IP and Asset Management- India Specific - Additions to Chapter-1 - 7

Clearing Corporations) Regulations, 2012, (‘SECC Regulations’) and SEBI circular CIR/MRD/DSA/33/2012 dated December 13, 2012, on procedural norms on recognition, ownership and Governance for Stock Exchanges and Clearing Corporation (‘SECC Circular’). Commodity derivatives exchanges shall transfer the functions of clearing and settlement of trade to a separate clearing corporation within three years. Till then, the exchanges may continue with the existing arrangement for clearing and settlement of trades. Commodity derivatives exchanges shall pay the regulatory fee in terms of Securities and Exchange Board of India (Regulatory Fee on Stock Exchanges) Regulations, 2006. The following are the excerpts from the pertaining to exchange regulations. • Existing Independent Directors on the boards of national commodity derivatives exchanges shall be deemed to be Public Interest Directors (PIDs) under SECC Regulations • Commodity derivatives exchanges shall segregate their regulatory departments from other departments • All commodity derivative exchanges shall appoint a compliance officer • National commodity derivative exchanges shall credit all settlement related penalties to their settlement guarantee fund (SGF) and other penalties to Investor Protection Fund (IPF). • The Commodity Derivative Exchanges are advised to submit a Monthly Development Report as per the prescribed format to SEBI by 7thof the succeeding month. • National Commodity Derivative Exchanges shall continuously meet the turnover criteria of Rs. 1000 crores per annum. In case the exchanges fail to meet this criterion for 2 consecutive years, they shall be liable to exit The Commodity Derivatives Exchanges have been using a ‘Spot Price Polling Mechanism’ to arrive at the prevailing spot prices. Transparent discovery of spot prices is a critical factor in smooth running of futures market as the same are used as reference prices for settlement of contracts traded on the exchange platform. To arrive at the prevailing spot prices, the exchanges are polling the spot prices from various spot price polling participants. Some exchanges undertake this activity themselves while some have outsourced this work to an external agency. In order to maintain the transparency of spot price polling process and dissemination of spot prices arrived at through spot price polling process, the commodity derivatives exchanges are directed to – have a well laid down and documented policy for the spot price polling mechanism; display the spot price polling mechanism adopted for every contract on its website; disclose, for every contract, details with respect to individual spot price polling participants on its website; endeavour in increasing the sample size used for fixing the daily spot prices during the last 15 days of the contract; review on a monthly basis the prices polled by the participants to identify participants habitually polling unrealistic prices; review on a monthly basis the prices polled by the participants to identify participants habitually polling unrealistic prices. IP and Asset Management – India Specific Page 51

Until 2015, commodity derivatives and the exchanges were regulated by the Forward Markets Commissions as per the rights and control vested in it by the Forward Contracts Act, 1952. However, after a crisis involving the National Spot Exchange, in 2015, the control of the commodities markets and exchanges was shifted to SEBI and the forward markets commission was merged with SEBI, giving the latter full control of the markets and paving way for better surveillance and regulation of the markets. There were six commodity exchanges in India viz. Multi Commodity Exchange (MCX), National Commodities and Derivatives Exchange (NCDEX), National Multi Commodity Exchange, Indian Commodity Exchange, ACE Derivatives Exchange and the Universal Commodity Exchange. However, in 2018, SEBI allowed exchanges to trade in commodity derivatives alongside stocks and laying down flexible norms for foreign investors but restricting cross-shareholding in mutual funds and credit rating agencies. This move benefited the top stock exchanges viz. BSE Ltd. (formerly the Bombay Stock Exchange Ltd.) and National Stock Exchange (NSE) to launch commodity trading. Exchanges shall examine following basic parameters and the commodity may be permitted to be included under derivatives if such commodity satisfies these parameters. • The total supply value of the commodity in each year is taken as a measure of the physical market size of that commodity in that year • The commodity should be either Homogeneous or should be conducive to standardization • The commodity should be durable and storable for better price discovery. • The commodity should ideally have a vast distribution across the country. The coverage can be in the form of production of commodity or the distribution of the commodity across the country Price controls are government mandated minimum or maximum prices that can be charged for specified goods. Government sometimes implements price controls when prices on essential items, such as food grain or oil are rising rapidly. Such goods which are prone to price control may be less conducive for derivatives markets. The Food control Regulation Act, Essential commodities Act, APMC Act etc., may have an impact on the commodities to be introduced for derivatives trading. Commodities which have excessive restrictions may be less conducive for derivatives markets. Commodities which have a strong correlation with the global market have higher need for price risk management. Such commodities are conducive for derivatives trading. The Indian commodity sphere is characterized by seasonality. The prices fluctuate with the supply season and the off season. The derivatives market is necessary to even out this fluctuation and facilitate better price discovery. Thus the commodities with higher seasonality are conducive for derivatives trading. Commodities with high IP and Asset Management – India Specific Page 52

volatility of prices have high need for hedging. Such commodities are conducive for Derivatives trading. For any commodity to continue to be eligible for Futures trading on Exchange, it should have annual turnover of more than Rs.500 Crore across all National Commodity Derivatives Exchanges in at least one of the last three financial years. For validating this criteria, gestation period of three years is provided for commodities from the launch date/re-launch date, as may be applicable. Once, a commodity becomes ineligible for derivatives trading due to not satisfying the retention criteria, the exchanges shall not reconsider such commodity for re-launching contract for a minimum period of one year. Further, a commodity which is discontinued/suspended by the exchange from derivatives trading on its platform shall not be re-considered by the concerned exchange for re-launching of derivatives contract on such commodity at least for a minimum period of one year. Commodities Futures and their Settlement Mechanism The following norms shall be applicable to the Agricultural as well as Non-Agricultural commodity derivatives at commodity level. Numerical value of overall client level open position limits shall be applicable for each commodity. The Exchanges, however, in their own judgment, may prescribe limits lower than what is prescribed by SEBI by giving advance notice to the market under intimation to SEBI. For the purpose of position limits, norms applicable on client level positions shall also be applicable to the proprietary positions of trading members and while calculating member’s open positions; his proprietary positions shall be treated and computed like a client’s positions. Following norms shall be applicable on Agricultural commodity derivatives at commodity level. For the purpose of calculating positions of a client, all long and short positions of the client across all contracts shall be added up separately and higher of the two shall be considered as his overall open position. For determination of numerical value of overall client level open position limits, following framework is prescribed for agricultural commodities. In any given year, based on the average of production data and import data of past five years on a rolling basis and keeping in view various extraneous factors that affect the trading in derivatives, the agricultural commodities shall be classified into three categories viz., sensitive, broad and narrow as below:  An agricultural commodity shall be classified as a sensitive commodity if it is prone to frequent Government/External interventions. These interventions may be in the nature of stock limits, import/export restrictions or any other trade related barriers; or has observed frequent instances of price manipulation in past five years of derivatives trading • An agricultural commodity shall be classified as ‘Broad Commodity’ if it is not ‘Sensitive Commodity’ and the average deliverable supply for past five year is at least 10 lakh Metric Ton (MT) in quantitative term and is at least INR 5,000 Crore in monetary term IP and Asset Management – India Specific Page 53

