If you are running a PMS or planning to start one, you need to be mindful for some big changes that might come your way.
The new recommendations are expected to filter out a large number of players from the PMS space and apparently, attract only the ‘serious’ players.
For a little background, SEBI (Portfolio Managers) Regulations, 1993 were notified on January 07, 1993. Since then, a few amendments in the regulations were introduced in the year 2012.
SEBI now felt the need to review the regulations comprehensively. It set up a Working Group of industry participants to recommend changes in the regulations.
This Working Group submitted a report on SEBI (Portfolio Managers) Regulations, 1993. The Working Group is of the view that the existing regulations may be redrafted as SEBI (Portfolio Managers) Regulations, 2019.
Subsequently, on August 2, 2019, SEBI issued the consultation paper requesting comments and feedback from the public on both the above mentioned documents.
Here is the summary of the key changes mentioned in the Working Group’s report and in draft regulations.
#1 – Changes in the definition of “Principal Officer”
It is proposed to change the definition of “principal officer” to include the responsibilities of the principal officer. As per the proposed definition, the principal officer will be responsible for the overall supervision of the operations of the portfolio manager.
The principal officer may not be the actual person managing portfolio of the clients but he / she will act as a Chief Executive Officer / Chief Investment Officer, responsible for key investment decisions for the portfolio management business.
This is a welcome change as the current definition did not include the role / responsibility of the principal officer. Currently, there is a possibility that entities may need to designate the person who fulfils the qualification requirements as Principal Officer without knowing the role of such officer.
#2 – Changes in the qualification requirements of principal officer
In the current regulations, a principal officer needs to have either the required education qualification or relevant experience.
It is now proposed to modify the requirement and make it mandatory that principal officer should have the required qualification as well as at least 5 years of relevant experience.
It is also proposed to introduce NISM certification too for principal officer.
It is specifically mentioned that if any person is acting as a fund manager, he / she also needs to fulfil the qualification requirements same as principal officer.
The role of the principal officer is that of a CEO. This was the much needed change to include qualification as well as experience for principal officer. As I mentioned earlier, entities can appoint a person who fulfills education requirement without having experience.
#3 – Change in the qualification requirements of employees
It is proposed that even the two employees required for portfolio management services have the required qualification, at least 2 years of relevant experience as well as NISM certification, which is not the case in the current regulations.
#4 – Change in the requirement of number of employees
In the current regulation, the entity is required to have minimum two persons in the employment who, between them, have at least 5 years of relevant experience, and a Compliance Officer. It is not clear whether the entities need to hire one more person and fulfill the requirement along with the principal officer or it has to be two separate employees. It is also not clearly mentioned if the additional employee can be designated as the compliance officer too.
In the proposed regulation it is clarified that in addition to the principal officer, the entity should have two other employees, who fulfill the qualification requirements.
The entity also needs to get on board a compliance officer. The compliance officer may also need to have certification from NISM to be designated as one.
So the entity needs to have at least 4 employees, i.e, 1 principal officer, 1 compliance officer and 2 other employees before making an application to SEBI.
This is a useful clarification, something my clients were already doing, thus following the regulations in spirit. The purpose of having two more employees is that PMS entity has resources to carry out portfolio management services.
#5 – Change in the net worth requirements
At present, the minimum net worth requirement for Portfolio Management entity is Rs 2 Crore. It is proposed that the minimum net worth requirement to be enhanced to Rs 5 Crore. Even the entities who are already registered as PMS need to increase their net worth to Rs. 5 crores.
The Working Group is of the view that increase in cost requires a higher investment from the Portfolio Manager in the business. Cost includes compliance costs, cost related to information technology and cyber security, increase in minimum number of employees, etc.
This one point will lead to a lot of debate. This proposed change may lead to only large and serious players to be in the business of portfolio management. Small players who cannot not fulfill the net worth requirements may shift to investment advisory.
#6 – Change in the minimum investment requirement by clients
In the current PMS Regulations, a Portfolio Manager cannot accept from their clients, funds or securities worth less than Rs. 25 lacs. It is proposed to increase the limit to Rs. 50 lacs.
The investors like HNIs who already have some knowledge and experience of investing in the markets opt for portfolio management services. PMS is not meant for the small retail investors. Hence this proposed change may help PMS entity retain the serious investors only.
#7 – Changes in performance reporting by PMS
There are no standard formats to report performance of PMS. Hence different PMS follow different practice and interpretation of regulatory requirements. In order to standardise the reporting, it is proposed to introduce standard formats and procedures.
This change will help investors take informed decisions as well as the PMS entities to comply with the reporting requirements by SEBI.
#8 – Introduction of the distributor fees
Lot of PMS entities have hired distributors to sell their products. These distributors are mutual fund distributors who have a client base and can pitch PMS for a distributor commission. Currently there are no regulatory provisions governing distributors of PMS.
It is proposed to introduce governing provisions for distributors. The distributors will also be required to fulfill minimum qualification criteria and follow code of conduct. It is also proposed to mandate disclosure of fees paid to the distributors by the PMS to deal with conflict of interest. Distributor commission may only be paid on trail- basis (and not up-front) and only from the fees charged by the Portfolio Manager.
The distributors do not carry out the financial analysis or risk analysis of clients. To earn commissions, they may recommend the services of PMS without knowing any details of the service or suitability of service for the client. This change is expected to curb the possibility of mis-selling and mis-information by the distributors.
#9 – Specification of investment instruments for PMS
In the current regulations, there is no restriction on the type of investment instruments where clients’ portfolio may be invested. It is proposed to permit portfolio manager to invest only in listed securities, whether equity, debt or commodity derivatives and units of Mutual Funds, on behalf of their clients. In case of investment in units of Mutual Funds, investment can be made in direct plans only.
KEY OPERATIONAL CHANGES
Other key operational changes have been introduced as well. Here are some of the key ones.
#1 – Confirmation of having understood fees and charges in own handwriting proposed to be done away with.
#2 – Disclosure Document to be provided at any time before or at the time of entering in to the agreement instead of at least two days prior to the execution of PMS agreement. Disclosure document can be provided vide hard /soft copy and to be made available all times on Portfolio Managers website.
#3 – The periodic reports provided to clients may have a timeline of not more than 3 months, instead of the existing timelines of 6 months.
#4 – Disclosure document to be filed with SEBI only before issuing it to the clients and only when there is material change instead of filing it every 6 months as mentioned in current regulations.
The consultation paper and draft regulation is open for your comments. The comments on the consultation paper should reach SEBI latest by August 30, 2019. The comments can be sent to pmsreview@sebi.gov.in.
Click here to view the consultation paper
Click here to view the report of the Working Group.
Click here to view the proposed SEBI (Portfolio Managers) Regulations, 2019.