8.1 DEBT MARKETS

8.1.1 Widen investor base through broad banding of pension/provident fund and insurance industries.

An increase in the number of well-capitalised players will help increase trading and also result in decreasing spread and efficient pricing in the secondary market

8.1.2 Liberalise investment norms and encourage active management of contractual funds.

In addition to helping funds generate higher returns, increased activity by long term players will help increase trading and result in narrowing spreads and efficient pricing in the secondary market.

8.1.3 Initiate steps to retail GOI securities through primary dealers, NBFC and Bank networks.

This will significantly enhance the trading interest in these securities, besides permitting the Government to borrow more efficiently.

8.1.4 Provide hedging opportunities to facilitate market making by primary dealers.

Hedging instruments would enable market makers give two way quotes with thin spreads and impart meaningful liquidity to the securities market.

8.1.5 Facilitate introduction of interest rate swaps and bond futures.

Derivatives would help classify exposures and lead to efficient management of liability mis-matches. It would also result in increase activity in the debt market leading to efficient pricing of the securities.

8.1.6 Allow short selling/borrowing of securities.

Short selling/borrowing of securities would impart additional liquidity to the system and enable market players take contrary views on interest rates and trades on the same. However, necessary supervisory control would need to be instituted to oversee this.

8.1.7 Make repos applicable across wider range of securities.

In addition to providing short term liquidity to the securities repos across securities would help rectify anomalies in the yield structure among different classes of short-term securities.

8.1.8 Make the trading and settlement process efficient through the setting up of depository for fixed income securities.

Currently, this facility is available only on Govt. securities. A Depository would help establish an efficient clearing and settlement system and reduce cost on transactions , a key factor, which in turn will lead to an increase in activity in the secondary markets

8.1.9 Establish nationwide access to trading infrastructure at affordable costs.

Lower trading costs and increased number of players in the market would bring in efficiency in the pricing process.

8.1.10 Encourage Debt Securitisation.

This should be effected through reduction in stamp duties, simplification of legal procedures, allowing pension/provident fund investment in these instruments, and widening the range of assets for securitisation. This would provide liquidity to otherwise illiquid assets and would also provide new instruments with different risk and maturity profiles to the market

8.1.11 Introduce tax incentives like indexation benefits on long term capital gains in fixed income securities (currently only available through income schemes of mutual funds).

This step would help rectify anomalies in the tax structure for the same class of securities and lead to increase in trading in the secondary market.

8.1.12 Encourage Foreign Institutional Investors in debt market.

The 20% withholding tax on FII investments in debt instruments and the limit on primary issuances to FIIs, should be removed to encourage participation of such players in the market

8.1.13 Rationalise tax and regulatory norms across players/instruments.

Debt instruments being traded by similar entities are subject to different regulations. The lack of clear regulatory jurisdiction and responsibility negatively impact the development of the Indian debt market. There is no clear jurisdiction given to either RBI or SEBI on their role in debt market development.

The total revenue from stamp duty across the different States (including stamp duty on transfer of assets/registration charges) is about Rs.50 billion, about 50% of which accrues to the States of Maharashtra and Uttar Pradesh. The majority of securities transactions take place in Maharashtra. A rationalisation of the stamp duty structure for securities would have a negligible impact on the revenues of these States. Further, there is a need to have a uniform TDS (Tax Deducted at Source) rate for all debt instruments and uniform tax treatment of income on all debt instruments. Rationalisation of the tax structure would help rectify anomalies in the yield structure among the same class of securities and also help develop a standard issue and transfer system

8.1.14 Mandate registration of all market intermediaries.

An informal unorganized secondary debt market exists in India. It is necessary to encourage informal debt market participants to become participants in the mainstream of the market. It should be mandated by RBI/SEBI that all market intermediaries be registered and be governed by uniform set of registration, capital adequacy and accounting and disclosure norms.

8.1.15 Mandate compliance with uniform valuation procedures by all players.

A uniform compliance and valuation procedure will enable performance comparison on a common platform and provide credibility to the system, a factor essential for increase in trading activity.

8.1.16 Introduce standard disclosure and reporting norms for all trades.

Standard disclosure and reporting norms will help compare secondary market yields enabling players to trade and take positions in the market . RBI and SEBI should work with FIMDA and FIBA to establish code of conduct for the market players

8.1.17 Make listing and credit rating of private placement compulsory as per public issuances and introduce guidelines for issue documentation, post-issue reporting and disclosure.

