I have a piece with Aniket Singh Charan and Varun Matlani in yesterday’s Financial Express on SEBI’s proposal to change regulations with respect to mutual funds, in particular it’s attempt to reduce the fees a fund can charge. We argue that a regulator, in the absence of proof that competition is not working, should not be setting rates. While it appears investor friendly, the second order effects of price caps include reversing financial inclusion and dis-advantaging smaller players to name two.
In 1774, a Dutch merchant and broker established what is widely regarded as the first mutual fund by inviting investors to form a trust named Eendragt Maakt Magt meaning “Unity Creates Strength.” Over time, the mutual fund structure has evolved across jurisdictions. Continuing this process, on October 28th, 2025, the Securities and Exchange Board of India (SEBI) released a Consultation Paper on Comprehensive Review of SEBI (Mutual Funds) Regulations, 1996 (MF Regulations)(Consultation Paper), proposing amendments to the existing framework to align the distribution of returns between Asset Management Companies (AMCs) and investors. A few of the major changes, that are the source of heated discussions in the industry are discussed below.
The first such change is the proposal to revise the Total Expense Ratio (TER) limits such that statutory levies (such as STT and GST) are excluded from the computation of the TER. It is proposed that such levies may be passed directly to investors. While this shift enhances transparency and aligns cost pass-through with regulatory intent, it also triggers a consequential downward revision of the existing TER limits. Specifically, the Consultation Paper recommends a reduction of 20 bps for close-ended schemes, and 15 bps and 10 bps for certain categories of open-ended schemes. The magnitude of the proposed downward revision lacks any clear basis and poses concerns for the growth of the mutual fund industry. The downward revision of the TER, exceeds the GST and other statutory components currently a part of the TER and the consequence is an additional, unintended reduction that directly compresses the operating margins of AMCs. In effect, AMCs are compelled to absorb a cost cut that goes beyond the statutory levy adjustment, with no proportionate benefit accruing to investors. Moreover, when AMC revenues are squeezed, the impact is often passed on to MFDs, weakening the distribution network that underpins financial inclusion. A large share of first-time and retail investors especially in smaller towns and underserved regions enter the mutual fund market through these last-mile channels. Any reduction in the economic viability of this network risks undermining the infrastructure that enables widespread investor participation. Mutual funds indeed compete with other assets like insurance and real assets such as property and gold.
In the present day, fees should be determined entirely by market competition, and price controls are increasingly viewed not only as outdated but also as counterproductive. Their second order effects are routinely underestimated in policy debates. Forcing fees artificially downward inevitably erodes service quality, curtails investment in research and investor support, and strips smaller or newer funds of the economic runway needed to grow. The result is predictable, entrenched dominance by a few large players and a shrinking, less diverse industry. Over time, such distortions choke innovation, reduce meaningful choice for investors, and weaken the resilience of the asset management sector that regulation is meant to strengthen. The only reason to impose price controls would be when the normal competitive forces are ineffective as in a monopolistic industry with network effects. Mutual funds are highly competitive an industry.
The Consultation Paper also proposes to permit AMC to charge its schemes investment and advisory fees that are identical, in percentage terms, for both direct and regular plans. While this could be viewed as a welcome and well appreciated move, the unintended impact of the same would be a consequent increase in the overall costs borne by regular plan investors who choose to access mutual funds through MFDs. This too, needs to be carefully studied as investors investing in the market though MFDs are often first time investors who may now be subject to higher overall costs.
Another significant proposal in the Consultation Paper is the steep reduction of the maximum permissible brokerage expense from 12 bps to 2 bps for cash market transactions and 5 bps to 1 bps for derivatives. The stated rationale is that brokerage costs in some instances include not only trade execution but also research services, and since AMCs already possess in-house research capabilities, such additional costs may dilute investor returns. While the objective of enhancing transparency and avoiding duplication of expenses is well-intentioned, the practical realities are more nuanced. In many market segments particularly mid-cap, small-cap, and emerging sectors broker-provided research offers timely, security-specific, and sectoral insights may not be readily available through internal or public sources. Such research plays a complementary role to in-house analysis and supports informed price discovery, ultimately benefiting investors. Brokerage commissions therefore often reflect an integrated service rather than an avoidable add-on cost. A sharp reduction in permissible brokerage limits may constrain AMCs' access to critical external research inputs and could inadvertently impair investment decision-making to the detriment of unitholders.
The Consultation Paper also proposes several amendments to Regulation 24(b) of the MF Regulations, which governs the permissible business activities of AMCs. One such proposal, that an AMC may undertake activities regulated by a domestic or foreign regulator only through a subsidiary and with prior SEBI approval, warrants reconsideration. Where an AMC already maintains adequate structural and operational segregation, and the concerned activities are carried out by a distinct business unit with appropriate oversight, compliance frameworks, and ring-fencing of resources, it may not be necessary to mandate a subsidiary structure. Allowing AMCs to undertake such activities directly, through a distinct business unit, subject to obtaining approvals or no-objection certificates from the regulators with whom they are already registered, would provide greater operational flexibility without compromising regulatory safeguards. This approach would also prevent unnecessary duplication of infrastructure and compliance costs while ensuring that investor interests remain fully protected.
The Consultation Paper walks a careful tightrope between rationalising costs and advancing investor-friendly reforms. However, several aspects warrant deeper examination. The proposed reductions in expense ratios and related regulatory changes compound the pressures already confronting AMCs and risk further eroding margins that are, in many cases of smaller players, already thin. What often remains underappreciated in policy debates is the inherently long gestation period of the AMC business model. Most AMCs operate at a loss for years before achieving the scale necessary to turn profitable. The contemplated amendments risk intensifying this structural challenge and may require deeper analysis of operational feasibility before implementation.
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