Sebi could make 'pre-trade' allocation mandatory in Indian markets

Pooled investors such as MFs or FPIs will have to state schemes under which they are acquiring shares

The Securities and Exchange Board of India (Sebi) will soon issue a set of rules for trade allocations of institutional investors such as mutual funds (MFs) or foreign portfolio investors (FPIs).

Sources say Sebi could make ‘pre-trade’ allocation mandatory. Currently, pooled investors, including MFs and FPIs, are allowed to buy blocks of shares from the market without assigning these to a specific scheme. Under the new framework, funds will have to determine beforehand how much of the purchased shares would go into each scheme.

The move comes after several MFs were reportedly allotting shares to their schemes on an arbitrary basis, often giving preference to flagship schemes. There is no uniform framework for allotment of shares to schemes. Some institutions currently apply scheme-wise for allocations in public issues; others do at a fund house or investment manager level.

Sources say Sebi has encountered several scenarios, especially during the anchor allotment of Initial Public Offers (IPOs) of equity, where fund houses have allotted the bulk of shares issued to their best-performing schemes, putting other schemes in a disadvantageous situation. 

Similar instances have been found even in the case of qualified institutional placements or bulk deals. Such a practice is held to short-change investors of some schemes within a fund. Sources say Sebi has been communicating to big-size FPIs and MFs on the issue. "The regulator is trying to standardise practises, so that it is the same across the board," said a person with direct knowledge of the issue. 

The person added that there often are problems with allocations in the case of IPOs and other public issues, as there is no way to know how much one might be allotted. The situation becomes tricky if, for example, the allocation is more than expected. A scheme might not be in a position to absorb the entire amount.

Pre-trade allocation could be implemented in two ways, hard or soft. In the first, fund houses will have to place separate orders for each scheme. In soft pre-trade allocation, brokers executing the orders will be given instructions beforehand as to how much of the equity purchased will go to each scheme. Regulators globally prefer hard pre-trade allocation, since the other is prone to misuse.

FPIs against

FPIs have already expressed reservations over adopting such practises. Their lobby, Asia Securities Industry and Financial Markets Association (Asifma), has written to Sebi to exempt foreign funds from the purview of the proposed rules, arguing it clashes with the fiduciary responsibility of their fund managers.

In certain scenarios, it is also in conflict with the laws of their home jurisdiction. For instance, fund managers in some European jurisdictions have a duty to allocate shares among various schemes at an equitable price. However, if the trades are done in multiple blocks, the entry price might be different for each scheme.
 

“If transparency is required by regulators at the fund account level on a pre-trade basis, the only way would be to place orders directly in the name of each fund account, with full transparency at the ultimate beneficiary level. The result would be different execution prices for the different fund accounts, since orders get filled at different times. The fund manager would then be forced to allocate different prices to fund account clients, which would be in breach of the fiduciary duty for equitable pricing as defined in their offering memoranda,” Asifma said in the letter to Sebi.

Trade allocation has been a controversial topic of debate in Western markets, too. In 2011, the Securities and Exchange Commission (SEC) in the US came up with a specific trade allocation framework. The regulations were enacted after SEC found fund managers and investment advisors were allocating all the profitable trades to their proprietary books, while dumping less profitable trades in less favoured accounts. Under SEC’s new framework, providing an equitable entry price became the duty of a fund manager or investment advisor.