Regressive regulation

New compensation rule for AMCs is illogical

In a recent circular, the Securities and Exchange Board of India (Sebi) decreed fund managers and other senior employees of asset management companies (AMCs) should be paid a minimum of 20 per cent of their gross compensation in the form of units held in schemes where they play a role, or have oversight. These units should have a lock-in period of three years. This comes into effect from June 1. The circular said this was to “align the interest of the key employees of the AMCs with the unit holders of the mutual fund schemes”, which is a bureaucratic way of saying it is designed to ensure AMC employees have some skin in the game. It may have been prompted by the fact that some employees of Franklin Templeton redeemed personal holdings in six of the AMC’s debt funds just before these schemes were shut down. It is also claimed this move would promote transparency in compensation and, thus, give investors more confidence.

 
The decision raises multiple concerns. Arguably, Sebi, the market regulator, is overstepping its mandate by imposing a rigid compensation structure. No regulator in any major economy forces fund managers to structure compensations in this fashion. Such a mode of compensation will inevitably require micromanagement in terms of further clarification, and that adds layers of complexity. The fund industry includes a multiplicity of schemes, offering exposures to different assets, in different mixes and modes. There is also a high degree of mobility in the financial services industry. Employees move between schemes, and shift between AMCs, as well as moving out of the fund segment itself. As such, implementing this circular, which is already complicated, could turn into a nightmare of detailed fine print and further clarification. For instance, the circular exempts managers of index funds and some categories of debt funds from this requirement. It also clarifies units awarded to senior AMC executives, who have a role to play in more than one scheme, must be structured by weighting across different schemes they oversee, using a formula that takes assets under management into account.

 
Sebi will also have to clarify compensation structures in other normal work-related situations. What is to be done with locked-in compensation if an executive changes jobs, or is assigned different responsibilities by the AMC? This circular also applies to research staff, dealers, and support-function heads. It is a considerable chunk of compensation. It will lead to constrained cash flows for financial industry workers if one-fifth of compensation is untouchable. This could lead to serious issues for those with EMIs to pay on mortgages or vehicle loans, for instance. This could also create some new, undesirable trends within the fund industry. One is an arbitrage in favour of exchange-traded funds, index funds, closed-end funds and the other exempted categories. Employees would gravitate towards these schemes, to free up personal cash flows. AMCs may also be forced to bump up compensation to ensure employees don’t feel a cash crunch. In other major economies, transparency is ensured by asking AMC employees to disclose their assets and personal trades, including any exposures to the funds they manage. This should certainly be done in granular fashion. Going beyond, and imposing a rigid compensation structure is undesirable.