The Indian capital market regulator, SEBI introduced a number of amendments to the PMS regulations instituted in 2020. These include certification requirements for fund management personnel, disclosure of client deal data, the undertaking of co-investment PMS, norms for PMS firms changing control, and related party rules and regulations. Earlier in 2020, SEBI had introduced the SEBI (Portfolio Managers) Regulations, 2020 (PMS Regulations), announcing several regulations relating to portfolio management services. From the doubling of minimum investment ticket size and manager’s net-worth increase, the regulations were aimed at increasing the PMS product’s transparency making it easier for retail investors to invest in these solutions.

Certification requirements for Distributors, Staff of PMS

In Sep 2021, SEBI put in place certification requirements for associated persons engaged by portfolio managers as distributors or employees having decision-making authority related to fund management. These persons need to obtain certification from the National Institute of Securities Markets (NISM). As per SEBI’s requirements, the associated persons, engaged by a portfolio manager as a distributor of the PMS, and associated persons functioning as principal officers of a portfolio manager or an employee having decision-making authority related to fund management, will have to obtain certification from the NISM by passing the certification examination.

Disclosure of Client Deal Data

In Nov 2021, SEBI made all portfolio management service (PMS) providers, who handle investments of the rich and ultra-rich, to submit information on the quantum of various securities bought by different kinds of clients. This is aimed at raising the reporting standards of PMS. This is in addition to sharing fund inflows from various categories – corporates, non-corporates, non-residents, offshore funds, and provident funds and reporting exposures to various baskets of investments: listed stocks, along with a break-up of investments in large-cap shares, mid-cap and small-cap shares; listed debt securities and the quantum of holdings in papers with a credit rating of below triple-B; unlisted equity and debt; stock and commodity derivatives and mutual funds

SEBI amended the SEBI (Portfolio Managers) Regulations, 2020 in Dec 2021 to include co-investment portfolio management services. A manager of an AIF who is also a SEBI registered Portfolio Manager, and intends to offer Co-investment services through portfolio management route, can do so under prior intimation to SEBI. In terms of compliance, Portfolio Managers are required to submit a monthly report regarding their portfolio management activity, on SEBI Intermediaries Portal within 7 working days of the end of each month, which includes details of Co-investment offered by Portfolio Manager.

New norms for PMS firms changing control

In June 2022, SEBI asked portfolio managers undergoing a change in control to allow their clients to exit the existing schemes without any exit load. SEBI requires the portfolio management services (PMS) firms to inform their investors about changes in control at least a month before. Also, PMS firms undergoing a change in control will now have to seek prior SEBI approval through an online application. These changes will be effective from June 15, 2022. These changes have been brought into effect in order to enable existing investors/clients to take a well-informed decision regarding their current investments in the PMS undergoing change in management.

Capping of PMS Investment in Securities of Related Parties

SEBI, in a circular released on 26th August 2022, notified frameworks regarding investments by portfolio management scheme (PMS) service providers. The move is expected to ensure proper disclosure to investors, cap over-exposure to investments in securities of related parties and ensure most of the investments are done in quality securities. The new rules allow the investor more control over any ‘conflicted investments’ by the PMS manager.  These rules will, however, not be applicable for advisory portfolio management services, co-investment portfolio management services companies, and those companies that manage funds under government mandates.

Limits on Investment in Securities of Associates/Related Party

SEBI said that portfolio managers shall invest up to a maximum of 30% of their client’s portfolio in the securities of their own associated or related party. SEBI further classified and laid down limits for individual securities.

In the equity asset class, the limit for investment in a single associated or related party shall be 15% of the client’s assets under management (AUM). The limit for investment across multiple associates or related parties shall be 25% of the client’s AUM. For debt and hybrid securities, the limit for investments in a single associated or related party shall be 15%, and for multiple associates or related parties, 25%.

The overall limit for equity, debt and hybrid securities shall be 30%. The limits mentioned shall be applicable only to direct investments by Portfolio Managers in equity and debt/hybrid securities of their own associates/related parties and not to any investments in the Mutual Funds.

Prior Consent of Clients

To be able to make investments in the securities of associates or related parties, portfolio managers will need the prior consent of the client at the time of onboarding. Even for existing clients, fresh investments in such securities can be made only after obtaining consent from the client.

