Crowdfunding platforms under regulatory glare

Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture

The Securities and Exchange Board of India (Sebi) is planning a crackdown on unauthorised crowdfunding platforms, which are gaining popularity in the country as alternative capital-raising facilitators.

Sebi has sent notices to as many as 10 crowdfunding platforms, which  predominantly operate through their websites. The market regulator has quizzed them on their business models and asked them how they are not in violation of the securities law, said sources in the know.

Similar to a stock exchange platform, crowdfunding websites act as a link between investors and companies, typically start-ups. Most of these entities are operating without any authorisation or registration with Sebi and, as a result, are not being governed under any law, said a source.

WHAT IS CROWDFUNDING?

Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture.   It makes use of easy accessibility of vast networks of people through social media and crowdfunding sites to bring investors and entrepreneurs together   Information on prior investments in crowdfunded markets includes a time stamp and the specific amount contributed

Grex, Kickstarter, Indiegogo, Ketto, LetsVenture, Milaap, Wishberry, Fueladream, BitGiving, Catapooolt, DreamWallets, Start51, and Fundlines are among the active crowdfunding platforms in the country catering to various kinds of projects.

The exact amount mobilised by these players isn’t known. However, these platforms claim to have empanelled hundreds of investors and start-ups. It could not be ascertained which of the platforms have received Sebi notice.

However, crowdfunding operators claim their business doesn’t fall under Sebi’s ambit. “We are just providing a platform to fund certain projects by facilitating monetary contribution from a large number of people,” said the founder of one of the crowd-funding websites, requesting anonymity.

Last month, Sebi had cautioned investors against participating against dealing with digital fundraising platforms operating on the lines of stock exchanges without regulatory approval. Sebi has a view that these electronic platforms might be facilitating investment in the form of private placement with companies, as the offer is open to all investors registered with the platform, which would be a contravention of the provisions of the Securities Contract (Regulation) Act, 1956 (SCRA) and the Companies Act, 2013.

According to Sebi, only recognised stock exchanges can provide a platform where equity and other securities issued by companies are listed and traded in accordance with the provisions of the SCRA.

Not only electronic platforms, unauthorised prize money schemes and apps linked to the securities market, too, have come under the Sebi glare.

“Each gaming site and fact scenario would require a review and analysis as to whether it has invoked the prescribed provisions and has complied with such laws. No doubt, in the coming times, fantasy trading games, apps or websites and their promoters will face increasing scrutiny,” said or Sumit Agrawal, former Sebi official and founder of Suvan Law Advisors, a Mumbai-based law firm.

Sebi may consider these apps or websites as engaging in “any act, practice, course of business which operates or would operate as fraud or deceit upon any person, in connection with the issue, dealing in securities, which are listed or proposed to be listed on a recognised stock exchange as prescribed under Section 12A of Sebi Act, 1992, he added.

Sebi had floated a discussion paper two years ago, when it had proposed a framework to enable domestic start-ups and small and medium enterprises to raise capital from multiple investors through crowdfunding. It had defined crowdfunding as “solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause”. The regulator, however, is yet come up with final regulations on crowdfunding.

No longer easy to cook up the books

If auditors disagree with the results, the financial impact of their observations will have to be plainly spelt out

As a regulator of listed companies, the Securities and Exchange Board of India recently issued a plethora of amendments to different regulations. One of the significant amendments relates to filing of a statement on impact of audit qualifications in a tabular format with stock exchanges.

Unlike certain developed jurisdictions such as the the US, where companies are not allowed to file financial statements with audit qualifications, Indian stock exchanges (or SEBI or other regulators) continue to accept financial statements with a qualified auditors’ report.

In the US, if financial statements do not conform to the generally accepted accounting principles or GAAP, they are presumed to be inaccurate or misleading, irrespective of any explanatory disclosures.

Matter of difference

Audit qualification is generally a matter of disagreement between the auditor and the management. A modified/qualified audit report indicates that the financial statements/results are materially misstated. The impact of qualification/s may be quantifiable or may not be determinable.

Still, the qualifications may indicate that financial results presented by the management do not reflect the true and fair affairs of the financial transactions of the company and may accordingly have a significant impact on stakeholders’/investors’ decision making.

An audit provides users of financial statements reasonable assurance that the statements are in conformity with GAAP and relevant regulations. The contribution of the independent auditor is to give credibility to financial statements, which are relied upon by creditors, bankers, stakeholders, the government and other interested third parties.

Ideally, qualifications should be avoided as they bring a negative perception for companies. This can be possible only if the issues are resolved between the management and the auditor. Further, for qualifications that are not quantifiable (e.g. lack of sufficient appropriate audit evidence/scope limitation), the auditor is permitted to state the fact through a limitation of scope or disclaimer of opinion.

