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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.

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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