The Securities and Exchange Board of India (Sebi) wants to plug the arbitrage play that mutual fund (MF) houses deploy during initial public offering (IPO) to benefit one scheme over another. To meet this end, the market watchdog wants to make pre-trade allocations mandatory for all institutional investors.
“By not informing in advance, which scheme would get what allocation, there is a gap in the system that can be easily misused. Post-allocation, some fund managers can take their own call on which scheme should get the allotted shares, depending upon their view of the company,” said a senior executive of a fund house.
“Such a practice benefits one scheme over another. Some of the arbitrage schemes also take advantage of this. If the investor appetite is strong, the fund house post-allocation might decide to transfer the shares to these schemes, which can make strong short-term gains in the IPO investment,” another executive added.
Apart from IPOs, similar issues have cropped during qualified institutional placements and also bulk deals.
To be sure, some fund houses are following the practice of pre-informing which scheme would get how much allocation, but the regulator wants uniformity in practices across the industry.
According to sources, the regulator also wants to include foreign portfolio investors (FPIs) into this regulation, but the latter may find it difficult to reconcile these norms with their own fiduciary framework.
Industry sources say that there have been cases of MFs misusing this lacuna to the advantage of their flagship schemes.
“A flagship scheme is important for a fund house as it accounts for the largest chunk of assets and lot of investor money is riding onto it. However, still it means that a fund house is giving preference to one scheme over another, which is not fair to the other investors,” said a fund manager, requesting anonymity.
In the case of FPIs, the problem is likely to arise from the regulations that they are already required to adhere to. “The proposal would mean placing orders directly in the name of each account. This would lead to different execution prices as orders get filled at different time. Fund manager would then be forced to allocated at different prices into different funds, which would again be in breach of the fiduciary duty of equitable pricing,” said an official of an industry body.
The proposal on pre-trade allocation was also being mulled over by Sebi in the past, but the regulator was unable to implement it back then.