Introduction
In recent years, a lot of funds have failed to meet expectations of their investors. In spite of being actively managed, there have been a number of challenges with regards to their performance.
It is a human tendency to show greater dedication when one’s own fortune is at stake. Naturally, having an investment in the fund they overlook has helped fund managers deliver better results.
That is exactly what SEBI has recently mandated. Executives of such funds will now be putting their money where their mouth is, so as to ensure better performance.
What are the new regulations?
On 28th April, Securities and Exchange Board of India (SEBI) issued a circular stating that key employees of Mutual Funds must be paid 20% of their yearly compensation in units of the mutual fund schemes that they have a role or oversight. This was done with a view to “Align interest of key employees with the unit holders”. The capital markets regulator also stated that 50% of this amount, i.e. 10% of their total compensation, must be invested in schemes that these employees directly manage and the other 50% can be invested in other schemes of the fund house that have an equivalent or higher risk rating. These units will also have a 3-year lock-in period. Meaning that the employees will not be able to sell or redeem these units and must hold them for a minimum of 3 years. To further complicate matters the half that is invested in schemes with direct oversight must be invested proportionately (to their AUM’s). AMC’s, especially the larger ones, may have upwards of 50 schemes each. Implying that certain employees will be required to proportionately invest a part of their salary across all these schemes!
To illustrate this using an example: say you are an equity fund manager responsible for managing 3 schemes, namely the Multicap Fund, Small Cap Fund, and Multicap fund at an AMC. For your hard work you are paid a yearly salary of INR 12 lakh (INR 1 lakh per month). Now instead of crediting your account with 1 lakh per month, the AMC will credit your account with INR 80,000 and pay you the remaining 20,000 in mutual fund units. Out of which INR 10,000 will be divided amongst the 3 funds you manage, in the ratio of their respective AUM’s. For the other INR 10,000 you can choose to invest in any other scheme of your AMC that has an equivalent or higher risk rating. All of these units that you receive are subject to a 3-year lock-in, therefore you will be able to redeem these for cash only 3 years from the date you receive them. Also remember, after a couple years your employer discovers that you engaged in fraud/negligence or were involved in a violation of the code of conduct, then can “Clawback” or take back these units.
Who is this applicable to?
SEBI has defined Key Employees as:
i) The Chief Executive Officer (CEO)
ii) Chief Investment Officer (CIO), Chief Operating Officer (COO), Chief Risk Officer (CRO), other CXO positions and departmental heads including Sales, Compliance and IT
iii) Fund Management and Research teams, including dealers
iv) Direct Reportees to the CEO (Excluding assistant/secretary)
v) Other Employees as identified by the AMC.
Why were these introduced?
In April 2020, Franklin Templeton Mutual Fund announced the sudden winding up of six debt mutual fund schemes. Reasons given were poor liquidity conditions in debt markets due to COVID-19 crisis. These six funds collectively were estimated to be at a size of over ₹25,000 crore at the time of winding up.
Generally, debt mutual funds are considered safer than equity funds. This sudden turn of events was a bolt out of the blue, which led to authorities pondering over ways to avoid this frequent occurrence of mutual fund related fiascos.
The situation led to unrest in the markets. Number of schemes, both debt as well as equity were hit due to exposure to poor-quality assets.
Previously, SEBI had ensured that AMCs have some skin in the game by mandating that an AMC invest in all schemes it manages. Now, top employees will be doing the same.
A Balasubramanian, managing director and chief executive officer of Aditya Birla Sun Life AMC, said: “There are individuals who are investing in their own schemes, but this move will ensure a higher commitment towards their own funds. Even from the investors’ point of view, this will improve their conviction to continue investing in mutual funds.”
The SEBI reasoning behind this mandate is to prevent instances of insider trading while also discouraging fund managers from assuming extremely high levels of risk.
Drawbacks
AMC employees have requested for more flexibility in the idea proposed. Their biggest concern is that key employees will be forced to invest in funds that do not align with their risk appetite or investment goals.
Employees affected will have a mandatory lock-in period of three years, even if they resign from the firm.
The SEBI circular covers a wide range of employees, including heads of HR, sales and IT. These people are forced to contribute a certain percentage even if they have no power in investment decisions.
While in larger firms CXOs are very well compensated, the same cannot be said about smaller firms. Employees of these smaller firms will have to contribute 20% of their total compensation (net of tax). This poses a problem since it does not consider everyone’s financial needs and circumstances.
Conclusion
Presently, only a few countries including China and the US which require a mandatory disclosure of manager investments in their funds. However, there is no precedence of a regulation requiring a certain portion of the individuals compensation being invested in the fund. India is the first country to implement such a rule.
This post was written in collaboration with Asif Yahiya Sukri LLP. Asif Yahiya Sukri LLP provides unparalleled personalized financial services to a broad range of clients across different geographical locations. With a presence in the USA, India and the MENA region, they ensure that all of your financial decisions are made carefully and with your best interests in mind. They are innovators who understand what goes into building companies.
You can also reach out to them on info@aysasia.com
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