Market regulator Securities and Exchange Board of India (SEBI) has recently directed that senior management of asset management companies (AMCs) will be paid 20 per cent of their compensation by way of scheme units in which they have played a role or have overseen.
If AMCs consider paying 20 per cent, according to SEBI’s circular, ‘Key Employees’ would the 20 per cent would have to come out of salary, bonus, perks, non-cash compensation net of income tax and any other contributions such as Provident Fund and National Pension Scheme. In this context, key employees would include CEOs, COOs, CIOs, fund managers, compliance officers, dealers of the said AMC or department heads. Anyone directly reporting to the CEO barring personal assistants or secretaries, fund management teams and research teams may also be treated as key employees.
The SEBI order, which will be brought into effect from July 1, excludes exchange traded funds (ETFs), overnight funds, index funds and other close ended schemes. The regulator also said that the compensation paid in the form of mutual fund units will be locked-in for at least three years or the tenure of the mutual fund scheme, depending on which of these is less.
Response to the new SEBI rule and implications
The reason behind the SEBI move is to curb fund houses taking greater risk than necessary with an eye of returns, thereby impacting the mutual fund scheme in itself. Thanks to the new rule, SEBI’s aim is to make sure that the interests of fund managers and unitholders are in harmony. In popular usage, SEBI’s intent is for fund managers to have “skin in the game” and show investors that fund managers have faith in the schemes they themselves manage. The SEBI rule may also boost investor confidence in schemes when fund managers repose faith in their own schemes.
The SEBI rules come on the back of the sudden closure of six credit risk funds in 2020. The regulator’s move to keep a portion of top employee salary locked in and including dealers is a consequence of sudden closure of well-known funds last year and the possibility of front-running in mutual fund houses. Front-running is the use of information that is non-public to buy/sell shares or get into F&O contracts ahead of a significant order from a fund or big institution in order to gain when the said institution completes the trade.
The mutual fund industry has mixed reactions to the scheme. One of the reactions is a practical issue. The new rule comes into effect in July but typically salaries, hikes or compensation for employees are drawn up at the beginning of a fiscal year. This means, in a span of four months, the packages may have to be amended.
Also, for a certain number of top employees, such as the CEO, the 20 per cent will be channelised into units of all schemes. Some fund houses may have several schemes and this apportunioning may impact the employee; in the case of a CEO, such an apportioning into all schemes may even impact the secretary/personal assistant’s packages. Further, for many of the employees, when a significant chunk of compensation is locked in and the fund house doesn’t raise their salaries, it means they may be illiquid.
Practical issues with the new rule
Further, many AMCs point out that fund managers and top management already invest a sizeable chunk of their wealth in their own schemes, and don’t necessarily rely on regulation or guidelines to do this.
The mutual fund industry also points out that the new rule may impact fund manager goals. A money market fund manager who has a large risk appetite may channel their investments in equity funds. The new SEBI rule effectively specifies the percentage of investment in different schemes, and this may come in the way of a fund manager’s investment goals.
The SEBI rule is aimed at making a fund manager’s compensation structure less opaque, and ensures that fund houses link performance of fund managers to their performance. It could also lead to whistleblowing if there are any hints of wrongdoing. If a fund manager or official is found guilty, the official will lose units and the fund house will sell the said units. The proceeds will be redeemed to the scheme.
The new rule of SEBI to ensure that key officials of an AMC need to be paid 20 per cent of their compensation by way of mutual fund units has come as a boost to investors. While giving fund managers “skin in the game” it also goes a long way in enhancing confidence of investors. The mutual fund industry has largely welcomed the intent behind the rule while pointing out certain practical issues that need to be ironed out. The new rule comes into effect from July 1.