The Great Squeeze, How SEBI’s New Mutual Fund Norms are Reshaping India’s Investment Landscape
In a landmark move set to redefine the contours of India’s burgeoning mutual fund industry, the Securities and Exchange Board of India (SEBI) has proposed a sweeping overhaul of the Total Expense Ratio (TER) structure and brokerage fees. This regulatory intervention, arguably one of the most significant in recent years, is driven by a clear and unwavering objective: to boost transparency, simplify regulations, and, most importantly, reduce costs for the end investor. However, beneath this straightforward goal lies a complex web of implications that will reverberate across the entire financial ecosystem, from the towering asset management companies (AMCs) to the bustling brokerage firms and, ultimately, to the millions of retail investors who form the bedrock of India’s equity culture. This is not merely a technical adjustment; it is a fundamental recalibration of the mutual fund industry’s economics, forcing a shift from a distributor-driven, high-cost model to a more efficient, investor-centric paradigm.
Deconstructing the TER: A Journey from Opacity to Transparency
To understand the magnitude of SEBI’s latest proposals, one must first appreciate the historical context of the TER—the annual fee that a mutual fund scheme charges its investors to cover management expenses, administrative costs, and distributor commissions.
The Pre-2012 Era: The Exit Load Quagmire
Prior to 2012, the industry operated with a less transparent model. Mutual funds were allowed to charge an exit load (a fee for redeeming units within a short period) and, crucially, this load was retained by the Asset Management Company (AMC). This created a perverse incentive. The collected exit loads were often used to pay hefty upfront commissions to distributors, effectively incentivizing them to churn investor portfolios—encouraging them to exit one scheme and enter another—to generate fresh commissions. This practice was detrimental to the long-term wealth creation of the investor, who bore the cost without a clear understanding of where their money was going.
The 2012 Reforms: A Step Towards Investor Protection
SEBI’s first major intervention came in 2012, mandating that all exit loads be credited back to the scheme’s assets, not pocketed by the AMC. This was a crucial step to align the interests of the AMC with the unit holders. However, to compensate AMCs for the loss of this revenue stream used for distributor payouts, SEBI allowed them to charge an “additional expense” of 20 basis points (bps) to the scheme. One basis point is one-hundredth of a percentage point.
The 2018 Tightening and the Transitory 5 bps
Recognizing that costs were still high, SEBI in its 2018 review slashed this additional expense from 20 bps to a mere 5 bps, explicitly stating that this provision was transitory. The current proposal finally pulls the plug on this temporary measure, eliminating the 5 bps charge entirely. This move squarely targets the practice of using scheme assets to pay for distributor incentives, forcing a more direct and transparent relationship between distributors and AMCs.
The New TER Slab System: A Balancing Act
To soften the blow for AMCs, particularly smaller ones, SEBI has simultaneously tweaked the primary TER slabs for open-ended equity schemes. The regulator has increased the TER by 5 bps for the first two asset slabs:
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For AUM up to ₹500 crore, the TER for active funds is now 2.5% (increased from the previous rate) and 2% for passive funds.
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For AUM between ₹500 crore and ₹700 crore, the TER is 2% for active and 1.75% for passive funds.
This adjustment provides a slight cushion to smaller fund houses that rely more heavily on a percentage-based fee to achieve operational viability. However, the narrative changes dramatically for the larger players. The TER reduces progressively across the three higher slabs as AUM grows. For instance, the TER for the largest schemes (AUM above ₹50,000 crore) has been directly cut from 1.05% to 0.90%, a reduction of 15 bps. This progressive slab structure underscores SEBI’s philosophy: economies of scale achieved by large AMCs must be passed on to the investors, not retained as super-normal profits.
The Brokerage Bombshell: Unbundling Research from Execution
Perhaps the most disruptive element of SEBI’s proposal lies in its drastic cut to permissible brokerage fees. Currently, AMCs can charge the scheme:
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Up to 0.12% (12 bps) of the trade value for cash market transactions.
