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Evolution and Regulatory Framework of Mutual Funds

Evolution and Regulatory Framework of Mutual Funds. K.Suresh Babu Vice President – Treasury Reliance Capital Ltd. Sunday, July 26, 2009 at SIES Management Institute. confidential. Session 1 Agenda for Discussion. Mutual Fund and Basic Terms Evolution of Mutual Funds

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Evolution and Regulatory Framework of Mutual Funds

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  1. Evolution and Regulatory Framework ofMutual Funds K.Suresh Babu Vice President – Treasury Reliance Capital Ltd. Sunday, July 26, 2009 at SIES Management Institute

  2. confidential Session 1 Agenda for Discussion • Mutual Fund and Basic Terms • Evolution of Mutual Funds • Growth of Mutual Fund Industry

  3. What is Mutual Fund ? • A Fund Established in the form of a Trust; To raise monies thru the sale of units to the public under one or more schemes For investing in securities including money market/ gold/ gold related instruments or real estates. • Pools the savings of a number of investors who share a common financial goal. • Investment of pooled savings by Fund Managers of a Mutual Fund in capital market instruments such as shares, debentures and other securities. • Sharing of income earned through investment and capital appreciation realised by unit holders in proportion to the number of units owned by them.

  4. Why Mutual Funds ? • Operates on the principle of ‘strength in numbers’ • Small investments within the affordable reach and with a wide choice of schemes • Spreads the investment risks by diversified portfolio • Professionally managed basket of securities at a relatively low cost • Easy liquidity by redemption at NAV based prices • Transparency & Flexibility • Well regulated • Tax benefits

  5. Investing in Mutual FundsRisk Return Matrix Higher Risk Higher Risk Lower Return Higher Return Equity Lower Risk Lower Risk Lower Return Higher Return Bank FDs/ Postal SavingsMutual Funds

  6. How Mutual Fund is formed ? • Constituted in the form of a Trust • Instrument of Trust in the form of a Trust Deed • Registered under the Indian Registration Act, 1908 • Executed by the Sponsor in favour of the Trustee indicated in the Trust Deed • Trust Deed contains clauses as per the Regulations that are necessary for safeguarding the interests of unit holders

  7. Mutual Fund – The Basic Terms • Unit The interest of the unit holder in a Scheme which consists of each unit representing one undivided share in the assets of a Scheme • Unit holder A person holding units in a Scheme of a Mutual Fund • Net Asset Value (NAV) per unit Market value of the securities held by the Scheme on any particular date. Value of all assets minus value of liabilities (Unit Capital plus reserves) divided by no. of units

  8. Mutual Fund – The Basic Terms • Sale Price / Offer Price Price payable for investment in a Scheme • Repurchase Price / Redemption Price Price at which units are repurchased by Mutual Fund • Repurchase Load / Back-end Load / Exit Load Charge collected by a Scheme when it buys back the units from the unit holders

  9. Types of Mutual Fund Schemes • By Tenor Open ended: offers units without specifying any duration for redemption. Close ended: where the period of maturity is specified • By Asset class Equity, Debt or Income, Balanced Schemes, Gold Exchange Traded Funds, Money Market Funds • By Position philosophy Sector Specific (min 65%), Fixed Maturity Schemes • By Geography Country Funds, Offshore Funds

  10. Types of Mutual Fund Schemes • Capital Protected Schemes Protects the capital invested thru orientation of its portfolio structure. Close ended and no repurchase before the maturity. • Index Fund Invests in securities in the same proportion as an index of securities • Fund of Funds Invests primarily in other schemes of the same MF or other MFs • Real Estate Mutual Fund Scheme Invests directly or indirectly in real estate assets or other permissible assets. Close ended Scheme and listed.

