He is seen as the new cop in town . K N Vaidyanathan , the executive director of the Securities and Exchange Board of India in charge of mutual funds and foreign institutional investors has been seen as an influential driver of policy changes in the mutual fund industry. In fact he was very much a part of the industry many years ago having worked with Morgan Stanley. Now on the other side of the table, Vaidyanathan has come to increasingly respect the work done by regulators. He spoke to Reena Zachariah and Shaji Vikraman recently. Excerpts.
For someone who has come from the mutual fund industry, you are seen as the new cop in town. There have been apprehensions in the way in which the changes were driven in the mutual fund industry. A year down the line, have those changes paid off.
The driver for the game changer change was to put it in one word - -the entry load, which reflected two payments--a payment by the manufacturer to the distributor and a payment by the customer to the distributor.The first is commission and the second is advisory fee. Both of which were consolidated and paid by the investor non-transparently and more importantly non-consciously.All we have tried to do is that who ever pays anything should pay it transparently and pay it consciously.So entry load abolishing is just that. We have not abolished asset management companies paying distributors directly. We have not abolished investors paying distributors directly. What we've said is all payments will be transparent and conscious. Thats been the game changer.
The mutual fund industry says that there isnt much left for the industry after the changes mandated by Sebi.
Now the biggest criticism that we are getting is that the changes we made has completely disincentivised the industry and the distributors from selling. I want to kind of factor this into two parts of data. We should not be looking at only outflows, Outflows are a function of market, of investor interest and many other things. So we should look at inflows, Inflows for mutual funds come from existing schemes and from new fund offerings(NFO). If you look at the 10 year period pre-entry loads, the inflow into existing schemes, the best year saw about Rs 6000-6500 crores per month. For the twelve month after entry load was abolished we saw Rs 5000 crores.
So in a ten year period, you've clocked the second best inflow in existing schemes post abolishing entry load. So if entry load was such a big determinant how come that didn't show up in the numbers, So obviously then we are missing something, So what we are missing is the true inflow net inflow for the industry came from something called NFO. Then you analyse NFO, you realise that NFO was a game beyond just entry load, NFO was a game where the fund paid 5-6 % commission, NFO was a game where funds were sold as Rs 10 facevalue, NFO was a game where products were launched to suit the flavour of the month and to suit distributor interest.
None of these three factors are in the long term interest of the fund industry so while a lot of people are barking the problem on entry load, actually the root if you analyse is that we have made NFOs more difficult. So in NFOs for example in 2006-07,you saw Rs 25,000-30,000 crores inflow, Post entry load abolishing that has come down to only Rs 5000 crore. So the real game changer behind the entry load is NFO is becoming more and more difficult for funds to come out and launch them. I think in the long term interest of the industry that is a very good thing.
There has been a tightening on the operational front also for mutual funds. What prompted the changes.
If you look at the mutual funds over a ten year period there were lot of delta X changes, each individual change actually looks very innocuous but if you look at where it started to where it is then you realise there was a big change. So what we have done in the last one year is picked up those things and reset the clock. I will give you an example. The funds used to pay dividend out of unit premium reserve.
Dividend reflects distribution out of profits and gains. Dividend can't be paid out of premium account â€" it is fundamentally flawed in accounting. But if you see the history of it you see that the changes were made to the regulations in delta X format, therefore when it culminated people were paying dividend out of premium reserve, So all that we have done is reset it to where it should belong that dividend can't be paid out of premium reserve. So it looks like a big change and yes it is a big change in operational tightening. We have tried to get tighter in disclosure norms, we have tried to get tighter in risk management areas.
How much have investors gained after the abolishment of entry load?
Since August 2009-August 2010,in thirteen months on existing schemes, the inflow is Rs 63,500 crore,at roughly 2% that translates into about Rs 1300 crores, which was given to investors which is now put productively in the investments. I don't think there are very many schemes in this country where a body of investors have gained Rs 1300 crores by a single regulatory action
At the end of all these regulatory induced changes, how have asset management companies coped with the reforms.
In fact in my view all the sponsors of asset management companies should be extremely happy with SEBI because two things have happened, One profits of AMCs have gone up and two on a risk adjusted basis they have gone up dramatically. Just think about it. In the past the AMC was almost like a quasi-guarantor in liquid-plus funds and I'm sure sponsors had sleepless nights and the 2008 crisis. We have kind of tightened it now.
