FUND FULCRUM (contd.)
November 2010

Regulatory Rigmarole

The Securities and Exchange Board of India (SEBI) has relaxed the norms on merger and consolidation of mutual fund schemes. The circular reverses the June 2003 ruling of SEBI that viewed any merger or consolidation as change in the fundamental attributes of the surviving scheme and hence made it mandatory for fund houses to follow certain procedures laid down in this regard. The recent SEBI order states that the mutual fund will have to “demonstrate that the circumstances merit merger or consolidation of schemes and the interest of the unit holders of the surviving scheme is not adversely affected”. After approval by the boards of AMCs and trustees, mutual funds will have to file such a proposal with SEBI. The regulator would then communicate its observations on the proposal. The letter to unit holders would be issued only after the final observations communicated by SEBI have been incorporated and final copies of the same have been filed with SEBI. The mutual fund industry may soon see consolidation of its plethora of schemes as SEBI makes the process easy.

According to SEBI, purchase and redemption of mutual fund schemes can now also be done through the clearing members of the registered stock exchanges, apart from the existing distributor facilities. Depository participants of registered depositories are now permitted to process redemption requests of units held in de-materialised form. Once the units are purchased or redeemed, the AMC would credit the units or pay the proceeds to the broker/clearing member's pool account. The brokers/clearing members would in turn forward it to the respective investor. This would end the obligation of the AMCs to pay the individual investors. One of the fundamental problems in the industry was that the clearing process was not centralised. This move is a lot better for the industry from an operational and settlement point of view. Close-ended funds would not fall in this category since they are anyway traded on the exchanges. SEBI further said that exchanges and depositories should provide investor grievance handling mechanism to the extent they relate to disputes between their respective regulated entity and their client and should also monitor the compliance of code of conduct for intermediaries of mutual funds.

Retail investors in mutual funds will have to compulsorily follow the KYC (know-your-customer) norms irrespective of their investments from 1 January, 2011. Till now, retail investors were not required to go through KYC procedures for investments up to Rs 50,000. The same rule was applicable for NRIs (non resident Indians) and other non-individual investors till September 2010. However, from October 1, 2010, KYC is mandatory for NRIs and other non-individual investors for any investment amount. CDSL Ventures Ltd. (CVL), a wholly owned subsidiary of Central Depository Services (India) Ltd (CDSL), has been assigned the task of processing the KYC norms. AMFI had also allowed distributors to carry out the task on behalf of their investors and then submit all necessary documents with CVL. If the documents are found in order in accordance with KYC requirements, CVL will issue an acknowledgement to such investor to the effect that he is KYC compliant. On the basis of the acknowledgement, investor routing his investment through distributors will be allowed to make investments without being asked to go through KYC process again through CVL. KYC norms were first implemented from 1 February, 2008, for all investors investing Rs 50,000 or more in mutual funds to comply with the Prevention of Money Laundering Act 2002.

The Association of Mutual Funds in India (AMFI) has asked fund houses not to accept third party payments after November 15, 2010, barring a few exceptions. Third-party payments would only be accepted in case of payment by “parents/grand-parents/related persons on behalf of a minor for a value not exceeding Rs 50,000 (each regular purchase or per SIP installment); payment by employer on behalf of employee under systematic investment plans (SIP) through payroll deductions and custodian on behalf of an FII or a client.”

In compliance with AMFI Best Practice Guidelines Circular dated October 22, 2010, fund houses offer its investors the facility to register multiple bank accounts in their folios to receive redemption / dividend proceeds with effect from November 15, 2010. While individual and Hindu Undivided Family (HUF) investors will be allowed to register up to 5 bank accounts, non-individual investors will be allowed to register up to 10 bank accounts. The unit holder can choose any one of the registered bank accounts as default bank account. However, in case a unit holder does not specify the default bank account, the Fund reserves the right to designate any of the registered bank accounts as default bank account. Unit holders may also note that the registered bank accounts may also be used for verification of pay-ins (i.e. receiving of subscription funds) to ensure that a third party payment is not used for mutual fund subscription. The following documents will be required for the registration/change of the bank account(s) mandate: (i) A cancelled original or self attested copy of cheque leaf with the account number and name(s) of the account holders printed on the face of the cheque. (ii) Alternately, the investor can also submit a certificate from the bank or the bank account statement or a copy of the bank pass book.

According to SEBI, redemptions in interval funds will only be allowed during specified transaction periods. The current option of redeeming units on any business day, subject to applicable loads, will no longer be available. The specified transaction period will consist of a minimum of two working days. The SEBI circular also mandates that the minimum duration of an interval period in an interval scheme/plan must be 15 days. Also, investments by these schemes will only be made in those securities which mature on or before the opening of the immediately following specified transaction period. According to the current regulations, there is no restriction on the tenure of the securities in which an interval scheme can invest. This, coupled with the daily redemptions, was resulting in an asset-liability mismatch. The circular makes it mandatory for the units of interval schemes to be listed. The Asset Management Companies will ensure compliance from the date of next specified transaction period or April 1, 2011 whichever is later.

With respect to the Net Asset Values (NAVs) of liquid schemes, SEBI has specified that the closing NAV of the previous day will be applicable if application is received before 2 pm (as against 12 noon at present) and funds are also available for utilisation before the 2 pm cut-off time. For applications received after 2 pm on a day and when funds are available for utilisation before the cut-off time, the closing NAV of the day of application will be applied for that purchase. In case of applications received at a time when funds are not available for utilisation, the closing NAV of the previous day on which the funds are available for utilisation will be applied for the purchase. The entire amount of the application must also be credited to the bank account of the respective scheme before the cut-off time. The funds to be allotted should be made available before the cut-off time by the respective scheme. This is to check on investing on borrowed money. Earlier, several fund houses were seen investing in debt papers by resorting to short-term borrowing even before the fund got credited into the account. This would reflect in the asset-liability mismatch. With the new ruling, we would have more bank accounts with direct credit facility which will ensure fund transfers do not take time. In a way, this move will make systems more effective and reduce operational risks.

The way investors are making a beeline exiting from funds in a rising market to book profits is hurting AMCs. The only way to survive in these tough times is to woo investors for the long-term. Having sold the idea of long-term wealth creation through systematic investment plans (SIPs), AMCs are now deploying new ways to retain investors by introducing exit loads and turning to capital protection funds. Take for instance the newly launched Reliance Small-Cap Fund; it levies a 2% exit load on redemptions in the first year and 1% for withdrawals made in the second year. Investors are being coerced to remain in this fund for the long-term. Capital protection funds are for investors who are conservative and prefer their investments to be in the form of bank deposits. There is potential upside and virtually no downside to these funds. All said and done, the investor exodus from mutual funds is a temporary phenomenon. Solid foundation laid at educating investors about the powerful potential of this investment vehicle will take the industry to great heights, albeit at a slow and steady pace.