  11. Schemes of a Mutual Fund • Plans: Dividend & Growth • Options: Payout & Reinvestment • Sub-options: Yearly, Half yearly, Quarterly, Monthly, Weekly, Daily • Sub-plans: Systematic Investment Plan Systematic Withdrawal Plan Systematic Transfer Plan

  12. Mutual Fund Options for Dividend Growth Dividend Div-Reinvst No.of Units 1,000 1,000 1,000 Face Value Rs.10 Rs.10 Rs.10 NAV Rs.15 Rs.15 Rs.15 Div.Declared per unit --- Rs. 5 Rs. 5 New NAV Rs.15 Rs.10 Rs.10 No.of Units (Ex-Div) 1,000 1,000 1,500 Value of Units Rs.15,000 Rs.10,000 Rs.15,000 Div. Declared --- Rs. 5,000 --- Total Rs.15,000 Rs.15,000 Rs.15,000

  13. Evolution of Mutual Funds • The first investment trust, Eendragt Maakt Magt (in English it means ‘Unity Creates Strength’) setup by a Dutch merchant in 1774 followed by more investment trusts. • The Foreign and Colonial Govt Trust formed in London in 1868. • The Massachusetts Investors Trust formed in US in 1924. • The Great Depression in 1929 lead to the birth of powerful regulators with enactment of legislations

  14. Growth in the US Mutual Fund Industry • The $ 500 million AUM in 1940 rose to $ 17 billion by 1960 • With new investment exposures and higher returns than banks, the AUM had reached $ 95 billion by the end of 1970 • With more maturity in the financial markets, the AUM had reached $ 7.4 trillion in 2004 with a retail investor base of 91 million.

  15. Evolution of MF industry in India1964-1987 - Birth of UTI • UTI gave birth to MF industry in December 1963 with the enactment of UTI Act and under RBI’s control and later delinked in 1978 to IDBI • The first IPO, US 64 in July 1964 mobilised 126,000 applications for Rs.17.40 crores and later AUM crossed Rs.1000 crores in 1991 • The second scheme, ULIP launched in 1971 • UTI Mastershare, India’s first true mutual fund scheme launched in 1986 and total AUM reached Rs.6,700 crores at the end of 1988. • AUM of UTI reaches Rs.6,700 crores in 1988

  16. Evolution of MF industry in India1987-1993 – Entry of Public Sector • PSU banks and insurers allowed to float mutual funds in 1987 • SBI was first to launch mutual fund in Nov 1987 followed by Canbank in Dec 1987, LIC in 1989 and Indian Bank in 1990 • The AUM of UTI crossed Rs.38,247 crores and PSU funds Rs.8,757 crores by 1993. • Investors shifting away from bank deposits to mutual funds by allocating > 6% of the savings to fund investments

  17. Evolution of MF industry in India1993-1996 – Entry of Private Sector • The entry of private sector and foreign players allowed in 1993. Kothari Pioneer was the first private fund house to start operations followed by 11 others. • Morgan Stanley was the first foreign player in 1994. • SEBI was setup in 1993 to regulate the MF industry with SEBI Mutual Fund Regulations came in force in 1996.

  18. Evolution of MF industry in India1996-2003 – Regulated Markets • Deregulation and liberalisation introduced competition and provided impetus to the growth of the industry • 33 Mutual Funds with AUM of Rs.121,805 crores; UTI with Rs.44,541 crores AUM ahead of others. • UTI bifurcated in 2002 and came under SEBI purview. • SEBI tightened regulations, banned agents from giving commissions to investors, made AMFI registration compulsory for new agents.

  19. Evolution of MF industry in India2003-2004 – Growth Phase • UTI bifurcation in February 2003 • Assured return schemes (US 64) with AUM of Rs.29,835 crores into specified undertaking of UTI under the Administrator controlled by Govt. • UTI Mutual Fund with AUM of Rs.76,000 crores comes under the purview of SEBI • AUM reaches Rs.153,108 crores by September 2004 with 29 funds and 421 schemes.

  20. Evolution of MF industry in IndiaJuly 1993 - June 2008 (15 years growth) • Beginning of the era of privatisation in July 1993 • 11 times growth in AUMs from Rs.47,000 crores to Rs.530,000 crores in 15 years • Top 5 of 35 MF houses account for more than half of the MF industry’s AUM. • Four of the Top 5 fund houses are privately owned.

