29th June 2012

The PM has cracked the whip - and how! Within days of assuming additional charge of the Finance Ministry, he has ordered a review of the MF and insurance businesses with a view to revive them from their current comatose state. Ministry of Finance has immediately called for a meeting on Monday, 2nd July, where it has invited the top 10 AMCs, AMFI and SEBI to hear suggestions on how to revive the MF industry. We humbly submit that this is a great opportunity for the industry to put forth a collective view - rather than individual opinions, and present a crisp agenda for business revival, which is both pro-business as well as pro-investor. We give below a suggested 5 point agenda for this crucial meeting, for the industry's consideration.

All important meeting scheduled for Monday, July 2nd

Prime Minister Manmohan Singh's statement about wanting to explore avenues to revive the mutual funds and insurance industries is having quite an impact among the babus in the Finance Ministry. The ministry, we understand, has summoned the top 10 AMCs, AMFI and SEBI to Delhi for a meeting on Monday, July 2nd, to discuss steps to revive the mutual funds industry. A breath of fresh air seems to be sweeping across the corridors of power, within just a couple of days of the PM taking over additional charge of the Finance Ministry.

As the industry scrambles to put together its wish list ahead of the July 2nd meeting, Wealth Forum submits a 5 point agenda that the industry can consider including in its wish list for this meeting. These are all points which either require a SEBI approval or FinMin approval. There are clearly a number of other steps that can and should be taken within the industry itself - which are therefore out of the purview of this wish list.

Time to offer a united view rather than individual opinions

We will only humbly request the industry to speak one voice at the meeting. Frankly, the last thing one would want as an outcome from the meeting is for the Finance Ministry to get an impression of a divided house - and therefore ask for consensus suggestions to be made formally later on, whenever that consensus is achieved. The Finance Ministry would certainly prefer if the industry makes a crisp presentation of its key recommendations - which all participants would be aligned with.

As we understand, one of the areas where the industry is a divided house is on the issue of re-introduction of entry loads. While some want it back, othes don't think it is a good idea. SEBI is clearly not in favour of bringing back entry loads. The mood seems to be an attempt to find solutions that can charge up business momentum without being seen as anti-investor. In keeping with this sentiment, here are our submissions :

Suggested 5 point agenda for the meeting

1. Expense ratio

We have recently written on this issue (See article on expense ratios) where we offered a politically acceptable solution to effectively increase the weighted average TER by 28-30 bps, without increasing the slabs rates, but by inflation-adjusting the slab amounts. This, we argued, will give some elbow room - with a sound justification - and can thus help counter any criticism about it being anti-investor.

Along with this increase, the industry has also been asking for fungibility in utilisation of the expense ratios - which means doing away with sub-limits within the overall expense ratio limit and thus allowing a little more freedom in utilising the expense ratio to the fullest. This frankly is something SEBI should have allowed a long time ago - there is nothing that is anti-investor in removing an unnecessary control on sub-limits within an overall TER. When the total amount to be charged to an investor is anyway regulated, what is the use of trying to regulate sub-limits? This needn't really go to the Finance Ministry for consideration - it can very well be approved by SEBI.

2. Rajiv Gandhi Equity Savings Scheme

Much has already been written on the need to make mutual funds as the eligible vehicle for RGESS. The only point we would like to highlight here is that it is critical to stress on the fact that the RGESS eligibility should not be restricted to any elaborate definition of "first time investor", but must be available for any tax payer in the country. If the Prime Minister himself has acknowledged that mutual funds have a crucial role to play in mobilising retail savings into capital markets - and that capital markets are being choked because of lack of domestic flows, and that tax breaks are the surest way to mobilise savings - not just in India, but worldwide - then it follows that every Indian tax payer must be incentivised to invest in RGESS. The truth is that the existing investor needs to be incentivised as much as a new investor. After all, it is the existing investor who has had a poor experience of equity markets in the last few years - it is he who needs to be brought back into the fold first, rather than leaving him out in the cold and running after a first time investor.