While qualification is a common practice in case of a disagreement, SEBI provided for a mechanism to address qualified audit reports. Till November 2015, listed entities were required to submit a form (Form B) for a qualified audit report together with annual report.

The qualified opinion was reviewed by a SEBI committee and the Institute of Chartered Accountants of India (ICAI), and based on their recommendations, SEBI could ask the companies to either get the opinion rectified or revise the financial information to address the qualifications.

The revised financial information was submitted as pro-forma results (revision to the results already filed/ submitted) and companies would further adjust their next year financial statements for a prior period error.

Further, it should be noted that Form B was required to be submitted along with the annual report which are filed must later than the financial results (filed within 60 days of the year-end). Also, no information about the qualifications was required to be filed for the quarterly results.

There’s more

While this process provided a meaningful mechanism to address the disagreement between the auditors and management, it failed to provide timely information to stakeholders.

Essentially, a financial result published by a company could be misstated by a significant amount and not known to the investors at the time investment decisions are being taken. Also, Form B provided for limited information — i.e. qualifications with management explanations and not matters such as quantification and the impact on the financial results.

In September 2015 and May 2016, SEBI amended listing regulations which now require a ‘statement of cumulative impact of audit qualifications’ to be filed instead of Form B. Further, the statement needs to be submitted along with the annual financial results.

It seems that statement may be required for quarterly results as well. The statement contains detailed information such as net worth, net profit, turnover, total expenditure, earnings per share, total assets and total liabilities in a tabular form.

The numbers need to be disclosed on the basis of audited financial results/statements and also after adjusting the related qualifications. Thus, instead of simple qualification information, SEBI requires filing of adjusted numbers.

Further, auditor needs to continue to report for each audit qualification separately, as far as the details, type and frequency of qualification is concerned.

The revision by SEBI is a welcome change and addresses most of the deficiencies noted in previous requirements. The new requirements could be challenging but nevertheless provide the much needed information at the right time.

Also, it seems the SEBI review mechanism of the qualified reports has been done away with. The review needs to be undertaken by stock exchanges now.

It is currently not clear on how the review will be performed but it is interesting to note that in June 2016, sections related to re-opening of accounts and revision to financial statements under the Companies Act 2013, have been made effective. These sections became effective along with the constitution of National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT).

These sections provide for the revision/ restatement for financial statements after approval from NCLT/ NCLAT. Additionally, unlike the existing Indian GAAP, the newly adopted IFRS converged standards (Ind AS) require restatement of previously issued financial statements, in case an error is noted for past periods. Reading all the requirements together, it seems India Inc. is entering the world of restatement (a common phenomenon in the western countries).

Necessary changes

Accordingly now, SEBI/ stock exchanges can apply to the Tribunal for restatement of financial statements of a company, if they believe that the accounts were prepared in a fraudulent manner, on the basis of qualifications filed along with financial results. This could be a significant change from the current practice of recording past period errors in the current year financial statements as a prior period item.

It should be noted that restatements have generally been viewed negatively as they reflect inaccurate financial reporting in the past. Most of the restatements have accompanied consequential adverse impact on the stock prices.

Overall, the amendments bring in some very necessary changes to improve financial reporting by corporate India and providing the relevant information on a timely basis.

As the changes have been introduced within a short-span of time, implementation of the same continues to be a challenge. It is imperative that corporates’ internal processes and systems are robust enough to address the changing requirements.

Infrastructure companies planning to mop up funds through Infrastructure Investment Trusts (InvITs)

IRB Infrastructure Developers is planning to raise ₹5,000-6,000 crore, expected to file the DRHP within a month. IRB intends to use the proceeds mainly to fund new road projects it intends to bid for and also for existing ones. The company would also be bringing its six NHAI toll road projects, valued at ₹7,000-8,000 crore, into the trust. The company has mandated Deutsche Bank, Credit Suisse and IDFC Bank as merchant bankers for InvITs, sources close to the development told BusinessLine.

Other players are in the queue

Companies such as Adani Group, GMR Infrastructure, IL&FS Transportation Networks and L&T are also understood to be looking at InvITs to raise funds. Sterlite Power Transmission, a company that was demerged from Sterlite Technologies, is also planning to file the DRHP for InvITs by September. SPTL had filed an application for InvITs with SEBI in June. According to the sources, it was planning to raise ₹2,500-3,000 crore.

About InvIT

IRB fund raising could be the first fund-raising through an InvIT after it was first proposed in the Union Budget in 2014. In this year’s Budget speech, Finance Minister had proposed that any distribution made out of income of a SPV to InvITs having specified shareholding will not be subjected to dividend distribution tax, giving a much-needed fillip to the trust.