  21. Unit holding Pattern of Mutual Fund Industry – March 2009 Category No.of Investors Net Assets (Rs.crs) Individuals 460,75,763 (96%) 155,283 (37%) NRIs 9,71,430 ( 2%) 22,821 ( 5%) FIIs 146 (<1%) 4,983 (1 %) Corporates/ Institutions 5,75,938 (1%) 236,233 (56%) Total 476,23,277 419,321

  22. Average AUM as at the end of June 2009 increased to Rs.670,937 crs An increase of Rs.106,185 crs (18.80%) over Rs.564,752 crs as at June 2008. Of the total AUM of Rs.670,937 crs as at the end of June 2009, Bank sponsored (4) Rs.113,386 crs Institutional (1) Rs. 32,415 crs. Private Sector (30) Rs.525,136 crs. AUM - June 2009

  23. Status of AUM - June 2009 No.of Schemes AAUM (Rs.crs) Income/ Debt oriented 485 488,653 Growth/ Equity oriented 341 162,242 Balanced Schemes 37 15,732 Exchange Traded Fund 18 1,636 Fund of Funds 10 2,673 Total 891 670,937

  24. confidential Session 2Agenda for Discussion • Constituents of Mutual Fund • Pricing & Regulations • Investment Restrictions & Valuation Norms • Accounting Policies & Standards

  25. Mutual Fund Constituents • Sponsors • Trustees • Asset Management Company • Agents/ Distributors • Custodians/ Depositories • Fund Accountants • Registrar & Transfer Agents • The Regulator - SEBI

  26. Sponsors of Mutual Fund • Initiates the idea to setup a mutual fund and establishes the mutual fund • Should have a sound track record and general reputation of fairness and integrity in all business transactions • Contributes at least 40% of the networth of the AMC • Should not have been guilty of fraud or has not been convicted of an offence involving moral turpitude or has not been found guilty of any economic offence • Has a net worth of not less than Rs.10 crs • Appoints the AMC, Trustee and Custodian

  27. Trustees • Holds the property of the mutual fund in trust for the benefits of the unit holders • Persons of integrity not convicted of any economic offence or violation of security laws • Internal regulators to protect the interests of unit holders. • Appointed by Sponsors with SEBI’s prior approval • Minimum 4 trustees with two-thirds be independent. • No Director/ Employee of a MF shall be eligible to be appointed as a Trustee of any other MF.

  28. Rights and Obligations of the Trustees • Accountable as the Custodian of the funds/ property of MF and hold them in trust for the unit holders’ benefit • Appoints AMC and enters into an IMA for making investments • Appoints Custodian and enters into a Custodian Agreement, appoints Key Personnel, Compliance Officer, R&T and designs internal control mechanism. • General and Specific Due diligence before the launch of any scheme by MF • Reviews quarterly all transactions of the MF, service contracts of AMC, investors complaints/ redressal mechanism and reports half yearly to SEBI • Right to obtain information from the AMC and to terminate the appointment of AMC • Appoints different auditors for MF and AMC.

  29. Asset Management Company • Investment Manager – Responsible to Trustees • Sound track record and reputation for fairness and integrity with a minimum net worth of Rs.10 crores • One-half to be ‘independent directors’ • No AMC/ Directors/ Officers of AMC shall be eligible to be appointed as a Trustee of any MF. • Appointment can be terminated by majority of unit holders or by Trustees • Handles operational matters from launching schemes to managing them to interacting with investors • Ensures that AMC Board has at least 50% directors who are not associated with the Sponsor or Trustees. • Directors of AMC shall not hold the office of Director of another AMC • Submits information / documents to the Trustees periodically

  30. Obligations of the Asset Management Company • Shall maintain proper books of account, records for each Scheme. • Shall follow the accounting policies and standards and provide details of distribution and accumulation of income accruing to the unit holders in a fair manner. • Shall submit quarterly report on the functioning of MF Schemes to the Trustees.

  31. Responsibilities of the Asset Management Company • Management of schemes as per the IMA • Due Diligence in all investment decisions • Responsible for regulatory compliance and submits quarterly reports to Trustees, SEBI on fund activities • Charges AMC fee as per Regulations • Appoints key personnel / R&T and set up systems for investment management, accounting, internal audit etc.