This would provide transparency and help information flow for increased activity in the market

8.2.1 Encourage book building (involves close dialogue with prospective institutional investors) and auctions (which can be done over computer systems to thousands of market participants) whereby the IPO does not come to the market with a stated offer price.

In this mechanism, the price would come out of the fixed supply of shares coupled with the demand from informed investors who participate in the IPO. These methods are currently used for pricing of GDR/PSU Disinvestment issues.

8.2.2 Give a strong thrust to the government divestment program.

This can provide multiple benefits to the equity markets because of the signal it sends on reform orientation and its ability to provide supply of good quality equity paper in to the market. The negatives – flood of paper and liquidation at low prices – can be countered by combining the public sale of shares with a thrust towards large strategic sales. Sale of Government’s equity in public sector units should be made to strategic investors in addition to portfolio investors. The sale of controlling interests to strategic investors can be made at significant premiums to market price and hence will improve the secondary market demand and prices of the stocks. These will have positive impact on the market because they will reduce supply overhang of stocks and also add to the list of stocks that are investible.

8.2.3 Divest PSU stocks at marked down prices.

Good quality PSU stocks owned by the Government of India should be offered at attractive valuations to retail investors. This will allow retail investors to acquire quality stocks at bargain prices and revive the dying equity cult in the country. Since this is an offer of sale of government shares this will not affect the underlying fundamentals of the company, and should not affect sentiment of existing institutional investors negatively.

8.2.4 Improve disclosure norms.

Quality and Quantity of information provided by companies needs to be improved and all investors whether institutions or retail should have access to all information. Though we have now moved to a quarterly reporting system which is a step in the right direction, international standards is still for a fuller audited report to be shown every quarter, which should also be instituted in India, to start with on a half yearly basis. We must slowly move towards the US GAAP accounting system. Today in India, GDR offer documents contain more information than that which is available to an Indian investor. This anomaly should be removed and all investors whether foreign or Indian should have access to the same information. By mandating disclosure of corporate stock performance vs. peer group performance and market performance benchmarks shareholders could use this information to assess management performance and participate in corporate governance.

8.2.5 Mandate market making.

An order drive system works best for those scrips that are actively traded. As is the case in The London Stock Exchange, a mandatory market making system should be allowed only in those stocks which are poorly traded. However this entails availability of hedging mechanisms.

8.2.6 Introduce rolling settlements and compulsory dematerialisation of securities.

A cash market with rolling settlement is closer to the ideal spot market as compared with a cash market, which uses futures style settlement. Rolling settlement eliminates the fluctuations of prices, which take place around settlement dates. The condition for introducing a rolling settlement is the full functioning of a depository; therefore dematerialisation of securities must be mandated. Demat trading should be made compulsory without allowing for conversion into the physical segment again.

8.2.7 Amend the SCRA to allow for derivatives trading.

International experience has shown that Derivatives trading has significantly improved the liquidity and price recovery of the underlying market, besides providing the market players with a variety of hedging instruments.

8.2.8 Encourage individual investment accounts for high income/high net worth individuals/corporates.

This can be managed by Mutual Funds. The product could be tailor made to suit individual needs including those of Individual retirement accounts and Pension/Provident accounts. This will provide a steady flow of funds in to equity markets from high net worth retail investors.

8.2.9 Ease entry for FIIs / foreign venture capital funds.

Simplifying FII registration and allowing them to hedge their currency exposure on domestic investments will encourage participation by FIIs and provide additional liquidity to the market.

8.2.10 Amend taxation norms on capital losses.

Setting up of Capital losses against income (if reinvested in dematerialised form back in the equity market) will provide incentives to investors to book losses and realign portfolios. This would attract players in the market when equity market is depressed and lead to greater volumes and liquidity.

8.2.11 Remove restriction on lending against shares by banks

Banks can currently lend only up to 5% of the incremental deposits, against shares. This restriction should be removed as it acts as an unnecessary impediment to flow of funds to the equity market.

