Clearing corporations to reform bond market

Trading will continue to happen on a bilateral basis, but after a deal is struck, the buyer and seller will transfer funds and securities, respectively, to the clearing corporation

1 December is likely to be remembered as the day the revival of the corporate bonds market in India was set in motion. All entities regulated by the Reserve Bank of India (RBI) and the Securities Exchange Board of India (Sebi) will compulsorily start settling their trades in corporate bond from Tuesday through clearing corporations of stock exchanges. This includes a large number of active participants such as banks, primary dealers and mutual funds.
Currently, corporate bonds are traded and settled bilaterally. Once a deal is struck, the buyer transfers the funds to the seller, who then hands over the bonds to the buyer. Since the bonds have to be handed over only after the funds have been received, it creates huge settlement risk from a buyer’s perspective.

Settlement through a clearing corporation will be vastly different. Trading will continue to happen on a bilateral basis, but after a deal is struck, the buyer and seller will transfer funds and securities, respectively, to the clearing corporation. It’s only after both parties have honoured their obligations that the clearing corporation will release funds to the seller and securities to the buyer. Counterparty risk will reduce considerably, leading to lower transaction costs, increased liquidity and better price discovery.
Of course, there’s still the chance that one of the parties would default, in which case the clearing corporation would return the funds or securities.
This is unlike the equities market, where the clearing corporation guarantees all trades. If, say, the seller defaults, the clearing corporation procures the securities from the market and transfers them to the buyer. Whatever loss the clearing house would have incurred in procuring the securities from the market at prevailing prices (vis-à-vis the traded price) is recovered from the margins collected from the seller. This process is difficult in the corporate bond market because they are far less liquid compared with equities, and hence isn’t being attempted.
But defaults are normally few and far between, and would hardly take away from the larger good a central clearing system will bring. Thanks to the reduction in settlement risk, players will be more comfortable trading.
According to a fund manager at an insurance company, foreign institutional investors haven’t been active in the corporate debt market primarily because of the counterparty risk involved in the settlement process.
What’s more, details of most trades will be captured by clearing corporations because of the compulsory settlement diktat, resulting in a higher degree of post-trade transparency. The transparent dissemination of corporate bond prices and quantities traded will also facilitate better participation by market participants. Once the settlement system is in place, it’ll pave the way for a corporate bond repo market. Ultimately, all this will help in reviving the primary market for corporate bonds.
There are likely to be some teething problems, however, with the new settlement system. The circulars by RBI and Sebi apply only to entities regulated by them. Pension funds, for instance, which are relatively large players in the corporate bond market, haven’t been issued any circular by India’s Pension Fund Regulatory and Development Authority (PFRDA).
Some market participants say that pension funds are likely to be slow adopters of the new system, and one large section of the market may be relatively inactive in the near term. It’s not that pension funds can’t register with clearing houses of stock exchanges, but regulated entities in India generally act cautiously and are unlikely to be proactive in registering unless a circular is issued.
Of course, this could be detrimental for them since a large section of the market, namely banks and mutual funds, will have to compulsorily settle through a clearing corporation. Unless they, too, register, they would have to trade with each other or with brokers, which will entail bigger spreads, and hence higher transaction costs. While this learning happens in the first few months of the new settlement system, trading with at least some of the small pension funds spread across the country could be affected.
This is a classic example of inefficiencies in some sections of the Indian markets because of multiple regulators. The corporate bond market will be governed be Sebi, but participants are regulated by multiple regulators such as RBI, Sebi, PFRDA and the Insurance Regulatory and Development Authority. One may argue that all new ventures have teething problems and that they would eventually get sorted out. But as one market intermediary points out, regulators should be involved in ironing out operational difficulties rather than making things more difficult.
Another example of the confusion caused by having multiple regulators is RBI’s decision to continue with the diktat that all its regulated entities have to necessarily use the reporting platform of the Fixed Income Money Market and Derivatives Association of India (Fimmda) to report their corporate bond transactions. Now that all RBI-regulated entities will be compulsorily settling their trades through clearing corporations, all their trades will be captured, and there’s no need for an additional level of reporting. Quite evidently, this makes the circular on reporting trades redundant.
Perhaps there is need for better coordination among regulators to see the obvious.

