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1. INDIVIDUAL ASSIGNMENT ON FINANCIAL SERVICES
SUBMITTED ON: 2ND SEPTEMBER, 2014
SUBMITTED TO: SUBMITTED BY:
PROF. SANJAY SHANBHAG MINAL GARG (2013153)

2. Q1. What does the government of India hope to achieve with the new draft RBI guidelines
for the wealth management industry? What are the reasons behind introduction of the
new regulations?
SEBI, RBI, IRDA, FMC & PFDRA is giving counsel to the Government of India for making
crucial amendments in the respective Acts and for creating definite provisions for regulating
wealth management as well as the investment advisers. The Acts are being revised so as to
introduce certain investment advisers’ regulations. The government came into play for these
after an exposé of a 400 crore rupees fraud which was ensued at Citibank’s Gurgaon branch,
where a relationship lured clients in a fictitious investment scheme guaranteeing a return of 2-
3% per month. The new regulations, along with a complaint redressal mechanism, will benefit
the investors and will lead to an orderly development of the wealth management and investment
advisory industry.
Owing to the current scenario, if a fraud happens, there are no concrete guidelines to
take action against the conspirators involved. By powering the new guidelines, banks will act
as an advisory as they won’t be having the direct power over the investor’s money. They will
only be able to charge money so as to give advisory benefits to the investors.
In these new guidelines, the bank will be prohibited from offering discretionary wealth
management services to their customers, whereas a portfolio manager will independently
manage the funds for the individual customers. The discretionary portfolio management service
will include portfolios broadly directed by the customer, or those wherein the customer gives
a negative list of investment products at the time of opening the account so that the fund
manager ensures that such investment products are not included in the portfolio.
In case of mandatory services, banks are working through different departments or
divisions or a subsidiary with the permission of the RBI. Reserve Bank of India allows these
banks to work independent subsidiary. RBI made a norm in which such a subsidiary or SIDD
require to be registered with market regulator Securities and Exchange Board of India (SEBI)
and RBI also follow with SEBI rule and regulation and also follow the policies of SEBI and
also provide these services, including the code of conduct, if any.
The Central Bank said, there should be a distant relationship between the bank and the
subsidiary if the wealth management services is offered, RBI has also stated that the marketing
or sales of third party product is the area where bank employees should involve in but products
should not be given any direct incentives in cash or non-cash form linked to their performance
to avoid mis-selling (practice of a salesperson misrepresenting or misleading) of products.
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3. Q2. Why did SEBI regulator CB Bhave ban entry loads on mutual funds? What were the
consequences of ban? What were SEBI regulator Sinha’s goals and what actions did he
take to aid the struggling mutual fund industry? How did this effect the competitiveness
of mutual funds vis-à-vis other financial products? Why?
CB Bhave banned the 250 bps “entry loads” that distributors charged the investors. Distributors
had traditionally driven the growth of the industry, as investors had to be weaned off a diet of
guaranteed returns and fixed deposits to accept volatility and risk for better long term return.
So, mutual funds had to be pushed and generous commissions were seen as vital incentives.
The abolition of entry loads saw a collapse in a key component of the distribution
channel, with the number of active distributors falling drastically from around 90,000 to just
10,000. Mutual funds became a high net worth investment vehicle which was earlier considered
to be a common man’s product. AMCs responded by paying upfront fees up to 100 bps from
their own pockets which also turned out to be an unfeasible option in the times when fresh
investments were almost completely neutralized by redemptions.
Sinha’s goals were primarily based on three aspects:
 Increase penetration of mutual funds
 Encourage persistency among investors
 Optimize disclosure standards
To bring the goals in effect following steps were taken:
 Entry load was removed.
 A 20 bps rise in expense ratio
 A 30 bps rise in expense ratio for small towns
 Service tax to be borne directly by investors
 No sub-limits within expense ratio
 Lower expense fee for direct investors
 Transactions up to 20,000 rupees allowed in cash
 Product labelling
Sinha was looking to make the distributor’s returns lucrative by keeping the
client’s investments for a long term. He discouraged the churn factor by mandating the exit
load charged to customers. SEBI created an alternative distribution channel in the form of direct
sales by AMCs which worked on a no commission basis. SEBI was thereby looking to create
different share classes. This, in turn helped in expansion of the industry into India’s tier-2 and
tier-3 cities in order to tap the retail investment.
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4. This move made the mutual funds industry much more competitive compared to other
financial products. But due to the increase in expense ratio, ULIPs became a much more
lucrative option than the mutual funds. The expense ratio increase by 60 bps gave the ULIPs a
much needed edge over the mutual funds. Long term investors have started to shift from mutual
funds due to this move. Some of the long term investors have even started opting for equity
shares because of the extra costs attached with these mutual funds and thus, investors are
looking to take complete control over their investments which is not possible in the case of
mutual funds.
Q3. What were the effects of higher long term capital gains tax and the new holding
period requirement on debt mutual funds? What are the goals of this new tax policy?
How does it impact FMPS?
The Finance minister of India Mr. Arun Jaitley presented the union budget 2014-15 on July 11,
which changes many of the financial/facial policies and its changes the way money flow in the
Indian economy its demand and supply.
