SEBI's Regulatory Framework for Execution-Only Platforms in India

The Securities and Exchange Board of India (SEBI), the regulatory authority responsible for overseeing India's capital markets, introduced a groundbreaking regulatory framework for Execution-Only Platforms (EOPs) in September 2023. EOPs are digital platforms that facilitate direct transactions in mutual fund (MF) schemes without offering investment advice. This regulatory update is aimed at addressing the growing demand for commission-free direct plans of mutual fund schemes in India and ensuring investor protection while promoting industry growth.

EOPs: A Growing Trend in the Indian Mutual Fund Market

Direct plans of mutual fund schemes have gained popularity in India due to their cost-effectiveness compared to regular plans, which involve distributor commissions. Investors have increasingly turned to digital platforms to access these direct plans, leading to the emergence of numerous Execution-Only Platforms (EOPs).

However, concerns have arisen as SEBI-registered investment advisers and stockbrokers have offered execution services through their digital platforms to investors not covered by existing regulations. To bridge this regulatory gap and provide clarity to EOPs, SEBI introduced a comprehensive framework that outlines their obligations, allowing them to monetize their businesses while addressing investor concerns and establishing a mechanism for handling grievances.

EOP License Framework

Under this new framework, EOPs are required to obtain a license from either SEBI or the Association of Mutual Funds in India (AMFI). EOPs currently operate under licenses, such as stockbroker or investment advisor (IA). The framework categorizes EOPs into two categories:

Category 1 EOPs (registered with AMFI): These EOPs act as agents of asset management companies (AMCs) and integrate their systems with AMCs and/or Registrar and Transfer Agents (RTAs) authorized by AMCs. They can aggregate transactions in direct plans of mutual fund schemes and provide services to investors and intermediaries.

Category 2 EOPs (registered as stockbrokers with SEBI): Category 2 EOPs operate as agents of investors and can only offer services through platforms provided by stock exchanges. They cannot aggregate transactions in direct plans of mutual fund schemes and can only provide services directly to investors.

Onboarding Requirements

Category 1 EOPs must adhere to onboarding requirements specified by AMFI, while Category 2 EOPs (registered as stockbrokers) are responsible for complying with Know Your Client (KYC) requirements during investor onboarding. They must verify investor identities by collecting the necessary documents and establish clear rights and obligations by entering into agreements with the stock exchanges.

Transaction and Onboarding Fees

Category 1 EOPs can charge a flat transaction fee, borne by AMCs within the upper limit set by AMFI. Onboarding fees, if levied, will also be borne by AMCs. In contrast, Category 2 EOPs can charge a flat transaction fee, which will be borne by investors within the upper limit specified by the stock exchanges. Onboarding fees, if applicable, will be borne by AMCs and/or investors.

Risk Management and Compliance

Both categories of EOPs must have comprehensive risk management frameworks in place, ensuring platform security, preventing unauthorized access, and maintaining data integrity and privacy. To avoid conflicts of interest, EOPs performing multiple activities within the same entity must maintain an arm's length relationship.

Advertising and Disclosure Requirements

EOPs are prohibited from displaying advertisements regarding mutual fund schemes on their platforms. They are required to provide factual information on mutual funds, including past performance, in a user-friendly manner while complying with minimum disclosure requirements. Interactive tools must be available for investors to screen and filter schemes based on selected criteria, with no display of recommendations or rankings for any scheme.

Exemptions for Platforms Associated with Investment Advisors and Stockbrokers

Notably, platforms associated with investment advisors and stockbrokers are exempt from obtaining EOP registration if their services are exclusively available to their existing advisory or broking clients. This exemption has raised concerns about the potential ambiguity surrounding popular direct investment platforms that offer both stockbroking and direct mutual fund investment services to their clients.

Impact of the New Framework

The introduction of SEBI's regulatory framework for Execution-Only Platforms is expected to have several positive impacts on the Indian mutual fund industry and investors:

Clarity and Certainty: Investors and EOPs now have a clear regulatory framework that defines the scope of EOP services and obligations.

Increased Competition: The framework is likely to promote competition in the mutual fund distribution market, potentially leading to lower costs for investors.

Improved Customer Protection: EOPs are now required to comply with specific risk management and customer protection norms, enhancing investor safety.

Access to Regulated Channels: The framework ensures that investors have access to transparent and regulated channels for investing in direct plans of mutual fund schemes.

SEBI's regulatory framework for Execution-Only Platforms in India represents a significant step in adapting to the evolving landscape of financial services. By balancing investor convenience and protection, the framework aims to create a more secure and competitive environment for investors and the growing EOP industry. The implications of this framework will likely have far-reaching effects on the mutual fund market in India, fostering growth, transparency, and investor confidence in the industry.