observed that arbitrage funds pay lower brokerage compared to other schemes. High brokerage on non-arbitrage funds often includes bundled services like research, causing investors to pay twice under TER and advisory fees. To protect investors, SEBI proposes to reduce brokerage limits to 0.02% for cash market and 0.01% for derivatives. Other transaction costs will be charged on an actual basis.

Impact on AMCs and Brokers

The reduction in TER will reduce AMC profit margins and force cost optimisation. TER is expected to fall by 15-20 bps across schemes, improving investor returns. Brokers will face greater pressure due to lower brokerage limits but may offset this by unbundling research services and charging separately. Growth in AUM may increase trading volumes, partially compensating brokers for lower rates.

Investor Benefits from Lower TER

For a ₹1 lakh investment in equity schemes, the TER reduction can save ₹150 to ₹200 annually. For example, a scheme with a 1.05% TER may reduce to 0.90%. The removal of the 5 bps additional charge and lower transaction costs further improve returns. This makes mutual funds more cost-efficient and attractive for investors.

Rationale Behind SEBI’s Reforms

SEBI’s reforms focus on simplifying mutual fund expense structures and enhancing transparency. By removing ambiguous charges and capping brokerage fees, SEBI aims to reduce overall costs for unit holders. The changes also promote regulatory clarity and ease of compliance for AMCs and brokers.

Questions for UPSC:

1. Point out the role of regulatory bodies like SEBI in protecting investor interests in India’s financial markets.
2. Critically analyse the impact of expense ratio regulations on the mutual fund industry and investor behaviour in India.
3. With suitable examples, explain how transparency in financial markets can influence economic growth and investor confidence.
4. Estimate the challenges and opportunities posed by technological advancements in asset management and their regulatory implications.

Answer Hints:

1. Point out the role of regulatory bodies like SEBI in protecting investor interests in India’s financial markets.

1. SEBI formulates regulations to ensure fair, transparent, and efficient markets.
2. It protects investors from fraudulent and unfair trade practices.
3. SEBI mandates disclosure norms to enhance transparency and informed decision-making.
4. It regulates intermediaries like AMCs, brokers, and exchanges to maintain market integrity.
5. SEBI imposes limits on fees and charges to prevent exploitation of investors.
6. It promotes investor education and grievance redressal mechanisms.

2. Critically analyse the impact of expense ratio regulations on the mutual fund industry and investor behaviour in India.

1. Lower expense ratios reduce costs, improving investor returns and boosting fund attractiveness.
2. TER caps pressure AMCs to optimize costs and improve operational efficiency.
3. Smaller AMCs may benefit less; larger AMCs face margin compression due to scale.
4. Reduced brokerage limits affect intermediaries’ income, leading to service unbundling.
5. Transparent fee structures enhance investor trust and encourage higher participation.
6. Some AMCs may reduce marketing spends, impacting distributor incentives and fund sales.

3. With suitable examples, explain how transparency in financial markets can influence economic growth and investor confidence.

1. Transparency reduces information asymmetry, enabling better investment decisions.
2. Example – SEBI’s mandate on exit load credit and TER disclosures improves clarity for investors.
3. Higher investor confidence leads to increased participation and capital inflows into markets.
4. Robust disclosures attract foreign and domestic investments, fueling economic growth.
5. Transparent markets reduce risks of fraud, enhancing overall market stability.
6. Improved trust encourages long-term investments, supporting sustainable development.

4. Estimate the challenges and opportunities posed by technological advancements in asset management and their regulatory implications.

1. Challenges – Cybersecurity risks, data privacy concerns, and regulatory lag in adapting to innovations.
2. Opportunities – Automated advisory (robo-advisors), AI-driven analytics, and cost-efficient fund management.
3. Technology enables greater accessibility and financial inclusion through digital platforms.
4. Regulators must balance innovation encouragement with investor protection and systemic stability.
5. Need for updated frameworks to address algorithmic trading, digital onboarding, and cross-border data flows.
6. Technology can improve transparency and real-time monitoring of market activities by regulators.