One of this changes which effected the long term capital investment and gain plan with
respect to mutual funds is that the tax on debt mutual fund will be increased by 20% from 10%
earlier and the holding period for the eligibility of long term would be extended to 36 months
(3 years) rather than 12 months (1 year) earlier.
This change can result in to situation:
 Investors will invest in bank saving deposit as it is more secure, or
 The investors will invest the money for long term mutual funds that is 36 months to get
tax benefit and long term gains.
Let’s now discuss this to situation in detail:
Note: (The date of this policies to come into action is not fixed as this is not declared)
1. Investors will invest in bank saving deposit as it is more secure:
This situation can arise because the investment in bank deposit are generally fixed and more
secure as compare to any other investment plan. More over mutual divide the risk which
reduces the risk but it’s still related to the market condition. This is the reason why every mutual
funds company says the linings “Mutual funds are subjected to market risk, please read the
offer document carefully before investing”. So now it when both the tax rate as well as holding
period are not in favor of long term investment people can fell more profitable and secure in
investing in banks and other fixed investment offers.
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5. But this is one part of change investment plan, the next plan is in favor of mutual funds which
is explained below:
2. The investors will invest the money for long term mutual funds that is 36 months
to get tax benefit and long term gains:
Now the question is how the increase in tax rate may still result in favor of long term investment
like mutual funds, the answer is due to beneficial tax rate. This can be explained with the
example: suppose Rs 100 is invested in the units of debt funds, which is sold in future for Rs
120 after a year. Assuming the inflation rate is 8%, the taxable gain would be adjusted down
to Rs 4, since the cost of investment of Rs 100 would be indexed to Rs 116, the making the
taxable gain lower. Appling the beneficial tax rate of 20% on Rs 4, the tax outflow would be
just 80 paisa. On the other hand if a person is investing in fixed bank deposit Rs 100 and assume
the interest generated out of it is Rs 10 @ 10% annual income. Let us again assume the inflation
rate is 8% then the taxable amount should be 40 paisa [(10-100*8%)*20%]. But it is not so the
taxable amount will be 10*20% that is Rs 2.
Its look like the goal of new tax rate is to bring parity between different instruments.
As the tax rate is increases from 10% to 20% and the period to become an investment long term
is also increases from 1 year to 3 years in should result in huge outflow from debt mutual funds
and the amount will be investment in some other part of economy. This will result in balancing
the investment plan in different forms.
One the other hand the increase in long term capital gain tax for debt funding would
encourage investors to come in longer term saving. Last year bond yields rises as foreign
investor started heavily selling Indian debts, but this year after the budget announcement,
mutual funds have sold as much as Rs 4500 crore of debt in two days. This has been the highest
amount sold on two consecutive days since 31 July 2013.
This changes can result in increase in investment in FMPs (Fixed maturity plans), as
the risk involve in such type of plan are zero, no what is and what will be the market condition.
For such type of plan investor did not need to worry whether to invest in short term plans or
long term plans. But one of the disadvantage of such type of plans is the date of maturity is
already decided earlier and hence the investors need to what for the maturity period in order to
get benefit out of it.
This situation in now applicable to the mutual funds also because the after the new
union budget any investment can be termed as long term unless as until it reaches the 36 month
maturity. It means now in mutual also investors has to wait for 36 months in order to get long
term capital gain and also the tax benefit out of it.
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6. There for investors who are not willing to take much risk can go for FMPs and the
persons looking for huge capital gains will take the long term risk and invest in mutual funds.
But in this war between the two one thing is sure that the investment in short term capital gain
will reduce which will result a better and controlled flow of money in the market. The
government market regulators now can able to control the market more easily and effectively.
Q4 (a) Why does private equity continue to struggle since 2010?
In India, Private equity firms are finding it very difficult to make money on their old
investments made during the boom period between 2006 and 2009. Because of the slowdown
in economy, many of the companies that private equity firms own have not grown as the firms
had hoped. Even the number of buyers for these companies are not enough. Which in return
making it very difficult for the private equity firms to make profits out of their investments.
In 2013, Indian companies managed to raise only $260 million through initial-public
offerings, the lowest amount of new equity raised in 12 years. Just three companies--
Mumbai-based Internet search firm Just Dial Ltd., Chennai-based Repco Home Finance Ltd.
and Delhi-based department store Company V-Mart Retail Ltd.--raised two-thirds of the new
equity issued last year. India’s economic growth is the prime reason behind the struggle of
private equity since 2010.Many investors are holding off allocating fresh money to Indian
capital markets until the federal elections, which are due before the end of May.
Recent figures suggest a surge in Indian private equity: funds have invested about
$1.2 billion in India so far in 2010, compared with $714 million in all of 2009. Average deal
size has also risen sharply, to over $77 million so far in 2010, from less than half that last year.
This does not, however, mean that India has become more hospitable towards private equity
investment.