Source: http://www.livemint.com/2009/11/30222605/Clearing-corporations-to-refor.html?h=B

'Beyond a point, wealth creation is more important than protection'

Birla Sun Life Mutual Fund, India’s fifth largest, is looking to increase the proportion of its equity assets to total assets from 16 per cent to 25 per cent in the next few years. CEO A BALASUBRAMANIAN, speaks to Neha Pandey and Joydeep Ghosh on wealth creation and impact of regulator arbitrage. Excerpts:

Are you happy with the industry’s debt-equity mix?

The equity portion could be much higher than the current exposure, somewhere around 25 per cent, for the industry as a whole. However, fixed income assets cannot be ignored, too, as they cater to the regular income needs of the conservative investor class. We believe this pie will continue to grow.

What is Birla Sun Life’s mix?

Our equity portion is roughly 16 per cent. Some of the bigger players have around 25 per cent. With our recent drive in creating awareness for our schemes, we would expect our equity assets to come closer to the top five industry average sooner than later.

Why have inflows in equities suffered?

The Indian investor does not realise the importance of wealth creation over the long term. Today, we are still talking about only five per cent penetration. In comparison, insurance penetration is much more, because people are seeking protection for themselves. But beyond a point you don’t need protection, you need wealth.

There is a regulator arbitrage because MF distributors have to negotiate their commission, whereas insurance agents are being paid as per the product specifications. How is this impacting the industry?

Regulator arbitrage is narrowing. While it exists today, it may cease to be there tomorrow. But investment decisions cannot be made on the basis of regulator arbitrage. Both investors and sellers have to decide what is best for them over the long run. Sellers cannot advise on the basis of commissions.

The industry is paying an upfront fee and higher trail commissions. How will it impact balance sheets?

This is a temporary phenomenon. The question is how much the fund house will be able to pay and for how long. It could be one year or more… but these numbers are variable in nature and will get revised.

In the past six months, stock market valuations have shot up significantly. What is your outlook on markets?

In the long term, for a three-five-year period, things look quite positive. For one, the overall economy’s confidence level is on the right track, in terms of the industrial production numbers. Second, interest rates are likely to be supportive. Third, the policy initiative from the government will be more favourable.

Will there be a spike in interest rates in the near future?

Despite inflation concerns, rates will not go up in a hurry unless there is a significant growth in credit off-take. The numbers to be watched are the bank credit numbers, which are quite low now.

What would you advise a new investor?

If you want to invest in equities, have a five to 10-year perspective. If you double the money in three to five years, one should be happy. Today, global investors are looking at India as it offers them growth substantially higher than the global growth. In such a scenario, even Indian investors should hold on to their conviction and stay tuned to the market. Going by the thumb rule, returns should be nominal GDP plus 6 per cent. So, in case of a 7 per cent growth and 4 per cent inflation, the nominal GDP would be 11 per cent. The returns would be around 17 per cent per annum in a normal scenario.

On the debt side, where should one invest?

One can invest in income and gilt funds with a two-three year horizon. Income funds are quite dynamic because the fund manager takes a view on interest rate movements regularly. But FMPs (fixed maturity plans) can be avoided, because rates are quite low.

Source: http://www.business-standard.com/india/news/%5Cbeyondpoint-wealth-creation-is-more-important-than-protection%5C/378155/

NSE's MF platform draws Rs78 lakh assets on Day 1

Though the start of the National Stock Exchange's Mutual Fund Service System on Monday was impressive, marketmen feel there could be hiccups ahead.

