Sunlight is the best disinfectant | Value Research SEBI Chairman, M Damodaran advocates greater transparency and more accountability in the fund industry

Sunlight is the best disinfectant

SEBI Chairman, M Damodaran advocates greater transparency and more accountability in the fund industry

To say that Securities and Exchange Board of India chairman M Damodaran is a busy man is to put it lightly. Back from London for just a day, en route to China, he met us in his office in Mumbai. As we sat outside his cabin, our eyes spotted an article in a foreign daily on China considering having a new “super regulator” and financial watchdog for it banking and finance industries.

When we asked him if there was anything coincidental about the article and his trip, he laughed and brushed it off and said he was going to sign an agreement on exchange of information. Though hard pressed for time, he showed no signs for stress or jet lag as he chatted about his views and plans for the fund industry.

Mutual funds have become powerful players over the past few years with fund managers having much more money at their disposal than Ketan Parekh or Harshad Mehta. This should trigger a proactive tightening of the regulations surrounding their market actions. What is SEBI's gearing towards this?
The first issue is: Who can manage funds? To distribute funds you need qualifications but to manage them you don't seem to need any. Almost anyone can be a fund manager since there is no regulation specifying any qualifications. We are addressing that. Interestingly, the board for prescribing qualifications for fund managers was cleared this morning. I think at the next board, we will clear the structure of what qualifications people need to manage funds. Other jurisdictions have that, no reason why we should not, especially when they are managing huge sums of money.

The second issue is in terms of what is happening within the business of asset management.

We believe trustees have an extremely important role to play. I think this business of trustees being the custodians of the fund and asset managers only being responsible to manage the investments properly, be consistent with regulations and deliver results over a long period of time - that somehow has got diluted in the public consciousness.

People have begun to believe that you give money to Asset Management Companies and they are the custodians of the fund. The theoretical possibility that trustees can tell the AMC that you are not performing well and we are ready to change you and bring in someone else should be conveyed to the public. I am not saying that the trustees can get up every morning and change the AMC. We don't want that destabilisation.

But the message should go across that the trustees have the responsibility to question the AMC if they do not deliver and, if not satisfied with the answers or believe that practices followed by the AMC are inappropriate, they have the right to change the AMC keeping the investor interests in mind.

The point is: Who are the people who are appointed as trustees? And I have said this before. They are people who come from good backgrounds and are appointed for the right reasons. That said, whether they have a complete understanding of not just the letter of the regulations but of the spirit of it - who are trustees, what are their responsibilities, what do they need to do? Not simply as one level of compliance but also as first level regulators of the industry. There is much more work involved.

This should be discussed more with them. We are now corresponding with them much more than earlier. We are writing back to them too. We want them to be more proactive and do their job correctly.

For instance, on new fund offerings we have told the trustees that they need to see if there is anything new in the scheme. Is there already a scheme in their basket which is being duplicated? At least now people have started to justify NFOs. Earlier there was no need for justification. In a couple of cases we have sent it back to the trustees telling them to look at this scheme again and tell us how this is different from the existing ones. At the end of the day, it is their judgment versus mine - is it different or is it not? Not that we are going to take the final call but we force them to look at it a little more closely. It is not that we will not clear it but we are certainly going to tell the trustees to certify that they looked at what is being offering and are of the opinion that it is different.

What other issues are you tackling?
We have now persuaded the asset managers to identify distribution as a problem. We are not yet regulating distributors but we have told them till such time as we do, they are your agents and you are responsible for any misconduct.

That is a kind of double whammy for them. On one hand they find that the distributor is walking away with the money and they are not getting too much because we have capped what they can get. On the other, they are being held responsible for the distributors. Yet, they say, how can we reach out to people, we need these distributors.

We told them is that if you find that the distributor has committed some wrong, you must get rid of that guy quickly and convey the message that you are serious.

Over time, driven by distributors, fund houses have come out with new schemes and never marketed the old ones even though they may be great performers for years. Simply because there is nothing in it for the guy marketing it. This cannot go on.

I have started telling the players that their success is not measured by the number of schemes they launch. Neither is it success measured by the Assets Under Management. This is something we want to get into now - the battle for AUMs. Everyone is taking credit for “my AUMs”. But if most of your money is in the market and the market goes up by 1000 points, your AUM will go up without you doing anything. We are saying, look at your unit capital and start reporting unit capital - we will operationalise this soon - then you will see whether the industry is growing or not or just moving from here to there because of stock prices.

