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Revised Framework for Portfolio Managers

Finsec Law Advisors

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On November 20, 2019, the SEBI board had approved a new framework for portfolio managers (PMs), which was based on the recommendations of the working group constituted by SEBI to overhaul the erstwhile regulations governing portfolio management services (PMS). Accordingly, on January 16, 2020, the SEBI (Portfolio Managers) Regulations, 2020 (New PMS Regulations) were notified, replacing the SEBI (Portfolio Managers) Regulations, 1993. Some of the key reforms introduced in the New PMS Regulations are discussed herein below:

Increase in Net-worth Criterion for PMs

With a view to deter non-serious players from operating PMS schemes, the net worth criterion for PMs has been increased from INR 2 crore to INR 5 crore, and existing PMs are required to meet the enhanced requirements within a period of 36 months from the date of the commencement of the New PMS Regulations. In our view, the role of PMs is limited to that of assisting clients in taking investment decisions, which require necessary skills, adequate experience, certifications and appropriate infrastructure. In view of the same, enhanced net worth requirements may serve as an unnecessary entry barrier to those entities which possess the requisite qualifications and expertise but do not meet the minimum capital adequacy requirements.

Enhanced Minimum Investment limits

Under the New PMS Regulations, the minimum investment in a PMS scheme has been increased from INR 25 lakh to INR 50 lakh, while existing investments in PMS schemes has been grandfathered till the end of the maturity of such investments or such date as will be specified by SEBI. This move will exclude clients with smaller portfolios from being covered within the ambit of the new regulations.

Investment Restrictions for Discretionary and Non-discretionary PMs

While discretionary PMs are permitted to invest only in listed securities, money market instruments, mutual fund units and such other securities as may be specified by SEBI, non-discretionary PMs can invest clients’ securities or offer advice for such investments in unlisted securities up to a maximum of 25% of the total assets under management. Under the previous regulations, there were no restrictions on the type of instruments in which investments could be made on behalf of the clients, which led to mis-selling of illiquid products by certain PMs.

Further, the New PMS Regulations mandate that investments in mutual fund units by PMs shall only be through “direct plans” and in such cases, no distribution related fees can be charged by PMs to the clients. Furthermore, PMs have been prohibited from investing clients’ funds based on advice of any other entity, thereby restricting PMs from outsourcing their PMS activities to any other entity.

Enhanced Eligibility Criteria for Principal Officers

PMs are required to appoint at least another employee, apart from the principal officer and the compliance officer, who is a graduate from a recognized university with at least two years’ experience related to securities market. Further, the eligibility criteria for principal officers of PMs with decision making authority have been enhanced. These eligibility criteria include:

  • Professional qualification in finance, law, accountancy, business management, CFA Charter from CFA Institute, etc.;
  • Relevant NISM certification; and
  • Minimum five years’ experience in activities related to securities market, including as a stock broker, investment adviser, research analyst or fund manager, of which at least two years’ experience is in PMS.

In addition to the above, a mandatory obligation has been imposed on all PMs to appoint a custodian, except for those providing only advisory services.

Further, the New PMS Regulations prohibit PMs from charging any up-front fees to the clients, either directly or indirectly. Additionally, off-market transfers from / to clients’ accounts by PMs have been restricted, except for certain cases, such as for settlement of client’s own trades, for providing margin / trading collateral for clients’ own positions, for dealing in unlisted securities, etc.

Guidelines for Portfolio Managers

In addition to the new SEBI (Portfolio Managers) Regulations, 2020 (PMS Regulations), on February 13, 2020, SEBI has issued certain guidelines further amending the regulatory compliance framework for PMs (Guidelines). Some of these guidelines are discussed below:

Supervision of Distributors

PMs can now only utilize services of distributors with a valid AMFI Registration or those who have cleared the NISM Series-V-A exam. Further, it has been clarified that fees / commissions shall be paid to distributors on a trail-basis only, and such fees / commissions can be paid only out of the fees received by the PMs. PMs shall also inform prospective clients about the fees / commissions earned by distributors for on-boarding them to investment approaches.

PMs must ensure that distributors abide by the Code of Conduct specified under the Guidelines, and have a mechanism for independent verification of such compliance by the distributors. Further, they shall obtain a self-certification from the distributors with regard to such compliance within fifteen days from the end of each financial year.

Fees and Charges

While the Guidelines specify that the brokerage paid by the PMs can be charged to clients as expense, the total operating expenses, excluding the fees charged for portfolio management services and brokerage, shall now be capped at a maximum of 0.50% per annum of the clients’ average daily assets under management.

Further, in case of partial / full redemption of a client’s portfolio, the exit load charged by the PM can be a maximum of 3% of the redemption amount in the first year of investment, 2% in the second year and 1% in the third year. No exit load can be charged after a period of three years from the date of investment. Additionally, charges for all transactions in any financial year, including those of broking, demat, custody, etc., undertaken by a PM either through self or its associates, shall be capped at 20% by value per associate (or self) for each service; and such charges cannot be more than those paid to non-associates providing the same service.

Direct On-Boarding of Clients

Clients shall now be given the option to be on-boarded directly by the PMs, without availing the services of a distributor, and such option shall be mandatorily disclosed in the disclosure document, marketing materials, and on the website of the PM. Further, in case of such direct on-boarding, no charges except statutory charges can be levied by a PM.

Investment Approach

A uniform ‘investment approach’ shall be provided in the disclosure document, marketing materials, etc., which shall inter alia include a description of the investment objective, types of securities, portfolio allocation, benchmark, indicative tenure, risks, etc.

Reporting and Other Disclosures

Compliance with provisions such as disclosure of performance of benchmark indices to clients, review of compliances by the board, etc., is now required to be reported to SEBI annually, instead of on a half-yearly basis. Further, PMs shall also submit a certificate obtained from a chartered accountant certifying the PM’s net worth to SEBI within six months from the end of each financial year. Additionally, a certificate compliance with the New PMS Regulations shall be furnished to SEBI within sixty days from the end of each financial year.

Further, it has been clarified that material changes in the disclosure document, which must be reported to SEBI within seven working days, would include changes in control, the principal officer, fees, charges, investment approach and any other change as may be specified by SEBI.

With regard to performance reporting, the Guidelines mandate that cash holdings and investments in liquid funds shall also be included for calculation, and performance data is to be calculated net of all fees and expenses. Further, the firm-level performance is also required to be annually audited. A confirmation regarding compliance with the performance reporting requirements, as specified in the Guidelines, should be submitted to SEBI within sixty days from the end of each financial year.

Besides this, a quarterly report should be provided to the clients by the PMs, describing their portfolio management activity and the performance of the portfolio. A monthly report shall also be submitted by the PM on the SEBI Intermediaries Portal, describing their portfolio management activity, within seven working days of the end of each month.