SEBI’s Rule on Compensation of Key Employees of AMCs in the Form of Mutual Fund Units

Market regulator SEBI has begun with a replacement guideline that would soon send the open-end fund industry knocking at AMFI's door for support.

For the sake of the 'Key employees' of the AMC with the unitholders of the open-end fund scheme, SEBI has agreed that some part of compensation (a minimum of 20% of the pay/ bonuses/ extra/ non-cash recompense (gross annual CTC) net of duty and some constitutional aids i.e. PF and NPS of the Key Employees of the AMCs are going to be paid within the sort of units of open-end fund schemes during which they need a role/ oversight.

It has further stated the following:

1. The units are going to be proportionate to the AUM of the schemes during which the Key Employee features a role/oversight. Exchange-Traded Funds (ETFs), Index Funds, Overnight Funds, and existing close-ended schemes are going to be excluded for this purpose.
2. This is to be paid proportionately over 12 months on the date of payment of salary/ perks/ bonus/ non-cash compensation. Just in case of compensation paid within the sort of employee stock options, the date of exercising such option shall be considered because of the date of such payment.
3. The amount is going to be locked certain a minimum period of three years or tenure of the scheme whichever is a smaller amount. the workers won't be ready to redeem the units during the lock-in period except just in case of exigencies like medical emergencies or on humanitarian grounds where they're going to be ready to borrow against the units.
4. Further, the redemption of units won't be allowed just in case of resignation or retirement before attaining the age of superannuation as defined within the AMC service rules. However, just in case of retirement on attaining the superannuation age, such units are often released from the lock-in and therefore the Key Employee is going to be liberal to redeem the units, apart from the units in close-ended schemes where the units shall remain locked in till the tenure of the scheme is over.
5. Additionally, to permit the Key Employees to diversify their unit holdings, just in case of dedicated fund managers managing only one scheme / single category of schemes, 50% of the aforementioned compensation shall be by way of units of the scheme/category managed by the fund manager and therefore the remaining 50% can if they so desire, be by way of units of these schemes whose risk value as per the risk-o-meter is equivalent or above the scheme managed by the fund manager.

The new rule on the compensation of Key employees will inherit effect from July 01, 2021. Rules for close-ended schemes are going to be notified separately.

The following will fall into the ambit of Key employees as per the new circular:

1. Chief military officer (CEO), Chief Investment Officer (CIO), Chief Risk Officer (CRO), Chief Information Security Officer (CISO), Chief Operation Officer (COO), Fund Manager(s), Compliance Officer, Sales Head, Investor Relation Officer(s) (IRO), heads of other departments, Dealer(s) of the AMC.
2. Direct reports to the CEO (excluding Personal Assistant/Secretary).
3. Fund Management Team and Research team.
4. Other employees as identified & included by AMCs and Trustees.

What is the rationale behind SEBI's circular?

Over the past few months, investors have grown wary of investing in mutual funds, especially equity-oriented schemes, thanks to the high underperformance rate across various categories. Since fund managers are directly liable for the performance of the scheme, they might not justify the hefty salaries drawn. The new circular is perhaps aimed toward gaining back the trust of investors.

SEBI's move works on the logic of fund managers having their 'skin within the game'. In other words, SEBI expects that getting the key employees to take a position within the schemes they manage can cause better accountability on the part of the fund management team paving way for a far better quality of securities and improved performance. Moreover, investors generally, will have a far better sense of confidence if the fund manager's interest aligns with their own.

The new move can potentially prevent such instances of trading also discourage fund managers from assuming higher risk than necessary.

It has also introduced the 'Clawback' provision so that the fund managers cannot wash their responsibilities just in case things turns haywire. Under this, if the key employees are found violating the code of conduct, or within the event of fraud, gross negligence by them, the units of the worker are going to be redeemed and credited back to the scheme

Issues raised by fund houses:

While fund houses have welcomed the thought of 'skin within the game', they need to express their desire for more flexibility in the implementation of the rule and fine-tuning of certain aspects of the circular.

One of the main concerns of the fund houses is that employees are going to be forced to take a position in an asset allocation plan which will not align with their risk appetite. as an example, a fund manager of fixed income securities will need to invest a considerable portion in debt schemes albeit his/her investment objective is more suited to an aggressive profile.

AMCs fear that the rule may hinder their ability to draw in fresh talent since the principles will apply to a variety of employees who may or might not be directly liable for making the investment decisions and therefore the performance of the scheme. Mandatorily investing a fifth of the compensation within the schemes of the AMC might not a feasible option for several employees because it'll constrain their cash flows. The mandatory investment and lock-in of three years might be especially difficult for workers if they need loans to service.

The fund house may request the SEBI for providing more flexibility in investing in schemes by the fund house. They'll also request the regulator to scale back the scope of 'Key employees'.

Impact on the investors:

SEBI's intent is sweet, but it'll in no way guarantee improved performance of the scheme neither will it assure that the fund house/manager will follow prudent investment processes despite having invested heftily within the scheme/s. Do note that a lot of fund managers already invest within the schemes that they manage or other schemes of the fund house.

What should investors do?

It is important that you simply select mutual funds carefully supported by several parameters (both quantitative and qualitative) not limited to the returns generated by the scheme/s. The fund should be ready to adequately reward investors with suitable returns without taking excessive risk.

Furthermore, you ought to be watching the portfolio characteristics of the scheme to assess its ability to get reliable returns by analyzing the following:

1. If the said scheme is well-diversified across stocks and sectors.
2. The quality of held securities. 
3. The rate of portfolio churning.

And since the fund's performance is directly hooked into the power of its fund manager, check the qualification and knowledge of the fund manager and therefore the diary of the opposite schemes managed by him/her. Capitalize in arrangements of account households that have a dependable presentation best and follow healthy asset procedures with passable risk organization schemes.

Footnotes

https://www.sebi.gov.in

https://www.personapfn.com

This Article Does Not Intend To Hurt The Sentiments Of Any Individual Community, Sect, Or Religion Etcetera. This Article Is Based Purely On The Authors Personal Views And Opinions In The Exercise Of The Fundamental Right Guaranteed Under Article 19(1)(A) And Other Related Laws Being Force In India, For The Time Being. Further, despite all efforts that have been made to ensure the accuracy and correctness of the information published, White Code Consulting & Governance shall not be responsible for any errors caused due to human error or otherwise.