The Portfolio Management Services (PMS) industry had a robust growth of 18 percent Compound Annual Growth rate in the preceding five years, with assets under management (AUM) rising from INR 6.04 trillion to INR 13.7 trillion. Furthermore, disruptions in the market, including technological advances, have affected the core portfolio selection, management and distribution side of the industry. The Securities and Exchange Board of India (SEBI) on 16 January 2020, undertook the first overhaul of the regulations governing PMS in over two decades by issuing the SEBI (Portfolio Managers) Regulations, 2020 (Regulations). The Regulations were introduced considering the recommendations of the working group constituted to review the erstwhile SEBI (Portfolio Managers) Regulations, 1993. The main objective for the new development is to enhance the regulations in the previously unregulated industry and bring in more transparency with the dual aim of protecting investors while maintaining the attractiveness of the industry. The Regulations came into effect from 21 January 2020.
The portfolio manager is a body corporate, who directs or advises or undertakes on behalf of the client, the administration or management of a portfolio of securities or goods or funds of the client and may deal in goods received in delivery against the physical settlement of commodity derivatives. All portfolio managers must obtain a certificate of registration from the Board.
Main changes introduced in the new Regulations as compared to the 1993 Regulations:
- Minimum Investment
Regulation 23(2) of the Regulations has increased the minimum investment amount per client to INR 50 lakh from the previous limit of INR 25 lakh. This particular change was to ensure that PMS is adopted only by high net-worth individuals (HNI) and that retail investors come through the mutual fund route. As compared to mutual funds, PMS is a more sophisticated investment choice with complicated and riskier products. Increasing the limit is judicious to the extent that retail investors having a limited understanding of the risk shall not deal with the product and be protected under the mutual fund's regime as they are subject to tighter regulation. However, the change may slow down the growth of the PMS industry since the market consisting of investors will reduce with the doubling of the investment amount. Thus, despite making the services more investor-friendly, it is not clear if the stellar growth thus far will continue.
- Minimum Net Worth
Regulation 9 of the Regulations have increased the minimum net worth required for portfolio managers to INR 5 crore from the previous requirement of INR 2 crore. A grace period of 36 months can be availed by the existing registered portfolio managers to increase their net worth. The increased threshold will limit the number of existing or new businesses that wish to retain or obtain their registration. The requirement is far away from the net worth required for investment advisors, which is INR 25 lakh (Regulation 8 of the SEBI (Investment Advisors) Regulations, 2013) though the services provided by both service providers are similar. The change has been introduced to deter the non-serious players, but it may be a restricting factor for other players who fulfill other criteria but do not reach the threshold for net worth. For the Regulations, "net worth" means the aggregate value of paid-up equity capital plus free reserves minus the aggregate value of accumulated losses and deferred expenditure not written off, including miscellaneous expenses not written off.
- Investment in unlisted securities
Portfolio managers offering advisory or non-discretionary services to clients may invest or provide advice for investment up to 25 percent of the AUM of such clients in unlisted securities, in addition to the securities permitted for discretionary portfolio management. (Regulation 24(4) of the Regulations)
- Standardization of fee and distributor's commission
Regulation 22(11) states that a portfolio manager shall charge an agreed fee from the client without guaranteeing any return and the fee so charged may be a fixed fee or a return-based fee or a combination of both, provided that no up-front fees shall be charged by the portfolio manager directly or indirectly to the clients.
- Standardized reporting
As per the previous regulations, a periodical report had to be submitted to the client every six months, but now a performance report to the client needs to be submitted every three months (Regulation 31 of the Regulations) along with disclosing the default in payment of coupons or debt security or downgrading of rating by the credit rating agency. The reporting to the clients shall contain the following details, namely, the value and the composition of the portfolio, description of goods and securities, number of securities, value of each security held in the portfolio, units and the value of goods, cash balance and aggregate value of the portfolio as on the date of the report; the default in payment of coupons or other default in payments concerning the underlying debt security and downgrading to default rating by the rating agencies, if any; details of commission paid to the distributor(s) for the particular client.
- Principal Officer
Regulation 2 of the Regulations elaborates that "principal officer" is an employee of the portfolio manager who is responsible for; the decisions made by the portfolio manager for the administration or management of a portfolio of funds or securities of the client, as the case may be; all other operations of the portfolio manager.
