India:Only Serious MF Players should Get Entry

The asset management industry has been hoping for a reversal of policy ever since UK Sinha, a former chief of UTI AMC, took over as chairman of Sebi over 18 months ago. But in his role as a regulator, he has chosen to look at structural issues of the industry rather than just band-aid solutions. Excerpts from an interview with Shaji Vikraman and Reena Zachariah There is growing unease about the 'export' of Indian capital markets, as reflected in the trading of Nifty futures in Singapore and listing of Indian firms there, which are issuing foreign currency convertible bonds. How do you plan to address this challenge?  It is not correct to assume that capitalraising in Indian markets is inefficient. If anybody is making that case, I would advise him to make a comparison with where we were five or ten years ago. There is a lot of improvement in the efficiency of our markets both with regard to timelines and cost efficiency. It is true that certain products are traded outside India, but the issues to be tackled in those specific products are mostly related to tax or forex regulations. People perhaps find it easier to trade outside because of these restrictions. The concerned authorities are aware of these things and my belief is that as and when we are a bit more comfortable with our foreign exchange management, there will be efforts on the part of all of us together to bring back the market to India, and make our market more attractive in comparison with foreign markets. There is now a growing feeling that business is coming back to India. I don't think right now anybody can expect the foreign exchange regulator in the country to make any major changes. But as and when things stabilize, the general consensus is that we should try and bring the market back. We should try and make our own market more attractive. Another aspect of it is the cost. If you look at the total cost, a very high percentage of it is statutory duties and taxes. This makes a case for us to reduce some taxes. In the budget this year, STT was slightly reduced. But even after this, in Sebi's view, there is need and scope for further reduction because if the volumes are going down then the tax realisation by way of STT is also going down. Sebi's view is that the tax structure should be such that it encourages long-term investment versus an investment that is purely speculative. We should seriously look at whether the tax structure for those who are buying in the cash segment is high. In our opinion it is high today.  Have you made any recommendations on changing the tax structure?  We had sent our proposals to the government at the time of Budget, basically highlighting these two broad policy considerations: one, compared to the rest of the world our market should be more attractive and two, we should encourage long-term investments versus pure speculative intraday transactions. My case is that the current cost structure for differentiated products is driving investment behaviour. For example, in option trading, till the time STT was being calculated on the value of the trade, it did not develop. Volumes were very low, while there were high volumes in the futures market, especially in single stock futures. But when the tax calculations were changed, volumes shifted to options. I am only trying to buttress my argument that how tax changes drive investment behaviour. The next thing is that while there were such taxes on the securities market there was none on the commodities side. So what is happening is that investment is now going more and more towards commodities. Even if there is a need to have caution and not provide any disincentive to agricultural products, I would argue that this is not the case with non-agricultural commodities .So at least for non-agricultural commodities there is a very strong case for having a tax similar to the securities transaction tax. Then investor behaviour will not be substantially guided by tax. People will come to the Indian market and they will get into longterm products. Then your worry that whether we are driving the market out of India can be partly addressed.  What is your view on GAAR. Is it a major deterrent to foreign fund flow as it has been made out to be. Does it worry you?  It is a question of source-based or residence-based taxation. On a long-term basis, I think the tax authorities have to address that question and because we are not able to address that question a lot of problems are coming up. All I can say is that we have received a number of representations from a number of FIIs and private equity players and we have been able to arrange discussions between them and the tax authorities. Sebi is happy that a high-powered committee is looking =into the matter. I'm hopeful that some solution will come through so that the legitimate concerns of the FIIs are addressed.  The Prime Minister had recently expressed concern relating to the state of the mutual fund industry. There have been calls for introduction of the entry load again. Sebi's MF advisory committee has also given its recommendations. How do you plan to address this?  I would request that we look at the matter in its entirety. Let us have a comprehensive look at the market rather than a small segment. And what is that? The number of IPOs has come down substantially. Secondary market volumes have also come down. Despite the Indian market giving positive returns of about 10% from January this year , very few companies are raising money from the primary or secondary market. Net mobilisation by mutual funds, especially ETF schemes, have been modest. In some months it is marginally positive and in some it is marginally negative. If you look at 2010-11, net sales was around . 