We are also looking at advertising. We are now in dialogue with AMFI and have got their written suggestions on this issue. Does the advertisement communicate the essence of the scheme or is it obscure and confuses the investor? Is the scheme wrong projected? We want all advertisements and marketing material to communicate clearly about the scheme and not mislead.

Another issue that happens with the lack of frequency of disclosure is exiting from questionable stocks just before the reporting date. Buying and selling into questionable stocks between two reporting periods because you don't want it seen on your portfolio. These are practices that happen and we cannot impose legislation or prescribe for all of these. But we can create a climate and that is what we are working towards.

In the next 12 months, the mutual fund industry will be a hot topic of discussion where we ensure that some of these issues will be raised and addressed by us and we will want the players to respond to it.

You mentioned frequency of disclosure. Transparency is a great deterrent to any scam. Why do you ask only for a six month disclosure of portfolio and not more frequently? In spite of this, most fund houses declares it on a monthly basis, but some stick to the regulations and declare it once in six months.
Well, if market practice is better than regulations - which is the case here where they are disclosing more often though they are required to do so only every six months - then we need to move regulation towards market practice rather than vice versa.

As they say - sunlight is the best disinfectant. The more things come out in the open, the better.

Having said that, you should not prescribe a regime which is extremely costly. No one is in this business for charity. At the end of the day, all the costs involved in some manner or the other get passed onto the investor.

Compliance is very good but should not become so costly that it's a disincentive to the investor. As regulators we are in the business of compliance but we also have to grow the market and ensure that first time investors see mutual funds as an entry level into the market and should not see it as prohibitive. They may see the high costs and shy away.

So you have to put in place a frequency of disclosure which is not disproportionate. For example, there is one regulation, when I was on the other side I found it quite amusing, every six months we had to declare all our holdings in all our schemes in a newspaper. We had to take out a 28 page advertisement. Now who would read a 28-page advertisement?

Frequency of disclosure in a cost effective manner has to be addressed. For instance, putting it on the company website is definitely a more cost effective method rather than a newspaper advertisement. It can be made available on a continuing basis on the website of an AMC. But, the problem with this country is that not everyone who is invested in the mutual fund industry is looking at a website. I would not call it a digital divide but a digital inequality and some will access it and some will not.

But, undoubtedly, it will bring accountability once put into the public domain. Clearly, frequency and disclosure on the website is something we can look at.

The issues that fund managers face is that if they disclose their portfolios everyday, their stocks ideas will be open to the public. So would you suggest disclosure with a time lag of a month or even longer?
I don't buy the argument of a time lag and of someone saying that I had this great idea that came into the public domain. Just because someone had a great idea does not mean everyone will buy into it and think it is great. The greatness of the idea will be known over time.

I don't think it is the issue of the time lag, I think that it is a matter of convincing people that if you have been doing something that is better than what the regulations demand, then continue with that spirit.

How happy are you with the fact that now all funds are launching close-ended schemes to take advantage of the amortisation ruling?
You have close ended funds being launched now or funds that are close ended for 18 months and then become open ended. Even during this 18 month close-ended time period, they have intermediate dates for exit.

We saw that there was a problem. We decided to fix it. Close-ended funds were discouraged at one point in time and everyone was told to make all funds open ended. I remember in the past (referring to his UTI days) where we too converted some close-ended funds into open-ended ones.

But now, the issues that faced the industry then are addressed separately so we do not see it as much of a problem as fund houses launch close-ended funds. The advantage of a close-ended fund if you do not allow too many intermediate entries and exits, you have a finite time frame. The investor will know for how long the money will stay locked and exit only at the end. The fund manager, on the other hand, will know how long the money will be with him and where he can invest for that time frame.

But taking advantage of it in order to curb the structure is something we will definitely look into. We are seeing how people are using their ingenuity to work around regulations. End of the day we will see how it affects the investor.

The issue which I find needs to be addressed is this: If someone in the fund for a short term, should he be subsidised by someone who is in the fund for the long term? The fee structure should reward the person who stays longer.

Another problem we have is the way funds are presented and judged by people who write about them. They look at performance over a month and then hype it up as the best performing fund. That is not in the interest of investors. I am not saying look at the lifetime performance of the fund because that will depend on the year the fund was launched and the market performance then. But look at reasonably comparable performances like a three- and five-year time frame.

End of the day, we also have to see how this industry can be grown. It is our firm belief that we need to grow the fund industry to see that more people come to the market. We don't want the average man to enter the market by himself and then come to grief.

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