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TER regulations: Balanced outcome with hope of a stable regime

The SEBI’s final rules on the total expense ratio (TER) for mutual funds are more balanced than the initial proposals. The removal of the 5-bps exit-load allowance was widely expected and should largely be passed on. Importantly, the TER reduction has been moderated to 10 bps (versus the 15 bps proposed earlier), which should keep the earnings impact negligible. The cut in brokerage caps is also less aggressive than initially outlined (6 bps versus 2 bps earlier). With greater clarity on regulations and their financial implications, we expect a positive sentiment for AMC and wealth-management stocks.

Revised TER structure

The new expense ratio structure framework is primarily aimed at enhancing transparency and consistency in expense ratio calculations and disclosures. As a principle, expense ratio limits, now called Base Expense Ratio (BER), shall exclude all statutory levies. The key changes include: (1) the removal of additional expense allowance. The additional 5 bps currently permitted to be charged to schemes has now been removed; (2) revised base expense ratio limits. The base expense ratio limits (see Exhibit 1) are revised so as to exclude all the statutory levies; and (3) the rationalization of brokerage limits. Cash market brokerage cap has been reduced to 6 bps (from 8.59 bps of the like-for-like number) and derivatives brokerage cap has been reduced to 2 bps (from 3.89 bps of the like-for-like number).

Final guidelines are relatively more balanced

We see the final guidelines as more balanced compared to initial proposals. The removal of the 5-bps allowance for exit load was expected to be part of the final guidelines. On the other hand, the reduction in TER slabs by 10 bps (compared to the 15 bps proposed in the consultation paper) is a positive and would provide some flexibility, in addition to offsetting the impact of GST on distribution commissions.

A 5-bps cut on the equity regular TER of 1.8% implies a 3% hit to the value chain. We expect AMCs to pass on 60-70% of the 5-bps impact (in line with TER sharing) to distributors and possibly some with RTAs. The residual impact (Exhibit 2), along with the possible benefit of the TER cut (10 bps) being lower than GST on distribution commissions (Exhibit 3), is likely to be zero-to-mid single digits.

AMCs and wealth players in focus

We believe that markets will view the final guidelines favorably, as they bring clarity and conclude the current regulatory cycle. Larger AMCs with strong performance (such as HDFC and Nippon) stand to benefit. Diversified wealth managers (360 One, Nuvama) will also gain from milder brokerage cuts and their lower reliance on MF distribution income. RTAs, however, may face pricing pressure if AMCs try to mitigate yield compression.

Expect a more stable regulatory regime going forward

We continue to maintain the view that India’s MF regulations compare quite well against other large countries on metrics such as (1) ban on entry/exit loads (one of the few countries), (2) expense ratio caps (probably the only large country), (3) concentration of top-10 players, (4) scale of non-bank promoted AMCs, along with non-captive distribution, and (5) easy availability of cheaper direct share class. The experience of the past decade also shows decent elasticity of market share with fund performance.

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