We have made everything mark-to- market beyond 90 days so it is there in the net asset value. The risk is being borne by the investor, And you have a four-fold increase in profits in absolute terms, In risk-adjusted terms it may be even 40-fold. So I think sponsors of mutual funds should be extremely happy. They are making lot of money that they now a business model which on a risk-adjusted basis delivers very good numbers. So from a regulatory framework all our tightening has been to improve the quality of operations, quality of disclosures, quality of risk management, quality of accounting standards.
How is Sebi planning to address other challenges such as ensuring that the number of investors in mutual fund go up, there is a wide dispersal of investors and that investors are not confused by the array of products sold by AMCs.
In my view going forward will be function of three challenges, The first is we have to figure out a way to simplify products, the industry has far too many products, At an industry level if you look at schemes, plans, options that number is 3000-4000. If you limit it to pure equity schemes that itself is about 400-500. For the size of the industry at the retail level is about 3 lakh crore, It is just far too many products.
What it does is you've transferred the decision making problem from the fund manager to the investor. Our view - again this is coming from having run an asset management company -asset management business is a business of scale, If you look globally either people run large index funds like Vanguard or large diversified funds like Fidelity’s Magellan. There will be one huge product and there could be some niche products around it but the main ballast of the asset management business will be a huge scaled product. We need to go to that.
So the industry's first challenge to me is how do you reduce this number of products into something more meaningful, into something easier to understand because at the end of the day if you see it is retail business and the value proposition has to be simple. I will give you an example the HSBC India fund from offshore investing to India attracts retail money and that fund is over $7 billion a single fund is about Rs 30000 crore plus.
There is not a single equity scheme of any fund house of that size. JP Morgan India fund is huge fund but you don't have so the business is business of scale. Now the value proposition is simple, What are they saying that the country-region is a great growth story. This fund will capture that growth. Now why shouldn't fund managers in India make the same value proposition to the Indian investors that everybody is betting on growth buy this fund to capture India growth.
The second challenge is technology, The current back-bone for investor service quite frankly cannot scale, the industry talks in folios â€" actually you should look at number of investors. In our view the number of unique investors is 75-85 lakhs - thats less then the number of equity investors in the country .If you want this number to grow four fold, is the existing investor servicing infrastructure geared for it?
Is there a better technology available out there that we can embrace, People thought that we were trying to push trading of mutual funds in stock exchanges. Actually what we are pushing is the technology of the secondary market to mutual funds, We want the technology of clearing and settlement and we want the technology of electronic holding(demat). We would be very happy if all institutional distributors go to the electronic platform. It will actually de-risk the system, So we would be very happy with that.
The third challenge is marketing and communication. If you look at the insurance business the private sector insurance business started after mutual funds but they have at least ten times the field force, which is an investment by the manufacturer and half that field force represents tied agents so there is some kind of loyalty to the manufacturer. The mutual fund has built a model around the distributor because it suited the distributor, It never suited the manufacturer. It certainly never suited the investor. So we have to break the egg and make the omelette and say this is not working, so let me look at other avenues. To me if we can address the issue of product consolidation, if we can create a technology robust to scale up investor service and if we can rework the communication and marketing mechanism, the oppurtunity to scale then to add an extra zero to the retail number is not difficult at all. But if you add zero that is 27 lakh more crores of AUM of the retail sector.
India has over 40 AMCS with a relatively small investor base concentrated in ten major cities. Everyone in the industry talks of consolidation but on one is willing to shut shop. Do you see a shake-out ahead.
The number of players in the game, I would leave it to the sponsors to address it. I believe that there is no khazanah which is infinite, Every sponsor is running a business I'm sure in their mind they have their finite tolerance limit on how much they will sustain losses. At a point they will stop. So the number of funds is not something that I need to worry that’s all a business issue. We need to worry about reach and penetration. So in fact one of the reasons why the stock exchange platform is helpful is automatically to enhance the reach. That doesn't mean you have to go to a broker to buy but it means there is a reach in the platform get your IFA to jump onto that platform either directly or through the AMC acting as an intermediary or through an existing broker. Reach is challenge and that can be done using technology and we have the technology in the country today. Product consolidation - people need to have a plan, it will be at least a 2-3 year task for every AMC. there is no short cut.
Given the number of products, will the regulator now be choosy about approving new products.
