Monday, December 31, 2012


December 2012

The year gone by must have been one of the worst for the Indian mutual fund industry. Whether it was rampant closure of equity folios (primarily retail), poor sales, action-packed regulatory environment, or in several cases shutting down of branches across the country - all had a telling impact on the struggling industry. However, industry officials are optimistic and expect the coming years to be less tough as they foresee improvement in the macro economic scenario and stability in the regulatory framework. Despite an unexpected rally of over 20% (the initial part of which was completely missed by fund managers) in the country's stock markets, participation from domestic investors remained abysmal till date. At every rise, the fund industry faced redemption pressure as the retail segment was quick to book profits and exit the mutual fund space. Amidst an uncertain environment with highly volatile equity markets, the sector witnessed closure of a massive 39 lakh equity folios during the January-November 2012 period - never before seen in the history of the industry. The last month of the year may not be any different. Poor sales and wafer-thin margins amidst tight regulatory framework burdened fund houses further. Expectations of rate cuts, continuation of easy global liquidity, bottoming out of economic data, more action from the government, and return of domestic investors into equity markets should propel equities to a new high next year.

Regulatory Rigmarole

Securities and Exchange Board of India (SEBI) has brought mis-selling of mutual fund schemes under its norms on prohibition of fraudulent and unfair trade practices. SEBI has inserted an additional clause whereby mis-selling of mutual fund schemes would be deemed to be a fraudulent trade practice. “Mis-selling” would refer to sale of units of a mutual fund scheme by any person, directly or indirectly by making a false or misleading statement or concealing material facts and associated risks or not taking reasonable care to ensure suitability of the scheme to the buyer. Distributors would now need to document each and every sale by risk-profiling clients. They may have to take the signature of their clients before executing a transaction in order to protect themselves. It appears that with SEBI now terming mis-selling as ‘fraud’, the penalty for distributors is likely to get harsher. If a distributor sells ETF or sector fund to a retired person it could be an act of mis-selling as per the client’s risk-profile. If investor insists that he/she wants to invest in a sector fund, then distributor could take a signature of the client to document the sale. In this regard, the market watchdog has brought in amendments to SEBI’s Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations. They would come into force on the date of their publication in the Official Gazette.

Mutual fund investors who have done their KYC before January 01, 2012 are required to provide certain additional mandatory information to invest in new mutual funds from November 30, 2012. The additional mandatory information includes father’s/spouse name, marital status, nationality, gross annual income or net worth and in-person verification (IPV) if they wish to invest in a new mutual fund (new AMC). Existing investors in a fund who are KYC compliant can continue to invest if their KYC status is verified by CVL KYC Registration Agency (KRA). All investors investing after November 30, 2012 with a new fund house need to comply with this rule. Only after complying with the new KYC norms, investors would be able to open a new account/folio with any other new mutual fund. Non-individual investors need to do their full KYC again. The KYC requirements for non-individual investors are stringent as compared to individual investors. For instance, corporates need to provide a copy of the balance sheets for the last two financial years, copy of latest share holding pattern, copies of the memorandum and articles of association and certificate of incorporation, among other things.

Distributors are not supposed to approach individual AMCs, RTAs for any modification in their employee unique identity number (EUIN) data from January 2012. AMFI-unit of CAMS will create a centralized comprehensive database of distributors that will comprise the list of employee unique identity number (EUIN) submitted by various distributors. SEBI, in its circular in September 2012 had directed mutual fund houses to capture the unique identity number (EUIN) of the employee/relationship manager/sales person of the distributor who are interacting with investors for selling mutual fund products. The AMFI-unit of CAMS will be sharing the list of EUIN with all RTAs. It will also update all RTAs on new EUIN generated and deletions/modifications of existing EUIN. It will also frame and implement procedure and business rules for EUIN. AMCs will not accept any modification related to corporate ARN, name of the corporate, employee name, EUIN, from any distributor from January 2013. Distributors have to approach the AMFI-unit of CAMS for any changes. AMCs shall highlight in the Key Information Memorandum the importance of providing EUIN, particularly in advisory transactions, and state that EUIN will help the fund houses to curb mis-selling even if the employee/ relationship manager/sales person/ distributor quits the company. The fund houses are also supposed to tally EUIN records with transactions and identify inconsistencies, if any, between the numbers of transactions by EUINs vis-à-vis total number of EUIN registered by the ARN holder or the total sales staff of the ARN holder. AMCS have been advised to put in place necessary systems and processes in order to implement the above system by January 15, 2013.

