In MFs' trading expense revamp, AMCs, brokerages see Rs 3.5k-cr blow

Markets regulator has proposed to bring trading and brokerage fee within TER limit

The Securities and Exchange Board of India’s (Sebi’s) proposal to overhaul the expenses charged by mutual funds (MFs) is likely to deliver a combined blow of up to Rs 3,500 crore to asset management companies (AMCs) and broking firms. Rs 3,500 is the estimated amount paid by MFs to brokerages in the 2022-23 financial year and was charged to investors over and above the total expense ratio (TER) of MF schemes, according to Sebi data.

In a consultation paper issued on Thursday, the markets regulator has proposed to bring the brokerages within the TER, a move that will force MFs to lower their own fees to accommodate the broking charges within the permissible TER.

Considering the impact on AMCs’ revenues, the watchdog has mooted the idea of AMCs bypassing brokers and executing trades directly by obtaining limited purpose membership with stock exchanges. This option will bring down the cost for MFs but will lead to revenue losses for brokerages.

"Institutional brokerage will get adversely impacted as brokerage income from mutual funds forms a substantial part of their revenue. As per rough estimates, broking industry earned around Rs 2,500 crore from transactions by AMCs in 2022," said Gurpreet Sidana, chief executive officer, Religare Broking.

The inclusion of brokerage or trading costs in the TER will put AMCs in a catch-22 situation as more the churn in portfolios, less will be the profit margins. "Fund managers may have to think twice before churning portfolios as the expenses will have to be borne by the AMC. This conflict of interest may be detrimental to unitholders' interest," said a senior AMC official.

In the consultation paper, Sebi has also recognised this issue. "It has been represented by industry that bringing brokerage and related costs within TER limits may discourage fund managers from churning of portfolios, which otherwise may be in the interest of unitholders," it said, but also highlighted that the positives of the move outweigh the potential issues.

Sebi sees several problems with the current set-up with respect to transaction cost and brokerage payments. The first would be 'double charging' of investors for research — through fund management fee and payment made to brokerages for research. The other being brokerage charges not ‘coming under the radar or attention of boards of AMCs’, due to it being out of the TER.

Overall, the new TER structure is likely to hit profits of most AMCs but the impact may be limited, said senior MF officials and experts. Brokerage firm Jefferies has estimated the proposed changes to impact AMCs' profits by 13 per cent, or even lower, if a part of it is passed on to distributors, brokers and registrars and transfer agents.

The other broad effect of the new expense structure is likely to reflect in the way AMCs use their investor education budget, for which they set aside 0.02 per cent of their assets under management.

At present, almost half of it is transferred to the Association of Mutual Fund in India and the rest is used to hold investor awareness programs and other initiatives. These expenditures might be curtailed to an extent to allocate budget for additional payment to distributors for bringing new women investors to MFs and any new investor from beyond the top 30 cities (known as B-30 incentive in MF parlace), said MF officials. The cost of the now-suspended B-30 incentive used to be borne by investors.