Under the regulatory framework it's so important that we don't start saying that this product don't do this product do. Yes we have ability to ask people to explain why this new product is required and how is it different from everything else because the regulatory framework is not about saying just a binary yes and no, It is for saying these are rules comply with it. But we have done everything to curb the NFOs. I will tell you what we have started doing we met with a bunch of trustees, I gave them example about there is a fund house with 20 equity schemes. if I cut out the sectoral schemes they still have about 15 equity schemes. If you accept my argument a lot of them were mimicking each other with small differences but the difference in performance was huge so as a trustee they need to worry about is the AMC treating everybody fairly. So I'm saying that these are the things you need to do so that then people will say hey do I need 15 schemes or can I manage this better with 3 schemes. So we are trying to get people to get sensitive to these matters and revisit some of their business model to consolidate. I think we can play a role of a facilitator, of a conscience and of a crusader but we can't play a role of a controller.
There is a feeling that trustees of fund houses have not quite fulfilled their responsibilities. Is Sebi reviewing the role of trustees .
The model we have is a brilliant model, it delinks the people who have to guard the money, which is the trustee from the people who manage the money. The issue comes when you feel that trustees have not exercised enough gravitas and that’s all what we are trying. All we are trying to do is get trustees to recognise that they have a major responsibility here and reach out say it is easy to manage and facilitate that process through a combination of one-one meetings and workshops that we have.
The response from Trustees has been terrific. So we want to retain the model but we want to feel their presence more and we will do everything for that. For example we made them the centre piece of the audit process, we said before we get to see the audit report we want the trustee to see. We want trustees to be the centre piece of investor servicing standards, we want the trustee to be the centre piece of new products. All that we want is wherever anything touches the investor,we want trustees to clear it.We have some terrific trustees, these are men and women who had fantastic first innings, So you just need to nudge them and tell them to throw their weight here.
And I can see that they have started making their presence felt.
How does Sebi plan to de-risk high investments by banks into MFs, which are like flighty deposits.
As far as banks investments into mutual funds is concerned I will leave that to RBI on whether they should or should not and I'm sure RBI through various means have send messages to them because we have seen that the total bank investments in absolute figures have come down by 50-60%. In fact in the last twelve months it has come down by 70%. The second part you raised was how do we de-risk the system. The big risk in liquid plus is, you provided liquidity on the basis on net asset value and that the NAV had no way to reflect reality because it was rarely marked-to market, only a very small component was marked-to market and that was the risk. If I give you assurance to redeem an asset but I'm not able to realise that value or somewhere thereabout, then I'm being so unfair to the remaining investors.
That was the single biggest risk point of liquid plus, we have addressed that by bringing down mark-to market exemptions which earlier used to be under 1 year, now we have made it under 90 days. Up to 90 days you dont need to mark-to-market. We have put in lot more requirements in asset diversification, we have told people that you have to disclose where ever you invest by asset category and the risks attached to each category. So I think from a systemic stand point what we have basically done is put in valuations so that the reflects a far better sense of reality than amortisation.
Sebi has progressively tightened rules for funs houses. How has it worked so far.
This is part of tightening overall regualtory framework regime. The spirit of FII was always that we want broadbase investors and the test of broadbase was that minimum 20 investors and no single investor with more than 49%. Over time what we had observed is that people had come out with various structures, where you maintain this compliance in lip service at the surface and underneath that there is absolutely no compliance and that is not the spirit of the FII framework in this. So that is what we are trying to fix and again in keeping with our philosophy as I said all regulatory tightening is prospective so We gave them time in April till this month end to come up and file the declarations so that what we are trying to do. If you look at the entrire universe of FIIs and sub-accounts 5 in 6 have complied that is 85%. If I look at the universe of active FIIs and sub-accounts 90% plus have complied. Contrary to perception, the reality is there is a 10% piece and of course in that 10% piece people may be in transit that I have send the papers and have not reached that we will look at it.
What happens to that 10%.
I think we have been extremely fair. What we have told them is there is no impact on their registration, there is no impact on their current position. Yes, they can retain it or they can sell down and unwind it so nothing is impacted to what they have done to date. Yes going forward they can't take new positions. we will not entertain, MCV if they have a commom portfolio we will entertain.
A contentious issue for long has been that of issuance of participatory notes (PNs) and the problems in identifying the ultimate investor. With regulatory tightening it is becoming tough for foreign funds to invest through the back door. When will PNs be done away with ?
You can actually connect the dots. What we have done is actually addressed a common problem to PN and FII, the invisible investor that irritated us and we have addressed that in both PN and FIIs. If you recall the orders on barclays and SocGen since then all PN issuers came to our office and they have reworked that entire model they will do KYC for the end investor and that information will be made available to SEBI whenever we ask.
Source: http://economictimes.indiatimes.com/opinion/interviews/MFs-must-be-happy-with-Sebi-for-strong-profit-rise-K-N-Vaidyanathan/articleshow/6686286.cms?curpg=4
Posts
