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Equity funds witness net inflows in June 2013 as redemptions ease to the lowest in four years

After continuous net outflows, equity mutual funds finally generated a net inflow of Rs872 crore in June 2013, but this has been due to lower redemptions and not better sales

Equity mutual fund schemes have seen a net outflow of over Rs31,000 crore in the past three years, according to the data released by the Association of Mutual Funds in India. The average monthly redemption from equity mutual funds has been around Rs5,200 crore over the same period. Redemptions in the month of June 2013 hit a record low of Rs2,455 crore. Even though the quantum of sales was lower than the average, equity schemes registered a net inflow of Rs872 crore for the month, the highest in 21 months. The average monthly sales of equity schemes have been around Rs4,300 over the past three years. Over the past 12 months the average monthly sales have fallen to around Rs3,600 crore despite a slew of regulatory changes to improve penetration of equity funds. There has been no effect on redemptions either, the average redemptions over the past 12 months have been around Rs5,100 crore.

The total number of equtiy mutual fund folios has declined by approximately 89 lakh from 4.11 crore as on March 2010 to 3.22 crore as on May 2013. The retail participation in equity mutual funds has also failed to pick up.

Last year, market regulator Securities and Exchange Board of India (SEBI) introduced resonable incentives for fund houses ensuring penetration beyond the top 15 cities. Even in the recent CII Mutual Fund Summit 2013, SEBI chairman, UK Sinha noted that “Only 52 branches have been opened so far. The total number of branches of the asset management industry in the country is 1600.” Looking at the lack of improvement in the industry despite introducing new reforms, Mr Sinha mentioned that, “Only 1% of the assets under management (AUM) is from the bottom 10 AMCs and this percentage has not changed substantially in the last five years. This gives an impression that we have got some non-serious players in the industry.”

Looking how people flock to Ponzi schemes, Mr Sinha mentioned that “People too are willing to experiment with new products as is evident from the huge amount of money raised by unauthorized entities. The industry will have to work hard and reach out to them.” Many retail investors have burnt their fingers in the past either by being mis-sold a product or by investing at the wrong time or in the wrong scheme. A lot of work needs to be done in educating and gaining back the confidence of retail investors.

However, for most fund houses, increasing penetration is just an asset gathering exercise. In order to have greater and more focused investor education, it was decided by the regulator last year that fund houses should set apart two basis points of the asset management fees annually for the investor education campaign. This translates to a total of around Rs150 crore, taking the current asset under management. How effectively this corpus would be used, is left to be seen.


RBI takes the wind out of NBFC’s sails: Imposes restrictions on private placement of debentures

Privately placed debt is undoubtedly the lifeline for majority of NBFCs. The stringent condition requiring sufficient security cover for privately placed debentures, including NCDs, will surely affect the NBFCs who primarily raise money by issue of debentures

The primary market for corporate debt in India is mainly dominated by private placements of debts (93% of total issuance in 2011-12) as corporates prefer this route to public issues because of operational ease, i.e. minimum disclosures, low cost, tailor made structures and speed of raising funds. Banks/financial institutions (42.3% of total issuances) followed by finance companies (26.4%) were the major issuers of debentures in 2011-12.


As per the Reserve Bank of India’s (RBI) report on “Trend and Progress of Banking in India”, 2011-12, NBFCs-D (loan and asset finance companies) borrowed Rs238 billion by issue of debentures during the year 2011-12 constituting 29.42% of total borrowings of these NBFCs. During the same period, Rs2,950 billion has been raised by NBFC-ND-SI constituting 46.11% of total borrowings. Such debentures consisted of both—secured and unsecured issues. As apparent from these figures, NBFCs-NDs are the companies having largest source of borrowings through issue of debentures. Thus, privately placed debt is undoubtedly the lifeline for majority of NBFCs.


However, with the intent to regulate such privately placed issues of debentures by NBFCs and to ensure minimum compliances, RBI vide notification dated 27 June, 2013 has inter-alia issued guidelines on private placement of securities by NBFCs. The guidelines have come into existence with immediate effect from the date of the notification.


The guidelines seem to have startled the NBFCs. This is evident from the quantum of queries and clarifications raised by the industry resulting in issue of another notification clarifying some of the provisions of the guidelines by the RBI within five days of the issue of the guidelines.

Definition of “Private Placement”

Ideally clarifications are issued solely for the purpose of clarifying things already stated or issued. Imagine the irony, as RBI in its so called ‘clarification’ has completely changed the meaning and applicability of the guidelines! Initially, the guidelines defined “private placement” as to include issue of capital by an NBFC pursuant to Section 81 (1A) of the Companies Act, 1956. It is pertinent to note that Section 81 (1A) requires approval of shareholders in case of convertible debentures only issued on preferential basis and does not cover any issue of non-convertible debentures (NCDs). However, RBI’s intent was to regulate the private placements of NCDs because for convertible debentures, there already exists appropriate regulations [for listed NBFCs—SEBI ICDR Regulations and for unlisted public NBFCs—Companies (Preferential Allotment of Shares) Rules, 2003 as amended from time to time]. Thus the very basis of issue of guidelines could have been lost.