Mutual funds (MFs) garnered Rs 77.69 lakh worth of assets from 300 applications on the first day of the system that allows transactions in mutual funds through stock-broker terminals.
To provide a fillip to MF sales through the stock platform -- initially rolled out through 1.5 lakh terminals of National Stock Exchange (NSE) -- goodies are being offered by all entities involved. NSE, National Depository Services (India) (NSDL) and stock brokers have waived charges for the initial period.
Sebi has also clarified that no entry load norm would be applicable on investments made in mutual fund schemes through the online platform launched by the NSE.
UTI Mutual Fund was the first to offer its 30 select schemes on the exchange. It received over 300 applications worth Rs 75 lakh on the first day. "Others such as Tata MF, Birla MF, Reliance MF, ICICI MF and Fidelity MF are expected to come on board soon," said Gagan Rai, MD and chief executive officer, NSDL.
However, while the move (new platform) is beneficial to institutional distributors, independent financial advisors (IFAs) could be hit.
"Post August 2009, when the MF commission regime changed, transactions in MFs through IFAs dropped almost 8-9%, while online MF transactions rose by 6-7%. This indicates that institutional distributors (equipped with adequate trading and online investment platforms) would benefit more," said Vinesh Menon, head - retail distribution at Bajaj Capital.
IFAs are enraged at the decision to permit selling through stock terminals. They say people without advisory skills should not be allowed to sell mutual funds.
Rajendra Dhulla, who runs advisory services via Pratham Services, said, "There are about 2 lakh Amfi-certified agents in the country. How will they sell mutual funds through the Bolt without knowledge about funds?"
Another IFA requesting anonymity said stock brokers would try to sell stocks to people who wish to invest in mutual funds, by promising higher returns.
An industry observer said there is an issue about trusting brokers. "Under the new system, the cheque of the amount to be invested has to be given in favour of the stock broker and not the fund house. People would not be comfortable with writing a cheque in favour of the broker as they are not sure about what would be done with the money."
He added that only individuals already exposed to investing in shares would opt for stock platform. "Only individuals, who account for 8% of the total holdings in BSE-500 stocks, would be interested initially," the observer added.
Though some claim that IFAs can use the platform to transact, it is questionable whether they would be willing to share the income with stock brokers. "There is no clarity on the trail commissions that IFAs and distributors earn," said the industry observer.
The Amfi platform for buying and selling MFs, which is likely to be launched in March as per Amfi chairman A P Kurian and Jaideep Bhattacharya, chief marketing officer of UTI Mutual Fund, would try to iron out the hurdles based on initial response to the stock platform, experts said.

Source: http://www.dnaindia.com/money/report_nse-s-mf-platform-draws-rs78-lakh-assets-on-day-1_1318614

UTI to be first on NSE mutual fund platform

Around 30 of the 100 schemes of UTI Mutual Fund will be listed on the new NSE Mutual Fund platform, which is set for a Monday launch.

The liquid schemes will not be included among them, said a top UTI official.

For the fund industry, it will be a new technology-driven initiative when UTI MF lists its schemes on Monday on NSE's new platform – the Mutual Fund Service System (MFSS).

In November 2000 a similar initiative by the Association of Mutual Funds in India made it possible for Indian funds to declare their NAVs on a common platform.

BSE to join soon

Around 10 mutual funds are expected to join NSE's platform within a week's time, an NSE official said. BSE too is readying a similar platform for launch, a BSE spokesperson said, without giving further details.

The new transaction platform allows investors who have demat accounts to transact in mutual funds online by logging on to their broker's telecom network, which will be linked to NSE's MFSS.

Those who do not have demat accounts will have to apply to their respective mutual funds for generation of a personal identification number (PIN), a user ID and password; this route will also facilitate online transactions, without the broker coming into the picture.

Such investors will have to provide their bank account details along with their PAN and fund folio numbers to get their PIN.

Transactions would be processed on the business day on which the investor's funds are credited to the mutual fund's bank account. Units will be allotted at the previous day's NAV for orders received up to 3 p.m.

In addition to online subscription and redemption, investors can apply for new fund offers and additional subscription in various schemes.

The facility will also enable switching of units from one scheme, plan or option to another.

No entry load will be charged for direct applications that are not routed through a broker or distributor, but are forwarded online to mutual fund houses through their online transaction facility, the Web site of UTIMF said.

There is no clarity on levy of brokerage and securities transaction tax. NSE officials declined to comment on this matter.