InvITs, much like mutual funds, enable individuals to pool investments into the infrastructure sector and earn a return on the income (after deducting expenditure). InvITs can invest in infrastructure projects, either directly or through SPVs, while in case of public-private partnership projects, such investments can be made only through SPVs.In India, InvITs are regulated by SEBI and are mandated to be listed.

Source: http://buff.ly/2b5YU1r

Treat HFCs on par with private banks: Assocham to SEBI

Assocham has asked SEBI to treat housing finance companies (HFCs) on par with the private banks and public financial institutions (PFIs).

Assocham said in a statement on Tuesday that the move will strengthen the role of HFCs in the government's mission of "Housing for All by 2022".

 "Debt investments in HFCs should be exempted from sectoral limits and securities issued under AAA rating for long-term instruments and A1+ for short-term instruments by HFCs should be treated on par with AAA rated securities and certificate of deposits issued by private banks," Assocham said in a communication to the Securities Exchange Board of India (Sebi) Chairman U.K. Sinha.

 Assocham said that mutual fund investments in AAA rated pass through certificates (PTCs) backed by mortgages should not be considered as exposure to the HFCs as these are serviced and secured by underlying pools of granular secured housing loans.

Sebi plans to ease funding, listing norms for start-ups

A revamp of the listing, fundraising norms on the anvil; Sebi to also expand definition of high-tech start-ups

Mumbai: The capital markets regulator is planning to expand the categories of investors eligible to fund start-ups; relax rules for listing shares; and ease promoter-holding and minimum trading-lot norms to help the country’s 3,100-odd start-ups to raise capital, two people directly familiar with the development said.

The Securities and Exchange Board of India (Sebi) also plans to further liberalize the norms related to alternative investment funds (AIFs) introduced in 2012, to increase access of capital to start-ups. The AIF route has made investments in start-ups more transparent and easier for private equity (PE) funds, venture capitalists and high networth individuals.

“Within the existing norms, certain changes in definition of eligible investors could be made to encourage more investors to put money in promising early-stage businesses,” said one of the two people cited above. “We are also examining if the minimum investment amount in the AIFs could be brought down slightly.”

Rules may also be relaxed to allow more early-stage companies to get listed.

The existing norms allow only so-called high-tech and new-age start-ups.

As many as 40 start-ups are ready to get listed either in India or overseas, according to Harish H.V., partner (India leadership team) at Grant Thornton India.

“Sebi’s thinking is in the right direction to liberalize the norms for start-ups, but the regulator should be careful while expanding the definition of a start-up eligible for listing,” said Harish.

“While amending the norms to attract more start-ups to get listed, it has to be ensured that no fly-by-night operator takes advantage.”

In June 2015, Sebi allowed the exchanges’ institutional trading platform (ITP) to be used for capital raising by start-ups which are intensive in their use of technology, information technology, intellectual property, data analytics, biotechnology or nano-technology, to provide products, services or business platforms with substantial value addition.

However, even among these companies, only those that have at least 25% of their pre-issue capital being held by qualified institutional buyers (QIBs) were allowed to access the exchange platform.

For other categories of startups to be eligible for getting listed, at least 50% of the pre-issue capital in the company has to be held by QIBs. Additionally, no person (individually or collectively with persons acting in concert) could hold 25% or more of the post-issue share capital in a listed start-up.

The norms laid down by Sebi, however, failed to attract any start-up to get listed.

The regulator is now considering expanding the definition of so called “high-tech” and “new-age” firms, which could opt for listing on ITP, said the second person. “The definition could be modified to include more categories of start-up companies to be eligible for the platform,” said the second person.

Further, the present norms allow only two categories of investors—institutional investors (with net worth of more than Rs.500 crore) and non-institutional investors (NIIs) other than retail individual investors to access the proposed ITP.

While getting listed on ITP, the minimum application size from such investors cannot be less than Rs.10 lakh and the minimum trading lot post-listing cannot be less than Rs.10 lakh.

These promoter-holding and minimum trading-lot norms are discomforting for startups, if and when they plan to get listed, according to a person associated with Indian Angel Network.

Sebi is planning to relax these norms, said the two people cited above.

“Sebi has received representations that the current cap on promoter holding on the company which is willing to list on the start-up platform, at 25% be relaxed to around 50-75%,” said the second person.

Also, the trading lot size at Rs.10 lakh is too high for any investor, and market participants have requested its reduction to Rs.5 lakh as earlier proposed. The regulator is actively considering these recommendations.

Although Sebi may not explicitly encourage retail investors to buy shares of start-ups, a lower minimum trading lot will enable more investors to invest in these early-stage companies.