The other reasons behind the struggle are slow-moving legal system and a business
culture which doesn’t place much value on outsiders’ opinions or expertise. A more likely
reason for the recent swell in activity is stifled pressure to do deals. India focused funds raised
$19.2 billion over the last 3 years, according to the Centre for Asia Private Equity. Pan-Asian
funds raised another $37.5 billion in the same period. Which depicts that a substantial sum of
capital is left to chase after deals that, on average, are far smaller than in the rest of Asia.
The results will be: returns will shrink as managers compete for business. More
specifically, funds eager to strike deals risk paying too high a price. Which means that India
still have to struggle.
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7. Q4 (b) What are some of the steps that some players are adopting to make successful
exits?
These are some of the exit modes for the private equity funded companies:
 IPO exit:
Private equity investments would be exited mainly through IPOs. Therefore IPOs accounted
for a mere 8 per cent of the exits by private equity investors between January 2005 and
September 2011. For example: Bharti, Shoppers Stop, India Info line, Info tech and PVR.
 Private transactions exit:
Exit through private transactions is also an option. It receives less attention but delivers strong
results. Purchasers in private transactions include domestic and international, financial and
strategic investors. For example: ICICI Venture’s stake sale in Metropolis to Warburg Pincus,
Motilal Oswal Private Equity’s stake sale in Parag Milk Foods to IDFC Private Equity stake
sale in Punjab Tractors to Mahindra & Mahindra.
Finding strategic investors is also a way which is comparatively very easy. Because
it brings in comfort about the company’s corporate governance, systems, processes and
information quality. There is also the possibility that in a few cases, the promoters may exit
along with the fund to a strategic buyer in a private transaction.
Private equity investors pulled out $108 million from 12 deals in the second quarter
of this year, compared to exits of $954 million from 18 deals in the April to June period last
year.
About $50 million of exits came via sales in the public capital markets, rest were
through “strategic” sales, such as an acquisition by another firm in the same business, or so-called
secondary sales, in which one private equity firm sells to another private equity firm.
One reason for the lower value of exits was the apprehension among investors about
that they might be taxed on their gains. Earlier this year, the Indian government introduced new
anti-avoidance tax rules, which could tax profits made by investors based in tax havens such
as Mauritius and others.
Q4 (c) What is the industry’s new strategy to fight slow growth?
After facing the low growth rates in the recent past, PE firms have changed the rules of the
investment game. The traditional model of silent investor, no longer works for them. To ensure
high returns and profitable exits. They are playing a more nuanced role in the companies they
have a stake in. they have adopted transformational approach. The rules of the same were:
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8.  Be aggressive:
Investors learnt that passive investments which give returns in the long term and require
minimal involvement are no more attractive. Because it does not give the control over company
and even do not give the power to take financial decisions. So they have adopted a more
aggressive approach to earn profits as well as powers.
 Build sector competence:
PE firms are shoring up their expertise in specific sectors. Most investors want to focus on IT,
pharmaceuticals, consumer goods and financial services. Because ‘An investor needs to expand
its universe of opportunities. Valuations are too high for existing good businesses, and starting
from ground zero does make sense sometimes. Teaming up with international chains even
before they enter a new market is one way to ‘expand the universe of opportunity’. Also, hiring
outside experts is always an option because they are realizing that unless they bring operational
expertise they can’t add value.
 Look at alternate investments:
Innovation is not just restricted to sectors or deals; PE firms are fine-tuning their fund themes
too. They are finding opportunities in tier-2 cities and also considering the scope in public
equity transactions. Meanwhile, some PE firms are taking a relatively new funding approach.
 Have a safe net:
With exits getting delayed, a note of discord often sets among investors and promoters over
alleged wilful deceit, non-disclosures and the non-honoring of shareholder agreements. This is
where the new concept of insuring PE deals is gaining ground. Such insurance covers ne known
as Representations and Warranties (R&W) in legal terms. These ‘reps and warranties’ options
ensure a clean exit for the investor. Typically, such covers are bought by the buyer or the seller
in a transaction. In the current context, they are mostly being considered by the buyers (PE
firms). Investors have also started planning about exits at the time of signing the deal, and not
as they reach the end of the investment period (which is usually five years; in India, this may
extend to even to ten years.)
 Find profit in debt:
There’s a consensus that the next big opportunity lies in the debt and structured deals space
some investors are building flexibility to structure deals that will cater to the requirements of
Indian promoters through equity, debt, mezzanine (a hybrid of debt and equity) or convertible
securities.
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9. The road ahead:
The tough economic cycle of the last few years has been a learning experience for PE firms in
terms of funding strategies, transaction structures, investor protection rights and level of
operational controls, The Indian PE industry is now “better equipped to generate returns going
ahead”.
Consider the demographic picture: Nearly 50 percent of the country’s 1.2 billion citizens
are below the age of 25, and 65 percent are under 35. The SEC B and SEC C population is
growing, and if the country manages even a 5 percent growth rate, PEs will reap returns. PE
fund managers believe that over the next 4-5 years, rural consumption will increase.
Investors are confident of a revival in the investment cycle, and expect the PE industry to
contribute to economic growth on a much larger scale. Over the next decade, deals in both size
and nature will start to resemble those in developed nations: They have the potential to reach
$40 billion in 2025.
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