Timothy Lopes, Senior Executive
Harshil Matalia, Assistant Manager
Updated as on 27th August, 2020
The securities market regulator has recently introduced the new SEBI (Portfolio Managers) Regulations, 2020 (PMS Regulations), bringing in several changes to the Portfolio Management industry, including doubling the ticket size for investments and increasing the net-worth requirement of Portfolio Managers.
The Portfolio Management Services (PMS) industry has witnessed substantial growth in its Assets Under Management (AUM) in the last 5 years as shown in the data below. There has also been a substantial increase in the number of clients, indicating that the PMS industry plays a significant role in managing funds of High Net-worth Individuals.
Source: SEBI PMS Data
This growth called for a need to review the existing PMS Regulations and provide for enhanced regulations to protect investor interest and increase transparency and disclosure norms for the benefit of investors.
SEBI constituted a Working Group to identify the areas that required change in the PMS Regulations. Based on the Report of the Working Group, SEBI introduced the new PMS Regulations on 16th January, 2020 which is primarily aimed at reducing risk for investors by imposing certain investment caps and increasing transparency in the PMS industry. Further, on 13th February, 2020, SEBI had issued Guidelines for Portfolio Managers. The implementation of the guidelines were extended vide SEBI circular dated 30th March, 2020 in light of market events caused due to the COVID-19 pandemic. SEBI further extended implementation of the guidelines by a further period of 3 months vide notification dated 29th June, 2020.
Furthermore, SEBI has also issued FAQs for Portfolio Managers, on 25th August, 2020, clarifying the position on some questions that may have arisen post the introduction of the new regulations.
We discuss some of the major changes made and their impact on the industry.
Increase in ticket size of investment
The new regulations prescribe an increase in the minimum investment limit from earlier Rs. 25 Lakh to Rs. 50 Lakh in the new regulations. The rationale behind the increase is that Portfolio Management Services unlike mutual funds are more complicated and riskier products, meant for investors with higher risk taking capacity. So to avoid retail investors with limited understanding of volatility and risk entering this product, it is thought prudent to increase the minimum investment limit.
This increase is likely to deny the benefits of PMS to retail investors in the Rs. 25 – 50 Lakh investment bracket. Further the growth of PMS industry is likely to decline as there will be fewer new investors entering this product due to the increased limit. However with the sharp and rather rapid growth in the economy and stock markets, the increased investment limits seems justified considering that the last increase in the minimum limit was done 8 years ago in February, 2012.
SEBI in its FAQs has clarified that investors are not required to top up their investments if in case the investment falls below the regulatory minimum threshold as a result of valuation of the portfolio. This seems valid due to the fact that market prices of stocks may fluctuate resulting in portfolio value falling lower than the minimum threshold. In such cases there is no need to top up the investment.
Net-worth requirement increased to Rs. 5 crores
The new regulations prescribe an increase in the capital adequacy requirement of Portfolio Managers from the present Rs. 2 crores to Rs. 5 crores with a view to act as a deterrent to non-serious players in the PMS industry and also put pressure on fringe players co-existing with serious managers.
The limit was also increased considering several other factors such as inflation, rising income levels, increased compliance costs, IT costs, etc.
New Investment norms
Earlier the investment made by PMS was liberal as opposed to mutual funds where there existed several restrictions on investment and exposure norms. The new regulations have brought in investment restrictions for both discretionary and non-discretionary PMS.
Discretionary PMSs are those wherein the Portfolio Managers have some degree of discretion with respect to managing the funds of their clients. While non-discretionary PMS have no degree of discretion and require prior client consent each time a transaction is undertaken.
The PMS Regulations, 2020 introduce restrictions on investment in unlisted securities by mandating discretionary PMS to invest only in listed securities, while non-discretionary PMS can invest in unlisted securities up to 25% of their AUM.
In its FAQs, SEBI has clarified that “Unlisted securities” for investment by Portfolio Managers shall include units of Alternative Investment Funds (AIFs), Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), debt securities, shares, warrants, etc. which are not listed on any recognized stock exchanges in India.
Further, SEBI has clarified through its FAQs that funds of clients availing discretionary PMS services are not permitted to be invested in unlisted bonds, which are traded over the counter but settled and reported to the stock exchanges.