8.2.12 Amend taxation norms on borrowings against shares.

The interest expense on borrowings against shares if allowed to setoff against income received from reinvestment into equity markets, will lower the return expectations on fresh investment. This would encourage investment in equity market and at the same time would only have a limited effect on Government tax collections

8.2.13 Encourage retail investment in the markets through mutual funds.

Mutual Funds are a crucial intermediary, which would be able to attract the savings of households into the capital markets. This is particularly true through the agency of index linked products e.g. index funds. Therefore distribution network of the mutual funds should be enhanced significantly. In the U.S. there has been an increasing tendency of the household sector to liquidate its holdings of individual stocks and make equity purchases through the mutual fund route. In 1997, households placed 40% of their net purchases of all financial assets in equities purchased through mutual funds.

8.3.1 Empower mutual funds that meet defined criteria to manage retirement funds in the economy.

This will provide a source of long term funds for investment in the economy through the capital markets as well as provide market-determined returns to the pension and provident funds.

Internationally there is an increasing need for funding vehicles for pension/retirement funds as the role of private investment in retirement savings is increasing.

Mutual fund retirement assets represent 17% of the US$9.4 trillion US retirement market. The share of mutual fund assets held in retirement accounts was around 35% in 1997, at US$ 1.6 trillion. The share of mutual funds of the IRAs was 42% in 1997, compared to about 23% in 1990.

In the US$ 2.7 trillion retirement market in Europe, with governments no longer being able to fund pensions, and corporations replacing the traditional pension plans with defined contribution plans, there is a significant outflow of funds out of (low yielding bank accounts) into private retirement plans and mutual funds.

In Japan the mutual fund industry has historically accounted for only about 3% of the estimated total household savings of US$ 10 trillion. The growing need of individuals for providing for post-retirement, and the corporations to improve returns on their financial assets, compounded by the loss of confidence in the banking and insurance sectors, are expected to result in a significant shift of funds to the mutual fund industry.

In Hong Kong, a major impetus to the mutual fund industry is expected to come from the Mandatory Provident Fund Ordinance (MPF), which proposes that all new MPF members would have their future savings accumulated through mutual funds. However it is expected that the funds that are used for the MPF will be required to be set up under Hong Kong law under a local trust deed. This will entail a rethink of the strategy on the part of the existing fund management companies that are set up outside Hong Kong.

In Singapore, (a country of 3 million savers and with a mutual fund penetration of only 4%) the pension fund industry is expected to receive a major impetus through government support. The Central Provident Fund (CPF) currently provides social security to the Singaporeans .Over the next 3 years. additional US$ 25 billion (S$ 40 bn) of (CPF) public funds and about S$ 40 bn statutory Board and government linked company reserves will be made available for fund management.

8.3.2 Increase capital adequacy in proportion to the assets managed and reintroduce minimum corpus criteria for mutual fund entry.

This will ensure that only the serious players are in the market, which in turn will instill confidence in investors

8.3.3 Prescribe stringent norms for intermediaries.

Prescription of entry level qualification and registration for selling agents/ franchise offices, so that they are able to explain clearly the risk inherent in a mutual fund product and the factors that impact the returns on mutual fund products .In Japan, Hong Kong, and Australia, dealer’s license is required for selling the product. In Japan sellers have to satisfy capital adequacy criteria.

8.3.4 Encourage development of fund supermarkets.

These are one-stop shops for retail investors, who would educate investors, supply application forms, prospectus, and annual reports and also attend to investor complaints by liaison with registrars and mutual funds. Such one-stop shops are popular in the USA.

8.3.5 Prescribe regulations on investing in unlisted companies including intragroup companies.

In the U.S. regulation has played a important role in the development of accounting and disclosure standards, as well as in defining norms that impact the funds’ portfolio and liquidity decisions. There are restrictions on transactions between affiliates-- for example, intra-family lending and inter-family security transactions are prohibited, with certain exceptions.

8.3.6 Introduce " Fund of Funds " concept.

Allowing mutual funds to float schemes to specially invest in close-ended schemes of other funds would help reduce market discounts on close-ended schemes.

8.3.7 Mandate active investor education and stringent disclosure norms.

Organising investor conferences by AMFI in major cities of India to position mutual fund products correctly in the minds of investors, explain the riskiness of mutual fund products and the fund management policies to handle the risk.

Mandate disclosure of investment objectives, total returns on a standardised basis, performance of the fund, track record of fund managers, fund management policies, strategies adopted, etc.

