Sebi ED Vaidyanathan Talks About MF Regulation After Abolishing Entry Load

He is seen as the new cop in town. KN Vaidyanathan, the executive director of the Securities and Exchange Board of India, or Sebi, 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, Mr Vaidyanathan has come to increasingly respect the work done by regulators. He spoke to Reena Zachariah and Shaji Vikraman recently.

Excerpts:

There have been apprehensions at the way in which the regulatory changes were driven in the mutual fund industry. A year down the line, have those changes paid off and how have fund houses coped with the reforms? 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 during the 2008 crisis. We have 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 fourfold 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 a lot of money because they now have 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 and quality of accounting standards.

How much have investors gained after abolishing the entry load?

During the 13 months since the abolishion of entry load, there have been inflows of 63,500 crore. Now, at roughly 2% of distribution fee, this translates into about 1300 crore. This is now invested productively. I don't think there are very many schemes in this country where a body of investors have gained 1,300 crore by a single regulatory action.

That's not what the industry says. Fund houses say that there's not much left in the asset management business and that the changes could have been rung in a phased manner. The biggest criticism that we are getting is that the changes we made has completely disincentivised the industry and the distributors from selling. If you look at the 10-year period before the entry load was abolished, inflow into existing schemes was about 6,000-6,500 crore per month. For the 12 months after entry load was abolished, we saw 5,000 crore (of inflows). So if entry load was such a big determinant, how come that didn't show up in the numbers. When 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 10 face value; 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. Although a lot of people are barking, actually the root, if you analyse, is that we have made NFOs more difficult. In 2006-07, NFO inflows was around 25,000-30,000 crore. After the entry load was abolished, this has come down to 5,000 crore. So the real game changer behind the entry load is NFO. It has become 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.

Given the number of products that fund houses offer, will the regulator now be more choosy about approving new products? Under the regulatory framework, it's important that we don't start saying that this product should do this or shouldn't do that. Yes we have the 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 yes or no. We have to just see if rules are complied with or not. But we have done everything to curb NFOs. I think we can play the role of a facilitator, of a conscience keeper and of a crusader. But we can't play the role of a controller.

Sebi has progressively tightened rules for FIIs. How has it worked so far?

This is part of tightening the overall regulatory framework. The spirit of FII system has always been that there should be a wide base of investors (minimum 20) and not just one investor contributing to more than 49% of funds. Over time, what we had observed is that people had come out with various structures, where you give compliance only a lip service. So that is what we are trying to fix. Keeping with our philosophy, all regulatory tightening is prospective. So we gave them time in April till this month-end to come up and file the declarations. If you look at entire 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.

What happens to that 10%?

I think we have been extremely fair. What we have told them is that there won't be any impact on their registration or on their current position. Yes, they can retain it or they can sell and unwind it. Going forward, they can't take new positions. 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 has actually addressed a common problem to PN and FII. The invisible investor irritated us and we have addressed that in both PN and FIIs. Since the orders on Barclays and SocGen, 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://epaper.timesofindia.com/