• An agricultural commodity which is not falling in either of the above two categories, viz ‘Sensitive’ or ‘Broad’ commodity, shall be classified as ‘Narrow Commodity’ The following norms shall be applicable to Non-Agricultural commodity derivatives at commodity level. • For calculating overall position of a client, all long and short positions of the client across all contracts shall be netted out. • Client level position limits shall be equivalent to the specified numerical level limit or 5% of market-wide open interest, whichever is higher • Member level position limits shall be 10 times of the numerical value of client level position limits or 20% of the market-wide open interest, whichever is higher Exchanges shall monitor the open position on a real time basis and shall endeavour that no client or member breaches the open position limits 'at end of the day' as well as 'during intra-day trading'. Penalty shall be levied on those breaching the position limits at end of the day as well as during intra- day trading. To facilitate larger participation by genuine hedgers by providing them with necessary incentives with a view to deepen the commodity derivatives market, the exchanges stipulate a Hedge Policy for granting hedge limits to their members and clients. Exchanges shall impose initial margins sufficient to cover its potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default. Exchanges shall therefore estimate appropriate Margin Period of Risk (MPOR) for each product based on liquidity in the product. However, the MPOR for all commodity derivatives contracts shall be at least 2 days. Minimum value of initial margin would be subject to commodity specific floor value as may be specified by SEBI from time to time. Currently floor value of IM applicable for Nickel shall be 5% and for all other commodities it shall be 4%. Margins shall be computed at the level of portfolio of each individual client comprising his positions in futures contracts across different maturities. For Trading/Clearing Member level margins computation, margins would be grossed across various clients. The proprietary positions of the Trading Member would also be treated as that of a client for margin computation. The margins should be computed on real time basis. The computation of portfolio initial margin would have two components. The first is the computation of initial margin for each individual contract. At the second stage, these contract initial margins would be applied to the actual portfolio positions to compute the portfolio initial margin. The exchanges are permitted to update EWMA volatility estimates for contracts at discrete time points each day (with a gap of not more than 2 hours between any two consecutive updates and at the end of the trading session) and the latest available scaled up IP and Asset Management – India Specific Page 54

WMA volatility estimates would be applied to member/client portfolios on a real time basis. Extreme Loss Margin (ELM) of 1% on gross open positions shall be levied and shall be deducted from the liquid assets of the clearing member on an online, real time basis. Exchanges may levy Additional Margins based on their evaluation in specific situations as may be necessary. All open positions of a futures contract would be settled daily, only in cash, based on the Daily Settlement Price (DSP). DSP shall be reckoned and disseminated by the Exchange at the end of every trading day. The mark to market gains and losses shall be settled in cash before the start of trading on T+1 day. If mark to market obligations are not collected before start of the next day’s trading, the exchange shall collect correspondingly higher initial margin (scaling up by a factor of square root of two) to cover the potential losses over the time elapsed in the collection of margins. Daily mark to market settlement and final settlement in respect of admitted deals in futures contracts shall be cash settled by debit/ credit of the clearing accounts of clearing members with the respective clearing bank. All positions (brought forward, created during the day, closed out during the day) of a clearing member in futures contracts, at the close of trading hours on a day, shall be marked to market at the daily settlement price (for daily mark to market settlement) and settled. All positions (brought forward, created during the day, closed out during the day) of a clearing member in commodity contracts, at the close of trading hours on the last trading day of the contract, shall be marked to market at final settlement price (for final settlement) and settled. Funds settlement shall be affected through designated clearing banks of NCL. Every participant shall be needed to have a separate settlement account with one of the approved clearing banks for commodity Derivatives Fund settlement. All the funds settlement will be conducted by effecting debits / credits through electronic transfer of funds in the accounts of participants clearing bank accounts. The pay-in and pay-out of mark to market settlement, final settlement of commodity derivatives, additional settlement shall be affected in accordance with the settlement schedule issued by the Clearing Corporation periodically. Along with mark to market settlement and final settlement of commodity derivatives there are few other transactions which are affected in settlement. The said transactions include EPI, Margin, Penalty, CTT, ABC/BC collection/release. These transactions are part of settlement which gets collected/released from/to members settlement account. Funds Supplementary Settlement would happen on basis of Quality difference, Quantity difference, Delivery centre, Packaging cost and penalty for short delivery. For such instances, NCL would create transactions and collect the same (Pay-in/Pay-out) from the clearing members. NCL will create funds transactions as a sum of compensation amount and replacement cost which is cumulatively termed as penalty and funds will be collected from the defaulting seller as a part of supplementary settlement. IP and Asset Management – India Specific Page 55

NCL sends pay-in obligation reports to clearing banks on clearing day mentioning the details of transactions of members along with amount for arrangement of funds on settlement day. Penalty as specified by SEBI shall be levied on seller in case of delivery default (default in delivery against open position at expiry in case of compulsory delivery contracts, default in delivery after giving intention for delivery).NCL shall have appropriate deterrent mechanism (including penal/disciplinary action) in place against intentional/wilful delivery default. Daily settlement price for Commodities futures contracts shall be the closing price of such contracts on the trading day. The closing price for Commodities futures contract shall be calculated on the basis of the last half an hour weighted average price of such contract or such other price as may be decided by the relevant authority from time to time. Theoretical daily settlement price for unexpired Commodities futures contracts which are not traded during the last half an hour on a day Theoretical daily settlement price for unexpired futures contracts, which are not traded during the last half an hour on a day, shall be the price computed as per the formula detailed below: F = S * e rt The Final Settlement Price (FSP) shall be polled price for precious metals and for base metals, for Brent Crude settlement price shall be the average of the five intra-month cash BFOE (BrentForties-Oseberg-Ekofisk) assessments' as made by ICIS on the last trading Crude Oil Contract and for Energy it would be the prices from LME and DGCX respectively or from any other source. Foreign Exchange Markets For a long time, foreign exchange in India was treated as a controlled commodity because of its limited availability. The early stages of foreign exchange management in the country focussed on control of foreign exchange by regulating the demand due to its limited supply. Exchange control was introduced in India under the Defence of India Rules on September 3, 1939 on a temporary basis. The statutory power for exchange control was provided by the Foreign Exchange Regulation Act (FERA) of 1947, which was subsequently replaced by a more comprehensive Foreign Exchange Regulation Act, 1973. This Act empowered the Reserve Bank, and in certain cases the Central Government, to control and regulate dealings in foreign exchange payments outside India, export and import of currency notes and bullion, transfer of securities between residents and non-residents, acquisition of foreign securities, and acquisition of immovable property in and outside India, among other transactions. The Reserve Bank of India is the custodian of the country’s foreign exchange reserves and is vested with the responsibility of managing their investment. The legal provisions governing management of foreign exchange reserves are laid down in the Reserve Bank of India Act, 1934. The Reserve Bank’s reserves management function has in recent years grown both in terms of importance and IP and Asset Management – India Specific Page 56

sophistication for two main reasons. First, the share of foreign currency assets in the balance sheet of the Reserve Bank has substantially increased. Second, with the increased volatility in exchange and interest rates in the global market, the task of preserving the value of reserves and obtaining a reasonable return on them has become challenging. The basic parameters of the Reserve Bank’s policies for foreign exchange reserves management are safety, liquidity and returns. The Reserve Bank of India Act permits the Reserve Bank to invest the reserves in the following types of instruments: 1) Deposits with Bank for International Settlements and other central banks 2) Deposits with foreign commercial banks 3) Debt instruments representing sovereign or sovereign-guaranteed liability of not more than 10 years of residual maturity 4) Other instruments and institutions as approved by the Central Board of the Reserve Bank in accordance with the provisions of the Act 5) Certain types of derivatives While safety and liquidity continue to be the twin-pillars of reserves management, return optimisation has become an embedded strategy within this framework. The Reserve Bank has framed policy guidelines stipulating stringent eligibility criteria for issuers, counterparties, and investments to be made with them to enhance the safety and liquidity of reserves. The Reserve Bank, in consultation with the Government, continuously reviews the reserves management strategies. Extensive relaxations in the rules governing foreign exchange were initiated, prompted by the liberalisation measures introduced since 1991 and the Act was amended as a new Foreign Exchange Regulation (Amendment) Act 1993. Significant developments in the external sector, such as, substantial increase in foreign exchange reserves, growth in foreign trade, rationalisation of tariffs, current account convertibility, liberalisation of Indian investments abroad, increased access to external commercial borrowings by Indian corporates and participation of foreign institutional investors in Indian stock market, resulted in a changed environment. Keeping in view the changed environment, the Foreign Exchange Management Act (FEMA) was enacted in 1999 to replace FERA. FEMA became effective from June 1, 2000. Structure, Functions and Regulation The Reserve Bank issues licences to banks and other institutions to act as Authorised Dealers in the foreign exchange market. In keeping with the move towards liberalisation, the Reserve Bank has undertaken substantial elimination of licensing, quantitative restrictions and other regulatory and discretionary controls IP and Asset Management – India Specific Page 57

