Private Wealth Management launched Indias first Advisory Index and Dynamic Synthetic Index for clients to identify the true value contributed by their advisor Won Best Growth Capital Investor-2012 award at the Awards for Private Equity Excellence 2013 Won Quality Excellence Award for Best Customer Service Result at the National Quality Excellence Awards 2013 Adjudged amongst the Top 20 innovators in BFSI at Banking Frontiers Finnovity Awards 2012. MOSL was the only capital markets player (other than NSEL) in the segment
Meet our Management: Please email us at investorrelations@motilaloswal.com or sourajit.aiyer@motilaloswal.com ; or call Sourajit Aiyer on +91 22 3982 5510 if you want to schedule a meeting to discuss this sector, its long-term opportunity and the companys strategy Recent regulatory changes enacted & proposed in capital markets: Opportunities & challenges Purpose of the study An evolving regulatory climate is part and parcel in every business sector, more so in emerging economies where new sectors are opening up continuously. Regulators need to ensure that the business is conducted in an appropriate manner to achieve long-term client satisfaction and business penetration, as that largely defines the sustainability of that business model. The purpose of this note is to highlight recent changes in the regulatory climate (enacted or proposed) in the Indian capital markets space, and the opportunities and challenges they present for the players. The depth of the Indian capital markets sector has grown, but is still lower than many countries. As India seeks sustained GDP growth, the role of the capital markets to mobilize investments is critical. The intent of the recently enacted and proposed regulatory changes is in the correct direction, (a) to increase the flow of savings into capital markets, (b) ensure that the intermediaries keep the clients interest as paramount, and (c) enable access to further participants and geographies. The challenges that the players face are numerous, however they will need to adapt and bear the short-term pains in order to build sustainable growth trends. Asset Management Mutual funds, PMS and Distribution Mutual funds are still largely a push-product in India, but the entry load ban led to distributor disinterest. New distributors registered were lower this year. About 300 distributors p.m. have not renewed their membership since Aug 2011. Active distributors declined from ~0.1mn in 2007 to ~40,000 in 2012, and are now ~50% of the total. Recent market volatility and poor fund performance made equity investors nervous. The industry lost ~3.2mn folios in the 10 months of FY13, of which equity funds lost ~4mn. Equity schemes have not seen inflows in most months of FY13. The Union Budget did try to address some concerns. It expanded the scope of the Rajiv Gandhi Equity Savings Scheme to include mutual funds/ETFs (schemes with RGESS eligible securities as underlyings) for new investors. To help boost institutional flows, it allowed pension/provident funds to invest in ETFs and debt funds. Reduction in STT on mutual fund/ETF transactions should be another relief. Given the overall sluggish interest from retail investors, this segment saw a number of changes in its regulatory climate recently. Key aspects of recent regulations (both enacted and proposed) Opportunities and challenges for capital market players Reviving distributor interest: AMFI waived registration fees for first-time distributors (from Feb to Jun 2013). It reduced registration renewal fee for advisors, banks, NBFCs etc significantly. SEBI opened up new distributor channels like postal agents, retired government officials, retired teachers, retired bank officers and bank correspondents. It also issued a notification to set up a SRO to regulate mutual funds distribution. AMFI revised the code of conduct for distributors by adding norms related to perpetrating fraud, anti-money laundering, ethical standards etc. Objective is to enlarge the distribution network and attract a new group of distributors. The fee cuts, coupled with market uptick, led to higher M-o-M renewal requests in Dec 2012 UTI inducted ~500 new distributors following opening of new channels. AMCs feel greater inflows without intermediaries may not be possible as retail investors still require advice Recent months also saw money coming from distributors who had registered earlier but did business for the first time Direct plans: Mutual funds will now offer a direct plan of each scheme, apart from regular plans. This excludes distributor commissions from the expense ratio for investors who come directly. For equity funds, the expense ratio is expected to be ~40-75 bps lower than regular funds. Mostly institutions have shifted to the direct version, yet to pick-up with retail investors. Distributors can still advice direct plans to clients for a fee Investors may take distributors advice and then buy directly Experienced clients with large assets may use the direct route Initial figures for difference in NAV between direct and regular plans were ~0.5-0.6% - a benefit to clients Shifts from regular to direct may attract capital gains tax Advisors cannot receive data feeds of direct plans from AMCs Small-town push: AMCs can charge extra 30 bps if they attract assets from small towns (higher of 30% of gross new inflows or 15% of average AUM). Also, until now, the service tax charge on schemes was borne by the AMC. This would now be passed on to the investors The dependence on larger cities continues due to lack of investor awareness and closure of retail operations in some smaller towns by some AMCs
