Get ready for a change in direct MF platforms

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Direct mutual fund platforms have emerged as an important stakeholder in India’s mutual fund (MF) industry. However, recent incidents have raised questions on where these platforms stand in the regulatory landscape.

A few months back, Paytm Money had announced that it will be moving its direct MF business from its advisory arm to its broking arm. More recently, the Securities and Exchange Board of India (Sebi) in an adjudication order penalised another platform for failure in complying with applicable regulations.

These incidents, when looked at in conjunction with the Sebi  consultation paper on Execution Only Platforms (EOP), are a harbinger of significant changes in the way direct MF platforms are structured.

To get to the crux of the matter, it is important to first understand how direct MF platforms operate. For their functioning, these platforms need two capabilities. First, to push transactions to different MFs , and second, to be able to receive data feeds from MFs on aspects like transaction status, payment processing, settlement updates, unit allotment, etc. These data feeds are shared by Registrar and Transfer Agents (RTAs) of MFs, like CAMS and Karvy. However, there are restrictions as to who can receive these data feeds.

A key question faced by direct MF platforms during their inception was how to get access to data feeds from RTAs. The option before these platforms was to either register as a mutual fund distributor (MFD), or as a registered investment adviser (RIA) or a broker. Given that these platforms offer direct plans of MFs, the MFD registration was not suitable. That leaves two registration options—either as an RIA, or a broker. Most platforms choose to register as an RIA, barring a few (like Coin by Zerodha, which already had a broking license).

Choosing an RIA license opened the door for the direct MF platforms to access data feeds and also provided an option to upscale from being just an execution platform to an advisory-cum-execution platform. But it also opened a whole new set of problems. What these platforms probably did not anticipate earlier was how onerous the compliance burden of maintaining an RIA license would become—particularly after Sebi amendments in RIA regulations in 2020.

For a platform that only wants to execute MF transactions, the compliance burden did not make operational sense- unless the direct MF platform was started with the objective of graduating into a full-fledged advisory business. Most direct MF platforms have no such aspiration.

Hence the move by Paytm Money to shift out of its RIA license, and move its MF business to its broking arm. However, not all direct MF platforms have an in-house broker registration to migrate to. 

This brings us to the recent Sebi consultation paper on EOP. The consultation paper proposes creating a new EOP registration which direct mutual fund platforms can apply for and use their EOP status to access transaction data feed from RTAs. However, the proposed regulations on EOPs also bring to the fore many issues—the most pertinent being on how the EOPs will earn revenue. 

There are two options —first, EOPs can charge users directly. This will not be their first preference as this is a tough hill to climb. Recall how Zerodha Coin had to roll back a paltry fee of 50 per month and make its platform completely free for use.

The second option is for EOPs to be compensated by MFs—and herein lies many important questions. Will the MF company pass on the cost levied by the EOP to the investors? Can one MF company extra compensate the EOP for favourable listing of its schemes? 

Another key issue is that as an EOP, the scope of the platform will be cut—execution of transactions only. But where do you draw the line between providing only transaction services and advice? For instance, if the EOP curates a list of top mutual funds to buy, is it only providing execution services? And if it is prohibited from curating as that may entail advice, what would the platform offer?

There is no doubt that the proposed new EOP regulations fill an important lacuna in the regulatory landscape. But there are important questions to be answered which will determine whether the new set of regulations will eventually benefit the investors or not.

Ravi Saraogi is a Sebi- registered investment adviser (RIA) and co-founder of Samasthiti Advisors

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