  32. Code of Conduct by AMC and Trustees • Shall maintain high standards of service, exercise due diligence, ensure proper care and exercise independent professional judgement. • Not to organise, operate, manage the portfolio of Schemes in the interests of sponsors, AMC and Trustees. • Disseminate to all unit holders of adquate, accurate, timely information about the investment policies, objectives, financial position and general affairs of the Scheme. • Avoid excessive concentration of business with broking firms and avoid conflicts of interest in managing the Scheme affairs.

  33. Custodian & Fund Administrators • Provide post-trading and custodial services for schemes • Keep securities and other instruments belonging to the Scheme in safe custody • Ensure the benefits due to the holdings of the MF are recovered • Be responsible for loss of or damage to the securities due to negligence • Accounting policies and standards prescribed by SEBI • NPA provisioning • Scheme Accounting, NAV computation and Audit

  34. R & T Agent • Accepting and processing investors’ applications for issue and redemption of units on behalf of fund • Handle communications with investors • Perform data entry services • Despatch account statements • Processing redemption and dividend pay-out • Payment of brokerage to agents • Systems facilities and back up of investors’ records • Responsible for customer service

  35. Agents & Distributors • Appointed by AMC • May act on behalf of different Funds • Independent individuals are appointed as Agents • Should be AMFI registered

  36. Regulators • SEBI • AMFI • RBI • Ministry of Finance • Company Law Board • Stock Exchanges for listed schemes • Office of the Public Trustee

  37. Pricing - Net Asset Value • Indicates the Market Value of the assets of a Scheme minus its liabilities • Indicates the Price at which units are subscribed/ sold and are repurchased/ redeemed • Calculated for each Plan or Scheme of the Fund every day including the close ended Schemes (other than ELSS) and published in 2 daily newspapers. • Value of Net Assets divided by the number of units outstanding in each Scheme/ Plan on the valuation date. • Updating the on the AMFI website by 10 am the following business day

  38. Load Structure • Exit Loads (Entry Loads since waived for all Mutual Fund Schemes effective August 1, 2009) • Redemption Price not lower than 93% of NAV • Of the Exit Load charged to investors, a maximum of 1% of the redemption proceeds shall be maintained in a separate account which can be used by the AMC to pay commission to the distributors and meet marketing / selling expenses. Any balance shall be credited to the Schemes immediately. • Adequate disclosure in the OD / SID/ SAI and modifications prospectively

  39. Regulations - Advertisements • Shall not be misleading or contain false and incorrect information • Shall disclose the investment objectives of each Scheme, names of the Settlor, Trustee and make a statement that all MF investments are subject to market risks and there can be no assurance that the fund’s objectives will be achieved. • Shall disclose prominently the risk factors • Shall be in conformity with the Advt code specified and submitted to SEBI within 7 days from the date of issue.

  40. Regulations – Borrowing Powers • Shall not borrow except to meet temporary liquidity needs of MFs for repurchase, redemption of units or payment of interest/ dividend to the unit holders. • Shall not borrow > 20% of net assets of the Scheme and duration shall not exceed 6 months.

  41. Regulations – Expenses of Scheme • Clear identification and appropriation of expenses in individual Schemes. • AMC advisory fee at : 1.25% of weekly average net assets outstanding for the Scheme in each year for the net assets upto Rs.100 crs and 1% of the excess over Rs.100 crs. 0.75% of the weekly average net assets in case of Index Fund Scheme • Recurring expenses at 2.50% for the first Rs.100 crs of average weekly net assets; 2.25% for next Rs.300 crs., 2% on the next Rs.300 crs. And 1.75% on the balance of the assets. 1.5% for Index Funds. Expenses Chargeable: Marketing / Selling expenses; brokerage, R&T/ Audit/ Custodian/ Trustee fees; Cost of statutory advertisements; Cost of providing statement of accounts, cheques for redemption/ dividend warrants.