Apart from easing restrictions on foreign exchange transactions in terms of processes and procedure, the Reserve Bank has also provided the exchange facility for liberalised travel abroad for purposes, such as, conducting business, attending international conferences, undertaking technical study tours, setting up joint ventures abroad, negotiating foreign collaboration, pursuing higher studies and training, and also for medical treatment. Moreover, the Reserve Bank has permitted residents to hold liberal amount of foreign currency. Residents can now also open foreign currency accounts in India and credit specified foreign exchange receipts into it The FEMA, 1999, provides the statutory framework for the regulation of Foreign Exchange derivatives contracts. Residents can hedge their foreign exchange exposures through various products, such as, forward contracts, options involving rupee and foreign currencies, currency swaps and cost reduction option structures in the OTC market. Foreign investors can also hedge their investments in equity and/or debt in India through forwards and options In addition, trading within specified position limits is permitted on exchange traded currency futures in four currency pairs and in USD for currency options. Residents are also permitted to hedge their commodity price risk, as per specific guidelines, in the overseas OTC markets and exchanges. Over the years, the foreign exchange spot as well as forward market has expanded quite significantly. The average daily forex market turnover has grown from approximately USD 16 billion in 2005-06 to nearly US$ 55 billion in 2014-15. The average daily trading volume in the inter-bank USD/INR forwards was at USD 6.43 billion and that of the USD/INR futures was at USD 2.64 billion during the financial year 2014-15. Foreign investment comes into India in various forms. Following the reforms path, the Reserve Bank has liberalised the provisions relating to such investments. The Reserve Bank has permitted foreign investment in almost all sectors, with a few exceptions. In many sectors, no prior approval from the Government or the Reserve Bank is required for non-residents investing in India. Foreign institutional investors are allowed to invest in all equity securities traded in the primary and secondary markets. Foreign institutional investors have also been permitted to invest in Government of India treasury bills and dated securities, corporate debt instruments and mutual funds. The NRIs have the flexibility of investing under the options of repatriation and nonrepatriation. Similarly, Indian entities can also make investment in an overseas joint venture or in a wholly owned subsidiary abroad up to a certain limit. Indian companies are allowed to raise external commercial borrowings including commercialbank loans, buyers’ credit, suppliers’ credit, and securitised instruments. Foreign Currency Convertible Bonds (FCCBs) and Foreign Currency Exchangeable Bonds (FCEBs) are also governed by the ECB IP and Asset Management – India Specific Page 58

guidelines. As a step towards further simplification and liberalisation of the foreign exchange facilities available to the residents, the Reserve Bank has permitted resident individuals to freely remit abroad up to liberal amount per financial year for any permissible purposes India’s exchange rate policy has evolved in tandem with the domestic as well as international developments. The period after independence was marked by a fixed exchange rate regime, which was in line with the Bretton Woods system prevalent then. The Indian Rupee was pegged to the Pound Sterling on account of historic links with Britain. After the breakdown of Bretton Woods System in the early seventies, most of the countries moved towards a system of flexible/managed exchange rates. With the decline in the share of Britain in India’s trade, increased diversification of India’s international transactions together with the weaknesses of pegging to a single currency, the Indian Rupee was de- linked from the Pound Sterling in September 1975. The exchange rate subsequently came to be determined with reference to the daily exchange rate movements of an undisclosed basket of currencies of India’s major trading partners. As the basket- linked management of the exchange rate of the Rupee did not capture the market dynamics and the developments in the exchange rates of competing countries fully, the Rupee’s external value was allowed to be determined by market forces in a phased manner following the balance of payment difficulties in the nineties. A significant two-step downward adjustment in the exchange rate of the Rupee was made in 1991. In March 1992, Liberalised Exchange Rate Management System (LERMS) involving the dual exchange rate was instituted. A unified single market-determined exchange rate system based on the demand for and supply of foreign exchange replaced the LERMS effective March 1, 1993. The Reserve Bank’s exchange rate policy focusses on ensuring orderly conditions in the foreign exchange market. For the purpose, it closely monitors the developments in the financial markets at home and abroad. When necessary, it intervenes in the market by buying or selling foreign currencies. The market operations are undertaken either directly or through public sector banks. Pricing of Forwards and Futures Exchange-traded currency futures are permitted in India. Such trading facilities are currently being offered by the National Stock Exchange, the Bombay Stock Exchange and the MCX-Stock Exchange. As the product is exchange traded, the conduct of currency futures trading facility is being regulated jointly by the Reserve Bank and the Securities and Exchange Board of India. The forward price or interest is agreed upon by both parties while signing the contract and will be paid by the buyer at the expiration, on the settlement date. The buyer is long as he purchases the IP and Asset Management – India Specific Page 59

underlying and the seller, who is in short position, is obligated to deliver the underlying. At the initiation of the forward contract, the arbitrage relationship that exists at the time of signing the contract between the forward and underlying as a result of the financing of the underlying asset at risk-free rate narrows down the price to zero. A currency future, also known as FX future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. The price of a future contract is in terms of INR per unit of other currency e.g. US Dollars. Currency future contracts allow investors to hedge against foreign exchange risk. Currency Derivatives are generally available on four currency pairs viz. US Dollars (USD), Euro (EUR), Great Britain Pound (GBP) and Japanese Yen (JPY). Cross Currency Futures & Options contracts on EUR-USD, GBP-USD and USD-JPY are also available for trading in Currency Derivatives segment. Daily settlement price for futures contracts is the closing price of such contracts on the trading day. The closing price for a futures contract shall be calculated on the basis of the last half an hour weighted average price across exchanges of such contract or such other price as may be decided by the relevant authority from time to time. Theoretical daily settlement price for unexpired futures contracts which are not traded during the last half an hour on a day. Theoretical daily settlement price for unexpired futures contracts, which are not traded during the last half an hour on a day, shall be the price computed as per the formula: F0=S0 e(r-r) fT, where, F0 = Theoretical futures price S0 = Value of the underlying r = Cost of financing (using continuously compounded interest rate) rf = Foreign risk free interest rate T = Time till expiration e = 2.71828 Rate of interest (r) may be the relevant MIFOR rate or such other rate as may be specified by the Clearing Corporation from time to time. Foreign risk free interest rate is the relevant LIBOR rate or such other rate as may be specified by the Clearing Corporation from time to time. Simple compounding price of currency future is – f(0,T)X/Y = S0,X/Y ((1+rX)/(1+rY))T where T = contract duration S0 = Spot exchange rate for X/Y rX = Risk free rate in domestic currency IP and Asset Management – India Specific Page 60

