Market regulator SEBI has floated a discussion paper on the usage of pool accounts in mutual fund transactions. The paper has alarmed many a MF intermediary since it proposed a halt in purchases and sales of mutual funds through pool or escrow accounts of brokers and online platforms. Let us take a look at the issue in detail, before arriving at any conclusion.
In order to provide more avenues for transacting in mutual fund units, SEBI had permitted that units of MF schemes may be transacted through clearing members of the registered stock exchanges and redemption requests for units in demat form may be processed by depository participants, in addition to transactions directly with the mutual funds and through stock brokers. For this purpose, units on purchase and redemption amount were allowed to be routed through broker’s/ clearing member’s pool account. For transactions on stock exchanges (equity and derivatives), funds and securities are routed through broker’s pool account.
MF distributors and investment advisors were also allowed to use the infrastructure of the recognized stock exchanges to purchase and redeem MF units directly from MFs/asset management companies on behalf of their clients. Many MF distributors (MFDs) registered with AMFI and SEBI registered Investment Advisors (IAs) are also providing digitalized services to investors to transact in mutual fund units. Through these platforms, investors can place single or multiple orders to transact in mutual funds units. These platforms are often pooling the client’s funds in an escrow account / nodal account and subsequently transfer them to AMCs either on per transaction basis or on lump sum basis. At times, MFDs/IAs/other online platforms have been enabled to operate through the pool account mechanism based on an understanding with AMCs.
Thus, the use of pool account gave greater ease of transactions, convenience, and flexibility to the investors in making mutual fund transactions.
With crown, comes thorns
However, certain challenges have come to the fore with the current process of using pool accounts. These concerns can be grouped as under.
1. Loss of traceability of transaction and funds - For units and funds that move in an aggregate manner from broker’s account to RTA’s (registrar and transfer agents)/AMC’s account, once pooling happens at an intermediary level, the traceability of funds/ investor details is lost to AMCs/ RTAs. RTAs are not able to identify the exact order details of the investors against which units have been moved / not moved, which in turn leads to a difference in balances between RTA and depository books. This can lead to a lack of traceability of funds for 2-3 days. Similarly, when AMC makes a redemption payment to the broker's pool account, it has little way to confirm if the money has indeed been transferred to the investor.
2. Potential misuse of pooled funds/ securities - In the recent past, instances have come to light where client’s funds/securities were allegedly diverted or mis-utilized by trading member/ clearing member toward margin obligations or settlement obligations of itself or for some third party or for raising loan against shares on its own account, etc. The share of MF transactions via pool account was about 52% in both exchanges combined during 2018-19. Since securities were potentially misused through pool account route, there is a chance that the same can happen to the MF unit float of clients in the broker pool account.
3. Digital platforms provided by MFDs and IAs also susceptible - The practice of acceptance of funds by these platforms poses several risks. One, AMCs lose the sight of the source of funds as they receive the funds from pool/escrow accounts, instead of investors’ bank accounts. Two, MFDs are not expected to handle clients’ funds and/or securities. In physical applications, MFDs are not allowed to take cheques/payment instruments from clients in their names. Instead, clients are required to give cheques/payment instruments which are in favour of Mutual Funds/AMCs. IAs are also envisaged to provide non-binding advisory services to their clients. Routing of funds/units through them may lead to potential misuse of funds/units. Similar risks also arise when funds/unitsare being pooled using an escrow account.
In this backdrop, SEBI has proposed banning pooling of funds/units by Stock Brokers, MFDs, IAs and other platforms for mutual fund transactions. This will certainly make mutual fund transactions safer and reduce the risk of fraud or default by intermediaries.
But the ban, when implemented, could greatly impact fintechs and their digital platforms since their business model is based on money volume they handle.
Also, there seems to be some ambiguity as to how brokers can charge for their services since at present they are deducted before paying out of the pool to the customer.