Mumbai: The Bombay Stock Exchange’s benchmark index Sensex has shed at least 56% since January and many blue-chip stocks have lost even more, eroding investors’ wealth hugely.
The Indian mutual funds industry has been hit the hardest in the meltdown, with its average monthly assets under management coming down from close to Rs6 trillion in May to Rs4.3 trillion in October. It’s been a double whammy for the funds as they have also seen redemption by corporations reeling under a liquidity crunch. The fixed maturity plans (FMPs) of the funds have been hit the most.
Now, India’s capital market regulator is set to tighten regulations for the industry. In an interview with Mint, C.B. Bhave, chairman of Securities and Exchange Board of India (Sebi), discusses critical issues ranging from the liquidity crunch to asset-liability mismatches of FMPs and investor education. The forthcoming Sebi board meeting this week is expected to address some of the issues pertaining to mutual funds.
Regulations: Chairman C.B. Bhave says the Securities and Exchange Board of India is looking into the issue of matching the maturity of fixed maturity plans with that of the underlying assets. Ramesh Pathania / Mint
Bhave said a lot of leverage is going out of the market, and even though the markets are down, the silver lining is now that equities are getting into the hands of more stable investors with a long-term view. Edited excerpts:
What’s your biggest worry at this point?
The biggest worry is liquidity. Lack of it will affect the real economy and the market.
How do you address that?
It’s a difficult issue. The Reserve Bank of India (RBI) is doing its best. In a sense, we are the recipient of the shocks. Since the shocks do not originate here, we can watch the situation carefully, and based on our September experience, try to decipher some early signs.
Any contingency plan?
As far as stock markets are concerned, we need to be certain that if some firms go under, our margin mechanisms are adequate enough and we are able to carry out settlements in the market. To that end, we introduced margins for institutional investors as far back as April this year. This got tested when Lehman Brothers Holdings Inc. filed for bankruptcy in September.
Our settlement could be done in a seamless manner. The system is working well and that gives us confidence about the market infrastructure.
But you have a crisis in the mutual fund industry.
The mutual funds were the victims of liquidity problems in October. A special line of credit was made available to them with the help of RBI. The borrowing went up to Rs22,000 crore. It has now come down to Rs3,000 crore. This is a good sign. This means the redemption pressure is not severe and the funds are experiencing inflows.
The fund houses have been able to redeem wherever the clients requested and have got back to normal business. But this should not make us complacent. We should be watchful all the time on how the situation develops.
The assets under management have come down substantially and, particularly, FMPs are in trouble.
When corporations are running short of liquidity, assets coming down is a natural consequence. Based on our experience, Sebi will use this opportunity to tighten the regulations and look at a more orderly growth of the industry. Bulk of the growth of the industry is attributed to tax arbitrage.
We need to see whether we can use the Indian mutual fund industry not for providing tax arbitrage alone. Tax arbitrage may be one of the benefits. But we need to see how we can channelize the savings of people and offer this as an (alternative) investment product. We must do this in a systematic manner that lends stability to the industry.
How would you do it?
We are discussing an idea of segregating schemes for corporates and retail investors. The corporate money can quickly go out when there is a liquidity crisis but retail money is relatively stable. If we segregate the two, then the impact of corporations pulling out of any scheme will be felt by other corporates but retail will be kept away from that.
We have asked the Association of Mutual Fund of India to prepare a paper on what can be improved in terms of regulations as well as industry practices in the context of the industry’s experience in the past two months. We will take that to the mutual fund advisory committee of Sebi where diverse interests are represented. Once the advisory committee considers the suggestions, we will put it out for public comments and take it to the board.
Any plan to regulate FMPs?
They are under regulations. One of the basic design defect is the way these schemes have been operating—while it is called a “fixed maturity” plan, investors are allowed early exits. It is misleading and we are not in favour of this. The fund managers will know that the money is available for a fixed time and can maximize the returns. It should be good for the investors also then, as the uncertainty on certain other investors walking out before the maturity of the scheme goes away.
What about the underlying assets?
We are looking into the issue of matching the maturity of the plan with the maturity of the underlying assets, which is not the case now. If the timelines of the two match, then there is no issue on whether these assets are marketable or not. On maturity of the assets, cash will be available to the mutual funds to redeem the units.
How about disclosure of assets? Will you also restrict their exposure to sectors such as real estate?
We expect these issues to come up in our discussions in the advisory committee.
How fast do we see Sebi implementing these measures?
We will be able to take quick decisions on some of the issues where there is not much of a debate. We will discuss other issues and take them to the board via the Sebi committee.
Total equity assets of Indian mutual funds are a little more than Rs1 trillion. Can the local funds counter-balance the foreign institutional investors (FIIs)?
Considering the size of the Indian economy and the size of FIIs, it’s not feasible for us to match them. The only way India can match the strength of the foreign investors is to continue to grow at 9% for the next 20 years.
At the same time, there is a scope for the mutual fund industry to expand and reach out to more retail investors. Even if it cannot be an exact counterweight of FIIs, it can at least have a sizable weight.
Has the regulator failed in educating the investors? You do not have a funds shortage, do you?
First, the present issue is about corporations’ withdrawals and they do not need to be educated by Sebi. Education of investors is a continuous process and needs effort by everybody. Sebi does this through investor associations, by putting out FAQs on its website, etc. We have initiated an effort in the northern region through an alliance with schools to train teachers...so that they can teach students in turn. The industry makes its own efforts. There is no doubt that this is an unfinished task.
It’s a gap that the business news channels are trying to fill in.
All of us should make efforts. We need to reach out to schools, colleges and universities… In India, we have only 1.5 crore demat accounts. This indicates that the equity cult has not spread far enough. There is a need for all round efforts.
What’s the impact of your ban on FIIs short-selling overseas?
They are not engaging themselves in these activities after we conveyed “regulatory disapproval”. In India, FIIs are not allowed to carry out lending and borrowing of these transactions over the counter and they can do it only through the exchange mechanism. That exchange mechanism was not working and some relaxations were required and we have given them and the exchanges are in the process of putting the software in place. We are hopeful that we will see some volume there. We do not want any arbitrage between what is allowed in India and what is allowed outside.
Is the worst over for the markets?
The worst is over for us as far as the liquidity problem is concerned. But we will have to be alert all the time. We still see institutions, especially in the West, getting into trouble. We do not know the news flow in future and so we need to keep a close tab on all developments. Even though we do not have any worry with regard to our banking system, we are indirectly impacted. If the credit markets in the West do not function, the Indian corporations are affected. So, we cannot relax.
The firms cannot raise money from the market.
The primary market is unlikely to see much action now and I doubt whether anything can be done at this stage. We will have to wait for the market to stabilize. Neither the investors nor the issuers (of equities) seem active in the market because of pricing. Uncertainties are not conducive to the primary market.
Some of the promoters who have pledged shares to raise money are caught in the downturn. A few of them may even lose their ownership.
There is a market for mergers and acquisitions, and a company can be taken over by some other entity. As long as it is done by observing all legal formalities, we do not have any view on that.
Has stability returned to the market?
A lot of leverage is going out of the market. Leveraged hedge funds and leveraged investors who were investing in India funds, all had to perforce sell when the asset value went down. Those securities are being bought by investors with a longer view on the market. Even though the markets are down, the silver line is now that the equities are getting into the hands of more stable investors with a long-term view.