Monday, December 29, 2014


December 2014

Regulatory Rigmarole

Fund houses have started complying with SEBI’s seed capital norm which requires them to invest in their own funds. Earlier in February 2014, SEBI board had approved a long term policy for mutual funds in which it had asked AMCs to invest 1% of the amount raised (subject to a maximum of Rs.50 lakh) in all open ended schemes during its life time as seed capital. The market regulator had asked fund houses to comply with this diktat by May 05, 2015. Fund houses are supposed to invest in both equity and debt schemes. While some fund houses like DSP Black Rock, Mirae, and Birla Sun Life have started putting seed capital in their open equity funds, majority of AMCs are yet to catch up. The concept of seed capital is prevalent in overseas markets. According to Investment Company Institute, an association of U.S. investment companies, US investment companies are required to have at least $100,000 of seed capital in each new fund before distributing its shares to the public; this capital is usually contributed by the sponsor or adviser in the form of an initial investment. It remains to be seen if this regulation proves effective for investors in the days to come.

In a bid to expand the reach of stock exchange mutual fund platforms, SEBI has permitted exchanges to accept non-demat transactions from investors. Now brokers can scan and send documents to stock exchanges just like the way Funds India and Prudent operate. Stock exchanges had approached SEBI to allow investors who do not have demat accounts to transact via the stock exchange platform. The move comes over one year after SEBI allowed mutual fund distributors to use stock exchange infrastructure for mutual fund transactions through demat accounts in October 2013. This was a major hurdle for exchanges in expanding the reach of mutual funds. Now, investors do not have to incur the costs associated with maintaining a demat account. After the entry loads were abolished, SEBI nudged stock exchanges to create a mutual fund platform with a hope that the distributors would find it a cost effective and convenient way to carry out mutual fund transactions. SEBI has recently permitted exchanges to give limited membership to distributors to use stock exchange platform at a marginal fee. Hence, BSE launched its StAR MF Platform in 2009. NSE too launched its NSE Mutual Fund Service System (MFSS) around the same time.

SEBI has clarified that individual research analysts associated with registered brokerages and fund managers of mutual fund houses would not require a separate registration under the latest guidelines regulating research analysts. The move follows representations made by brokerages, asset management companies and law firms, seeking clarity on the applicability of the new guidelines. The new norms called Securities and Exchange Board of India (Research Analysts) Regulations, 2014 took effect on 1 December, 2014. Among other things, it states that entities and individuals wanting to recommend stocks as research analysts need to get registered after meeting the prescribed criteria regarding qualifications, capital adequacy, establishment of internal policies and procedures, firewalls against conflict of interest, sufficient and timely disclosures, among others. Individuals employed as research analysts with a registered entity are not required to obtain a separate registration certificate. The research entity which employs individuals as research analysts is, however, required to get a registration under the new regulations. SEBI has given six months’ time for entities to get registered. Further, SEBI has clarified that the definition of research report in the latest norms does not include comments on general market trends, broad-based indices, economic, political and market conditions. Periodic reports or other communications prepared for unit holders of mutual funds or alternative investment funds, or clients of portfolio managers also will not fall under the category. Statistical summaries of financial data of a company or technical analyses on demand and supply in a particular sector or index too are exempted from the scope of definition of research reports. The new regulations would not be applicable on investment advisors, credit rating agencies, portfolio managers, asset management companies, fund managers of alternative investment funds or venture capital funds. Taking a strict view, SEBI has also clarified that the regulator can take penal action against erring research analysts in the form of cancellation of registration or debarment. Technical analysts, who earlier had one-page recommendation notes issued multiple times a day, will now have to come out with a full-fledged report each time they respond to the market on an intra-day basis.

AMFI has shot off a letter asking AMCs and distributors to update the missing information of investors who had done Know Your Client (KYC) before January 1, 2012­­. AMFI has also asked them to seek only additional documents from such investors. The investors who had undergone KYC registration before January 1, 2012 will have to be asked to provide additional information. This includes name of father/spouse, marital status, nationality and gross annual income/latest net worth, etc. In addition, the investors will have to go through personal verification. In a few instances, the KRA system shows invalid KYC for investors. However, there is no specific information on missing documents. AMFI had taken up the matter with the KRAs, who have confirmed that the issues have been addressed and resolved. On checking the websites of the KRAs, it is observed that all KRAs are now showing details of the missing information. Besides, AMFI has attached the SEBI guideline on KYC in which the market regulator had clarified that individual investors who had completed KYC before January 1, 2012 with CVL will have to submit additional KYC details along with in personal verification. The regulator had told distributors that such updates can be done by using ‘KYC Details Change Form’. However, corporate investors who had done KYC before January 1, 2012, have to undergo fresh KYC by submitting the necessary documents.

The capital market regulator has plugged the loophole that allowed savvy mutual fund investors to lower tax by bonus stripping. The Securities and Exchange Board of India has spelt out that it is not in favour of fund houses launching new schemes with bonus option in their arbitrage funds. The regulator has told some of the asset managers that it will not give the go ahead to these schemes if they are filed for approval. Investors are misusing this for tax avoidance purpose. Most of them are big investors and not retail investors. The bonus option involves an investor selling the original units for a loss and holding on to the bonus units which are sold later to realise long-term capital gains. For instance, in a 1:1 bonus issue, the investor who holds 100 units receives another 100 units. Under the tax laws, the cost of the bonus units is considered as zero. Since the net assets of the scheme remain the same and only the number of unit increases, the net asset value (NAV) drops proportionately. Investors then sell the original units at the reduced price and set off losses against capital gains in other assets. The accumulated bonus units are treated as tax free after a year since arbitrage funds are treated like equity funds for tax treatment. In addition, SEBI rules say bonus units are not subject to exit load.

To re-energise the mutual fund industry, SEBI plans to set up an expert panel to suggest measures for increasing distribution of mutual fund products through digital modes such as internet and mobiles. The panel, a sub-committee of SEBI’s Advisory Committee on Mutual Funds, will look into various options and steps required to boost the penetration of mutual fund products through use of digital channels for their sale. The new panel is also likely to suggest steps to enhance the online investment facility and tap the internet savvy users, especially the youth, to invest in mutual funds. It will also suggest ways to tap burgeoning mobile-only internet users for direct distribution of mutual fund products. According to an estimate, number of internet-enabled mobile phones in the country is expected to increase from 10-15 millions in 2010 to 300-400 millions in 2015. The Securities and Exchange Board of India is of the view that a greater use of internet as a distribution channel can help increase the penetration of mutual funds, especially among young investors. As per the regulator, the online phenomenon is growing rapidly as more and more people, especially the younger generation, prefer to carry out most of transactions online such as internet banking, shopping, and ticketing. At present, many fund houses are offering facility for online investment, but industry insiders say that there is a need to promote and make it more user friendly for investors by improving the infrastructure and efficiencies. Nearly 45 fund houses together manage assets worth around Rs 11 lakh crore in India, but fund mobilisation has been a tough task for them in the past few years. One of the biggest reasons behind this low fund mobilisation is the lack of healthy participation from a large part of the country. A SEBI conducted study had said that mutual fund presence in the country is heavily skewed in favour of the top 60 districts of India. Out of 60 districts, a lion's share of the mutual fund presence originates from Mumbai as the city houses the headquarters of most of the large companies, thereby getting a bulk of investments through the non-retail or institutional routes.

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