“In order to make listing feasible for start-ups, it is very important to keep the minimum trading lot size less than the minimum required subscription amount,” said Harish. “The suggestion we made is to keep the minimum trading lot-size at Rs.2.5 lakh if the minimum subscription amount in the listing issue of the startup is fixed at Rs.5 lakh. Otherwise, if the value of the stock comes down even slightly after listing, it will be difficult for the investor to trade in the start -up stock.”

In January, an advisory panel headed by Infosys co-founder N.R. Narayana Murthy had suggested changes to facilitate capital raising.

Sebi’s latest plans are somewhat in line with the panel’s recommendations.

Th panel had suggested that Sebi change its eligibility norms for investors to put money in alternative investment funds.

The current norms require a person to invest at least Rs.1 crore in an AIF. The rules also say that any individual with total annual income of at least Rs.50 lakh should be allowed to put money in AIFs.

According to market experts who deal with AIFs, Sebi may consider easing some of these restrictions.

“The minimum investment required in the AIFs could be reduced to include more potential investors,” said the first person.

AIFs collect funds from high net-worth investors to invest primarily in unlisted securities and start-ups to promote entrepreneurship.

According to latest available Sebi data, AIFs got funding commitments worth Rs.30,687 crore by the end of December. Of this, at least Rs.14,031.39 crore has been already invested.

According to the Murthy panel, pension funds, insurers, domestic financial institutions and banks should contribute more to develop the AIF industry. Domestic pension funds in India, including the National Pension System (NPS) and the Employee Provident Fund Organization (EPFO) should allocate up to 3% of their assets to AIFs by 2017 and 5% by 2020, the panel had suggested.

Cross-currency trading: taking the next steps forward

This is a milestone in financial liberalization and perhaps a step towards making India a South-Asian hub for financial markets

The Reserve Bank of India (RBI) first announced its intention to allow cross-currency derivatives last September. Not many paid attention, except perhaps the exchanges and some intermediaries. While everyone thought it would take a year or more to operationalise, RBI and the Securities and Exchange Board of India (Sebi) moved with speed and are set to launch cross-currency derivatives trading in three of the most liquid pairs in the world—US dollar versus euro, British pound and Japanese yen. To facilitate trading, the cross-currency derivatives markets will be open from 9 am to 7:30 pm, so as to cover Japanese and European market timings and the first hour of the US markets.

This is a milestone in financial liberalisation and perhaps a step towards making India a South-Asian hub for financial markets. It is not often that an entirely international product is allowed to trade on our exchanges. In fact, it is a message that relevant products of all hues will be listed in India, so as to attract all stakeholders and participants to make India a world-level market. Over the years after electronic trading was introduced, the expanded product line is impressive—demat, futures, options, commodities futures, currency futures, interest rate futures and now this.

Significantly, a lot of the technology is already in place. With ready infrastructure and a close association between the RBI and Sebi, it is inevitable that more such steps are on the anvil; we have already seen the move to allow foreign direct investment (FDI) in commodity broking.

Is it also an allied effort to finally free-float and internationalise the rupee? Perhaps inspiration has also been taken from China, which has determinedly focused on internationalising the yuan, which has seen its active trading turnover increase four-fold. But this will require a two-way endeavour. Not only will we have to promote cross-currency trading in India to attract global traders, we will also have to head to the world’s largest currency trading playground—London—and work our way into that circuit so that the rupee is actively traded. It also means stocking up our foreign exchange reserves, which we have been doing.

There could be immediate benefits to the domestic trade. Intermediaries stand to benefit from the new product as it will strengthen currency futures and options (F&O) as a revenue line. It also uses the existing dealing set-up and the employees are already familiar with the products. Only brokers’ research teams will have to master the global currency pairs and put out trading recommendations. Not a big task, yet something to work on as trading multiple assets can get complex. Specialist currency research analysts will be required to decipher global and country-specific business cycles and factors.

How other assets like commodities are faring will also affect this as much as exchange rates affect commodity prices. In case of commodities, the impact of release of economic data from several countries can have tremendous impact on a range of currencies. Witness the continuous changes in the strength of the US dollar as every move by the central banks of the US, the UK, Europe and Japan is analysed. There are many such determinants; as I said earlier, it gets complex. And so there is money to be made.

For clients, it is a new trading opportunity. It also allows full price linkage between asset classes. For example, the price of gold in US dollars primarily depends on the strength of the currency versus the euro. It also reduces one leg of the transaction for traders who, till now, had to synthesise two currency pairs to create the dollar-euro pair. With abundant real-time information available online in these pairs, and market timings designed to capture overseas news flows, this is an ideal product for traders in pursuit of profit.