Charges: AMCs to be allowed to charge extra expense of 20 bps for exit load (exit load will now be credited back to schemes). SEBI would allow fungibility in expense ratio by removing internal sub-limits. AMCs can levy transaction costs up to a ceiling of 0.12% in cash and 0.05% in F&O. Also, it now has to pay upfront commissions from its own pocket and cannot pay dividend from unit premium reserve. Fund managers have asked to remove TDS on advisory income earned on investments from overseas The 20 bps will compensate for the loss in exit load collection AMCs will be free to spend the money it collects as TER Distributors have the flexibility to levy transaction charges Even the proportion of AMC fee within TER can be increased Other discussion areas are banning of upfront commission, as some MFs are luring distributors with high commissions Awareness: AMCs to put 2 bps from assets p.a. for educating investors. SEBI directed AMCs to popularize RGESS by launching RGESS funds Increasing investor awareness will help deepen the market Launching of RGESS funds may attract retail money further SEBI hiked the minimum investment limit in PMS to Rs2.5mn Some inflows may now go to MFs, which used to go to PMS MFs via cash: SEBI allowed cash transactions of upto Rs 20,000 in MFs Cost of handling cash and inability to redeem units in cash New launches: SEBI asked AMCs to reduce the number of new launches and merge similar plans. Due to several non-performing plans, SEBI also questioned why non-performing plans are not wound up before new launches. It also mandated informally that new schemes need to raise a minimum amount or will need to refund within 20 days of the NFOs close. It also warned against selling risky products in uncertain markets
Aimed to reduce the confusion of multiple similar products and help clients choose the right product Fund managers will need to ensure performance of existing schemes before applying for new schemes Will ensure that only serious NFOs are launched, but may give advantage to large AMCs with stronger distribution Sameer Kamath, Chief Financial Officer As part of our ongoing initiative to share knowledge on the Indian financial services sector, Motilal Oswal Investor Relations presents its article series Fin Sight. In each issue, we discuss a topic impacting this sector. We draw upon the Groups learning, experience and current thinking to develop these insights. We look forward to your questions and feedback to help us provide you a better perspective of this sector
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Investors can now conduct mutual fund transactions through SMS Eases convenience; but need to specify details before-hand Due diligence: SEBI sent a lengthy mandate to AMCs for distributors due- diligence, also In-Person Verification to verify investors' physical presence Distributors find the requirements lengthy and duplicative Requires investors to visit a branch physically - often difficult Disclosures: SEBI has asked AMCs to disclose performance details to help investors assess the fund quality and caliber of fund managers. MFs may soon have to carry colour codes to signify their risk-grade. SEBI has also brought the practice of mis-selling under the ambit of fraudulent practices Aimed to help investors take more informed decisions and for fund managers to justify their fees. Avoids product pushing by making misleading statements or concealing facts Ensure suitability of products as per investors risk appetite QFIs: SEBI may not relax KYC norms for QFIs investing in mutual funds. Qualified DPs can now hold funds on behalf of QFIs before redeployment Money may not flow as anticipated, as global investors may not tweak their established mechanisms to suit Indias norms Entry load ban remains a debate. But the ban was done to limit its misuse as distributors resorted to frequent churning of assets since it earned them more, while investors lost opportunity for gains. It aimed to weed out product pushers and make distributors do what is correct for the client. Even UK has banned commissions for selling mutual funds to promote advisory structure. Amongst other discussion areas:- AMCs are seeking open-end status for RGESS funds. Secondly, investors are currently charged capital gains tax during merger of schemes as it is a withdrawal from one scheme to another. Hence, AMCs are concerned over tax incentives to investors for scheme mergers. SEBI is also mulling whether to increase the minimum share capital for AMCs as it will help to absorb shocks. SEBI is also advocating to AMCs to launch pension products and offer life-cycle products (dynamic asset allocation that changes as the investor ages).
Retail Broking Shrinking retail participation, high transaction costs, falling cash volumes and revenues, and risk management are recent concerns which shaped the intent of regulators. Related to KYC, SEBI asked brokers to identify the ultimate beneficial owner during the time of account opening itself. Key aspects of recent regulations (both enacted and proposed) Opportunities and challenges for capital market players STT: Following the STT cut in cash delivery in the previous Budget, this Budget announced STT cut in equity futures to address issues like shift of Nifty futures trading to SGX (SGX volumes now ~50% of NSE volumes) Might be positive for traders & arbitrageurs, But post-cut trading cost still lower in SGX due to other advantages CTT: Commodities transaction tax of 0.01% on non-farm commodity futures (excludes agri commodities like food etc) Level playing field with equities, so some funds may flow into equities, But may impact arbitrage returns and food inflation Risk Management: NSE asked brokers to pre-define order limits (based on criteria) of each terminal they operate in both cash and F&O. NSE/BSE also imposed surveillance obligation wherein they will send transaction alerts to brokers, who will then review those and report back if found adverse Pre-defined order limits will ensure checks and balances are in place, esp. in context of flash crash situations Surveillance mechanisms will ensure closer monitoring RGESS: RGESS for first-time investors with gross income <= Rs 1.2mn, with max Rs 50,000 investment for tax benefit, Tax benefit extended to 3 years Entry of first-time investors into shares/MFs will help increase participation, but lock-in period remains a concern Registration: Common registration certificate proposed for brokers across all segments. Single KYC norms will reduce switching costs between brokers These steps will simplify the registration process, for both brokers as well as clients Exchanges can give liquidity incentive schemes to brokers in cash segment Needs to be continued till scrip reaches impact cost of <=2% Investors dont need to pay service tax on the late payment charges paid Clarification removes the ambiguity regarding this matter Offshore trading: US$ Sensex futures in Dubai, JPY Nifty futures in Osaka Will attract individual and institutional investor base there The Finance Ministry is also considering a change in STT accounting, from deducting from business income to setting off against actual taxes.