13,000 crore negative in equity. Compared with that 2011-12 was marginally positive at . 150-200 crore. So when you compare it with 2010-11, it is a big improvement. Coming to the current year, net sales are marginally positive. Mutual fund sales are not happening … yes it is a matter of worry, but the larger picture is that even primary or secondary markets are not seeing large numbers. Secondly, even in the US and Europe, net sales in equity mutual funds is negative. Or the total mobilisation is vastly less than in previous years. The point I am making is, this is also a global trend. India is not alone in that sense. So now the question is what can we do about this. And since it is a larger and deeper problem, the response also has to be structural rather than only aimed at enhancing the revenue stream for AMCs. And to make a structural change, Sebi is contemplating that there should be a mutual fund policy of the government. And that policy should envisage, for example, the tax treatment. The policy should envisage the investor protection measures and the sales practices. And also, how to ensure that genuinely serious players come into the market. Right now, for example, the capital requirement for entry into the segment for an AMC is, in my view, very small. Whereas in businesses like banking and insurance it is high to start with and goes up based on the size of the business. The argument here is that an AMC is a passthrough, so where is the requirement for capital? But Sebi or the government has to worry that by allowing those who come with such insignificant capital, aren't we putting investors money in jeopardy? And you are aware that during the crisis in 2008, one or two AMCs actually had difficulties. They were rescued by either sponsors or by others. But for quite some time there was a worry whether the interest of the investors are being protected or not. But in addition to this aspect of capital, Sebi also has to go into its long-term desire to spread the growth of mutual funds in remote areas. If that is a stated goal, then the mutual fund policy should also put some obligation on the AMCs about spreading out.  Are you saying that it will be mandatory for fund houses to operate in the hinterland like banks or insurance firms?  I am only giving you the broad contours which a policy should have. But it will not be fair for me to tell you what the policy is going to be because I am only coming out with the idea that we need a policy. What could be the broad contours I can have some views. But unless that policy is decided, it will be wrong for me to give the impression that this will be contained in the policy. But so far as the broad contours are concerned, I think everybody will agree that the mutual fund industry should spread to other parts of the country rather than being confined to 5 or 10 cities. As a policy objective, a mutual fund policy should address this. If you agree that this point has to be addressed, I think it will flow that there has to be some obligations on the part of the mutual funds to spread to new areas and mobilise a certain amount of business from those areas. It is there in the insurance sector and in the banking industry. Some people are saying that no, we are only a pass through vehicle, why do you put this. I would rather argue that the time has come that we should put some of these obligations. To what extent, how many and how far it is practical, those  are things to be considered. Also I would strongly argue that whatever Sebi does or the govt does should not be disruptive for existing players. So we should provide a good mechanism so they don't feel threatened. But going forward, these things have to be brought in, that is my view. Now if you agree that there has to be a broad policy and Sebi is going to start that practice, the second aspect is what are the tax benefits that will be provided. The draft DTC paper created certain amount of uncertainty that whether ELSS schemes qualify for tax breaks or not. Subsequently we were assured that all products with a lockin requirement and all long-term products will be treated similarly. But that has to be stated clearly because what has happened is that after the discussion paper on DTC, the net accretion in ELSS schemes has started turning negative. People are worried that for FY 12-13 it is there, but maybe from 13-14 it will not be there, or from 14-15. So the government has to give a clear-cut direction about what is going to be the tax treatment of mutual funds. Again, I will come back to the point that we need a longterm mutual fund policy. These things could be a part of it. I have also highlighted my views that it makes sense that if a mutual fund is floating a pension product it should be really permissible. There are two fund houses, which have today pension products – UTI and Franklin Templeton. The beauty is that in both cases there have been specific notifications by Sebi allowing investment in these products and they qualify for tax exemption. My case is that the mutual funds industry, which has a track record of a good amount of quality fund management, I hold this view, that they have a good track record, then why deprive them