rY = Risk free rate in country foreign currency In case of continuous compounding, the future price is calculated as below. f(0,T)X/Y = (S0,X/Y e-ryT ) erxT If the future is not “fairly” priced, the trader may earn a risk-free arbitrage profit. Concept of Interest Rate Parity If the difference between the interest rates of two countries equals the difference between their forward and spot exchange rates, it is called interest rate parity. It plays an important role in the currency markets. F = S * ((1+ia)/(1+1b)) where, F is the forward rate; S is the spot rate; ia and ib are the interest rates in the two countries. Theoretically, irrespective of the respective interest rates of countries, the returns from hedging in those different currencies is always the same. Supposing the risk-free return on one currency is higher between two countries, the one with higher return is priced more in the future market than in the spot market. Conversely, it can be said that arbitrate opportunities do not exist in currency markets between two different currencies. Real Estate, Gold and Collectibles Real estate, precious metals such as gold, and collectibles are three other asset classes like equity, debt, commodities and currency. These too have different risk, expected return, recommended average period of holding, liquidity, marketability and taxability. Hence, before including these asset classes in the asset allocation of the financial plan and apportioning them to various financial needs and goals, they must be studied individually in detail. Forms of Realty – Land, Residential and Commercial Real Estate has been the cherry pick of Indians for ages. But the trend turned into obsession in the last half century in India. The youth, in present days, no sooner are they through with their higher education and landing up in some job, go for a housing loan and buy property. This happens either because they are too excited seeing ample money in their hands or want to accumulate wealth for themselves or sometimes, because they want to appease their parents. What everyone fails to notice is that they are not just acquiring property, but by taking a loan, they are creating a huge liability that they will carry until their middle age, for 20 years or so. And, importantly, those who encourage them to buy property do not journey with them through the years and render proper advice when the latter is striving to pay off the liability and suffering from compromised cash flows. IP and Asset Management – India Specific Page 61

Property bought through loan, though convenient enough, usually eats away a lion’s share of an individual’s savings potential often leaving one with meagre or no surplus at all. Since the property bought will not be used to sell off and create pension or regular income in old age, and the future growth in earnings is used to adjust towards the increasing prices and changing lifestyle and planning for other needs and goals, critical needs are usually left out, unplanned. Alternately, individuals may consider buying a piece of land in the suburban, if they can identify a scheme that allows payment in instalments. However, appreciation of such an investment takes many years and even after exhibiting such remarkable patience, non-development in the geography where the property is located will prove disheartening. Real estate or property is one asset class that needs huge capital to invest in, except when someone is borrowing but it rewards the investors handsomely in the long-term. However, there are drawbacks. Liquidity is the first hurdle in property. Suppose one has dire need for money and gets ready to sell the property, but the market is so low, and prices have drastically come down that even if the person is ready to part with it at a reduced price, finding a buyer may not be so easy. Added to that, political uncertainty, and high expenses for either of the party might prevent one from being able to sell the asset. Since time immemorial, land has been one of the most preferred investments and asset classes for mankind. The powerful ones fought for it and the ordinary, strived to earn or buy it. As times changed, the kings and knights disappeared, and the fights for land and property shifted from the real battle fields to the courtrooms. With the turn of the century and increasing population, the definition of property extended beyond land. In India, real estate is the investment that is largely favoured by the yester-generation, though the fascination has been induced and imposed into the present generation also, to some extent. In comparison to other asset classes, Real Estate or Realty is expensive i.e. it commands higher percentage allocation than the rest, such as equity, debt and gold etc. Hence, it is best to understand first what different types of investment opportunities exist in India, which can be infused into a financial plan for achieving financial needs and goals. Let us take a look at some types of property. Broadly, real estate investment can be categorised as Commercial, Residential and Hospitality. Commercial properties are constructed primarily to yield higher return on investment either in the form of capital appreciation or rent. These are generally office spaces, shops, hospitals, institutions etc. Residential properties are generally in the form of bungalows, apartments and holiday homes etc. Properties of businesses such as manufacturing, engineering and warehouses etc. are somewhat different from the regular commercial properties. IP and Asset Management – India Specific Page 62

Most families and investors are attracted to residential land and constructed property, be it an apartment or house and easy and affordable housing loans has made it easier for retail investors to venture into this asset class, whether for investment or residential purpose. Commercial property is favoured if at all by high net-worth individuals, who have the resources to make a large investment. In the present, increasing demand for commercial office spaces supported by start-ups and rapid business development and expansion is contributing to the growth of real estate sector across all major cities and the tier two cities in India. Several initiatives being undertaken by the central and state governments in India such as the creation of hundred smart cities and sanctioning of affordable houses to the eligible households under the Prime Minister AwasYojana (PMAY) within the defined timelines is a big booster to the sector and the economic growth in the medium to long term. Permitting the setup of the Real Estate Investment Trusts (REIT) by SEBI is a big step to encourage all types of investors including foreign direct investments (FDI) in the real estate sector. All these factors are contributing to a shift in the management of the businesses in a more professional and organised manner than ever before. Real Estate vs REIT Owning a real estate asset has the elements of a huge lump sum investment, accurate price discovery and valuation, title search and genuineness, costs of transaction, cost of furnishing or refurbishing to make the property habitable or income-generating asset. The transaction and furnishing costs are understandable when the property is for self-occupation. The same become painful if the property is let out as the returns by way of rental get impacted by the opportunity cost of such investment on furnishing and transaction costs. And such costs are not one-time expenses. The maintenance cost has to be borne as well as the broker’s fee and agreement expenses. And the most crucial aspect is the return on investment. As a ratio of acquisition and set up cost of the property, the rents received are in low single digits. Depending on the location of property, the rental yield barely nudges past 3% after accounting for the municipal taxes and maintenance costs. Real Estate Investment Trusts (REITs), as the name suggests are trusts set up in a similar fashion as mutual funds but these trusts have obligation to invest in REITs instruments defined by SEBI under such regulations, SEBI (Real Estate Investment Trusts) Regulations, 2014. A REIT has to invest 80% of the collected money through the sale of units into completed rent generating commercial properties. The investment made by a REIT is not directly but through a special purpose vehicle (SPV) where it holds a majority stake. The remaining 20% Shall be invested in a mix of assets such as under- constriction properties (with stipulation to sell such properties within 3 years of completion, the listed or unlisted debt of companies or body corporate in real estate sector, mortgage backed securities, listed as well unlisted equity shares of companies which derive not less than 75% of their operating IP and Asset Management – India Specific Page 63

income from real estate activity, unutilized floor space index (FSI) and transfer of development rights (TDR) of a project where it has already made investment, government securities and money market instruments. The investments have to be approved by valuers, have to be audited and the compliance norms have to be strictly followed in a REIT structure. Thus, the asset mix gives a REIT sure income derived from such investments majorly in the immovable property. There are good chances of capital appreciation as well. Ninety per cent of the rental income earned by a REIT has to be distributed to unit holders as dividend or interest. This is taxable in the hands of unit holders at slab rate, which is not much different from rentals received in owned property. However, the return profile of REITs is between 7% and 9% which is much better when compared with owning a property. The added benefits are small amounts of investment. The value of each allotment lot of REIT shall be Rs 50,000 and above. With this ticket size, a large investment can be made. In buying a property however, a bulk amount of tens of lakhs of Rupees is needed. The investment in a REIT, as against a physical real estate, also saves other overheads. REITs can be traded on stock exchanges and hence the liquidity of investment is assured. The liquidity aspect is very adverse in case of directly owning a real estate. The price discovery is bad and in case of a desperate sale, prices can correct for a particular property. Moreover, so many factors which are not in one’s control may depress the value of a property and the rental income therefrom, e.g. some adverse development in the geographic area or society of which the property is a unit, state development in and around property, reputation of neighbours and society’s maintenance and governance, etc. Even by holding more assets in different locations and cities may not provide the type of diversification of risk which a EIT provides. REITs vs InvITs We have studied what REITs are in the above para.InvITs are similar investments which are made under such regulations of SEBI, Infrastructure Investment Trusts Regulations of 2014. Structurally REITs and InvITs are very similar. InvIT also pool money from investors and have a trustee, a sponsor, and a manager. The value of each allotment lot under a InvIT shall not be less than Rs 1,00,000. An InvIT can have as its underlying investments majorly as infrastructure projects, roads, highways, pipelines, power plants and transmission lines, bonded warehousing, etc. They hold these under long- term contracts. There are some inherent risks of investing in InvITs as compared with REITs. The large infrastructure projects involve huge capital investment, mostly by centre and state governments, and relatively large working capital requirements. There are political and environmental risks which may lead to substantial time overruns, which in turn may lead to compounding of costs and thus project unviability. IP and Asset Management – India Specific Page 64