Credit Rating of Investments by Portfolio Managers

Portfolio managers shall not be allowed to invest funds of their clients’ funds “in unrated securities of their related parties or their associates”. Both in the case of discretionary and non-discretionary portfolios, managers shall not make any investment in below-investment-grade securities. However, managers may invest up to 10% of the assets under the management of such clients in unlisted unrated securities of issuers other than associates/related parties. Such mandated prudential limits on investments are expected to ensure high-credit-quality investments.

Disclosures with respect to Related Parties

Portfolio managers will have to provide their clients with a disclosure document with all the details of investments in related parties or associates, rectification policy, and credit ratings of investments in debt and hybrid securities.

Appendix:

Rules and Regulations announced as part of SEBI (Portfolio Managers) Regulations, 2020 (PMS Regulations)

Minimum ticket size & Net-worth Increase

The minimum ticket size for PMS investment increased from Rs 25 lakh to Rs 50 lakh. The minimum net worth of a PMS provider also witnessed a hike to Rs 5 crores from Rs 2 crores. The latter will act as a deterrent to keep the non-serious players at bay from the PMS industry. The hike was accounted for, by taking several factors into consideration like inflation, rising compliance costs, income levels, etc.

Restrictions on Investments

In India, there are primarily three types of PMS from which an investor can choose to fit his/her convenience and financial goals and objectives. These include the Discretionary, Non-Discretionary, and Advisory PMS types. In Discretionary, the sole investment decisions rest with the fund manager, who is the decision-making body. The new regulation implied for Discretionary fund managers restricts them to invest in listed securities only, mutual fund units, and specific money market instruments.

Clients opting for Discretionary PMS cannot be allowed to invest in unlisted securities, which includes units of Alternative Investment Funds (AIFs), Real Estate Investment Trusts (REITs), debt securities, shares, warrants, etc.

In the second Non-Discretionary type, the client holds the entire decision-making power, and the professional fund manager plans out investment strategies but cannot execute the trade without the consent of the client. In the third, the Advisory type, the professional fund manager only plays an advisory role to the client and holds no power to make investment decisions or execute the trade. With the restrictions mentioned above for Discretionary managers, the Non-Discretionary and Advisory Portfolio Managers cannot invest more than 25% of their AUM Assets under management (AUM) in unlisted securities. These restrictions on unlisted securities will help improve liquidity — a constant concern for PMS products.

This 25% limit in case of non-discretionary PMS again involves an active and a passive breach. In the former case, non-compliance would be reported if there is an investor action in accordance with corporate actions such as subscribing to a rights issue. However, a case of a corporate action such as a bonus issue, (that has no involvement of the investor) would be considered a passive breach of limits.

On Operational Expenses

The portfolio managers would not charge any upfront fees in any form to the client. Without any overall cap on the charges, just the operational costs, except the ones charged on brokerage, get capped at 0.5% of the corpus. This implies that ‘the operating expenses levied on the client for portfolio management services shall not exceed 0.5% a year of the client’s daily average asset under AUM.

There have been restrictions regulated on off-market transfers from or to client’s accounts (with certain exceptions) to facilitate operational convenience.

Performance Data Regulations

The performance report of PMS managers comes into regulation. They would be now required to have a standardized reporting manner. Compared to earlier, where the performance data was before the fees and expenses, the regulation states that Portfolio managers will now be required to report the performance data containing all details on costs and fees, including taxes. This will help the new investors do their research better with crisp information available.

Other Regulations

One of the reporting regulations involves acceptance of a standard nomenclature called the Investment Approach of Portfolio Managers that should be used in reporting and disclosure documents of PMS.

 

Another regulation aims at enhancing the eligibility criteria for the PMS’s principal officer role. This additional person employed by the PMS provider will be holding the roles and responsibilities along with the principal officer and the compliance officer.

A recommendation for the distributors coming from the SEBI Working Group states that those who have passed the National Institute of Securities Markets (NISM) exams and are already registered with the Association of Mutual Funds in India (Amfi) would be permitted to distribute PMS products.

Mandatory Appointment of a Custodian

Custodian appointments are mandatory for all PMS providers (except for the ones offering Advisory services only). This custodian will act as a third-party who’ll indeed hold all of the client’s financial securities. This rule is aimed to provide protection to the investors in case the PMS providers go bankrupt.

These regulations proposed and changes implemented are the right steps in increasing not only investor’s trust with improved portfolio management service’s transparency but also to bring about standardization in the industry. Improving for a better understanding and transparency with the clients, these rules will cater to enhanced communication and trust.

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