Another critical point that we think the industry should stress is that there is no need to create a separate set of new funds which are eligible for RGESS. All existing schemes which are equity oriented (not necessarily pure equity) should qualify for RGESS eligibility. This will give investors a chance to invest in existing schemes with good track records rather than forcing a slew of NFOs for the purpose of RGESS eligibility. The ministry can be reminded that several years ago, it had a similar provision - under Sec 54EA and 54EB of the IT Act, where all existing schemes qualified for those tax breaks and the investments were locked in for a period of 3 years, but within the same scheme itself. A similar provision can be created for RGESS, where investments upto Rs. 50,000 per annum can be earmarked for a 3 year lock in within existing schemes.

3. Change the definition of equity oriented schemes

Finance Ministry should be asked to direct CBDT to change the definition of equity oriented schemes for the purpose of all tax breaks from at least 65% equity exposure to at least 51% equity exposure. The existing tax breaks on long term capital gains tax as well as the proposed tax breaks for RGESS should be applicable to funds that have a minimum 51% in equities. The country needs savings to be channelized into equities, but investors get frightened by volatility of equity markets. Precious little money therefore comes into equity funds. The best way to break this logjam is to give a little more flexibility to fund houses to protect the downside by allowing non-equity exposure to go upto 49% rather than only 35%. This can spark off a lot more interest in genuinely balanced Balanced Funds and get retail investors to participate more willingly in funds that fit into the new definition of equity oriented schemes.

4. Allow flexibility in utilisation of exit loads

When SEBI abolished entry loads, it almost simultaneously cut off flexibility on exit loads - which is what caused most of the grief in the industry. After Mr. UK Sinha took charge, SEBI gave a partial leeway by allowing upto exit loads of upto 1% to be utilised by the AMC for marketing expenses. Rolling back the exit load regulations and reverting back to the pre 2009 scenario is not anti-investor in our view. There is no additional cost the investor pays on the way in - and, if he is a long term investor, there will be no cost he pays on the way out either. Short term investors will pay a price on the way out - but it is clearly not the regulator's intent to reward short term investors at the cost of long term investors. If the existing rules on utilisation of exit loads are removed, the industry can vigourously adopt a CDSC - contingent deferred sales charge structure - or a graded exit load. Investors can be charged, say 3% exit load for redemptions within 1 year, 2% within 2 years, 1% within 3 years and nil beyond 3 years. AMCs will have the comfort of either having the money for 3 years or collecting exit loads should the investor exit earlier. Based on this comfort, AMCs can formulate commission structures that incentivise distributors, without imposing incremental costs on the investor.

Of course, the issue of churn needs to be tackled - on a war footing. We have been arguing that formulating an anti-churn policy and implementing it is really in the hands of AMFI. There is no need to look towards SEBI or FinMin for this. It is indeed a matter of regret that AMFI is unable - in the forthcoming meeting - to confirm to SEBI and FinMin that it has indeed put in place a mechanism to check churn. Had it done this, it would have bolstered its case substantially for concessions on loads of any form.



5. Single cheque for fee collection

The variable entry load model - or the single cheque system - has been widely discussed in recent weeks. Clearly, for those distributors who wish to charge or who believe they have an ability to charge fees, there is a strong case to allow them to do so within a single cheque system - based on an amount specified in the application form itself. This again is not anti-investor, as the power still remains with the investor to decide how much he wants to pay to his advisor.

To conclude.....

We firmly believe that these 5 measures, if implemented, can bring in a lot more momentum into the business - in the short as well as long run. And, we also believe that none of them are anti-investor, and should therefore be "acceptable". We will only reiterate that it is really time that the industry seize this opportunity that the Finance Ministry is giving, and make a clear, crisp and united case for what it strongly believes will help revive the fortunes of the industry. This is a time for a collective voice rather than individual suggestions. This is a time for making the Finance Ministry and SEBI understand that what the industry is asking for is pro-business and pro-investor.

What do you think of our proposed 5 point agenda for lobbying with the Finance Ministry? Will they help revive business momentum as well as safeguard investor interests? Do you have any other suggestions you would like to give to the industry ahead of its meeting on July 2nd? Share your views with the industry, by posting your comments in the box below - its YOUR forum !