Source: http://www.thehindubusinessline.com/2009/11/29/stories/2009112950990100.htm

Dubai's debt default fears shake investor confidence, rattle stock markets

Indian stocks and the rupee skidded on Friday as Dubai's debt woes sparked fears over corporate exposure to a key trading partner and that foreign funds will lose their appetite for risk.
Banking, property and construction-related shares were among those hardest hit, after Dubai said two of its flagship firms planned to delay repayment on billions of dollar of debt. Foreign investors have poured roughly $15 billion into Indian stocks this year, helping drive a 75 percent rally through Thursday, and were among the sellers on Friday.
Dubai said on Wednesday it wanted creditors of Dubai World and property group Nakheel to agree to a debt standstill as it restructures Dubai World, the conglomerate that spearheaded the emirate's breakneck growth. Dubai World had $59 billion in liabilities as of August.
"Whenever this sort of situation arises you will see a flight to safety, but I think within the emerging markets space India and China clearly are the favourites, so to that extent they will be protected on the downside," said Manish Sonthalia, portfolio manager at Motilal Oswal.
The benchmark Sensex pared losses to 2.2 percent on buying at lower levels in mid-afternoon trade after falling as much as 3.8 percent, outperforming the 4 percent drop in the MSCI Index of non-Japan Asia.
India and the United Arab Emirates, of which Dubai is a member, are separated by the Arabian Sea and closely linked by the millions of Indians who work in the region. Indians make up about 40 percent of the UAE's population, accounting for 10 to 12 percent of India's inward remittances, CLSA said in a report.
The UAE was the second-biggest export destination for India during the nine months through December 2008, accounting for $14.6 billion, or 11.15 percent of India's total -- a share that has been rising and closing in on the United States.
"This event would be a trigger for investor risk aversion and that could slow down the flow of capital into emerging markets, and Indian stocks would be affected by that," said Gaurav Kapur, senior economist at ABN Amro Bank in Mumbai.
Minister for trade Anand Sharma said India's economy was unlikely to be hard-hit by the situation in Dubai. "India is a very large economy. I don't think some development in the real estate in Dubai is going to impact the Indian economy," he told reporters.
While Indian banks are heavily focused on the domestic market, they are active in handling remittances from overseas workers and India's banking index was down 3 percent.
Bank of Baroda, which had a total exposure in the UAE of around 100 billion rupees ($2.1 billion) according to its chairman, saw its shares fall about 7 percent. The mid-sized lender has 10 branches in the Gulf, more than any other Indian bank, according to CLSA, but the exposure is mostly related to remittances, the brokerage said.
SENTIMENT HIT Several market players said the biggest impact of Dubai's difficulties would be on sentiment. "The market was expensive, and it was looking for a reason to correct, and Dubai happened to be one," said Anand Shah, head of equities at Canara Robecco Mutual Fund. "Fundamentally, we are not impacted. But, if the risk appetite comes off, the liquidity flow could reduce," he said.
Many Indian companies were quick to play down their exposure to Dubai. Engineering conglomerate Larsen & Toubro said it had exposure to Dubai of $20 million to $25 million. India's largest listed realty firm, DLF, and second ranked Unitech said they had no exposure to Dubai, and leading private bank ICICI Bank said it had no material exposure.
Real estate shares were down 3.83 percent. Nagarjuna Construction said it was slowing down its real estate operations in Dubai. "We have only one real estate project in Dubai, to develop 1.45 million sq feet ... and right now in the Dubai real estate market we are going slow on this project," Y D Murthy, executive vice-president, finance, said.
Emaar MGF, a joint venture between Indian financier MGF and the UAE's Emaar Properties, is one of several Indian property firms planning a listing. It has filed papers with the market regulator to raise about $830 million, about half the amount it had planned to raise in 2008.
Emaar MGF declined comment, saying it was in a silent period after having filed the prospectus for its share offering.
"For real estate per se, the pressure would be due to lack of investor appetite at a time when a slew of IPOs are lined by local real estate companies," ABN Amro's Kapur said.

