Why pooling of accounts in MF transactions is a problem

Regulator SEBI has announced that the usage of pool accounts will be discontinued for mutual fund (MF) transactions. The ban comes into effect from July 1. To push the MF industry to speed up implementation, New Fund Offer (NFO) launches have been halted during the ensuing period. Here is a complete low-down of pooling of accounts in MFs and how things will change now on.

Pooling explained

If you have been investing in MFs through stock brokers or mutual fund distributors (MFDs), there is a possibility that your MF investment money was first going into the intermediary's bank account. To safeguard the interest of unit-holders and prevent any misuse of funds, SEBI, back in October 2021, announced it was clamping down on this practice. It gave time till April 1, 2022, to stop this practice. But the industry did not become ready in time and hence the ban will take place from July 1.

The market regulator has announced a ban on intermediate pooling of funds and/or units in MF transactions by MFDs, Investment Advisers (IAs), Mutual Fund Utilities (MFU), Channel Partners or any other service providers/platforms. Similarly, it has discontinued the pooling of funds and/or units by stock brokers/clearing members in any manner for MF transactions on stock exchange platforms. The regulator had also directed the industry to implement a two-factor authentication for redemption and verification of source accounts when MF investments are made.

Need for ban

MFs are a popular investment avenue among retail investors. Individual investors held ₹20.81 lakh crore in MFs as of March 2022. Hence, the regulator is being extra careful.

For an investor, pooling of accounts was not visible right away. Often, investors in various online platforms saw investor balance. The money in this balance/wallet was used for all the transactions on that platform and so this arrangement appeared convenient.

There have been instances where stock brokers, such as Karvy, have defaulted. Investing through a pooled account increases the chance of fund misuse as the intermediary gets unnecessary financial power to transact with the fund house on your behalf. In the period between the money getting debited from your bank account and ultimately being credited to the fund house's bank account, the money can be anywhere.

Pooling of accounts could also a reason for errors or delays in transactions.

Do note that NFOs enable a mechanism wherein investor money can lie with the intermediary for a longer time. In a normal MF transaction instance done within a day's cut-off period, your money gets debited and unit allotment is credited shortly thereafter. In case of NFOs, there is a period for which the NFO is open; the day the money gets debited from your bank account is not the day when the money may go to the fund house. Technically, the money can be given to the fund house only on the last day of the NFO. Under a pooled account structure, the intermediary can hold back investors' money and do anything with it as long as the money is given to the fund house before the NFO closure.

Take note

NFOs enable a mechanism wherein investor money can lie with the intermediary for a longer time

The new way

With the ban on pooling of accounts coming in, there will likely be only operational changes if you have been investing through a platform where this practice was prevalent. For instance, the balance/wallet in certain platforms may no longer be used for your MF transactions.

Initially, it may seem the convenience factor has gone down a notch, but in reality your money would be safer.

Till recently, some intermediaries have been reportedly taking money from investors as SIP (systematic investment plan) but making lump-sum investments for reasons best known to them.

Recently, the overall industry limit for foreign investments was getting close and so for regulatory reasons Motilal Oswal AMC stopped fresh investments in Motilal Oswal S&P 500 Index Fund. The AMC stopped fresh investments only for lump-sum investments, but allowed existing SIP investors to continue. This posed a problem for certain platforms who took SIP mandates from investors to conduct transactions, but on the specific day did a normal non-SIP transaction of that amount. Investors who thought they were doing SIPs saw their investments stop suddenly, as in reality they were lump-sum investors due to the platform’s pooled account operation style. This can no longer happen when pooled accounts are phased out for MF transactions.

Since the pooled account of market intermediaries holds money across different asset class, it was very difficult to track usage of MF investors' money lying in pooled account. With the new system, tracking usage of MF investor money will not be a problem.

As you may have noticed, NFO launches are on hold these days. As soon as the MF industry is ready with efficient technology overhaul and smooth transition to serve growing investor needs, the NFOs will return.

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