Direct Mutual Fund platforms have emerged as a significant stakeholder in the Mutual Fund (MF) industry of India. However, recent events have raised questions about where these platforms stand in the regulatory landscape.
A few months back, Paytm Money had announced that it would move its direct MF business from its advisory branch to its broking arm. Recently, the Securities and Exchange Board of India (SEBI) penalized another platform for failure to comply with applicable rules in a judgment order.
These developments, when viewed in conjunction with the SEBI Consultation Paper on Execution Platform (EOP) only, herald a significant change in the way direct MF platforms are structured.
To get to the root of the matter, it is important to first understand how direct MF platforms work. For their functioning, these platforms require two capabilities. First, to forward transactions across different MFs, and second, to be able to receive data feeds from MFs on aspects like transaction status, payment processing, settlement updates, unit allocation, etc. These data feeds are shared by Registrars and Transfer Agents (RTAs). ) MFs, such as CAMS and Karvy. However, there are restrictions on who can receive these data feeds.
One of the important questions faced by Direct MF platforms during their inception was how to access the data feed from the RTA. The options before these platforms were to register as either a Mutual Fund Distributor (MFD), or a Registered Investment Advisor (RIA) or a broker. Considering that these platforms offer direct schemes of MFs, MFD registration was not appropriate. This leaves two registration options – either as an RIA, or as a broker. Most platforms choose to register as RIAs, except a few (like Coin by Zerodha, which already had a broking license).
Choosing the RIA license opened the door for direct MF platforms to access data feeds and also provided the option to upscale from just an execution platform to an advisor-cum-execution platform. But it also opened up a whole new set of problems. These platforms may not have anticipated earlier how difficult the compliance burden of maintaining an RIA license would become—especially after SEBI’s amendment to the RIA rules in 2020.
For a platform that only seeks to execute MF transactions, the compliance burden had no operational meaning—until the Direct MF platform was launched with the aim of graduating into a full-fledged advisory business. Most of the Direct MF platforms have no such aspiration.
Hence the move by Paytm Money to exit its RIA license and shift its MF business to its broking branch. However, not all Direct MF platforms have in-house broker registration to migrate.
This brings us to the recent SEBI consultation paper on EOP. The consultation paper proposes to create a new EOP registration, who can apply for the Direct Mutual Fund platform and use his EOP status to access the transaction data feed from the RTA. However, the proposed rules on EOPs also bring up a number of issues – the most relevant being how EOPs will generate revenue.
There are two options – first, EOP can charge users directly. This would not be his first choice as it is a difficult hill to climb. Recall how Zerodha coin had to withdraw a nominal fee of 50 per month and make its platform completely free to use.
The other option is for EOP to be compensated by MF- and there are several important questions here. Will the MF company pass on the cost levied by the EOP to the investors? Can an MF company make additional EOP compensation for favorable listing of its schemes?
Another important point is that as EOP approaches, the platform’s scope will be reduced – just the execution of transactions. But where do you draw the line between merely providing transactional services and advice? For example, if EOP compiles a list of top mutual funds to buy, is it only providing execution services? And if it refuses to curate because it may contain advice, what will the platform offer?
There is no doubt that the proposed new EOP rules fill a significant gap in the regulatory landscape. But there are important questions to be answered that will determine whether the new set of rules will ultimately benefit investors.
Ravi Saraogi is a SEBI-registered investment advisor (RIA) and co-founder of Samasti Advisors
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