Source: http://timesofindia.indiatimes.com/biz/india-business/Dubais-debt-default-fears-shake-investor-confidence-rattle-stock-markets/articleshow/5275349.cms

Fund management fees rise with markets

Management fees to equity fund managers and investment advisors rose 42 per cent, or Rs 224 crore, in the first half of financial year 2009-10.
Fund houses pay management fees on the basis of assets and since assets under management (AUM) of equity schemes have risen 75 per cent, or Rs 83,000 crore, in the first half of the current year, fund managers’ fees have gone up to Rs 759 crore.
The over 100 per cent rise in markets during the period has led to a considerable increase in assets of equity funds. This resulted in higher payment towards management fees, said Anil Chopra, Group CEO, Bajaj Capital.
In the second half of 2008-09, fund houses paid lower fees (Rs 535 crore) to their managers due to the over 50 per cent decline in value of equity portfolios, he added. In the first half of 2008-09, when the market fell off its peak, excessive portfolio churning led to higher administration expenditure. Also, outflow due to management fees stood at Rs 891 crore.
The record shows that fund managers and investment advisers’ remuneration varies in a volatile market. In 2007-08, when the Sensex moved up from 12,000 to 21,000, fund houses paid Rs 1,673 crore to fund managers. Conversely, in the second half of 2008-09, when the Sensex fell to 8,000-10,000, the fees dropped to Rs 535 crore.
During a lean period, inflow into equity funds through new fund offerings (NFOs) and sale of existing schemes fell sharply from Rs 52,701 crore in 2007-08 to Rs 4,084 crore in 2008-09. Mutual fund investors were cautious in the rising market too and subscribed to no more than Rs 5,344 crore of NFOs in the first half of 2009-10.
The turnover of mutual funds on the bourses declined sharply from Rs 2.46 lakh crore in the second half of 2007-08 to Rs 1.61 lakh crore in the first half of 2008-09, and Rs 1.19 lakh crore in the second half of 2008-09. With the BSE-500 index appreciating around 125 per cent from its 52-week low on March 9, 2009, the MFs’ turnover on BSE and NSE has more than doubled to Rs 2.75 lakh crore since April 1.
Reliance MF topped in the list of fees, with payment of Rs 132 crore, followed by UTI MF (Rs 86 crore), HDFC MF (Rs 81 crore), SBI MF (Rs 68 crore) and Franklin Templeton MF (Rs 61 crore).

Source: http://www.business-standard.com/india/storypage.php?autono=377774

Lagging behind in performance

Quant funds should be used only for portfolio diversification, and are suited for high net worth investors.

Computers have replaced humans in many walks of life. And now, these machines are finding their way in the investment world too. Financial institutions like banks and mutual funds are using them for jobs that traditionally required a huge amount of human experience – picking stocks, for instance.
Consequently, mutual funds are launching products, based on quantitative analysis. Currently, two fund houses have such funds. Reliance Mutual Fund’s scheme is called Quant Plus and Religare Mutual Fund has AGILE. The latter has two variations – an open-ended equity fund and an equity-linked savings scheme. The latest to join the bandwagon is Canara Robeco. The company plans to launch Large Cap+ Fund, based on quant.