Institutional Broking/Foreign Investors The GAAR proposals caused a lot of uncertainties to FIIs in 2012. Its subsequent deferment to 2016 gave a positive boost to FII flows, and gives ample time to investors to review their investment structures. Changes in the disclosure norms of FIIs beneficial ownership and similar details were on the immediate agenda of regulators to control flows of Indian money via the FII route. Key aspects of recent regulations (both enacted and proposed) Opportunities and challenges for capital market players Disclosure norms: Finance Ministry will soon announce new disclosures related to source of funds and beneficial ownership while investing in sensitive sectors. Foreign investors need to furnish these upfront to FIPB. New format of Mauritius Tax Residency Certificate is expected to include disclosures from investors availing treaty benefits - like address of assessee, tax identification number and status (individual, partnership, company) Will help identify the source of funds as closely as possible Will help control the round-tripping of Indian money through the FII route and vet suspicious investments at initial stage Help avoid foreign investors from abusing tax treaties, especially when investing in sensitive sectors SEBI announced a cap on execution charges earned from mutual funds (12 bps for cash, 5 bps for F&O trades) Will have a negative impact on institutional broking revenues
FIIs can participate in currency derivatives, to the extent of its INR exposure Will improve participation, liquidity & covering currency risk FIIs allowed to approach any bank to hedge currency risk on investments Should help ease norms for FIIs, despite the eligibility criteria Apart from the QFI guidelines introduced recently, SEBI also set up a committee to study a single route for all foreign investments like QFIs, foreign financial investors, VCFs, NRIs. It should simplify the investment process for overseas entities, though PAN and taxation are concerns.
Wealth Management Investment Advisor regulations Wealth management as a segment is still largely unregulated in India, in terms of both distribution and advisory. The Investment Advisor norms were an attempt on this front. SEBI recently announced these guidelines and it is expected to be applicable by mid-2013. Key aspects of recent regulations (both enacted and proposed) Opportunities and challenges for capital market players Investment Advisor norms: Will make it mandatory for investment advisers to register with SEBI and disclose (a) issues that could lead to conflict of interests, (b) risks associated with product, (c) fee received for their advice, (d) records like KYC, risk profiling, record of advice and time of advice etc, as well as complying with net worth and qualification requirements
Will help to segregate investment advisory services from other activities of the entity (including distribution) Disallowing transactions on own account contrary to the advice given (for upto 15 days from date of advice) will ensure further transparency and accountability
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Investment Banking Fundraising, M&A etc The industry has been hit due to a slowdown in fundraising activities. The regulators focus was to further the bankers accountability in the IPO process to bring back the confidence of the investors, and also ease the access to the primary markets. Key aspects of recent regulations (both enacted and proposed) Opportunities and challenges for capital market players OFS/IPP: In order to comply with the 25% minimum public shareholding rule for listed cos., SEBI created two new ways by which firms can sell shares without public issue- Offer for Sale and Institutional Placement Programme. SEBI also amended the OFS rules to allow sale of up to 10% stake to AIFs. Faster and cheaper methods to raise money for promoters Expected to infuse ~Rs300bn worth of shares in the markets Realty cos. opting for IPP instead of OFS as the shares are sold only to institutional investors under IPP, not to retail IPOs: IB firms need to disclose track record of price performance of their previous IPOs. SEBI may also ask companies to compensate retail investors if prices crash within months of the IPO, after factoring market movements Will tighten the pricing process and avoid over-aggressive pricing during IPO issues Will require more exhaustive due-diligence process Usage of proceeds: SEBI plans to make the issue manager responsible for the end-use of IPO funds. Cos. cannot deploy more than 25% of proceeds for general corporate purposes, and may not be able to access the markets if the utilization plan is vague or does not create a tangible asset Will avoid misuse and diversion of the issue proceeds It may require the investment banker to submit periodic reports on the usage for almost a year after the issue date SEBI allowed issuance & listing of preference shares on exchanges, and waived 6 month lock-in for DIIs during preferential allotment of shares Will help cos. to improve net worth and debt-equity ratio Relaxed the pref. allot. norms for MFs and insurance cos. SEBI relaxed IPO norms for SMEs of achieving profits in 3 out of 5 years Will enable such issuers to have access to primary markets Among others:- Fair trade regulator CCI asked companies to define their market and possible anti-competitive effects for M&A approvals. Companies may face an M&A tax, as corporate guarantees given to their subsidiaries abroad may attract tax since they earned fees for the financial facility. MCA may not allow unlisted companies to raise funds through private placement of shares from more than 49 persons p.a.
