The Securities & Exchange Board of India (SEBI) has introduced a new regulatory framework for direct mutual fund investing, which mandates that execution-only platforms (EOPs) register with regulators and refrain from offering regular plans of mutual fund schemes.
An EOP is an online or digital platform that facilitates various transactions, including subscription, redemption, and switching, specifically for direct plans of mutual fund schemes.
Previously, there was no established framework for technology/digital platforms (including those provided by investment advisors/stock brokers to non-clients) to provide execution-only services for direct plans of mutual fund schemes.
According to the circular issued by SEBI on June 13, any entity intending to operate as an EOP must obtain registration from SEBI or the Association of Mutual Funds in India (AMFI), depending on the applicable requirements.
Having said this, the EOP framework will not be extended to platforms offered by SEBI-registered investment advisors and stock brokers exclusively to their advisory or broking clients.
Classifying EOPs
SEBI has classified EOPs into two categories.
Category 1: The EOPs must obtain registration with AMFI, the mutual fund industry body. In this particular category, Category 1 EOPs would serve as agents for asset management companies (AMCs) and establish system integration with AMCs and/or Registrar and Transfer Agents (RTAs) authorized by AMCs. Their primary objective would be to facilitate transactions related to mutual funds. These entities may also act as transaction aggregators for direct plans of mutual fund schemes, providing services to investors and other intermediaries.
Category 2: The EOPs, in order to operate, must register as stock brokers with SEBI and are limited to acting as agents of investors exclusively through the platforms provided by stock exchanges.
These entities are not permitted to function as transaction aggregators for direct plans of mutual fund schemes. Instead, they can offer services directly to investors.
To operate as an EOP, any entity has the option to obtain registration under one of the two available categories.
Rules concerning onboarding of EOPs
The specific requirements regarding the onboarding of investors would be determined and specified by the Association of Mutual Funds in India (AMFI). These requirements would need to be followed by Category 1 EOPs while onboarding investors onto their platforms.
In the case of Category 2, EOPs that are mandated to register as stock brokers must comply with the Know Your Client (KYC) requirements when onboarding investors onto their platform. This entails verifying the identity of investors by obtaining and verifying the necessary documents.
Additionally, these EOPs are obligated to establish suitable agreements with the stock exchanges. These agreements should precisely define the rights and obligations of the EOPs in relation to the provision of EOP services.
SEBI in its circular said, “The responsibility of ensuring compliance with KYC requirements, with respect to transactions executed through both categories of EOPs by investors in mutual funds, shall lie with the AMCs.”
The entity operating as an EOP is required to enter into agreements with the AMCs. These agreements should clearly outline the rights and responsibilities of the entity in relation to the provision of EOP services.
Additionally, the entity must have an objective, fair, and transparent policy in place for providing execution services for the products offered by the AMCs. This policy ensures that the entity maintains integrity and transparency while facilitating transactions through its EOP platform.
Details of costs and expenses
Under SEBI guidelines, EOPs that have registered with AMFI are permitted to impose a flat transaction fee for the services they offer. This fee is not based on the trade amount (ad-valorem) but rather a fixed amount. The responsibility of bearing this fee lies with the AMCs, and the fee charged by the EOPs must not exceed the upper limit specified by AMFI.
Furthermore, as per the guidelines, any onboarding fees, if charged, are to be borne by the AMCs in the case of Category 1 EOPs. Conversely, Category 2 EOPs are allowed to levy a flat transaction fee (not ad-valorem), which will be borne by the investors, within the upper limit specified by stock exchanges.
In terms of onboarding fees, Category 2 EOPs may have these fees borne by either the AMCs or the investors, depending on the specific circumstances. Moreover, it is important to note that AMCs are not permitted to charge any fees or charges paid to the EOPs to the mutual fund schemes.
In addition to these requirements, EOPs in both categories must establish a comprehensive risk management framework. They are also directed to implement measures to prevent unauthorized access to their platforms and ensure the integrity and privacy of data.
In its circular, SEBI also added, “Maintain investor-level segregation between EOP services and distribution services for mutual fund products, at the entity’s group level. Thus, an investor at the EOP’s group level may either avail EOP services for transacting in direct plans or distribution services for regular plans of mutual funds.”
Furthermore, EOPs are strictly prohibited from displaying any advertisements pertaining to mutual fund schemes on their platforms. This includes the prohibition of proxy, surrogate, or common brand-related advertisements.
In addition, EOPs have an obligation to present factual information about mutual funds in a manner that is easy for users to understand and navigate on their platforms. This information should include publicly available details, such as the past performance of schemes. EOPs are also required to adhere to the minimum disclosure requirements set by the regulatory authorities to ensure transparency and compliance.
Furthermore, EOPs are obligated to provide investors with an interactive tool that allows them to screen and filter various mutual fund schemes based on their chosen criteria. This tool should enable investors to refine their search based on factors such as past performance, assets under management, and other relevant parameters. Apart, EOPs must refrain from automatically displaying recommendations or rankings for any of the schemes.
Additionally, EOPs are required to cease using pool accounts for transactions involving units of mutual funds. This stipulation applies to EOPs as well, ensuring the discontinuation of such practices.
SEBI has instructed existing platforms to obtain suitable registration under one of the categories of EOPs within a three-month period from the circular's effective date, which is September 1, 2023. It is mandatory for existing platforms to comply with this registration requirement within the specified timeframe.