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Up to 0.05% (5 bps) for derivatives transactions.
SEBI’s investigation revealed a critical anomaly. The brokerage paid for arbitrage funds—where the primary goal is execution speed and cost-efficiency—was significantly lower. This indicated that the higher brokerage charged for other equity schemes was not purely for trade execution but was a “bundled” payment that included services like research provided by brokers to the fund managers.
This bundling creates a clear conflict of interest and leads to double-charging. Investors were effectively paying for research twice: once implicitly through the high brokerage fees charged to the scheme, and again through the fund’s management fee, which is supposed to cover the cost of the AMC’s research and decision-making. This lack of transparency obscured the true cost of investment management.
SEBI’s solution is sharp and uncompromising. It proposes to slash brokerage charges to:
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2 bps for cash market transactions (an 83% reduction from 12 bps).
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1 bps for derivative transactions (an 80% reduction from 5 bps).
Any other costs for trade execution and statutory charges can be billed on an actual basis. This forces a clean separation—a “unbundling”—of execution services from research services. Brokers can no longer bundle a high research fee into their execution costs. If AMCs want to use a broker’s research, they must pay for it directly from their own P&L, not from the scheme’s assets, thereby bringing accountability and transparency to the process.
The Ripple Effect: Winners, Losers, and a Changing Industry Dynamic
The impact of these changes will be asymmetrical, creating distinct winners and losers while forcing a strategic rethink across the board.
1. The Investor: The Clear Beneficiary
The retail investor is the unambiguous winner in this new regime. As illustrated by Vinayak Magotra of Centricity Wealth Tech, an investment of ₹1 lakh in an equity scheme with a 1% TER (costing ₹1,000 annually) could see costs drop to approximately ₹800-₹850. This reduction of 15-20 bps in TER, coupled with an estimated 10 bps saving from lower transaction costs, will directly and positively impact the scheme’s Net Asset Value (NAV). Over the long term, thanks to the power of compounding, these saved basis points can translate into a significantly larger corpus for the investor.
2. The Asset Management Companies (AMCs): A Margin Squeeze and Strategic Shift
AMCs are facing a direct hit to their profitability. The reduction in TER, especially for large fund houses, will compress their margins. This will force a period of belt-tightening and operational efficiency. AMCs will need to innovate, leverage technology to automate processes, and rationalize their product portfolios. The era of launching me-too funds with high marketing budgets may be coming to an end. Competition will increasingly be based on genuine fund performance and operational efficiency rather than the ability to spend on distributor commissions.
3. The Brokerages: The Hardest Hit
Brokerages, particularly those with a significant institutional business model reliant on providing bundled research, are poised to be the most affected. The 80-83% reduction in permissible brokerage fees represents a seismic shock to their revenue stream. They can no longer use the mutual fund scheme’s money as a blank check for research. To adapt, brokerages will have to fundamentally restructure their offerings. They will need to:
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Unbundle and Price Research Separately: Create standalone, high-quality research products that they sell directly to AMCs, who will then have to pay for it from their own pockets, forcing a valuation of the research’s true worth.
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Scale Execution Business: Focus on becoming ultra-efficient, low-cost execution venues, competing on technology and transaction speed.
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Diversify Revenue: Increase focus on retail brokerage, investment banking, and other advisory services.
While the sharp growth in India’s overall AUM may lead to higher trading volumes, it is unlikely to fully compensate for the drastic cut in per-trade revenue in the short term.
The Long-Term Vision: A Mature and Transparent Ecosystem
SEBI’s proposals are not isolated actions but part of a consistent, long-term vision to mature India’s financial markets. This vision includes:
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Promoting Passive Investing: By making active management more cost-competitive, the new norms indirectly make passive funds (like ETFs and index funds), which already have lower TERs, even more attractive. This aligns with global trends where investors are questioning the value of high-cost active management.
