Latest Compensation Regulation by Sebi Favours Index Funds

A section of mutual fund houses feared that markets regulator Securities and Exchange Board of India’s (Sebi) new framework on compensation will adversely affect their key employee cash flow and make it difficult to retain talent. In addition, the new rule will create regulatory arbitrage in favour of index funds and exchange-traded funds (ETFs) and will result in the potential death of active fund management, fund houses said.

On Wednesday, Sebi asked asset management companies (AMCs) to pay at least 20 per cent of the gross salary of key employees in the form of the units of the scheme managed by them. The new rule covers all key employees who have been defined as heads of various functions and all employees who are involved in the fund management process-fund managers, research teams, and dealers, among others. The rule, aimed at aligning the interest of the key employees of AMCs with the unitholders of the mutual fund schemes, will come into effect from June 1. As per Sebi, compensation paid in the form of units needs to be proportionate to the asset under management (AUM) of the schemes. Index funds, ETFs, overnight funds, and close-ended funds have been exempted from the new rule.

CEO of Quantum Mutual Fund, Jimmy Patel, said, "Sebi's circular is arbitrary and illogical, looks like drafted hurriedly as the circular applies to junior staff and other members who are not at all connected with fund management." He further said that not all AMCs pay high costs to key personnel nor everybody, as defined under key personnel, earns a high salary. In fact, it would become difficult for a small fund house to retain talent. In this tough time, it will be difficult to comply with the new framework.

According to him, the cash flows of the employees will be adversely affected due to prior commitments of equated-monthly installments (EMIs). "This will also create regulatory arbitrage in favour of index funds and exchange-traded funds (ETFs) and will result in potential death of active fund management," Patel added. 

Edelweiss AMC’s CEO Radhika Gupta said that the circular on the skin in the game, while a good idea in spirit, is going to be problematic in implementation. "This circular applies to not just senior employees but junior research staff, dealers, and support function heads. These people don't earn the kind of money CEOs and CIOs (Chief Investment Officers) do," she said. "It is forcing them to lock 20 per cent of their income for three years. It mandates how much one saves. For a guy earning Rs 15-20 lakh, imagine how difficult it is to put away Rs 3-4 lakh. We are constraining employee cash flow," she added.

Morningstar India Director (Manager Research) Kaustubh Belapurkar said, "Manager skin in the game is always a positive signal for investors." The one point to ponder though is that the individual risk profile of some managers may be different from the risk profile of schemes they manage. The regulation states the investment needs to be made wherever the key employee has a role or oversight on a pro-rata basis, depending upon the AUM of the schemes.

"Typically, fund managers investments by that guideline would be in the funds that they manage. But, for roles with oversight like CEO, Chief Investment Officer (CIO), Chief Risk Officer, their investments would be made in all schemes of the AMC." Similarly, an equity CIO, equity analyst will have their investments spread across equity and hybrid funds," he said.

Globally, a few countries like the US and  China require disclosure of fund manager investments in their funds. But, there is no precedence of a regulation requiring a certain portion of the salary being invested in fund units, Belapurkar said. "The circular needs some flexibility in terms of choosing other funds from the product stable in exceptional cases could be useful," he added.

Omkeshwar Singh, head (RankMF) at Samco Securities, said the move will bring accountability of the performance of the schemes that are dependent upon the key employees of the AMC. This is to share the risk at par with unitholders of the schemes not just with code of conducts as it was earlier but also personal financial accountability with a portion of remuneration getting invested in such schemes, he added. "This will further increase the trust of mutual funds investors in mutual funds, he added.