To ensure that end-users also utilise the markets and it does not become a ‘punters only’ segment, one important bridge still remains to be crossed. Since this market is not deliverable, unlike a position in a bank, the enterprise will have to ultimately convert its forex position back to the bank where there will be a rate differential from the futures or options prices. This will make hedging a challenge. The second test will be liquidity in contracts beyond the immediate months; something that still has to be successfully tackled in our existing commodity and currency markets.

We will also have to surmount operational challenges. Currency is traded 24 hours every day, starting Monday morning in Japan to Friday evening in New York. Trading continues on holidays as well. If there is a holiday in, say, the US, trading will still take place in the rest of the world.

Read in conjunction with the recently announced benefits to Gujarat International Finance Tec-City Co. Ltd, also known as GIFT City, Sebi’s growing responsibilities, FDI in commodities broking, and trying to get interest rate futures off the ground (which is a necessity before the rupee becomes fully convertible), the big picture is clear. There are many ifs and buts, yet allowing cross-currency derivatives is a brave move with far-reaching consequences for the vibrant financial services industry in India.\

Sun Capital

Is Sebi nudging investors in mutual funds to go direct?

The websites of the fund houses will provide details of the money managers and chief executive officers earn

The Securities and Exchange Board of India’s (Sebi) circular dated 18 March 2016—that mandated additional disclosures about how much money your mutual fund distributor makes on your investment in absolute terms and how much salary your fund managers (and other top mutual fund officials) earn—kicked up quite a storm.

Fund houses will now need to disclose how much commission your distributor has earned on your investment—on a half-yearly basis—in your half-yearly common account statement (CAS), in absolute terms. The statement will also show the expense ratio of direct and regular plans of your MF scheme. The fund houses’ websites will provide details of how much their money managers and chief executive officers earn. Scheme Information Documents of every MF scheme will also mention how much—if at all—they have invested in that scheme. There are a few other requirements, but they are not as important, so we will leave them aside for now.

I want to turn the attention to two of Sebi’s most crucial requirements. The need to disclose distributor’s commission in absolute terms, and the mention of expense ratio of direct and regular plans in your CAS.

What the numbers show

Let’s begin with disclosing distributor’s commission. Why does Sebi want you—the investor—to know how much your agent is earning? Presumably, to ensure that you are sold the right product, that you get comfort from the fact that your distributor has not earned anything out of the ordinary, like an expensive foreign holiday, to sell you the MF scheme. That’s fine. Nothing wrong here.

But how will investors react if they see distributors’ earnings, in absolute terms? There could be three possibilities. First, no reaction. Second, some investors might be tempted to pull out if they feel distributors are earning way too much on their investments and go direct. Third, they may ask for a rebate. Let’s see how and why.

Click here for enlarge

Take a look at the table. We assumed a mid-cap fund and that you invest Rs.50,000 every month in it, through a systematic investment plan, between March 2006 and March 2016. Over the 10-year period, you would have invested a total of Rs.60 lakh. As on 1 March 2016, your portfolio value would be Rs.1.46 crore. As per rough calculations, your latest half-yearly CAS (as on March 2016) would have shown your distributor having earned aboutRs.77,800 as commission for the period between September 2015 and March 2016.

These are rough numbers as we have assumed a trail fee of 1% per annum and have also calculated the trail fee based on the 6-monthly average assets under management of the portfolio.

Actual numbers will vary depending on the formula each fund house uses. Also, how MFs account for gifts and money spent on distributors, apart from commissions, remains to be seen. This is a simple illustration of one way of how trail commissions could look in your CAS.

My point is: will it not bother you knowing that your distributor has earned Rs.77,000 as commission on your investment? That too, for just the previous six months? In this example you have been investing for the past 10 years.

Take a closer look. Between September 2010 and March 2011, due to market volatility, the scheme’s net asset value dropped and so did the value of your investments, from Rs.42 lakh to Rs.39 lakh. Now see your distributor’s commission. It went up marginally, from Rs.18,936 to Rs.21,888. This is due to short-term volatility and also because trail fees in this example are calculated using the past six-month average corpus. In a continuous market fall, the trail fee will go down. Still, it could bother many investors.

A susceptible investor is likely to be alarmed if she sees that her corpus has gone down, but the distributor is still earning a commission, and which has gone up. Step forward to 2016 and we now know that this investment grew to become Rs.1.54 crore (as on 23 March) but it’s a real possibility for the same investor to have been upset in 2010-11 when the economy was in a bad patch.

It’s also human psychology. While a percentage figure of 1% doesn’t bother you, an absolute number just seems larger and might make you reconsider your investments. The moment you put a figure, and if that figure runs into thousands—which it will if, ironically, you have a good distributor and one who convinces you to stay invested for the long run—it sets the cat among pigeons.

