Monday, March 30, 2009


(March 2009)

Regulatory Rigmarole

A good 16 years after it first started taking shape, India is just a day away from finally having a pension system that is meant for private individuals. From April 1 2009, any individual will be able to start a New Pension System (NPS) account with designated 'point of presence' (POP) and start saving up for a pension. Of course, the system is not just for private individuals. The pension of all central government employees who have joined service after January 2004 are also part of NPS. The design of the new system is simple. The POPs will be the front end, the National Security Depository Limited (NSDL) will be the record keeper and six mutual fund houses - UTI Retirement Solutions, SBI, ICICI Prudential Life Insurance, Reliance Capital, IDFC AMC and Kotak Mahindra AMC - selected by the Pension Fund Regulatory and Development Authority (PFRDA) will be the fund managers. The fund managers will run different plans that comprise of equity, government securities and corporate bonds. The distinguishing feature of the NPS is the extremely low cost. The annual cost of record-keeping is Rs.380, each transaction costs Rs.6 and the most amazing of all-the investment management fee is 0.009 per cent per annum. But NPS takes a severe beating on the liquidity, tax and legal fronts. Liquidity is very low - you cannot withdraw the money till you are sixty years old, except for critical illnesses and for building or buying one house. Even at sixty, only 60 per cent of the corpus can be withdrawn as cash. The rest must be used to buy an annuity. The gains will be treated as taxable. With the PFRDA Bill yet to be approved by Parliament, the pension watchdog’s punitive powers have been restricted as compared to other regulators such as SEBI or IRDA.

SEBI has invited public comments with regard to variable load structure, whereby, the investor and advisor — also called distributor or broker — would mutually decide on the fee, instead of the flat 2.25% entry load as is the norm now. At present, mutual fund distributors are paid a commission by the fund company. This commission is deducted from the investment that the investor has made. The quantum of the commission is a matter between the distributor and the fund company. The new rules envisage a system under which the distributor and the investor will negotiate and decide upon a commission. The payment will be made either directly by the investor to the distributor or through the fund company. Regardless of the route of the payment, if these proposals are implemented as rules, there will be free pricing which will be negotiated between the two parties. Understandably, going from the current administered pricing regime to free, negotiated pricing is a scary prospect for distributors. At present, AMCs pay a commission of anything between 50 basis points and 3.5 per cent to their distributors. This commission is over and above the 2.25 per cent entry load that is paid by investors. As distributors' commissions vary according to different schemes and fund houses, investors are often kept in the dark regarding this payment. As a result, it becomes difficult to ascertain whether the advice a distributor renders is in the genuine interest of the investor, or if it is influenced by the amount of commission he is paid by the AMC. If implemented, this move will bring a paradigm shift for the mutual fund industry.

A better way to bring investment transparency is by standardising — and making it public — commission charges across investment products. A few fund sellers are also lobbying for multiple share-classes load structures that are popular in the US. Such schemes allow investors to select the fee options from broad categories like higher entry load-but-low annual charges, low annual charges-but-higher entry load and such other cost combinations. Transparency is needed in the mutual fund industry. But multiple no-load or low-load options may lead to lack of interest on the part of advisors to recommend good schemes to investors. Customer-agreed pricing structure might prompt distributors to push non-mutual fund products, which do not publicise intermediary cost - ULIPs offer distributors 20-40% commission, corporate fixed deposit schemes yield 1.7-2.5% or even RBI tax-relief bonds give 1% as commission charges.

The High-Level Committee on Capital Markets will introduce uniform norms for investment advisors across banks, brokers and agents.
The new norms will include the areas of commissions, certification and disclosures. The investment advisory business that runs into thousands of crores every year is in a mess because of regulatory overlaps. Banks are regulated by the Reserve Bank of India, the insurance agents are regulated by the Insurance Regulatory & Development Authority (IRDA) while mutual fund agents are regulated by the Securities and Exchanges Board of India (SEBI). A year-and-a-half ago an attempt was made to bring them all under one common jurisdiction — the then IRDA Chairman CS Rao was asked to head the committee but not much progress was made. Rao subsequently retired and now the High Level Capital Market Committee — headed by the RBI Governor — has taken over.

SEBI has delivered the latest instalment in the wave of reforms that have swept over mutual funds after the liquidity crisis in 2008. Earlier, the regulatory agency has fixed some of the obvious problems that contributed to the liquidity crisis - NAVs based on illiquid investments, closed-end funds which allowed premature redemption and long maturities in liquid funds. Now, SEBI is cleaning up the funds’ portfolio revelations. SEBI has issued a circular stating a new format to AMCs for disclosing the portfolio of debt oriented close-ended and interval schemes/plans on a monthly basis on their respective websites in order to enhance the transparency of portfolio. The new disclosure of the portfolio as on the last day of the month shall be made on or before the 3rd working day of succeeding month. For example, portfolio as of 31 March 2009 shall be disclosed by 4 April 2009 - 3 April 2009 being a non working day.

In their portfolio declaration, funds generally list the name of a security and the quantum of their investment in it. There can be more information, but this is the core set that is always there. For equities, this is quite enough. However, in the case of debt, the very identity of a debt security is difficult to determine. For starters, the same company can—and normally does—issue many different debt securities. Unlike equity, there is no standard nomenclature that can identify and differentiate between these. Worse, the lack of a standard nomenclature means that the same security could appear under different names in different funds’ portfolios. This has grave implications for investors. As things stand now, investors cannot reliably combine the portfolios of different debt funds and see what their combined exposure to a given security or borrower or sector is. SEBI’s new rules mandate a richly detailed format for declaring debt portfolios that takes care of all these problems. This is a huge step forward in bringing transparency to individual funds’ portfolios. However, they are not a complete solution for investors. Debt investors need to easily aggregate their holdings across different funds to be able to analyse their risk exposure without doing heavy detective work. This need can only be met by each security having a specific identification symbol that is universally recognised. Such a system already exists and is called the International Securities Identification Number (ISIN). In India, ISINs are there for many but not all debt securities. The logical final solution for the declaration of all investment portfolios, be they of mutual funds or insurance schemes or anything else, is to make them purely ISIN-based. This will work for equities and also for international holdings because the ISIN system is global.

According to a Merrill Lynch Survey of 213 Fund Managers who manage US$ 533 billion in investments, investors are optimistic about the global economy since December 2005 but, the prolonged banking crisis seems to be stopping them from putting cash into equities. The survey reveals that for the first time in more than three years, investors do not predict lower global economic growth over the next 12 months. The renewed optimism about China`s economy lies at the heart of this revival. Just two months ago, a net 70% of respondents thought China`s economy would worsen in the year ahead. That figure fell to a net 1% this month. Though respondents were noticeably bearish about Japanese and Eurozone equities, the survey in March shows signs that investors want to believe in an economic recovery.

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