The analysis involves using historical data of stocks and prediction of stock movements, accordingly.
But returns, as of now, have not been too impressive. If you look at the performance of the existing fund, human intelligence has outperformed the artificial intelligence. Religare Agile has returned 57.11 per cent since January. The ELSS scheme has 84.80 per cent returns. And, Reliance’s scheme has fared better with returns of 86.14 per cent.
Equity diversified schemes have fared much better comparatively. Out of the total 189 equity diversified funds that existed before January, 110 have given higher returns than any of these quant funds.
But that’s in their characteristic. As Vetri Subramaniam, head – equities at Religare Mutual Fund and also the fund manager for the AGILE scheme, explains, “These funds work on historical data. The volatility seen globally, and in India, in the past year- and a-half has not happened before.”
WORKING OF QUANT FUNDSThese funds pick stocks based on a computer programme. This computer programme is made on trends of various stock market parameters observed in the past 10-15 years. The parameters could range from price-to-earnings (PE) ratio, stock price movement, market sentiment, earnings expectations and so on.
Every fund house has a proprietary model based on the parameters they choose. For example, Canara Robeco uses PE and price-to-book ratio, upgrades and downgrades recommendations by analysts, stock momentum of the recent past, earning valuations and earning expectations by analysts.
Analysts in one of the mutual fund’s parent company, Robeco, used this model at headquarter in Netherlands. “The programme is further tweaked to Indian markets based on what is perceived to drive stock prices in the country,” said Anand Shah, head – equities at Canara Robeco.
Reliance uses parameters such as periodical moving average of the stock, liquidity, market capitalisation, PE and PB ratios, earnings before interest tax depreciation & amortisation (EBITDA) & EBITA margin and other parameters, based on the balance sheet and profit and loss account.
These models assume that stock markets or companies will continue to behave the way they have in the past. “But under different situations like the sharp fall of 2008, mathematical models might not hold good. These funds can, therefore, generate significant losses to investor,” said Chintamani Dagade, Head of Research at Morningstar (India).
Religare AGILE faced the same problems last year when market fell. The one year returns for the fund is mere 36.65 per cent. The category average of the equity diversified funds delivered 90.56 per cent returns in the same time.
Another industry expert said that quant funds are more likely to succeed in the developed countries, where markets are efficient. He also added, “As the models are proprietary, asset management companies (AMCs) keep them secret. This causes transparency and accountability issues.”
The existing funds from Reliance Mutual Fund and Religare Mutual Fund are very aggressive. With their benchmark as 50-share Nifty index, their portfolio comprises of less than 20 funds. They also use futures and options extensively.
“As the portfolio consists of a few stocks, these funds will tend to outperform the market in the bull phase and fall heavily in downturns,” said Subramaniam.
These funds tend to use a lot of technical analysis and hence, suited for seasoned investors only. Pankaj Narain, director, head private clients at Deutsche Bank also said that quant-based funds are for investors who have a large portfolio of investment and they have their asset allocation in place. “This is essentially for investors who are looking for diversification in investment strategy. Such investors can put in 3-5 per cent of their portfolio in these funds,” said Narain.

Source: http://www.business-standard.com/india/news/lagging-behind-in-performance/377200/

Finance ministry sets up panel to study foreign capital flows

The Union ministry of finance has set up a working group to study and suggest changes to the legal and regulatory framework on foreign portfolio investments, it said in a statement Tuesday.
The committee will also study rules and regulations relating to foreign institutional investors (FIIs), non-resident Indians, and venture capital and private equity investors.

One person nominated to the panel said the committee will also look into issues relating to debt capital inflows and the policy on external commercial borrowings. “The panel has been given four months to submit the report and a meeting will be convened soon,” he said on condition of anonymity.
The committee will be headed by U.K. Sinha, chairman and managing director, UTI Asset Management Ltd, the fourth largest mutual fund manager in India. Ravi Narain, chairman of National Stock Exchange Ltd, economist Ajay Shah, finance ministry official K.P. Krishnan and corporate lawyers Bahram Vakil and Somasekar Sundaresan will be part of the 16-member group.
The group will review and suggest rationalization of policy on foreign inflows with a view to encourage foreign investment and reduce hurdles while maintaining know your customer norms. It will identify challenges in meeting financing needs of the Indian economy through foreign investments.
Currently, foreign capital flows come in through foreign direct investment (FDI), FIIs and foreign venture capital investment, with different rules for each.
While some sectors have been fully opened up to FDI, there are caps on others such as insurance and retail. The government has also prescribed maximum investment levels under the different routes.
Foreign investors, though, have often used loopholes to exceed limits by registering a sub-account with markets regulator Securities and Exchange Board of India, and buying shares of Indian companies in excess of FDI limits. Although legal, it defeats the purpose of the limits.
The group will also study participatory notes and re-examine the taxation of transactions through securities transaction tax and stamp duty.

Source: http://www.livemint.com/2009/11/24231153/Finance-ministry-sets-up-panel.html?h=B