Standardised benchmarks and risk norms need to be specified for different types of fund to be used as the yardstick of comparison of performance. This would greatly facilitate investors in making informed investment decisions.

8.3.8 Make valuation norms uniform.

The Accounting and Valuation Committee appointed by AMFI has worked out a uniform methodology for valuation of non-traded debt securities. SEBI could mandate all mutual funds to adopt this methodology and also review the norms for valuing non traded equity securities

8.3.9 Strengthen the role of trustees.

SEBI should define clearly the responsibilities and extent of liability of the trustees of a mutual fund. There should be stringent guidelines for appointing trustees. This will greatly strengthen the operational structure of the mutual funds.

The removal of minimum lock in period for investments and allowing chequing facility to such funds would help attracting retail money in money market mutual funds for deployment in short term debt securities

8.3.12 Appoint Ombudsmen.

This should be considered as in developed markets like UK to resolve issues between Sponsors, mutual funds and the investors

UTI is a symbol of retail investors participation in mutual fund. Viable and credible steps should be initiated by Government of India to strengthen UTI and maintain confidence in this premier institution.

8.4.1 Convert the Government Pension System to fully funded accounts.

In the long term Government pensions and provident funds should be moveable, i.e. linked to the contributor, not the employer. Fully funded pension schemes would increase national saving and demand for long-term debt, making more funds available for infrastructure finance. This could however be implemented only after a sustained improvement in government finances.

8.4.2 Move towards a privately managed pension/provident fund management system.

Contract fund management to dedicated professional fund managers. The mutual fund industry in the U.S. received an impetus in 1981 with the introduction of individual retirement accounts (IRAs) and the shift of corporate and nonprofit organisation pension funds from defined benefit plans to defined contribution plans -401(k) and 403(b). This in effect led to a shift in the investment risk from employers to employees, with the latter having to make their investment decisions.

For instance, Chile, which runs a Government mandated but privately managed pension system, the private fund management firms are under the supervision of a Pension Fund Superintendence --an independent regulatory body -- which prescribes and oversees adherence to entry norms, investment guidelines, minimum returns payable by each fund manager, guidelines relating to liquidation, etc.

This will ensure that limited but financially strong players manage these funds

This will allow diversification investment opportunities with high yields, and will in turn attract additional investments into these funds.. Allow pension and provident funds to invest in income schemes of mutual funds. Mandate investment of at least 10% of the incremental flow (including interest) should be permitted in private equity.

Government should actively support infrastructure projects by providing long term funds for the same. For example, the Government could issue long term zero coupon bonds to kickstart the long term market and also provide a long term benchmark for other long term issuers in the market.

Insurance companies are currently required to invest a substantial portion of their funds into debt securities issued by the government. This leads to a reduction in the rate of return achieved on the investment funds of the insurance companies, thereby limiting their ability to offer attractive terms to the policy-holders.

There is an urgent need to liberalise the investment guidelines applicable to insurance companies, so that they can optimise their returns by investing in a wider range of securities, including equities and corporate debt instruments.

The system of brokers should be introduced to bring about improved customer service. This arrangement should be common for both Life and Non-Life business.

Annual licensing of brokers, depending on technical expertise and capital adequacy, should be the responsibility of the IRA. The licensing of brokers could be linked to their experience, knowledge, internal systems and size of operations

At present a significant portion of the general insurance business is subject to tariff regulation. However, this has resulted in rigidity in the system with consequent impact on customer service. Hence the tariff mechanism should be simplified with greater freedom being given to insurance companies to fix the same. However, supervision should be tightened as also the prudential norms for operators made more stringent.

Tariff rates should be reviewed at regular intervals and revised in the light of changing claims experience.

The Malhotra Committee has recommended that GIC should continue as the Notified Indian Reinsurer. The new players should be asked to cede a certain percentage of their business to GIC by way of statutory cessions. Similar arrangements should also be made for Life Insurance cessions to LIC.

In order to ensure healthy growth of the Insurance industry, the existing concessions allowed by Sec.44 of the Income Tax Act vis-à-vis Reserves for Unexpired Risks (as a specified percent of net premium) should be continued. Transfers to Claims equalisation reserve and Catastrophe reserve should also be tax free as per global practices.