Finding worth

Some believe that distributors should not get trail fees in the long run because if advice is what is required to convince investors to stick around, then Sebi-registered investment advisers (RIA) should be the ones giving the advice, and not the distributors. We’ll come to that in a short while.

Meanwhile, upon looking at the absolute commission figures, some large and mass affluent investors might use this as an opportunity to demand a cut from their distributor’s commission. It is possible that distributors, especially those from Beyond Top 15 cities where financial literacy is poor, might feel obliged to give a cut from their commission to investors in volatile markets when customers see a drop in valuations. Corpus can fall not just due to bad advice, but also market volatility. Although commission passback is banned, it still happens privately. And it could potentially get worse.

After telling you how much money your distributor has been making on your investments, Sebi now wants you to turn your attention to another detail that your CAS will now disclose; your scheme’s expense ratio of the regular plan (the plan in which you have invested in) as well as the direct plan (the cheaper cost plan that is devoid of distributor fees). Suffice to say that if you have already been riled up at the fact that your distributor has been making money even as your fund may have shown a short-term loss, say, during volatile times, you may get tempted to go direct and save the commission. This may not be Sebi’s intention but investors switching to direct plan is a possibility we cannot ignore.

That’s the danger. Direct plans are not for everyone. They are only meant for those investors who have the knowledge and the skill to pick and choose MF schemes on their own. And for those who have the time to do the added work of tracking funds regularly. Unknowing investors who think they can manage portfolios on their own without a distributor’s help, face the danger of investing in a wrong scheme and suffering far greater damage than just the difference in the expense ratios of the two plans.

Why, then, not go to a financial planner or a Sebi-registered investment adviser, pay her fees for advice on investments and financial planning and then invest through the direct plan? Also, if distributors are merely vendors, then why should they advice and earn fees (trail fees)?

Sebi’s vision appears to be to have two classes of sellers; one is a distributor who is a vendor and should, therefore, disclose all commissions that she earns from the fund house. The other person is the adviser who charges fees to you—the investor—and then routes your investments through direct plans. In doing so, Sebi has nudged distributors to either become registered investment advisers (RIA) or remain as distributors but disclose fees.

RIAs are supposed to disclose fees too, but since Sebi has now allowed them the direct plan route (starting 2016), they are now in a better position to justify their fees.

There are two problems with this approach. RIAs—who can demonstrate value—will be able to pull in customers who are willing to pay. But this breed of customers is still small in India. The remaining investors—who don’t want to pay an adviser and therefore choose to stick to a distributor who doesn’t charge a fee—will now get to decide if their distributors are paid adequately or not.

Secondly, disclosures are good. But the scheme’s total expense ratio (TER) figure is what we should be looking at. If Sebi feels that the TER is high, it should simply reduce it. Or, if it feels that the trail fee—after a point in time—should be capped, then it should say so. Such measures are not only enforceable, they also send out a message that if Sebi feels that higher costs prevent MF penetration, then a reduction in costs will now lead to higher penetration.

Further, disclosing a tad too much also looks like a soft nudge by Sebi to distributors to become financial advisers. The regulator seems to be thrusting a change into a distributor’s business model, based on which some distributors will stop earning trail fees, overnight. A standalone distributor cannot become an RIA presently unless she decides to let go of her trail commission overnight. Unless she forms a company and keeps her distribution business (that earns trail commission on legacy clients) in a separately identifiable department. That bit is allowed by Sebi’s RIA guidelines.

That brings me to my earlier question: should distributors—or vendors, as some people call them—earn trail fees? If trail fees is earned for advice provided, then why should distributors earn trail fees? And if so, why fear the disclosure of trail fees in the CAS?

Since trail fees are paid to the distributor for as long as the investor stays invested, it doesn’t naturally mean that the distributor is giving investment advice here. It need not be a fee paid for advice. Even to convince the investor to stay invested for a long period of time itself is a task, which—in cases of those distributors with a high persistency ratio—is hard work.

And if the distributor has gone out and acquired a customer, there should be no harm in paying a trail fee, especially since it’s a fee that rewards the distributor for investor’s patience. Sure, there are investors who readily stick around and distributors earn trail fee without doing anything. But such investors are in a minority; else MF penetration numbers would have been much higher.

The last point

Disclosures are a must. But how much disclosure is good? Ultimately, what is the aim of a disclosure? To encourage MF investments? To reduce misselling? More importantly, are investors armed to make sense out of a particular disclosure or does it have a danger of being misinterpreted?

Also, if Sebi is keen to change its own rules (for example, distributors can earn trail commission till the investor stays invested), then it should allow time for existing distributors to shift to the new fee-based model. By influencing investors’ behaviour without first educating them to correctly interpret the added information they are about to get, Sebi has not sent out the right signal. The intent is good, but the method is not.

