29th Aug 2012

FIFA members met senior SEBI officials today to express their apprehensions on the introduction of a direct share class at a lower TER. While SEBI gave FIFA a patient hearing, it has not held out any assurances of a review of its decision. It would rather prefer to work on implementation of all its decisions and review progress in due course, while keeping communication channels open. It now appears that the ball is now in the MF industry's court - to determine what would be a fair level to price the two share classes at - in a manner that does not disenfranchise distributors and yet passes on actual cost savings to a direct investor. Read on to get a gist of SEBI's message to FIFA and the possible road ahead on this contentious issue of the direct share class.

FIFA has made a formal representation to SEBI, highlighting their concerns on SEBI's recent decision to introduce a direct share class at a lower TER.

Click on their logo to view FIFA's representation

FIFA's representatives met senior SEBI officials - Mr. Prashant Saran (Whole Time Member) and Mr. Murli Dhar Rao (ED - Mutual Funds) today, to discuss their apprehensions on the direct share class. Dhruv Mehta, Chairman - FIFA was accompanied by other key FIFA members including Roopa Venkatakrishnan, Yasir Varawala, Masarrat Fakih and Lalit Gianchandani, at this meeting.

     Meanwhile, KAMFA also sent in its lettter to SEBI, expressing similar apprehension.

     Click on their logo to view KAMFA's representation

We spoke with Dhruv Mehta to understand SEBI's reaction to FIFA's apprehensions on direct. Here is a gist of the key messages that SEBI appears to have given to FIFA :

1. SEBI has taken note of distributors' anxiety on introduction of a direct share class at a lower TER

2. SEBI however believes that distributors may be getting a little more anxious than is perhaps warranted. SEBI does acknowledge that some impact may happen, but it does not think this will become a significant issue that can potentially destabilise the system

3. SEBI believes that it is unfair that if an investor comes directly to an AMC, while the AMC saves on distribution costs on that transaction, it lands up earning that incremental money rather than passing on that benefit to the investor who chose to come directly to the AMC. The crux of the decision on a direct share class is to ensure that what the AMC may save in such cases, goes to the investor and not to the AMC.

4. SEBI is very keen to see the MF industry grow and believes that the measures announced can provide a framework for a more robust and widespread growth of the industry. The role of the distributor in catalysing this growth is beyond doubt and indeed SEBI is keen to see multiple models and innovation in distribution to help achieve meaningful growth.

5. SEBI is keen to see the decisions taken by its Board implemented soon, and would like to see how the market responds and develops in the months ahead. Rather than focussing on reviewing decisions even before they are implemented, the preference seems to be to implement the decisions made and review progress as we go along.



6. SEBI signalled that it does not wish to micro manage the MF industry, but wants to set a broad policy framework that encourages growth and investor protection. It is in this context that it has permitted fungibility in TER, which allows AMCs more freedom in their operations, as well as a hike in TER as an incentive to expand meaningfully into smaller towns - without getting into directives or regulation on driving penetration. Likewise, SEBI does not wish to get into directives on pricing, but is only concerned that the principle be upheld that if there is a cost saving somewhere in the system due to an investor's preference to go direct, that saving should accrue to the investor alone.

7. SEBI appreciated FIFA's efforts on establishing a dialogue and has welcomed a move to keep the communication channels open. SEBI would like distributors to understand its point of view, reflect on its concerns on being fair to the investor and then consider its position accordingly.

So, that's what is SEBI's message to FIFA, and through FIFA, to the distribution fraternity. A patient hearing has been granted. Positions have been explained on both sides. From what we understand from this interaction, it may appear that SEBI's intention is to move towards implementation rather than a review of a decision that its Board has just taken, even before the decision is implemented.

How will the two TERs be determined?

A lot will now depend, we believe, on how the two TERs will be actually priced - ie, what will be the gap between the two expense ratios of direct share class and distributor share class. The larger the gap, the higher is the pain for distributors. The lower is the gap, the more prone are AMCs to a frown from SEBI about not implementing the spirit of the regulation. This is going to be quite a tight rope walk for AMCs.

We believe that a good way forward - which can uphold the principle of passing on the cost savings to the investor - and yet be fair to all , will be to first ascertain what will be the cost of servicing the investor who comes direct to the AMC. The principle clearly is that costs saved by the AMC must not be pocketed by it, but must be passed on to the investor. To ascertain costs saved, one side of the equation is the commission saved. Against this saving, one has to consider the cost that the AMC will now incur on servicing this investor. This will start right from the AMC's branch office costs on accepting and processing the application, doing KYCs where necessary and will go on to include costs of call centres that will now be the investor's only port of call for any clarifications, information, service request etc - since he does not have a distributor to lean on for such matters.

Whatever be the costs as ascertained above should be deducted from the commission saved and the net savings should be ascertained. This should become the starting point to determine a fair TER at which both the share classes should be priced. This could be done at each AMC's individual level or can be done collectively through an AMFI committee that can be set up for this purpose. Whichever way this exercise is done, for AMCs to walk this tight rope of supporting their distributors and acknowledging their legitimate concerns, while at the same time adhering to the letter and spirit of SEBI's regulations, it calls for astute leadership skills and a transparent process of determining the fair price.

We have to hope that the industry rises to this enormous challenge and finds a middle path that is fair on all stakeholders.