Private Equity - Alternate Investment Fund (AIF) Guidelines Key aspects of recent regulations (both enacted and proposed) Opportunities and challenges for capital market players AIF Guidelines: This requires all Alternate Investment Funds to register with SEBI. The SEBI (VCF) Regulations, which currently regulates Venture Capital funds, would be repealed. Existing VCFs would continue to be regulated by VCF Regulations till they are wound up, though they may seek re-registration under AIF subject to approval of 67% of investors by value. The AIF Regulations defines AIFs as Category 1 (VC, SME, Social Venture, Infra funds), Category II (PE, Real Estate and Debt funds and Fund of Funds), Category III (Hedge funds which may employ diverse/complex strategies and leverage). It has prescribed a threshold limit of Rs10mn for investors in PE/VC funds Complying with:- Minimum investment of Rs10mn from an investor, minimum fund corpus of Rs200mn, sponsors interest of lower of 2.5% of initial corpus or Rs50mn, financial disclosures of portfolio cos. as well as risk disclosures at fund level (within 180 days from Year-end) Units of an AIF may be listed on the exchange subject to a minimum tradable lot of Rs10mn, which may impact traded volumes and participation in the markets positively Foreign investments into AIFs: SEBI has proposed to the Govt. to allow foreign investments into AIFs under FDI. SEBI has also clarified that it would not regulate fundraising from overseas markets done by the PE players Inflow of those funds may get easier if they come under FDI. Foreign capital may also bridge the demand-supply gap as demand cannot be mobilized from domestic sources alone Control by PE investors: SEBI is also looking at the control practices of PE investors, whereby they often have veto powers over key decisions despite just a minority stake. According to SEBI, PE investors will now be identified as promoters not only when they have a majority stake but also when their holdings are actually higher than the original promoters Being termed as promoters will require PE investors to maintain a 3 year lock-in once the companies go public. This has led to some PE firms resorting to secondary deals Some PE firms are also preferring larger stakes as it ensures greater influence over company decisions Given the challenging conditions in the industry, private equity firms are now widening the scope of the indemnity clause which covers losses or liabilities, in order to safeguard their capital and make promoters more accountable for the funds. Potential changes in the future include a proposal in the tax laws aimed at bringing in place valuation and pricing norms for domestic PE/VC investors.
Other areas Key aspects of recent regulations (both enacted and proposed) Opportunities and challenges for capital market players Margins: NSE's decision to allow brokers to use open-ended mutual funds as collateral for margin requirements, apart from cash and bank guarantees Should widen the scope for investors as they can pledge their mutual fund holdings Price bands: SEBI restricted dynamic price bands at 10% of the previous close for stocks on which F&O securities are available. This band can be relaxed in increments of 5%, if a trend is observed in either direction Will prevent acceptance of execution orders that are placed beyond the set limits and help avoid flash crash situations SLB: SLB grew 3x in 2012 as regulations boosted institutional interest. Citibank opened a new SLB counter, Deutsche Bank and BNP Paribas are also evincing interest. IRDA may allow insurance companies in SLB SLB depends on reverse arbitrage opportunities in the market Lower client-level position limits is a challenge as there are few active participants frequently trading in limited counters Structured products: SEBIs new rule on structured product valuation requires appointing a credit rating agency as a third party valuation agency Developing the structured product market further Introduction of inflation indexed bonds in the future is another welcome step to protect the interest of savers from the impact of inflation.
Conclusion The challenges are immense - to replicate the risks and returns of physical assets to capture that savings flow, educating investors about capital markets, increase opportunities for cross-selling and ensure an incentive structure to intermediaries in order to increase inflows. But the intent of the regulators are in the right direction to ensure the clients interests are kept paramount, achieve higher inflows and participation, increase market access to participants, ensure a fair framework is in place for these segments and remove the scope for mis- selling and over-aggressive pricing which can negatively impact long-term inflows into capital markets. Companies in the financial services space need to adapt to the changing regulatory climate and build their ability to showcase their role as value-creators for client assets.
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