  42. Regulatory RestrictionsClose-ended Schemes • Disclosure of portfolio of debt oriented close ended and interval Schemes/ Plans on a monthly basis within 3 days • Prohibition of disclosure of indicative portfolio/ yields in debt/ fixed income Schemes. • Restrictions on investments in/ purchase of debt and money market securities with maturity of upto 91 days only effective May 09. • Mandatory listing of units of all close ended Schemes (except ELSS) launched after December 12, 2008. Such units shall not be repurchased before the maturity. • Repurchase price of units of close ended Schemes prior to December 12, 2008 not lower than 95% of the NAV.

  43. Investment Restrictions • Investments in accordance with the investment objectives of the relevant MF Scheme • Inter-Scheme transfer of investments done at prevailing market price, without charging AMC fee and as per the investment objectives of the relevant Scheme. • Buy/ Sell securities on delivery basis and get transferred in relevant MF Scheme. • No investment in unlisted / listed security-privately placed of group company of the Sponsor. • Restrictions on lending in call money market • Derivatives for hedging and portfolio rebalancing as per norms

  44. Investment Restrictions • Not invest more than 15% of NAV in rated debt and 10% in unrated debt issued by a single issuer. • No MF under all Schemes own >10% of any company’s paid up capital. • Not to invest >10% of the Scheme’s NAV in equity of any company, except in case of index fund/ sector specific fund. • Aggregate value of illiquid securities not to exceed 15% of the total assets of the Scheme • No MF shall invest > 30% of its net assets in MMIs of an Issuer except for investments in GSec, TBs and CBLOs.

  45. Regulations on Investments in ADRs/ GDRs/ Foreign Securities • Overall ceiling limit of USD 7 bln. • Individual MF sub-ceiling 10% of net assets managed as on March 31 of each relevant year subject to a maximum of USD 300 mln. Per MF.

  46. Investment Restrictions - NFOs • No Scheme shall park more than 15% of the net assets in STDs of all banks together. (Can be raised to 20% with Trustees’ approval) • No Scheme shall park more than 10% of the net assets in STDs with anyone scheduled bank. • Tenor not to exceed 91 days. • No funds of a Scheme shall be parked in STDs of a bank which has invested in that Scheme. • No AMC charges on parking of funds in STDs in case of liquid/ debt oriented Schemes.

  47. Investment Valuation Norms • Value of the traded securities shall be at the last quoted closing price on any Exchange on the valuation day or day not more than 30 days before. • Non-traded securities shall be valued in good-faith by AMC. • All expenses and incomes accrued upto the valuation date shall be considered for computation of NAV. • Valuation of Debt instruments and G-Sec on Y-to-M basis on the prevailing market rates with appropriate discount for lower liquidity, if any. • The value of Rights Shares, until their trading, shall be calculated on the basis of the number of rights divided by original shares multiplied by the difference between ex and cum Rights offer. • All investments shall be shown at market value with necessary provision for exclusion of unrealised gain arising out of appreciation of investment which cannot be distributed to unit holders.

  48. confidential Session 3 Agenda for Discussion • Investors Rights and Information • Investors Service Standards • The Road Ahead for Mutual Fund Industry

  49. Investors Rights – Initial/ Regular Subscription • Right to get refund of application money within 6 weeks from closure of subscription if MF fails to receive the minimum subscription. • Entitled for interest at 15% pa from the expiry of 6 weeks from closure of subscription for failure to get refund • 15% interest for delayed redemptions of more than 10 working days. AMC liable for penalty for failure to despatch redemption proceeds within stipulated time. • Unclaimed redemptions and dividend at the prevailing NAV up to 3-year period • Uniform cut-off timings for applicable NAV • Minimum investors limit of 20 and 25% of the AUM

  50. Investor’s Rights • Right to obtain any information and inspect material documents • Right to receive Scheme portfolio before the expiry of one month from the close of each half year unless published in local newspapers • Right to receive the Schemewise Annual Report of a MF or abridged summary within 4 months from accounting closure. • Right to approve change in Fundamental Attributes of the Scheme • Right to wind up a Scheme and terminate the AMC with 75% voting • If NAV of a Scheme differs by >1% due to non-recording of transactions, whereby unit holders are allotted/ charged at higher/ lower price for sale/ purchase of their units, the AMC shall pay the difference in amount to/ by the Scheme. • Investor Complaints Redressal Mechanism

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