SEBIs new regulation aligns Fund Managers-Unitholders interests

The Securities and Exchange Board of India (SEBI) has released a circular on April 28, 2021, stating that 20% of the compensation of top executives/key employees of Asset Management Companies (AMCs) will be paid in the form of units of mutual fund scheme that they oversee. Key employees of an AMC include the Chief Executive Officer (CEO), Chief Investment Officer (CIO), Chief Risk Officer (CRO), Chief Investment Security Officer (CISO), Chief Operations Officer (COO), Fund Managers, Compliance Officers, Sales Heads, Investor Relation Officers (IRO), Heads of other departments, Fund Management Team, Research Team, Direct reportees to CEO and other employees as identified and included by the AMC.

The move will align the interest of the top management of the AMC with that of the unit-holders of the schemes managed by the AMC. There have been several instances in the past wherein the performance of the mutual fund scheme has been compromised due to the poor selection of securities. Now the top officials of AMCs will have a vested interest, in the good performance of their funds.  Investors can expect better returns and risk management from their mutual fund investments as key employees including the investment teams will have skin in the game. 

Highlights of the circular:

• 20% of the compensation of the top executives/key employees will be paid in the form of units of the mutual fund scheme that they oversee.
• The compensation units will be paid on a monthly basis through the year. 
• If an employee manages multiple funds, then she/he will receive compensation units of all these funds in the proportion of the Assets Under Management (AUM) of these funds. However, Exchange Traded Funds (ETFs), Index Funds, Overnight Funds and, Existing Close Ended Schemes shall be excluded. For example, Mr. A is managing the below schemes.  Of these, the Index fund does not qualify for the compensation rule.  So, if he receives 10,000 compensation units they will be allocated as below
  

  Scheme	AUM Size (Cr)	% of Total Aum	Compensation Units allotted
  Large Cap Equity Fund	5,000	46%	4,546
  Mid Cap Equity Fund	4,000	36%	3,636
  Index Fund	4,000	0%	–
  Open Ended Debt Scheme	2,000	18%	1,818
  Total	15,000	100%	10,000
  Total eligible AUM	11,000

• To allow diversification of risk for employees managing a single fund, up to 50% of their compensation units can be of other funds with comparable or higher risk.
• There will be a lock-in period for the units allotted. The lock-in period will be for three years or the tenure of the scheme whichever, is less. This is done to ensure that employees don’t manipulate investments in the short term for increasing their personal income.
• In case of resignation, the redemption of compensation units can only happen after the end of the stipulated lock-in period.
• In the case of retirement before attainment of superannuation age, the redemption of the compensation units is not allowed before the expiry of the lock-in period. However, in case of retirement on attaining the superannuation age, such units will be released from the lock-in and the employee will be free to redeem their units.
• In the event of a violation of code of conduct, fraud, or negligence by the officials as determined by SEBI, the units allotted to them will be redeemed by SEBI and the redemption proceeds will be credited back to the scheme.
• The circular states that every scheme will disclose the aggregate compensation units paid to the key employees on the website of the AMC.

 Conclusion:

The rationale for introducing this regulation is to create accountability amongst the key management personnel. This move will generate confidence among the existing as well as new investors park their savings in Mutual Funds. The regulatory framework for the securities market in India is still developing. SEBI has time and again introduced and implemented various regulations to promote transparency. While this move boosts investor confidence, it might not suit all key employees. As individuals, these employees may have different propensities for savings and risk. Thus, a mandatory allocation of 20% of their compensation to mutual fund schemes may not suit their personal investment goals.