Registered InvITs can raise funds via public and private placement and in lieu of that issue units to unit holders and apply leverage. This leverage which is restricted to just 49% for listed InvITs though infrastructure projects require high leverage. Only with AAA- rating and a continuous 6-year track record of dividends, the leverage can be increased to 70%. The other constraint is that investors have to depend on auditors’ valuation reports to know the true viability of such projects. The tax treatment of InvITsae same as that of InvITs as are other provisions of distribution. Recent 2021 budget offers some benefit on tax compliance and increasing funds flow to REITs and InvITs. The 10% withholding tax has been withdrawn to help in the tax compliance by investors. The FPIs now have enabled provisions to invest in the NCDs issued by such trusts, thereby replacing costly capital. The current AUM of REITs and InvITs at Rs 2 lakh crore is set to rise as they are gaining popularity. Investors can diversify their debt portfolio where they have income requirements. However, when it comes to a choice between REITs and InvITs, the better income visibility in REITs and a comparatively reduced political, regulatory and environmental risk of stalling a project can be viewed favourably by investors. Precious Metals – Gold Gold can be bought in the form of jewellery, coins, bars, or gold exchange traded funds, gold fund of funds or e-gold or through any scheme offered by gold shops. If Gold was purchased in Oct2008 and held for 5 years i.e. till Oct-2013, the return would be 14.77%. If it was bought for an average of Rs. 29600 in 2013, at the beginning of 2019, with the price being 28800, the five-year return on gold calculates to -2.60%. If the same is calculated for longer period say last 30 years i.e. 1988 to 2018, the compounded growth rate calculates to 7.68% per annum, assuming gold was bought only once in three decades i.e. 30 years ago. Globally, advisors suggest that allocation to gold be maintained at 5%-7% of the total portfolio. In any case, the maximum allocation to gold shall not exceed 10%. There is another theory that did rounds in the advisor circle some time back according to which, if people were buying a dozen of apples 500 years ago and paid in gold (say, 0.15 gram), even today, if they have to pay in gold they have to shell out similar quantity i.e. 1gm Gold = 3000 and 1dz Apples = 450 This is the reason for technically calling gold as ‘hedge against inflation’. That means, Gold always keeps pace with inflation and is not a wealth creation tool. At least, it is said so in the present times. Advisers in India expect an average return of 5% to 7% per annum from gold in the long term, at par with inflation rate. Gold is an asset. Gold means wealth. But in India, it is a lot more than that. Gold is a part of life. It is a way of life. You may agree with this because, a man’s (of course woman’s too) relationship with gold begins when he is born into this world and will only end when he leaves this world. It is one metal (and one thing) that Indians are attached to irrespective of age, region, and religion than anything else. You IP and Asset Management – India Specific Page 65

may want to double the gold worn on you but never think of cutting it down even if it is a little uncomfortable. Had you bought 1 ounce of gold (31.1034 grams) on 01-Jan-1980 for 4190/- (135/- per gram), it would be worth 89900/- today. Do you know what that means in terms of annualised rate of return? That is a return of 9.40%. At least if you had bought gold when the price went down two years later to 2900, your compounded annual growth rate would be 11.30% p.a. If you had bought it another two years later for 3900, your return would be 11%. But, if you say these are all old stories, let us look at the new ones. Had you bought 1-ounce gold ten years back for 17200, the returns calculate to 18% per annum. If you say you already know how gold created wealth over the centuries, the question is, have you bought gold for investment and not for ornamental purpose? The two illustrations above may seem contradictory. In one paragraph you saw that gold acts as a hedge against inflation and the next, how gold created wealth in the long term. The idea is to tell you how gold may create wealth in the exceedingly long term while in the short term it can be volatile like equity and is influenced by many factors some of which may not be foreseeable except for believing in sentiments and trends that may or may not repeat. A report by the US Geological Society mentioned that the gold reserves in 2012 were 51000 tonnes globally. This is after mining 2560 tonnes in 2010 and another 2700 tonnes in the year 2011. With that kind of increase in production year-on-year, the gold reserves were estimated to last for another 13 years. That means gold mines across the globe will be completely depleted by the year 2025. But that is only the supply side of the story. With countries like China producing an average of 350 tonnes of gold every year that does not leave the country, comparatively very low reserves with India’s central bank, an estimated 18000 tonnes of gold stacked in the hands of the people of India in the form of jewellery and an average of 1.5 Crore weddings per year estimated for the next ten years in India alone, the ever increasing demand for gold among the public and the governments alike is surely going to take gold prices through the roof like never before. With a majority of Chinese buying high quality 24 Karat gold, 1.30 billion Indians securing their jewellery in lockers forever and 350 million Americans (third largest nation in terms of population) finding new fashion trends with gold, where do you think the gold prices will be when there are no mines to dig out gold? Another interesting story found on the internet some time back reported by multiple sources was that a good number of states in the US are seeking permission to introduce and use gold and silver currency as they lost confidence in their federal reserve and are in the final stages of the process. Now, if one decides to go ahead and invest in gold, particularly at every dip, then the next question is, what form should one buy it in? What is the convenient way of buying gold? For some of us, 5 grams IP and Asset Management – India Specific Page 66

may be too much to invest on a monthly or regular basis. Moreover, you may laugh it off or ridicule it, but the risk of losing it to the robbers is always present. The risk only goes down but not eliminated when you store it in a locker with the bank, thereby increasing the costs. If you are still okay with all that and want to buy gold in physical form that is all right. You can start a monthly investment scheme with a gold shop or buy randomly from banks or showrooms on auspicious days or whenever you want to. However, in today’s developed world, it is recommended that you buy goal in securitised form i.e. either in the form of gold exchange traded funds or through gold fund of funds, which in turn invest in the gold exchange traded funds. Gold ETFs track the price of physical gold, which is held by the issuing fund house. Since the fund houses have gold deposits against the units they issue to the buyers, value of one unit of gold corresponds one gram of physical gold. This supplies an opportunity to invest in gold from the comfort of one’s home. Furthermore, there is no risk of theft and increased costs in the form of locker etc. A lay customer may be confused when he sees a different unit price for each fund house that is offering the ETFs. However, be advised that the unit price is irrelevant in the case of gold ETFs and the difference between the net asset values of various schemes is due to a range of factors. As the units are traded on the stock exchanges by investors at large, sometimes a buyer is willing to pay extra to buy a unit while a seller, sometimes is ready to compromise on the price if he needs money. Another reason is the charges or what it is technically called - the expense ratio. I am not saying that the expense ratio vastly differs. Suppose X fund charges 1.45%, Y fund charges 1.50%. The difference is only 0.05% i.e. on a unit value of say 3000, the difference amounts to Rs. 1.50. But, be advised that the NAV or unit price you see on the exchanges is net of the expense ratio. So, when you calculate your returns, you do not have to discount the charges from the profits. Exchange-traded funds may not always invest 100% of the monies in gold. A small portion may be usually invested in debt & money market products and some is maintained as cash reserve. Also, the root-mean-square of the difference between the gold ETF and the spot gold (also called as tracking error) ranges from usually 0.05% to 0.07%. All these reasons add up to the difference among the unit prices of schemes managed by various fund houses. There is no problem of liquidity either, as these ETF’s are listed on the bourses. As to the taxation, since this is categorized as a mutual fund, investment in gold exchange traded funds is exempt from wealth tax and securities transaction tax. However, the sale proceeds are subject to long term and shortterm capital gains tax as applicable. The only difference between the ETF and the Fund of Fund is that, in case of the latter, you can start a systematic investment plan or the SIP directly with the AMC. In case you want to sell, the AMC will buy the units directly from you, without you having to find a buyer on the exchange (not that you will not usually find buyers on the exchange). Some big brokers lately have started providing tailor-made SIP facility to their customers. IP and Asset Management – India Specific Page 67

