Market regulator Sebi suspends small town-linked incentive for MFs

Mutual funds (MFs) can no longer charge extra expenses in lieu of bringing assets from beyond the top 30 cities (B30). The Securities and Exchange Board of India (Sebi) has suspended the incentive until asset management companies (AMCs) put a stop to the misuse of the mechanism — both by asset management companies (AMCs) and MF distributors.

“It is desirable to keep the B30 incentive structure in abeyance until AMCs place effective controls to address the concerns,” Sebi said in a letter to the Association of Mutual Funds in India.

The regulator added that either the incentive structure will be restored with necessary safeguards or a new mechanism will be brought in to incentivise bringing inflows from first-time investors rather than the location-based model being followed right now.

The B30 incentive allows MFs to charge up to 30 basis points over and above the expense ratio if a certain portion of their assets is from B30 regions. MFs pass this incentive on to distributors bringing assets from smaller towns and villages.

The concerns shared by Sebi are the splitting of transactions and churning of investments by distributors, variance in the calculation of B30 incentives among AMCs, and inclusion of switch transactions while calculating the incentives, among others.

Last week, Business Standard reported that Sebi is planning to do away with the incentive over misuse of the framework by distributors to generate higher income. Since the B30 incentive is paid only in the first year of investment, certain distributors allegedly resort to shifting investor money from one fund to another every year to continue receiving the incentive.

The splitting of transactions is a practice that sees MF distributors invest clients’ money in tranches rather than in one go to earn incentives even on transactions exceeding the Rs 2 lakh limit.

“Sebi’s algorithms identified that during 2019-2022, 5,987 purchase transactions from B30 regions for 1,049 investors amounting to Rs 91.71 crore were split and based on which B30 incentives were determined, despite AMCs confirming that processes and systems for identification of splitting of transactions are in place. No action was taken by AMCs against those responsible for the misuse,” observed Sebi.