Sebi set to intervene in controlling MFs' upfront commission

Market regulator working on a formula to put control on high commission payout by fund houses

The Securities and Exchange Board of India (Sebi) is all set to intervene as select mutual fund houses continue to pay unreasonably higher upfront commission to distributors.

Further, asset management companies (AMCs) would have to include two more color codes while doing the product labelling to make investment risks more clear to investors.

The market regulator is working on a formula to put a control on high commission payout by fund houses. Sources told Business Standard that Sebi is mulling to put cap on difference of brokerages paid in the first and the subsequent years.

For instance, if the fund house pays 1.5% upfront in the first year, the commission (trail) should not be more than 1% in the next year. They further indicated that a cap on quantum of upfront may also come, anywhere between 1.5% and 2%. This will be applicable on both close-ended as well as open-ended schemes, they added.

In the mutual fund advisory committee meeting, convened on Monday, Sebi acknowledged that upfront brokerage is important for distributors and vital for penetration of mutual fund products. But, 'too much of the brokerage" has become a problem and needs to be dealt with.

In the recent past, Sebi raised concerns over high commissions and had warned fund houses of a possible mis-selling if the practice is not curtailed in time. U K Sinha had even urged fund houses "to be reasonable" in commission payout. There have been several cases where upfront fees went up to as high as 7-8%.

Last week, at least 15 fund houses had put their suggestions about handling the menace of high payment to distributors. Many had suggested for a cap, instead of banning upfront. They, rather, had also asked the regulator to cap the fees at 1.5%.

Industry executives, Business Standard spoke to, said that Sebi's intervention would be welcome as only a select few fund houses have indulged in abnormally higher advance payments, especially in their closed-ended schemes.

Mutual funds would also be asked to bring in two more color codes - pink for very high risk and purple for very low risk - on the front page of initial offering application forms. With this, there will be five colors along with blue (low risk), yellow (medium risk) and brown (high risk). It was in March, 2013 that Sebi brought in color-coding while labeling the mutual fund product. This was effective from July, 2013.

Industry insiders say that this could make life further uneasy. "Already, with existing color labeling, investors tend to become uncomfortable when s/he sees the high risk brown color. Now, with 'very high risk' labeling, it would not be easy to sell products which fall in that category," said a national sales head of a large fund house.