Physical Gold vs. Gold Funds vs. Sovereign Gold Bonds vs Gold ETF Gold is a favourite commodity which Indians consume as well as invest into. This may be due to a natural love for this precious metal, ingrained through ages, and due to customs and ceremonies across regions where gold is exchanged as gift. An estimate has it than the gold residing in Indian homes would be to the extent of 25,000 tonnes. A specific genre of corporate has gold loans and gold monetization as their primary objective. This role is also performed by some banks in a limited way. The Government of India came out with Gold Monetization scheme in 2015 to mobilise gold held by households and institutions to facilitate its use for productive purposes and to reduce gold imports. The deposit certificates are issued by banks in equivalent of 995 fineness of gold for the certified value of physical gold ornaments tendered. Other steps to reduce the tendency of public to buy physical gold at least for long-term investment purposes are: Sovereign Gold Bonds (SGB) by the government and Gold Funds and Gold ETFs by mutual funds. SGBs are RBI issued digital units denominated in grams of gold, allowing individuals, HUFs, trusts, charitable institutions and universities to take exposure to gold. These tranches of SGB are for 8-year duration, carry in general 2.5% interest on the subscribed amount and offer goldlinked returns, tax- free if held for those 8 years to maturity/redemption. They seek to shift a part of the domestic savings that were used for the purchase of yellow metal. The SGB units are added to an individual’s demat account and can be traded in the market. On sale in the secondary market within the maturity period, the long-term capital gains come with indexation benefits, akin to debt mutual fund products. Gold ETFs also have the feature of gold-linked returns as in the SGB. But they do not carry any interest and have a definite cost structure toward management. They can be exchanged in digital form as well and have structure of taxation akin to mutual fund debt products for short-term and long-term holding periods. Gold funds however are of different nature in the sense of their investment logic. The pooled money of investors in Gold Funds is invested in the stocks of gold mining companies, distribution channels, etc. on the global level. The performance of such invested stocks would vary greatly depending on dynamics of demand supply and other industry logistics, and hence the returns from Gold Funds can be not just linked to gold prices but can outperform or even underperform. The taxation is as applicable to Gold ETFs. Thus, we see the scenarios of physical gold investment which can be beset with quality issues, making expenses and storage obligations versus other forms of gold-linked investments such as SGB and Gold ETFs, which are held digitally, tradeable at far lower impact costs than physical gold. There is less tax arbitrage other than on SGBs which exempt capital gains tax if held through the entire 8-year tenure of the tranche. Another category, Gold Funds, is to profit from the dynamic factors associated with the IP and Asset Management – India Specific Page 68

gold metal like its actual mining, demand and supply scenario which impacts the prices of stocks of such companies. Such stocks held in a Gold Fund can outperform the cardinal gold returns during a particular period, but it comes with associated management expenses and other risks which may see even underperformance as well. Gold Futures vs Gold ETFs Gold has a tendency of negative correlation with the equity movement. It has become an active asset class in diversifying portfolios, even at institutional level, say mutual funds and Portfolio Management Schemes, etc. It is sort of a hedge against an economic downturn. Gold is said to be a hedge against inflation as well. There is good negative correlation reported between gold and the US dollar. A strong dollar, and hence presumably a healthy state of the US economy, will makes the gold prices tend lower. Gold exposure can be had in several ways, buying bullion in pure form or through digital means such as buying Gold ETFs or buying Sovereign Gold Bonds (SGBs). A gold future is another form of taking exposure to gold. It is a hedging tool worldwide for those in the business of gold and for commercial producers. It helps in the price discovery of gold. Gold futures are traded on international exchanges, the New York Mercantile Exchange, the Tokyo Commodity Exchange, CME Group, COMEX, and in India, the Multi Commodity Exchange (MCX), National Commodities and Derivatives Exchange (NCDEX), Indian Commodity Exchange (ICEX) and National Multi Commodity Exchange (NMCX). MCX is the largest exchange. Gold futures are a safe mode of trading in gold, because of safety and purity concerns and convenience. These futures can be held till maturity where physical delivery can be pressed upon, or they can be squared off prior to expiry. On MCX, The gold futures contracts are of three months’ rolling cycle. The settlement of Gold futures takes place on the 5th of every month (preceding trading day if 5th is a holiday) but in case of no delivery the squaring off has to be effected before the 1st of the month. The buyer’s delivery intention therefore has to be notified 5 working days prior to expiry of the contract including expiry day. Incremental margin of 4% for last 5 days on all outstanding positions is applicable toward tender period margin. Such margin will be in addition to initial, additional and special margin as applicable. All outstanding positions on the expiry of contract, not settled by way of delivery in the aforesaid manner, will be settled as per the Final Settlement Price (FSP) with penalty as per penal provision. The designated vault is at Ahmedabad with additional centres at Mumbai, Delhi and Chennai. Delivery is in numbered gold bars of 995 purity, the Goods and Services Tax shall be applicable apart from Rs 75 per gram as coinage. Hence, it becomes incumbent on traders who do not want physical delivery of gold to square off their positions well in time. IP and Asset Management – India Specific Page 69

There is convenience to trade in gold futures in several contract sizes – 1,000 grams (the Big Gold), 100 gm (Gold Mini), 8 gm (Gold Guinea) and 1 gm (Gold Petal). They are also the trading units for each such category contract. The Big Gold is the most popular and liquid contract. Sizeable positions can be taken as the margins are just 4 per cent. Gold options are also available on the MCX now. Several players ranging from gold producers, large gold companies and users of gold, industrial users, institutions, fund managers to even individuals can trade in gold futures to optimize on respective utilities, especially hedging. Gold futures settled in cash shall involve taxes payable as applicable to trading business. Individual investors have this at their applicable tax slabs. If settled by delivery, GST and stamp duty may be applicable besides logistics such as block conversion to coins, bars, etc. For individual investors and fund managers, Gold Exchange Traded Funds (Gold ETFs) present a safer opportunity to invest in Gold. A Gold ETF is a mutual fund product issued in units representing 1 gm of gold (purity usually of 995). The gold equivalent to the issued units is deposited with a custodian. Gold ETFs are listed therefore facilitating liquidity. It is feasible to buy small amounts of Gold ETFs in digital form without incurring costs toward making, storage and other concerns toward purity. As with ETFs there are no concerns on holding period and trading. The costs are fractional when compared with buying/selling physical gold. The expense ratio is around 0.5%. There are tax advantages when selling. The long-term capital gains tax is as applicable to debt mutual fund schemes, i.e. 20% on indexed cost of acquisition when held for more than three years, or slab rate if held for a period of less than 3 years. Art, Antiquities and Collectibles As you have seen so far, asset classes are many but all of them are not for everyone and some are not within the reach of many investors and if they are, they do not match the risk profile and goal time horizon of the investors. Art, photographs, antiquities, vintage cars, collectibles such as stamps and coins etc. are high-risk investments. They can take many years to appreciate, conversely suffer from probable erosion in value overtime, exposed to physical damage or wearand-tear, theft and other kinds of risks. Also, returns from these asset classes can vary greatly over different periods, across geographies and several factors such as rarity, quality and condition. One must study all these factors thoroughly before investing or recommending these investments to an investor, whether or not such investment is linked to a need or goal IP and Asset Management – India Specific Page 70

