Sebi Overhauls Mutual Fund Rules with Performance-Linked Expenses from April 1

Securities and Exchange Board of India (Sebi) has announced significant changes to mutual fund regulations, including permitting performance-linked base expense ratios for schemes starting on April 1. These changes, approved in December's board meeting, amend the existing three-decade-old regulatory framework, providing greater clarity through improved disclosures to investors and enhanced governance over all aspects of mutual fund operations.

The new rules require an asset management company to have stronger governance than what has been in effect for the past three decades. As a result, all asset management companies will be required to have compliance officers oversee the operations of the company. The reasons for the changes include providing better value and increased transparency to investors with respect to cost versus benefit. This will also allow for more clarity in comparing fees when investing in large funds.

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Performance-Linked Base Expense Ratio

In connection with the new base expense ratio, asset management companies will now have the ability to link the expense ratio to performance based on criteria established by the SEBI and provide disclosures regarding performance in order to facilitate investment decisions. The base expense ratio only includes the fee paid by the asset management company for managing a customer's money.
All additional costs associated with brokerage, securities transaction taxes, stamp duty and exchange fees will appear on a separate line item. The elimination of these items from the total expense ratio will assist investors in determining the actual total costs of their investments. 

Tighter Brokerage Caps and Governance

Sebi has reduced brokerage limits on cash markets by 6 bps, from a previous 8.59 bps, and on derivatives from 2 bps to 3.89 bps. Additionally, these new limits limit all hidden charges.

Under revised governance rules, trustee obligations and manager accountability are further defined. All mutual funds must also comply with stricter governance norms, which allow for a reduction in risk and increase investor trust.

Impact on Investors and Funds

Large-sized funds may be negatively impacted under the disclosed fee structures. However, on the other hand, the investor has the ability to reap the benefits of additional performance incentives, which incentivise funds to produce better returns.

The fee structures take effect from April 1, allowing funds to prepare for this major change in their operations. The process will help modernise the industry by creating independent management fees and pass-through costs for mutual funds, allowing for the creation of a more equitable and informed marketplace.