The principal officer is required to have;
- a professional qualification in law, finance, accountancy or business management;
- minimum five years' experience in related activities in the securities market (minimum two years of relevant experience to be in portfolio management or investment advisory services, or in areas related to fund management); and
- a relevant National Institute of Securities Markets certification.
A portfolio manager who was granted the registration certificate before the commencement of the Regulations is required to comply with requirements (1) and (2) above within a period of three years. Additionally, specific qualifying criteria must be met by at least one employee of the portfolio manager other than the principal officer and compliance officer.
- Payment of fees, and the consequences on failure to pay the fees
Every applicant who is eligible for grant of a certificate shall pay the fees within 15 days (Regulation 15 of the Regulations) of receiving intimation from the Board in the manner specified in Schedule II. The Board may on sufficient grounds being shown permit the portfolio manager to pay such fees at any time prior to the expiry of one month from the date on which such fees become due. The consequences of failure to pay the fees remain the same. Failure to pay the fee as specified in Schedule II may result in the suspension of the certificate by the Board, and the portfolio manager shall forthwith cease to carry on the activity as a portfolio manager for the suspension period.
- Disclosure Document (Regulation 22(4) of the Regulations)
The Disclosure Document shall include the following:
- the manner and quantum of fees payable by the client for each activity for which the portfolio manager renders the service directly or indirectly (where such service is outsourced);
- the portfolio risks including risks specific to each investment approach offered by the portfolio manager;
- complete disclosure of the transactions with related parties according to the accounting standards specified by the Institute of Chartered Accountants of India;
- the details of conflicts of interest concerning the services offered by group companies or associates of the portfolio manager;
- the portfolio manager's performance, provided that the performance of a discretionary portfolio manager shall be calculated using 'Time-Weighted Rate of Return' for the immediately preceding three years and in such cases performance indicators shall also be disclosed. The portfolio manager may be permitted to disclose performance segregated on the basis of investment approach;
- the portfolio manager's audited financial statements for the immediately preceding three years.
Further Regulation 22(5), 22(6) and 22(7) of the Regulations specify that the contents of the Disclosure Document are to be certified by an independent chartered accountant, and the portfolio manager shall further ensure that a copy of the Disclosure Document is available on the portfolio manager's website at all times and as soon as the registration is granted. The portfolio manager shall file a copy of the Disclosure Document after the grant of certificate of registration with the Board before circulating it to any client or whenever any material change including change in the investment approach is affected. The portfolio manager shall file the disclosure document with the material change within seven working days from the date of the change.
- Investment approach
The PMS sector did not provide a formal concept of an "investment approach". An investment approach is a wide outlay of the types of securities and instruments permissible to be invested in for the client by the portfolio manager, taking into account factors specific to clients and securities.
Portfolio managers use several investment approaches to manage portfolios and market their portfolio offerings in their individual ways. If portfolio managers are not required to report the performance based on the different investment approaches, accurate information will not flow to potential clients and the SEBI. The portfolio manager is mandated to disclose the investment approach in the Disclosure Document shared with a prospective client, and the same is also required to be included in the client agreement.
An investment approach shall include:
- the objective of the investment;
- describing the types of securities, e.g., listed or unlisted, equity or debt;
- the portfolio's allocation across types of securities;
- the basis of selecting such types of securities as part of the investment approach;
- the appropriate benchmark for comparing the performance and the basis for the choice of the indicative benchmark tenure or investment horizon;
- the risks associated with the investment approach; and
- other salient features, if any.
It was further specified that the information concerning the investment approaches offered by portfolio managers should be uniform across all types of disclosure materials, reporting, and marketing.
The magnitude of changes introduced by SEBI is aimed at building the investor confidence and promises a positive outlook for the industry. The changes such as increased investment by clients and increased net worth for portfolio managers are preferred goals, but did SEBI consider the implementation aspects of these goals if the ultimate objective is to increase the participation in PMS? The downfall could be, for example, minimum investment by the client will hurt the wider objective of amplifying the investor base and in turn will diminish the market and also have a bearing on the freedom to contract and the right to choose from the available investment options. The enhanced eligibility criteria for the principal officer will result in increased compliance costs for the portfolio manager. It is yet to be concluded whether the new Regulations will be a boost to the industry as it intends.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.