Sun Capital

Sebi may peg M&A ‘control’ cap at 25%

Regulator’s move is aimed at removing ambiguities that companies confront during takeovers

Mumbai: The market regulator is set to clarify what the term ‘control’ means in the context of mergers and acquisitions (M&As) by pegging the shareholding threshold of an acquirer at 25%, two persons familiar with the development said.

The move is aimed at removing ambiguities that companies currently confront during takeovers, one of the two persons said, requesting anonymity.

Currently, the definition of ‘control’ under the Substantial Acquisition of Shares and Takeovers (SAST) Regulations, 2011—popularly known as the Takeover Code—doesn’t specify a threshold for shareholding.

“The numerical threshold for determining control is a globally accepted norm and should be the prescribed criteria along with the other factors which may signify control,” said Tejesh Chitlangi, a partner at law firm IC Legal.

The current takeover code states that an acquirer is in ‘control’ only if the board of the company that’s being acquired gives the former the right to appoint a majority of the directors, and have the final say on management and policy decisions.

The control of management or policy decisions is through shareholding or management rights or shareholders’ agreement or voting agreements.

“The Securities and Exchange Board of India board will clear a discussion paper on Saturday, which proposes to peg the numeric threshold of voting rights (shareholding) at 25% and giving protective rights to the acquirer,” said the second person, who also declined to be named.

A Sebi spokesperson did not respond to an e-mail seeking comment.

According to the discussion paper, there could be a framework for protective rights with an exhaustive list of rights that do not lead to acquisition of control.

These protective rights would be granted to the acquirer if they are cleared by 51% of the minority public shareholders.

“While it will be important to have a list which considers the commercial realities of merger and acquisition transactions, it may be a practically onerous task to have an exhaustive list that captures all the exempted protective rights and Sebi may need to grant an exemption on case-to-case basis,” the second person said.

According to Lalit Kumar, partner at J. Sagar Associates, there is currently no clarity on whether or not protective (veto) rights to investors will lead to control.

“This issue came up in the matter of Subhkam Ventures where Sebi held that protective rights lead to control. However, in appeal to the Securities Appellate Tribunal (SAT), SAT held that protective rights only lead to negative control and not positive control,” Kumar said.

“The matter went in appeal to the Supreme Court, which did not pass any order on this issue but said that SAT’s order will not act as a precedent. Therefore, presently, there is no decided case on this issue although the general view is that protective rights do not lead to control,” he explained.

Kumar’s reference is to private equity investor Subhkam’s 17.9% stake in MSK Projects. In 2007, when it bought the stake, Subhkam sought and received several so-called negative rights (such as the power of veto on key decisions). In 2008, Sebi ruled that this constituted control. On appeal, SAT ruled in favour of Subhkam. Sebi appealed the case in the Supreme Court which dismissed the case. However, because it said SAT’s order would not be a precedent, private equity investors are still not sure as to whether negative rights such as the one Subhkam had constitute control (such rights are common in agreements between promoters and private equity firms).

Some in the legal fraternity say the definition of control cannot be set in stone.

“The question of control is a nuanced one primarily of fact and secondly of law… Anything set in stone on defining control would lead to false positives and negatives. Sebi should adopt a more nuanced approach and go by court rulings as precedents,” said Sandeep Parekh, founder, Finsec Law Advisors.

Sebi first started reviewing the definition of control in 2014. Finalizing a proposed framework took longer than expected, nearly 20 months, in wake of the number of suggestions.

Sebi decided to re-examine the definition of control following the 2013 acquisition of a 24% stake in Jet Airways (India) Ltd by Abu Dhabi-based Etihad Airways PJSC for Rs.2,058 crore.

In May 2014, Sebi ruled that the deal did not attract the provisions of the Takeover Code, as it found a lack of substantial controlling powers with Etihad after the transaction.

Private Equity

Banks will have to lower lending rates in April

Mumbai Irrespective of whether the Reserve Bank of India (RBI) cuts its policy rate on or before the April 5 policy review, banks will have to cut their lending rates by at least 25-30 basis points (bps) in April, to catch up with the lag in transmission.

The central bank has, so far, cut its repo rate by 125 bps and banks have passed on between 60-70 bps of the cut. If the central bank cuts some more, as is expected by the market, banks' lending rate cuts should be steeper, too. One basis point is 0.01 per cent.

But, the lending rate cuts might not happen immediately in March, as banks would ideally want to shore up their treasury profits by taking advantage of the recent dip in bond yields, and also enjoy an improvement in spreads in the last month of the financial year, when credit demand generally picks up.