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Enforcing Fiduciary Duty: The regulations reinforce the fiduciary duty of AMCs. They are trustees of investor money, and every basis point spent from the scheme must be justifiable and in the investor’s best interest.
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Encouraging Direct Plans: The push for lower costs further strengthens the case for direct plans, where investors bypass distributors and invest directly, saving on the distributor commission embedded in the TER.
Conclusion: A Necessary Disruption for Sustainable Growth
The initial reaction from the industry has been a mix of apprehension and acceptance. While AMCs and brokers grumble about margin pressures, the overarching principle of the reforms is undeniable: the investor must come first. SEBI has effectively called the industry’s bluff on opaque charging practices and misaligned incentives.
In the short term, there will be pain. Brokerage revenues will plummet, and AMC profits will be squeezed. However, this disruption is necessary for the industry’s long-term health and credibility. It will force a much-needed evolution, weeding out inefficient practices and compelling all players—AMCs, brokers, and distributors—to compete on the basis of genuine value, transparency, and efficiency. The ultimate destination of this regulatory journey is a market where the investor’s returns are not eroded by hidden costs, and where the growth of the mutual fund industry is built on the solid foundation of trust and shared prosperity. The great TER squeeze is, therefore, not a constraint but a catalyst for a more robust and mature Indian financial market.
Q&A: Unpacking SEBI’s New Mutual Fund Regulations
1. What is the primary objective behind SEBI’s proposed changes to the Total Expense Ratio (TER)?
SEBI’s primary objective is threefold: to boost transparency, simplify regulations, and reduce the overall cost of investing for mutual fund investors. The reforms specifically target practices where investors were potentially paying twice for the same service (like research) through opaque charging structures. By slashing the TER and unbundling costs, SEBI ensures that economies of scale achieved by large fund houses are passed on to the investors, directly boosting their returns.
2. How does the removal of the “additional expense” of 5 bps promote transparency?
This additional expense was a temporary measure allowed to AMCs to compensate for the loss of exit load revenue, which was previously used to pay distributor commissions. By removing it, SEBI is cutting off a channel that allowed AMCs to use the scheme’s own assets (i.e., investors’ money) to pay for marketing and distributor incentives. This forces a more transparent model where such commissions must be borne by the AMC from its own profits or negotiated directly with the client, making the cost clear and separate from the fund’s management.
3. Why is the reduction in brokerage fees considered so significant, and what problem does it solve?
The reduction is drastic—from 12 bps to 2 bps for cash markets—and it solves the problem of “bundled” payments. SEBI found that high brokerage fees were not just for trade execution but also included payments for research from brokers. This meant investors were indirectly paying for research through the brokerage charged to the scheme, while also paying the AMC a management fee for its research capabilities. This “double-charging” was non-transparent. The new rules force a separation, making AMCs pay for research directly from their own accounts if they choose to use it, thereby bringing clarity and accountability.
4. Who is most impacted by these new regulations: AMCs or Brokers?
While both are impacted, brokerages are expected to be hit harder in the immediate term. The 80-83% cut in permissible brokerage fees represents a direct and severe blow to a key revenue stream for institutional brokers. AMCs face a margin squeeze due to the lower TER, but they can adapt through operational efficiency and economies of scale. Brokers, however, must fundamentally rethink their business model, unbundle their services, and start charging separately for research, a transition that will be challenging.
5. How will a typical retail investor benefit from these changes?
A retail investor will benefit through higher effective returns. For example, on a ₹1 lakh investment, the annual expense could drop from around ₹1,000 to approximately ₹800-₹850, thanks to the combined effect of the lower TER (a 15-20 bps saving) and reduced transaction costs (an estimated 10 bps saving). While this saving may seem small in a single year, over a long investment horizon of 10-20 years, the power of compounding ensures that these saved costs translate into a significantly larger final investment corpus.
