EXECUTION ONLY PLATFORMS
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Context: The Securities and Exchange Board of India (Sebi) has published a circular that establishes a new type of intermediary: execution-only platforms (EOPs).
Details
Background
- Direct plans of mutual fund schemes do not involve any commission or fees paid to distributors. They are cheaper than regular plans and offer higher returns to investors. However, investing in direct plans requires some research and knowledge on the part of the investors, as they have to choose the schemes and execute the transactions themselves.
- Over the past few years, several online platforms have emerged that provide the facility of investing in direct plans of mutual funds without the help of distributors. These platforms are called execution-only platforms (EOPs), as they only provide execution services, such as subscription, redemption and switch transactions, in direct plans of mutual fund schemes.
- However, until now, there was no specific regulatory framework for EOPs. Some of them were registered as investment advisers or stock brokers with Sebi, while others were not registered with any regulator. This created a regulatory grey area and posed risks to the investors who were not aware of the credentials and obligations of these platforms.
Why this regulation?
- The new regulations are aimed at addressing a regulatory grey area, wherein digital platforms were using registered investment adviser (RIA) licences and offering execution services only.
- An RIA is only allowed to charge an advisory fee and not any execution or commission fees, which is why an RIA is only allowed to offer direct plans of a mutual fund. Now, if these digital platforms want to charge a transaction fee to investors, they can do so after registering themselves as EOPs.
What are EOPs?
- EOPs are digital or online platforms that allow investors to buy and sell direct plans of mutual fund schemes without any advice or recommendation. Direct plans have lower expense ratios than regular plans and can offer higher returns in the long run.
Why did Sebi introduce EOPs?
- Sebi noticed that some digital platforms were registered as investment advisers (RIAs), but they were not providing any advisory services to their users. They were only facilitating transactions in direct plans of mutual funds. This created a regulatory gap, as investors who were not advisory clients under the RIA regulations did not have any protection or recourse for the risks associated with such transactions.
Sebi also wanted to ensure a level playing field among different types of intermediaries offering direct plans of mutual funds, such as stock brokers, mutual fund distributors and RIAs.
Sebi has proposed two categories of EOPs:
- EOP1: These platforms will act as agents for mutual funds and integrate their systems with fund houses and registrar & transfer agents (RTAs) to facilitate transactions. They can charge transaction fees and client onboarding fees to the fund houses, but not to the investors.
- EOP2: These platforms will act as stock brokers and register themselves under the EOP segment of stock exchanges. They can charge transaction fees directly to the investors, subject to a permissible upper limit specified by the stock exchanges. However, any client onboarding fees will have to be borne by the fund houses, not by the investors.
The circular also lays down the eligibility criteria, registration process, code of conduct, disclosure requirements and other obligations for both categories of EOPs.
The new regulatory framework for EOPs is significant for several reasons:
- It provides clarity and certainty to the investors who use EOPs for investing in direct plans of mutual fund schemes. They can now check the registration status and category of the EOPs they use and be assured of their compliance with the regulatory norms.
- It protects the interests of the investors by ensuring that EOPs do not provide any advice or recommendation to them and disclose all relevant information about their services, fees, risks and conflicts of interest.
- It promotes fair competition among EOPs by creating a level playing field for both categories of EOPs and ensuring that they do not indulge in any unfair trade practices or misrepresentation.
- It encourages innovation and digitization in the mutual fund industry by facilitating the provision of execution-only services in direct plans of mutual fund schemes through online platforms.
While the new regulatory framework for EOPs is a welcome step by Sebi, it also poses some challenges for both EOPs and investors:
- For EOPs, complying with the new regulations may entail additional costs and efforts. They may have to upgrade their systems, processes and policies to meet the registration requirements and disclosure obligations. They may also have to deal with increased regulatory scrutiny and supervision by Sebi or AMFI.
- For investors, choosing an EOP may become more complex and confusing. They may have to compare different categories of EOPs based on their features, fees, services and performance. They may also have to be more vigilant and informed about their rights and responsibilities as users of EOPs.
How will this affect digital platforms?
- So far, the business models of various digital platforms were focused on offering direct plans of mutual funds to investors for free of cost and gradually offering other investment products such as equities, IPOs (initial public offers of companies), futures & options, international equities, etc., where they could charge brokerage fees.
- Given the high competition among the digital platforms, it is unlikely that they would want to start charging any significant transaction fees to mutual fund investors, although if they opt for the EOP2 category, regulations allow them to charge investors.
- However, they will have to comply with certain disclosure and process requirements as per the circular, such as obtaining consent from investors before charging any fees, displaying all available direct plans on their platform, providing an option to switch from regular plans to direct plans without any charges, etc.
Conclusion
- The new regulation for EOPs is a welcome step by Sebi to bring more clarity and transparency to the mutual fund industry. It will also help investors make informed choices about their investments and the platforms they use. However, it remains to be seen how the implementation and enforcement of these rules will take place in practice.
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Securities and Exchange Board of India (SEBI): https://www.iasgyan.in/daily-current-affairs/securities-and-exchange-board-of-india-sebi
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