This move is likely to reduce the risk for clients of PMS and disallow high exposure to investment in unlisted securities. It is important to note that similar restrictions on investment are also imposed on Mutual Funds in 2019. Investment in listed securities only brings in higher levels of disclosures and transparency to the clients investment portfolio.
Further investment in mutual funds may be done by Portfolio Managers only through ‘Direct Plans’. This is with a view to avoid charging any distributor’s fee from the clients.
Other investment norms are largely the same as 1993 PMS Regulations.
Active and passive breach of 25% limit in case of non-discretionary PMS –
Non-discretionary PMS are permitted to invest in unlisted securities to the extent of 25% of their AUM. The question that arises is whether a breach of this 25% limit due to corporate actions such as bonus shares, rights issue, etc. would be considered as non-compliance by the non-discretionary PMS?
Here, SEBI has bifurcated the breach of the 25% limit into 2 parts. An active breach and a passive breach. In its FAQs, SEBI states that an active breach due to investor action pursuant to corporate actions such as subscribing to a rights issue would be treated as non-compliance.
However, a passive breach of the limits due to corporate actions such as bonus issues (where there is no real investor action), the same would not be treated as non-compliance.
Nomenclature “Investment Approach”
The Working Group recommended the adoption of a standard nomenclature called the Investment Approach of Portfolio Managers, permitted to be used in reporting and disclosure documents of PMS as the same does not compromise the bi-laterality of the Portfolio Management Contract.
Adopting the nomenclature for reporting and disclosures by Portfolio Managers will allow them to easily compare performance of multiple investment approaches under the umbrella of one Portfolio Manager. There are concerns as to whether investors would then get confused between a Mutual Fund Scheme and the Investment Approach of a Portfolio Manager. This is unlikely as the Working Group addressed this issue by stating that the investors in PMS are highly sophisticated with higher understanding of the differences between Mutual fund schemes and Portfolio Managers.
Performance reporting standards were revisited in light of the need for standardized & accurate reporting for all Portfolio Managers. Proposals were made by the Working Group for reporting at the client level, reporting to SEBI and reporting for marketing materials as well. Since, there was no standardized reporting in the earlier framework, several issues were pointed out by the Working Group such as –
- Cherry picking certain portfolios by Portfolio Managers;
- Performance calculation differed among several Portfolio Managers;
- Portfolio managers showing model returns;
- Portfolio managers inflating returns by annualizing partial periods;
- Comparing the strategy’s returns with incorrect benchmark returns;
- Not taking into account the cash component in computing returns
- Ignoring withdrawn portfolios;
- Not disclosing qualitative parameters such as a change in the identity of the fund manager, change in the investment strategy.
The PMS Regulations, 2020 address these issues by bringing in standard performance reporting for all Portfolio Managers. The Regulations prescribe calculation of performance of a Portfolio Manager using a standard ‘Time Weighted Rate of Return’ (TWRR) and has also increased the frequency of reporting to clients from the earlier half yearly reporting to quarterly reporting to clients.
The TWRR calculation breaks up the return on an investment portfolio into separate intervals, based on whether money was added or withdrawn from the fund. An illustration and steps to compute TWRR in this regard is provided in Annexure 1 of SEBI FAQs on Portfolio Managers.
Qualifying criteria for employees of a Portfolio Manager
Considering the importance of educational qualification as well as work experience in the PMS industry, the working group recommended a change in the qualifying criteria of the Principal Officer (PO) as well as employees of the PO. The new qualifying criteria is depicted hereunder –
|Particulars||PMS Regulations, 1993||Working Group Recommendation||PMS Regulations, 2020|
|Definition of PO||Reg 2(d) – “principal officer” means an employee of the portfolio manager who has been designated as such by the portfolio manager;||Reg 2(l) – “Principal Officer” means an employee of the portfolio manager who is responsible for:-
(A) The decisions made by the portfolio manager for the management or administration of a portfolio of securities or the funds of the client, as the case may be.
