By Sandeep Parekh
In 1774, a Dutch merchant and broker established what is widely regarded as the first mutual fund (MF) by inviting investors to form a trust named Eendragt Maakt Magt (Unity creates strength). Over time, the MF structure has evolved across jurisdictions. Continuing this process, on October 28, the Securities and Exchange Board of India (Sebi) released a Consultation Paper on Comprehensive Review of Sebi (Mutual Funds) Regulations, 1996, proposing amendments to align the distribution of returns between asset management companies (AMCs) and investors. A few of the major changes, which are the source of heated discussions in the industry, are discussed below.
Proposal to revise TER limits
The first such change is the proposal to revise the total expense ratio (TER) limits so that statutory levies (such as securities transaction tax and goods and services tax [GST]) are excluded while computing TER. It is proposed that such levies are passed directly to investors. While this shift enhances transparency and aligns cost pass-through with regulatory intent, it also triggers a consequential downward revision of the existing TER limits. Specifically, the consultation paper recommends a reduction of 20 basis points (bps) for close-ended schemes, and 15 and 10 bps for certain categories of open-ended schemes. The magnitude of the proposed downward revision lacks any clear basis and poses concerns for the growth of the MF industry.
The downward revision of the TER exceeds GST and other statutory components that are currently a part of it, and the consequence is an additional, unintended reduction that directly compresses the operating margins of AMCs. In effect, AMCs are compelled to absorb a cost cut that goes beyond the statutory levy adjustment, with no proportionate benefit accruing to investors. Moreover, when AMC revenues are squeezed the impact is often passed on to MF distributors (MFDs), weakening the distribution network that underpins financial inclusion. A large share of first-time and retail investors, especially in small towns and underserved regions, enter the MF market through these last-mile channels. Any reduction in the economic viability of this network risks undermining the infrastructure that enables wide investor participation. MFs indeed compete with other assets like insurance and real assets like property and gold.
Fees should be entirely determined by market competition, and price controls are increasingly viewed not only as outdated but also counterproductive. Their second-order effects are routinely underestimated in policy debates. Forcing fees artificially downward inevitably erodes service quality, curtails investment in research and investor support, and strips smaller or newer funds of the economic runway needed to grow. The result is predictable, entrenched dominance by a few big players and a shrinking, less diverse industry. Over time, such distortions choke innovation, reduce meaningful choice for investors, and weaken the resilience of the asset management sector that regulation is meant to strengthen. The only reason to impose price controls would be when the normal competitive forces are ineffective, as in a monopolistic industry with network effects. MF is highly competitive an industry.
What does the consultation paper recommend?
The consultation paper also proposes to permit AMC to charge its schemes investment and advisory fees that are identical, in percentage terms, for both direct and regular plans. While this could be viewed as a welcome move, its unintended impact would be an increase in the overall costs borne by regular plan investors who choose to access MFs via distributors. This, too, needs to be carefully studied as those investing in the market though MFDs are often first-time investors who may now be subject to higher overall costs.
Another significant proposal is the steep reduction of the maximum permissible brokerage expense from 12 to 2 bps for cash market transactions, and 5 to 1 bps for derivatives. The stated rationale is that brokerage costs in some instances include not only trade execution but also research services, and since AMCs already possess in-house research capabilities, such additional costs may dilute investor returns. While the objective of enhancing transparency and avoiding duplication of expenses is well-intentioned, the practical realities are more nuanced. In many market segments—particularly mid-cap, small-cap, and emerging sectors—broker-provided research offers timely, security-specific, sectoral insights that may not be readily available through internal or public sources. Such research complements in-house analysis and supports informed price discovery, ultimately benefitting investors. Brokerage commissions therefore often reflect an integrated service rather than an avoidable add-on cost. A sharp cut in permissible brokerage limits may constrain AMCs’ access to critical external research inputs and inadvertently impair investment decision-making to the detriment of unitholders.
The consultation paper also proposes amendments to Regulation 24(b) of the MF Regulations, which govern the permissible business activities of AMCs. One such proposal—that an AMC may undertake activities regulated by a domestic or foreign regulator only through a subsidiary and with prior Sebi approval—warrants reconsideration. Where an AMC already maintains adequate structural and operational segregation, and the activities concerned are carried out by a distinct business unit with appropriate oversight, compliance frameworks, and ring-fencing of resources, it may not be necessary to mandate a subsidiary structure. Allowing AMCs to undertake such activities directly, through a distinct business unit—subject to nods or no-objection certificates from the regulators they are registered with—would provide greater operational flexibility without compromising regulatory safeguards. This would also prevent unnecessary duplication of infrastructure and compliance costs while ensuring investor interests are fully protected.
The consultation paper walks a tightrope between rationalising costs and advancing investor-friendly reforms. But several aspects warrant deeper examination. The proposed reductions in expense ratios and related regulatory changes compound the pressures confronting AMCs and risk further eroding margins that are, in case of many smaller players, already thin. What is often underappreciated in policy debates is the inherently long gestation period of the AMC business model. Most AMCs operate at a loss for years before achieving the scale necessary to turn profitable. The contemplated amendments risk intensifying this structural challenge and may require deeper analysis of operational feasibility before implementation.
The writer is a Managing Partner at Finsec Law Advisors. This peice has been co-authored with Aniket Singh Charan and Varun Matlani, associates, Finsec Law Advisors.
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