The resultant profit will also mend their bottom line to some extent, as they have been severely hit by RBI's asset quality review programme, which will continue to exert pressure in the March quarter as well. "Transmission will happen, irrespective of the rate cut quantum (by RBI)," said Soumya Kanti Ghosh, chief economist, State Bank of India.

However, that will likely not be in March, said A Prasanna, chief economist at ICICI Securities Primary Dealership Ltd.

"There is pressure on bank balance sheets now. Transmission will improve with liquidity in April," Prasanna said.

From April 1, RBI's marginal cost-based lending rate (MCLR) would kick in, which will prod banks to use their incremental cost of funds, rather than average cost of deposits to arrive at the lending rate. Since money market rates move faster than deposit rates and banks tap into these money markets, the incremental cost will add dynamism in lending rate calculations. And, 10-year bond yields have fallen 15-20 bps since the Budget. If this trend continues till March-end, banks would have to factor in this drop.

Finally, with RBI infusing longer-term liquidity in the system through secondary bond market purchases, banks should have less reason to complain that system liquidity tightness is not letting them pass on rate cuts. Under the new liquidity framework, RBI ensures call money rates are anchored at around the repo rate, no matter how much liquidity infusion is needed. However, bankers have complained that the liquidity infused is short-term, and more permanent liquidity needs to be infused through secondary market bond purchase. The central bank does so through its open market operations, or OMO. Including a scheduled Rs 15,000-crore OMO purchase on Thursday, RBI's liquidity infusion is close to Rs 50,000 crore in recent months.

The OMOs, and with government spending picking up, have ensured that from an acute shortage of Rs 1.6 lakh crore at the end of January, banking system liquidity has improved to less than Rs 1 lakh crore now.

But there would be stress on the liquidity front again, starting March 15, when advanced tax outflow starts, pointed out Gaurav Kapur, India economist at Royal Bank of Scotland.

The tight liquidity condition would be needed to be evened out first before banks can move with rate cuts and that would be by the next financial year, Kapur said.

However, whether the rate cut would be of any meaning to revive growth is a different question altogether, articulated IDFC Bank's Chief Economist Indranil Pan.

"With MCLR pricing the incremental cost, pass-through of the cumulative 125-basis point rate cut is expected to be at 25-30 bps. So, even after a transmission of 85-90 bps if credit growth doesn't take place, one needs to ask if the problem lies with the RBI rate cuts and transmission mechanism or the credit channel itself," Pan said.

Investment Banking 

Banks now have room to raise funds via tier 2 bonds: RBI

With the Reserve Bank of India (RBI) tweaking of banks’ core capital to include a part of real estate assets and foreign exchange, lenders will now have additional headroom to raise funds through tier 2 bonds, RBI deputy governor R Gandhi said on Thursday.

He told reporters on the sidelines of Gyan Sangam, a brainstorming session with financial sector players convened by the finance ministry, that Rs 25,000 crore of capital allocated for public sector banks in FY17 should be enough. “Banks can also go to the markets next year, so we believe it will be enough,” he said

On asset quality review, Gandhi said it is unlikely bad loans will spill over from FY16 to the next fiscal. “Spillover of bad loans unlikely in FY17 after the asset quality review,” he said. State-owned banks have been under severe stress arising out of delinquency in loans mostly belonging to infrastructure, power and steel sectors. As of September 2015, the stressed asset ratio — a combination of bad loans and recast assets — of public sector banks stood at 14.1%, versus 4.6% in private sector banks.

As per the RBI’s latest move, which is in sync with the Basel III capital norms, banks can account for 45% of their revalued real estate assets as tier 1 capital subject to riders.

The revised regulations on tier 1 capital include treating revaluation reserves, subject to conditions, as Common Equity Tier 1 (CET1) capital at a discount of 55%, instead of as tier 2 capital; treating foreign currency translation reserves, subject to conditions, as CET1 capital at a discount of 25%; and several directives on how to treat deferred tax assets vis-à-vis CET1 capital. These changes could improve the capital adequacy ratio of major PSBs by up to 100 basis points.

According to estimates, these relaxations, particularly that of treating revaluation reserves as CET1 capital, given the huge amounts of physical assets PSBs are sitting on, will free up capital upwards of Rs 30,000 crore-35,000 crore for them and upwards of Rs 5,000 crore for private sector banks.

Hinting that the RBI is looking at all such possible measures to augment the existing capital of banks, which would reduce the burden on them to raise fresh capital to a certain extent, governor Raghuram Rajan had hinted that the RBI is trying to identify non-recognisable capital, such as undervalued assets, already on bank balance sheets and could allow some of these to count as capital under Basel norms, provided a bank meets minimum common equity standards.

Sun Capital