(B) The overall supervision of the operations of the portfolio manager.
|Reg 2(p) – “principal officer” means an employee of the portfolio manager who has been designated as such by the portfolio manager and is responsible for: –
(i) the decisions made by the portfolio manager for the management or administration of portfolio of securities or the funds of the client, as the case may be; and
(ii) all other operations of the portfolio manager.
|Qualifying criteria for PO||The principal officer of the applicant has either–
(i) a professional qualification in finance, law, accountancy or business management from a university or an institution recognized by the Central Government or any State Government or a foreign university; or
(ii) an experience of at least ten years in related activities in the securities market including in a portfolio manager, stock broker or as a fund manager;
(iii) a CFA charter from the CFA Institute.
|Principal Officer of a Portfolio Manager shall have minimum qualification as given below:
1. a professional qualification in finance, law, accountancy or business management from a university or an institution recognized by the Central Government or any State Government or a foreign university and relevant NISM certification
2. an experience of at least Five years in related activities in the securities market including as a portfolio manager, stock broker, Investment Advisor or a fund manager.
|the principal officer of the applicant has–
(i) a professional qualification in finance, law, accountancy or business management from a university or an institution recognized by the Central Government or any State Government or a foreign university or a CFA charter from the CFA institute;
(ii) experience of at least five years in related activities in the securities market including in a portfolio manager, stock broker, investment advisor, research analyst or as a fund manager; and
(iii) the relevant NISM certification as specified by the Board from time to time.
Provided that at least 2 years of relevant experience is in portfolio management or investment advisory services or in the areas related to fund management.
|Qualifying criteria for employees of the PM||The applicant has in its employment minimum of two persons who, between them, have at least five years’ experience in related activities in portfolio management or stock broking or investment management or in the areas related to fund management;||Minimum two employees with –
(i) a professional qualification in finance, law, accountancy or business management from a university or an institution recognized by the Central Government or any State Government or a foreign university and relevant NISM certification
(ii) an experience of at least two years in related activities in the securities market including as a portfolio manager, stock broker, Investment Advisor or a fund manager.
In addition, any employee of the Portfolio Manager who has decision making authority related to fund management shall have the same minimum qualifications as the Principal Officer.
|In addition to the Principal Officer and Compliance Officer, the applicant has in its employment at least one person with the following qualifications :-
(i) graduation from a university or an institution recognized by the Central
Government or any State Government or a foreign university; and
(ii) an experience of at least two years in related activities in the securities market including in a portfolio manager, stock broker, investment advisor or as a fund manager:
Provided that any employee of the Portfolio Manager who has decision making authority related to fund management shall have the same minimum qualifications and experience as specified for the Principal Officer in clause (d) of sub-regulation (2) of regulation 7:
There are several legal and regulatory compliances required on part of a Portfolio Manager under the PMS Regulations. This called for the need to mandate appointment of a Compliance Officer, in addition to the Principal Officer, who shall be responsible for all legal and regulatory compliances.
Under Regulation 34 of the PMS Regulations, it is specifically stated that the role of the compliance officer shall not be assigned to the principal officer or employees of the Portfolio Manager. This was not stated under the PMS Regulations, 1993. This means that a person having the necessary legal background and qualifications will be required to be additionally appointed by each Portfolio Manager and it must be ensured that the role is not assigned to the principal officer or employees of the Portfolio Manager.
Additional clarifications from SEBI FAQs on Portfolio Managers –
Some other highlights of the FAQs that has brought clarity to the regulatory framework governing portfolio managers is provided in the table below –
SEBI FAQs on Portfolio Managers
|Approval of services and disclosure documents of PMs||SEBI has clarified that it does not approve any of the services offered by Portfolio Managers. SEBI also does not certify the accuracy or adequacy of the contents of the disclosure document.|
|Imposing lock-in on investors||Portfolio Managers cannot impose a lock-in on investment made by their clients. However, in line with SEBI circular dated 13th February, 2020, portfolio managers can charge an exit fee for early exit.|
|Offering indicative or guaranteed returns||Just like other capital market intermediaries, portfolio managers cannot offer indicative or guaranteed returns.|
|Filing complaints by investors||Investors will find the requisite information regarding grievance redressal in the disclosure document of the portfolio manager. However, in case of non-redressal of complaints by the portfolio manager, the investor can approach SEBI for lodging a complaint through the SCORES platform of SEBI at this link – https://scores.gov.in/scores/Welcome.html
Alternatively, investors can send their complaints at the address provided by SEBI in its FAQs.
The changes in the PMS Regulations bring in enhanced disclosure and standardization for the PMS industry. Clients of PMS will be able to better understand and compare the terms of services offered by various Portfolio Managers.
Although the changes in the regulations are most welcome, the growth of the PMS industry will likely see a slowdown due to the increased investment minimum limit for clients of PMS of Rs. 50 Lakh.