The Securities and Exchange Board of India (Sebi) appears to have learnt from global experience about the pitfalls of sharply separating brokerage from research. In 2018, European regulators, under the Markets in Financial Instruments Directive II (MiFID II), mandated the unbundling of investment research costs from trading commissions.
The outcome, however, was far from ideal. The move led to a sharp contraction in the supply of analyst research, as many firms found the standalone cost of research unsustainable. Within three years, regulators were forced to partially roll back the framework after brokerages stopped covering small and medium-sized companies with market cap below €1 billion.
Rejection of MiFID II
As Sebi Chairman Tuhin Kanta Pandey noted on Wednesday, “This model is not feasible today, and attempts to implement it elsewhere were unsuccessful.” Critics may argue that the report of the high-level committee on conflict of interest should not have been delayed. But given resistance from employees and the absence of fully developed operational modalities, the regulator arguably deserves some additional time to put a workable framework in place.
That said, the Sebi board has approved a significant cut in brokerage fees—from 12 basis points (bps) to 6 bps in the cash segment and from 5 to 2 bps in derivatives. For a brokerage industry that earns roughly Rs 1,500-1,800 crore annually from asset management companies (AMCs), this implies a revenue hit of around 50%. However, it is still far less severe than the nearly 80% cut proposed earlier in the consultation paper. Industry sources say brokerages are likely to prioritise more remunerative client segments going forward, even as the AMC business continues to provide a stable funding base.
For investors, the news is largely positive. Mutual fund expense ratios are expected to decline further, and with the cost structure clearly demarcated—basic expense ratio, brokerage, and statutory and regulatory fees—the framework should become easier to understand and monitor.
Fund houses, however, are less enthusiastic. The revised guidelines are expected to pressure profitability. Initial estimates following the earlier proposals suggested that some large AMCs could see earnings decline by nearly 30%. In an industry with more than 45 players managing assets of around Rs 80 lakh crore but generating profits of only about Rs 15,000 crore, even a 5-bps compression in margins is meaningful. While larger AMCs may be better positioned to absorb the impact due to scale and bargaining power with distributors, smaller and newer players could face greater strain as they attempt to build investor traction.
Leaner Rulebook
Perhaps more noteworthy is Sebi’s parallel push to simplify regulation and cut compliance clutter. After the Reserve Bank of India recently consolidated 9,445 circulars into 244 master circulars, Sebi has unveiled a streamlined regulatory framework that reduces operational and compliance requirements by 44%, shrinking documentation from 162 pages to 88. The number of provisos has been cut from 59 to fewer than 15, while overall word count has been slashed by 54% to about 31,000 words from 67,000, including footnotes.
The board has also amended the ICDR (Issue of Capital and Disclosure Requirements) regulations for non-promoters who have pledged shares prior to an initial public offering, placing the onus on depositories to ensure that such shares remain locked in for the balance period. In addition, Sebi has approved measures to rationalise disclosures in abridged prospectuses and allowed debt issuers to offer incentives to select categories of investors in public issues.