from this benefit? If they have to give pension products, Sebi should sanction it, allow it, and tax authorities should permit their treatment. This should be part of the larger picture. Coming to the short measures, certain representations have been received by Sebi. The MF advisory committee has also come out with certain suggestions. The Sebi board will be discussing those issues. We will be guided by two or three main considerations, on how to ensure that incentives for churning are removed. So we will be guided by that consideration and we will also be guided by the consideration that what can Sebi do to encourage or incentivise raising money from beyond top 5, 10 or 15 cities. If you are bringing more money from those cities, how does Sebi incentivise. So we will be guided by these considerations. We have received certain suggestions and guided by that we will decide. If data shows that 85-90% of investment is coming from main cities, then it is time for us to act.  But aren't you setting yourself up for another regulatory turf war with the pension and insurance regulator on this ?  My position is that the mutual fund industry has already been permitted and allowed to launch pension products. My second position is that they have done a good job of it. And a pension product where there is a lockin is possible under Sebi regulations. So if more and more companies come to Sebi with this request, we will find it difficult to say no. On what grounds can Sebi say no? If tomorrow, I receive ten product requests then we are going to have a product with a 3- or 5-year lock-in and our asset mix will be such that it will meet general requirements of long-term old age savings, I doubt how Sebi can say no. Second part is even if Sebi says yes, will tax authorities provide it. I am arguing that tax authorities should consider similar products in a similar manner. That's all I am saying. Now, which regulator is happy or unhappy, that I leave to you.  We have seen many companies drop their IPO plans over the past year or so. There has hardly been any issuance to comply with the public holding norms. Will these norms be eased again?  Sebi has moved away from the old practice which was called merit-based pricing, to disclosure-based regime. Sebi is not going to move away from this. So disclosurebased pricing will be there. But Sebi has identified certain lacunae or shortcoming in the operation of this scheme. So what we have already implemented in the last 8-9months is that the due diligence record has to be kept by merchant bankers and Sebi inspectors can go and review that. Secondly we found that track record of merchant bankers in past issues was not known to people. If one has come out with 10 issues, for example, and 9/10 issue prices have fallen much more from the index versus some other banker where only 2 or 3 out of 10 have gone down, this information should be known to the public. Sebi feels that providing this information will make investors make better choices. The other issue was about volatility on opening day. So Sebi has, in the past six months, already put in place a system called pre-market call auction on the opening day. Four issues have come out after that and you will discover that volatility has vastly reduced. Basically, all three measures we have taken amount to very high degree of due diligence and care in pricing. This does not mean that Sebi is prescribing the pricing; it only says that if you have not been careful as a merchant banker about pricing, then tomorrow if you come out with a second issue, let that issue be known to the public. Going forward, what we are looking at is how to have the spread of IPOs across the country. How to take advantage of the existing mechanism in the market such that forms are available all over the country than in one place. Then we are looking at how to make ASBA more widespread. What Sebi has done in the past 4-5 months is that earlier limited options were available. We have been enhancing those options. Our effort would be to provide in a transparent way more and more options to facilitate this. But in spite of this ,if people refuse to comply, then they are taking a conscious call; that's all I can say at this stage.  Isn't there a case for tighter norms for GDR after a recent regulatory probe showed that many mid-cap firms were misusing this route  The GDR regulations are administered by the government. Based on our experience we have already given our suggestions to the government for making certain changes in the GDR regulations.  Sebi has been criticised for micromanagement of stock exchanges. Is this criticism valid ?  Unlike other normal for profit companies, which a stock exchange is, it also has a large regulatory role and in order to avoid that conflict the Bimal Jalan committee, for example, had come out with very serious prescriptions on how much profit they can make to put a cap on that and had prescribed a cap on the remuneration also. All Sebi is saying that follow a due process and that process should be substantially removed from an influence of the beneficiaries of that remuneration. If you are the chief executive officer or the managing director and you are also party to your own remuneration then there is a conflict. Sebi has said form a committee of independent directors and let them decide. Sebi has also said that it is very important for an institution like a stock exchange not to take risks for short term gains. UK SINHA CHAIRMAN, SEBI