However, realizing the same, in guise of clarification the RBI immediately replaced the definition of “private placements” to include “non-public offering of NCDs by NBFCs to such number of select subscribers and such subscription amounts, as may be specified by the Reserve Bank from time to time” and the excluded instrument of the guideline became the main crux of the clarification. What was the only thing excluded in the guidelines became the sole substance of the clarifications!

Time gap between two successive issues of debentures

Borrowing by issue of debentures is the backbone of an NBFC. Some NBFCs issue debentures almost every month, every week to fulfill their funding needs. However, previously, in the guidelines, RBI seemed to adopt a stricter norm and provided a minimum time gap of at least six months in between the two private placements. However, after receiving several comments from the non-banking industry regarding this condition, the RBI has withdrawn the minimum time gap condition for the time being.


Taking away the current facility of issuing NCDs and implementing the minimum time gap requirements between two issues will surely lead to Asset Liability Mismatch (ALM)

Restriction on number of subscribers in a private placement

Overriding the provisions relating to “deemed public offer” as prescribed by Section 67(3) of the Companies Act, 1956, which exempted NBFCs, the guidelines have put a limit of maximum number of subscribers as 49 under a private placement issue or issue on preferential basis of debentures. Thus, though the Companies Act exempts NBFCs, the RBI guidelines have now introduced the “deemed public offer” provision for NBFCs for issue of debentures at least.

Other highlights of the guidelines

The other highlights of the guidelines, as amended/clarified by the clarification are as under:


  • Names of all subscribers to be identified upfront;
  • NBFCs to issue secured debentures only. If the security cover is not sufficient at the time of making issue, sufficient security to be created within one month and till then issue proceeds are to be kept in escrow account. However, security cover will not be required on issue of sub-debt instruments;
  • Offer document should be issued within maximum period of six months from the date of the board resolution authorizing the issue and the documents should contain the phrase “for private circulation only”;
  • Minimum subscription amount for a single investor shall be Rs25 lakh and in multiples of Rs10 lakh thereafter;
  • Debentures shall be issued by NBFCs only for deployment of funds on its own balance sheet and not to facilitate resource requests of group entities/ parent company / associates (with an exemption to CICs as clarified by RBI)

Our Analysis

The requirement of maintenance of security cover at all points of time was initially applicable to all debentures issued, including short term NCDs. However, realizing that subordinated debt are primarily unsecured, later excluded the same in the clarifications.RBI by this notification has also suitably amended Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998, thereby clarifying that only debentures that are compulsorily convertible into equity or fully secured would be exempted from the definition of public deposits. Further, it has been clarified that hybrid debt or subordinated debt would be excluded if such instruments have been issued with no recall option within the tenure of the instrument.


As the directions now have been amended to exclude debentures “compulsorily convertible into equity”, the route of raising funds by way of issue of Optionally Convertible Debentures (OCDs) has been put an end by the RBI. Generally, companies followed a practice of issuing OCDs with an option to issuer to convert them into shares of the company and no need to mention that such an option is never intended to exercise. Thus in guise of OCDs, companies were taking advantage of the existing clause in the directions and were getting exemption from the applicability of directions by issuing OCDs on tailor-made terms and conditions. However, NBFCs-NDs will now require to mandatorily issue Compulsorily Convertible Debentures, as issuance of OCDs will qualify as public deposits.


The guidelines seem to have been issued against the backdrop of recent ruling of the Supreme Court in the Sahara Real Estate Corporation case pertaining to raising of money by issue of OCDs which were issued on “private placement basis”, wherein nearly Rs20,000 crore of money had been raised, from 22.1 million investors, using services of nearly a million agents, at 2,900 branches. And all this were regarded to be a private placement. In view of such adverse features brought to the notice of the RBI, wherein NBFCs have been raising resources from the retail public on a large scale, through private placement, especially by issue of debentures, RBI has issued the guidelines overriding other instructions in this regard for NBFCs, wherever contradictory and has introduced the concept of “deemed public offer” for NBFCs also.

The purpose behind issuing the guidelines is to curb the practice followed by NBFCs of raising resources from the retail public on a large scale, through private placement, especially by issue of debentures and to ensure proper resource planning to be undertaken by NBFCs. In view of the same, as per the clarifications, the RBI has directed NBFCs to formulate a board approved policy for resource planning, covering the planning perspective and periodicity of private placement, before close of business on 30 September 2013.


Despite being excluded from the limit of 49 investors under the Companies Act, NBFCs will not be able to privately place their debentures with more than 49 investors as per the guidelines. The stringent condition requiring sufficient security cover even for privately placed debentures, including NCDs, will surely affect the NBFCs who primarily raise money by issue of debentures. However, the RBI seems determined to correct the faulty resource planning of NBFCs and may come up with a circular specifying the minimum time gap between two private placements too in near future.


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