Chapter – 3: Investing in Capital Markets and Investment Products Learning Objectives  Identify the needs and objectives of your clients and their specific category  Understand norms and operations for introducing clients to various investments  Discuss direct investments in equity and debt products  Understand mutual funds and other pooled investments  Explain small savings instruments and other schemes Introduction It becomes very important for a market intermediary to know one’s client before initiating any financial or investment advice or a product sale. The regulators across the domains of banking and finance, securities and investment, insurance and pension have laid down guidelines that intermediaries must comply with know-your-client (KYC) norms with regard to their clients. Besides the statutory maintenance of basic records which identify a client, an intermediary must disclose to the client his/her capacity, viz. a certification or license, which authorizes him/her to deal with the client. The intermediary should know the product features, operational norms and market dynamics of different financial products which are found suitable for a client. The suitability of the product being advised with respect to the financial situation of a client has to be strictly adhered with. The client should also be made aware of its various rights and obligations while an act of advice or sale is initiated/ completed. Operational Aspects KYC/FATCA requirement The customer due diligence is at the base of every Know Your Customer (KYC) norm and is south to be completed by collecting and verifying the Proof of Identity (PoI) and Proof of Address (PoA) of a client or investor. These lay the foundation of Anti-Money Laundering (AML) process. The need of physical documents is slowly giving way to completing KYC process online. The evolution of technology and innovative platforms for dealing in securities and financial products also meant simplifying and harmonizing the policies around KYC process by the clients as well as intermediaries. For instance, SEBI IP and Asset Management – India Specific Page 71

has recently recommended the use of eSign service, an online electronic signature service that can facilitate an Aadhaar holder to forward the document after digitally signing the same. These are further facilitated by the change in PML rules of the electronic equivalent of a document and the recognition of electronic signatures in the Information Technology Act, 2000. Thus, a client’s KYC can be completed through online or App-based KYC by submitting Officially Valid Document (OVD) under e Sign. The mobile number of client, accepted as part of KYC, should preferably be the one seeded with Aadhaar, which is verified through UIDAIs authentication/verification mechanism. Mobile and email is verified preferably through One Time Password (OTP). The Permanent Account Number (PAN) is verified online using the Income Tax database. Bank account details are verified by Penny Drop mechanism or any other mechanism using API of the Bank. It is important to have information about a client in terms of the capacity in which the client is represented, e.g. in own capacity, in a beneficiary capacity of a Trust or through a corporate arrangement, or through a power of attorney. Also, the client residency is a determining factor in ascertaining the admissibility of various financial and investment products, as well as the taxation aspect thereof. The documentation including that of KYC will thus be different as also the compliance and reporting norms for such individuals/entities. India is one of the countries with which the United States has an agreement regarding FATCA, which stands for Foreign Account Tax Complaint Act. This Act was introduced in the USA in 2010 to prevent tax evasion through offshore investments that some US citizens may have. As per the Act, by virtue of India agreeing to FATCA, financial institutions in India are required to disclose details of their client’s income if they are residents of the US or financially connected to the USA or have tax residency in the US (including green card holders). FATCA applies to individual as well as non-individual investors. The compliance requires a declaration giving information of PAN, country of birth, country of residence, nationality, occupation, gross annual income, and details whether one is a politically exposed person. Like FATCA in case of US, the European Union has Common Reporting Standard (CRS) for automatic exchange of financial account information. CRS is a global standard developed by the Organization for Economic Cooperation and Development (OECD), with more than 100 countries committed to the standard. Investor types and their on boarding processes The KYC compliance is the first need when on boarding a client. It can be completed online as given below: • Log on to the website of any KYC Registered Agency. • Create an account and fill in all the details on the online form. IP and Asset Management – India Specific Page 72

• You will have to provide your registered mobile number, PAN Card and other identification details. • Upload self-attested documents online. You may invest a lump sum amount in a mutual fund through a direct plan with the asset management company. You could opt for the offline or online mode of investment. You must complete your KYC by submitting a self-attested identity and address proof along with passport size photographs at the branch of the mutual fund house. You may invest in mutual funds through a Demat account with your stock broker or through any depository participant. The mutual fund units would be held in the dematerialised form. You can buy and sell mutual fund schemes through your Demat account just like shares. It is a dematerialised account that can hold stocks, mutual funds and other securities. Hindu Undivided Family or HUF consists of individuals from a common family tree or who have descended (lineally) from the same ancestor. It also includes wives and daughters who are unmarried. The “karta” is considered as the head of the HUF. He/she is legally allowed to take decisions for the HUF. Contrary to popular belief even a woman can be a karta. The following steps need to be completed by the karta in order to make any investments. First complete the KYC formalities. While filling the KYC Form, the karta needs to opt for the “Non-Individual” category and mention HUF along with his or her name. The following documents need to be shared with the agency: • The PAN Card of HUF and the karta • HUF’s Passbook or statement from the Bank • Photograph • Identity Proof issued by a government body • Address Proof • Deed of declaration or the List with the names of the coparceners • Details of the Karta (also referred to as Ultimate Beneficiary Owner) • Foreign Account Tax Compliance Act (FATCA) Form Once the KYC process is successfully completed, a 14-digit unique number (referred as the KYC Identification Number) is generated. The KIN is e-mailed to the Karta post 15 days of the verification process. Now the Karta can fill in the application form for investment in the Mutual Fund. Some important points to note while filling up the application form. IP and Asset Management – India Specific Page 73

• The Karta should explicitly mention “Hindu Undivided Family” after his or her name in order to differentiate it from personal investments. • HUF investments and portfolios (even demat accounts) are held and operated solely on a solo holder basis. An HUF is not allowed to allocate a nominee for any of its holdings. Platforms for submission of mutual fund application There are multiple channels through which one can apply for the mutual fund investments. • Website or digital portal of the concerned Asset Management Company If the karta (or HUF) does not want to go through any intermediaries, he or she can directly apply for the mutual fund investment through the fund house’s website. • R&T Agents- Registrar and Transfer Agents refer to institutions that handle the paperwork and other formalities involved in investor servicing. They register and maintain an extensive database of all transactions made by the investors. Some examples of RTAs that the Karta can approach for the HUF’s mutual fund investments are Karvy and CAMS. One limitation of this platform is that one can invest in only those schemes which are registered with the R&T agents. • Mutual Fund Utilities- MF Utilities is a common infrastructure shared by the Asset Management Companies in our country. It significantly helps in improving process efficiency by reducing duplication. This aggregator portal enables investors to transact in different schemes across AMCs. The Karta can take this route to invest in mutual funds on behalf of the HUF. He or she would need to fill in the Common Transaction Form (CTF) post which a Common Account Number (CAN) will be issued. This can be accessed online by visiting the link - https://www.mfuindia.com/eCANFormFill This is a convenient and economical way to make investments as one can choose from 33 participating AMCs  Robo-Advisors-These are online advisors that provide automated and customized investment plans without any human intervention. Many financial institutions provide this service these days. The USP of this platform is that it is devoid of any human error or bias. However, some investors prefer other platforms as they like to have some degree of human involvement in the whole process. If one wants to opt for this platform, one should ensure that the service provider has adequate domain experience, robust research background, database and goodwill in the industry. Whatever be the platform or channel through which the Karta decides to invest in Mutual Funds, the objective remains same – maximize the wealth for the HUF. There is no one right method. You need to choose the mode or platform which is right for you. IP and Asset Management – India Specific Page 74

