Mutual fund distributors would be allowed to use stock exchanges' infrastructure to purchase and redeem mutual fund units on behalf of their clients. What benefit is it for investors?

The Securities and Exchange Board of India (SEBI) recently issued a circular to the stock exchanges, clearing corporations and depositories to enable the mutual fund distributors to transact on the stock exchange platform on behalf of their clients. A mutual fund distributor registered with Association of Mutual Funds in India (AMFI), would be able to use a recognised stock exchanges' infrastructure for purchases and redemptions of mutual fund units directly from the fund houses or asset management company (AMC) on behalf of an investor. At present, this facility is available for stock brokers and clearing members only. Though this service was introduced in November 2010, it found few takers as an investor would have to bear additional costs.
 

Mutual funds are sold through large nationwide distributors like banks and also small independent financial advisors. Most distributors log in applications for redemption and purchase requests through the registrar and transfer agent (R&TA) of a fund house. The stock exchange platform would open up a new route for transactions. However, the mutual fund distributor just enables the transaction, with the units credited and debited directly from the demat account of investors. Therefore, it would be necessary for an investor to open a demat account if they do not have one already.
 

There could be other issues as well. According to Ramesh Bhat, former president of IFA Galaxy, an association of over 10,000 independent financial advisors, “How the exchange will take the money from the client account? Even if the money is taken out of the account will he get the same day NAV? An investor should not lose a single paisa on this deal. Pay in is the major issue (From client account to exchange). Let us wait for the amendment in their existing byelaws, rules and regulations.”
 

Uday Dhoot, deputy CEO, International Money Matters, a financial planning-cum-investment advisory organisation mentions that, “The stock exchange route brings in a different process of transaction execution. In a normal account where there is no client—distributor power of attorney (POA) involved, the client still has to give a written instruction for a transaction to be processed, which is equivalent to signing of a transaction slip/ form. If there is a POA setup the distributor still needs to keep records of client confirmations of transactions on email or recorded phone lines.”
 

He further says that, “The stock exchange merely provides an order routing system with the above processed getting added. Some clients would prefer signing a POA, some may not and others are comfortable signing transaction slips. All this means additional processes and costs for the distributor to cater to all kinds of clients.”
 

There are also liquidity concerns. Mr Dhoot mentions that there is a possibility that one might want to sell some units and there may not be buyers for the same. In such a situation, you are then compelled to go back to the old system of signing a form and submitting it to the AMC or R&TA.
 

SEBI’s move to get investors to buy mutual funds through the stock exchanges has failed to work in the past and the regulator seems to be looping in mutual fund distributors to enable investors to transact in mutual funds through the stock exchanges. One can't assume that there are large numbers of eager investors who would want to invest through a demat account. If they don't yet have a demat account, it means that they simply don't want to invest in markets or do not wish to go through the hassle of paperwork and the burden of poor grievance redressal.
 

In his email reply, Mr Bhat expressed his concern that, “More than 40 % of the clients (in Tier-1 City) have a demat account, and yet 60 % do not have maybe due the annual charges levied by the demat service providers. These demat service providers must charge only ONE TIME FEE for these accounts to increase its reach across all investor class. Clients having demat MF units may be less than 5% in Tier-1 cities and may be 1% or less in Tier-2 and Tier-3 cities”
 

Mutual fund units are already offered by fund companies in electronic form as there is no physical certificate for MF units. Why would anyone want to demat something that already exists in electronic form? Mr Dhoot mentions that, “Opening of a demat account requires further paper work in addition to the mutual fund KYC. Moreover, holding units in a demat account involves additional costs charged by the depository participant. Investors already have an option to buy/sell units online. There are also some third party platforms that allow distributors to buy/sell units for the clients which are cheaper, involve less processes and paper work.”
 

A demat account may consolidate all of one's holdings and allow a view of investments in a single snapshot. Buying and selling in dematerialised units is supposed to be faster and simpler, but this would come with a transaction costs as well. SEBI's decision to continuously push the demat route shows that the regulator has lost touch with what is happening on the ground. Taking this route has not added benefits and will continue to keep investors away.
 

There are several layers of costs associated with holding mutual fund units in demat form. One would have to pay a charge to open the demat account, as well as the annual demat fees. Sales of units would also involve a charge on each occasion. This charge varies from DP to DP.
 

Leading registrar and transfer agents, CAMS and Karvy, both of which service almost the entire industry, have a system to provide consolidated statements across all mutual funds to investors. AMFI is also in the process of developing a platform to enable mutual fund transactions online. With this in place, what need it is for the regulator to ask exchanges to amend their infrastructure to enable mutual fund distributors to transact through the stocks exchange when it has no additional benefit for investors.
 

SEBI mentions that this would allow MF distributors to improve their reach. But would this move benefit distributors? Mr Bhat says, “Provided there is no complicated registration procedure and clear route for the transfer of money from the clients’ account to the AMC account and issue of proper allotment of units in clients demat account on time. This will be definitely a boon for distributors in Tier-2 and Tier-3 cities to expand their business. However, more clarity is needed on the operating guidelines”
 

Mr Dhoot says “We do not think that the stock exchange route for mutual fund transactions would benefit a large section of distributors as it involves a lot of added and some parallel processes which mean extra costs. This makes it a viable option only for very large distributors. This also requires distributors to register with the stock exchange or have tie ups with registered broking houses there by giving up their own title as the primary distributor. There is also no significant advantage to hold mutual fund units in a demat account.” He adds that, “AMFI is anyways planning a MF wide platform for order routing therefore we would not like to take up the stock exchange platform.”