Canadian Securities Administrators, the securities market regulator of Canada, has barred Indian asset management companies from selling investment products to local investors, dealing a blow to these fund houses, which raise a sizeable amount from that country. The Canadian regulator has mandated a registration process for investment managers, which also includes AMCs managing monies of local residents outside Canada, to protect the investments of local residents. Non-resident investment fund managers that manage one or more investment funds that have distributed securities to residents of a local jurisdiction will have to register as an investment fund manager in that local jurisdiction unless an exemption from registration is available. By local jurisdiction, the regulator refers to the Canadian provinces of Ontario, Quebec and Newfoundland and Labrador. The ruling will have a significant impact on Indian fund houses, which raise a significant amount of investments from Indians settled in that country. Domestic fund house Franklin Templeton Investments has already said it will not sell its India-domiciled funds in Canada. Other Indian asset managers such as UTI, Birla Sun Life Mutual, Kotak Asset Management, Reliance Mutual Fund, ICICI Prudential Mutual Fund, and Religare Mutual Fund, among others, may follow suit.

The Securities and Exchange Board of India has set up a committee headed by Cabinet Secretary K.M. Chandrasekhar which will look into a single route for all different categories of FIIs.

A total of 48 warning letters have been issued to mutual funds regarding violations of norms in the past three fiscal years. Of these, 30 letters were issued in 2010-11, 14 in 2011-12 and four letters were issued in 2012-13 up to November 2012. In addition, Sebi has issued 26 deficiency letters in 2010-11 and 6 such letters in 2011-12. For the year 2012-13 (up to November, 2012), no deficiency letters have been issued by Sebi. 5 entities have been prohibited from buying, selling or dealing in securities directly or indirectly, till further orders and required to deposit the illegitimate gain identified in the investigations in an escrow account till further orders, in the last two years. During the same time a consent order has been issued in 5 cases. In 7 cases, related to 2011-12 adjudication proceedings are underway. SEBI takes administrative action by way of issuing warning and deficiency letters against mutual funds found to have committed irregularities. Enforcement actions such as direction, adjudication, enquiry, etc. can be initiated under SEBI's norms, depending upon the severity of the violation observed.

Three years after the then SEBI chief CB Bhave shook up Indian fund houses, the mutual fund industry is now in the cusp of another big change. Come January 2013, several bank and corporate treasuries that comprise the largest investor group in mutual funds will sidestep intermediaries and invest directly to earn higher returns. A fortnight ago, many such big ticket investors who regularly park surplus funds in liquid mutual fund schemes, have communicated their decision to leading distributors. These investors will subscribe to 'direct plans' which will be cheaper by 50-75 basis points as customers have the flexibility to invest directly without incurring any incidental costs. According to a SEBI decision taken earlier in 2012, every fund and scheme must have a direct plan for investors who do not want distributor support and the net asset values of such plans will be given separately.

The Indian mutual fund industry has come a long way from the launch of India’s first mutual fund – Unit Trust of India. However, there is a huge gap between India and global peers in terms of penetration as well as AUM, according to CRISIL Research. The domestic mutual fund industry’s AUM is less than 5% of the country’s GDP, whereas it is 77% for the US. Among developing economies, certain markets such as Brazil, where assets managed by the mutual fund industry are 41% of its GDP, highlight the gap that needs to be bridged. Global mutual fund assets stood at USD 25 trillion as of June 2012. Of these assets, the Americas comprised 57%, Europe 30%, Asia-Pacific 12% and Africa less than 1%. Equity funds constitute 40% of global mutual fund assets, bond funds 25%, money market funds 19%, hybrid funds 11% and others less than 5% of total assets. This is in sharp contrast to the distribution of assets in the Indian mutual fund industry where bond and money market funds together constitute close to 65% of the AUM. After two consecutive years of plunge, the Indian mutual fund industry managed to register a smart turnover in 2012, with its assets base seen nearing Rs 8 lakh crore with an increase of about Rs 2 lakh crore this year. As some wide-ranging reforms initiated by the market regulator SEBI and the government are yet to translate into true business gains for the investors and fund houses, the industry is hopeful of even better days ahead in 2013.

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