In a letter to AMFI on February 24, 2023, Securities and Exchange Board of India (SEBI) has asked mutual funds to keep the B-30 incentive structure on hold till fund houses put a system in place that addresses the concerns of the market regulator.
Do note, the mutual fund industry classifies cities into two categories: Top 30 (T30) and Beyond 30 (B30). T30 cities include metro areas and major cities like Delhi, Mumbai, Pune, Bangalore, Kolkata, and Lucknow, while B30 are referred to as cities beyond the T30 list.
What is the reason behind this temporary suspension on B30 incentives by AMFI?
Previously, in a bid to attract investments from retail investors beyond the Top 30 cities (i.e., B30 locations) and promote financial inclusion, the market regulator SEBI permitted mutual fund houses an additional expense ratio of 30 bps on new inflows (up to Rs 2 lakh).
However, SEBI observed a lack of system-driven mechanism to check the misuse of B30 incentive structure. The market regulator found various flaws and inconsistencies, including ‘splitting of transactions,’ ‘churning of investments,’ and the way incentives were calculated, including switch transactions for B-30 incentive computation, and charging B-30 incentive only in certain schemes rather than all schemes.
Further, SEBI has pointed out that few large investments from smaller cities were split below Rs 2 lakh by distributors for availing the B-30 incentives. These investments have gone through without any check by mutual funds. Also, it said multiple transactions of the same investor were carried out on the same day in the same scheme by the same distributor instead of executing it in a single transaction for earning the incentive.
According to SEBI’s algorithms, during the financial year 2019-2022, 5,987 purchase transactions from B-30 cities for 1,049 investors amounting to Rs 91.71 crore were split and based on which B-30 incentives were determined. This was despite the AMCs confirming that mechanisms and processes for identifying transaction splitting were in place. The regulator observed that AMCs did not take any measures against those in charge of the misuse.
Regarding churning of investments, SEBI stated that for FY2019-20, around 2,000 instances of churning involving a total of Rs 3.32 crore were discovered by SEBI’s algorithms across 19 mutual funds where mutual fund units from B-30 cities were held for more than one year and then redeemed and re-invested in the same schemes within 5 days of redemption. This indicates that the misuse was carried out with the intent of receiving higher B30 incentives.
Thus, SEBI has instructed mutual funds to develop a system-driven mechanism to detect and prevent splitting, churning of investments, and other misuses after noticing the fact that the AMCs lack processes and systems to detect the misuse of B30 incentives.
In a circular, AMFI specified, “SEBI has stated that it is desirable to keep the B-30 incentive structure in abeyance till AMCs put in place effective controls to identify and take action against wrongdoing so as to address the abovementioned concerns of SEBI, and has advised AMFI to revert to SEBI after ascertaining the compliance by the AMCs, within one month from the date of the above letter. Based on the aforesaid review and implementation of appropriate mechanisms, the incentive structure will be appropriately re-instated by SEBI with necessary safeguards.”
SEBI has requested that the AMCs suspend the B-30 incentive structure on temporary basis to address its concerns. Accordingly, AMFI has asked its members to strengthen their process regarding the B30 incentive mechanism as a top priority. SEBI is also exploring other measures for financial inclusion to put in place an effective mechanism.
AMFI clarified that the temporary suspension will be lifted as soon as fund houses put in place a system to detect and monitor distributors’ and AMCs’ misuse of B30 incentives. The regulator has also advised the industry body to revert to SEBI after ascertaining the compliance by the AMCs, within one month from the date of its letter which is latest by March 24, 2023.
Meanwhile, AMCs can continue to make the payment of the B-30 incentive on inflows in B-30 cities already received prior to the letter.