Account opening of Non-Resident Investors (NRIs) Types of Accounts NRE Account • Any Indian not residing in India can open a NRE account and maintain foreign currency earnings in Indian Rupees. • The balance in the account is freely repatriable. • Interest earned in this account is exempt from tax in the hands of NRI. • Funds in this account can be easily transferred to FCNR Account and vice-versa. • NROs. OCBs, PIOs are eligible to open this account. • It has nomination facility available NRO Account • These are non-repatriable current/savings/fixed deposit accounts which can be opened jointly by residents of India. • When an Indian flies to another country for employment purpose, his account gets designated as NRO account. • Interest Account from NRO Accounts is reportable and taxable. • Repatriation is allowed up to US Dollar 1 million per calendar year subject to applicable taxes. • This amount also includes sale proceeds of immovable properties held by them for a period of 10 years. FCNR (Foreign Currency Non-Resident) Account • NRIs/PIOs/OCBs open this account in US Dollar, Canadian Dollar, Australian Dollar, Yen, Euro, and Sterling Pounds. • The account is opened only in form of term deposits with maturity period varying from one to five years, respectively. • Interest earned is entirely tax free if the NRI status remains intact Various Investment Products and Vehicles Fixed Deposit: Banks offer three types of accounts NRE FD, NRO FD and FCNR. IP and Asset Management – India Specific Page 75

The interest earned on company FD are taxable. So returns wise it would be better to go for NRE FD with bank. If you are not paying or in lower tax bracket, one can prefer company FD to NRO FD. Equity Investments: NRIs can invest in Indian stock markets, mutual funds, PMS etc. under the portfolio investment scheme (PIS) of the Reserve Bank of India (RBI). Under this scheme, an NRI must open an NRE/NRO account with an RBI-authorized Indian bank. An individual opens only one PIS account for buying and selling stocks. The tax liabilities for NRIs are the same as that of a Resident, the only difference being that in case of NRIs, tax is deducted at source(TDS). Public Provident Fund (PPF): One of the safest investment options in India is investing in the Public Provident fund. The Public Provident Fund is a scheme backed by the Indian government. Any Indian or non-Indian resident is permitted to invest in the Public Provident Fund. The present return rate on the investment of PPF is 6.4% per annum (as of April 1, 2021). The Public Provident Fund comes in with a lock-in period of 15 years. The maximum sum that can be invested is Rs 1.5 lakh each year. Moreover, investing in the Public Provident fund also offers tax deductions within Section 80C of the IT Act. National Pension Scheme (NPS): The National Pension Scheme is another reliable investment option as it is government-backed. Just like the Public Provident Fund, investing in the National Pension Scheme comes along with tax benefits. The accumulated amount during maturity remains tax-exempt. Investing in the NPS is as safe as investing in the FD or a PPF. Any individual aged between 18 years and 60 years can invest in the NPS and offers yearly interest of 09per cent to 12 per cent. So, Investment in NPS can be made by Citizen of India living in India or NRI who holds an Indian citizenship. Real Estate: Investing in the real estate sector is a traditional and an all-time favourite investment method for most NRIs. Indians leave their country and become NRIs. But, having a home or property back in your own country is considered a valuable possession. In addition to financial appreciation, it gives you a sense of emotional security as well. The real estate sector is considered a lucrative investment option for NRIs. As an NRI, you can purchase both residential and commercial properties. IP and Asset Management – India Specific Page 76

There is no restriction on the no. of properties owned. But you cannot buy agricultural lands, farmhouses, or plantations. Although, you can have ownership of agricultural land through inheritance or gift. However, the selling of property comes with some restrictions by FEMA (Foreign Exchange Management Act), especially in the case of repatriation transactions. So, you need to plan things well in advance by hiring a professional who will guide you with all the legal documentation and procedures at the time of purchase/sale. Bonds/Government Securities: The Government and companies require money from time to time for various projects or their expansion. Hence, bonds are issued for borrowing money. If you invest in bonds, you will be considered as a lender unlike equity where you have an equity stake in the company. Being an NRI, you have the freedom to invest in bonds and government securities. Investors get fixed returns on such bonds issued by companies or government institutions. If purchase is done through NRE/FCNR accounts, the proceeds are easily repatriable to the country where you live. Certificate of Deposits: NRIs also have the option to subscribe to Certificate of Deposits but on a repatriable basis. Certificate of Deposits is non-negotiable money market instruments issued in Demat form or the form of promissory notes. CDs yield a higher rate of interest as compared to bank deposits. Their maturity period ranges from 7 days to 1 year and is best suited for people having short-term financial goals. Ramifications of PMLA and FEMA Foreign Exchange Management Act, 1999 classifies two types of NRIs Non-Resident Indian holding Indian Passport (NRI) Person of Indian Origin (PIO), i.e. Non-Resident Indians holding foreign passports. From FEMA’s point of view, we must see who NRI is and who is not an NRI? Certain sub-sections of Sec. 2 of FEMA have dealt with the definitions of ‘person resident outside India’ and ‘person resident in India’. Section 2 (w) of FEMA has defined “person resident in India” means a person residing in India for more than one hundred and eighty-two days (182 Days) during the preceding financial year but does not include- • A person who has gone out of India or who stays outside India, in either case a) For or on taking up employment outside India, or b) For carrying on outside India a business or vocation outside India, or c) For any other purpose, in such circumstances as would indicate his intention to stay outside India for an uncertain period. IP and Asset Management – India Specific Page 77

• A person who has come to or stays in India, in either case, otherwise then a) For or on taking up employment in India, or b) For carrying on in India a business or vocation in India, or c) For any other purpose, in such circumstances as would indicate his intention to stay in India for an uncertain period. Prevention of Money Laundering Act, 2002, money laundering has been defined as “any process or activity connected with proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property”. The sources of funds invested by an NRI are subject to fulfilment of the following conditions:  The amount invested by NRI should be of remittance from abroad through normal banking channels or by transfer of funds from the investor’s NRE/FCNR/NRO accounts with a bank in India  The proprietary or partnership concern in India is not engaged in any agricultural/ plantation activity or real estate business, i.e., dealing in land and immovable property to earn profit or earn income there from. Limits on Demat account It is mandatory to trade with a Demat account in India, whether you are a resident or non-resident. Even NRIs if they wish to trade in bonds, stocks, IPOs, mutual funds, and more, should opt for a Demat account to do so. An NRI is a person with residence outside of the country. All NRI transactions are governed by FEMA regulations. Demat account for NRIs is both opened and operated the same way it is for resident Indians, so the opening procedure is nearly identical. Even the account charges for a Demat account for NRIs are often the same as they are for the Demat account of a resident Indian. The only core difference between a Demat account for NRIs and resident Indians has to do with opening the account. Before opening a Demat account, keep in mind that NRIs should have the following in hand or completed: • PAN Card of the NRI applicant • NRI Bank Account (NRO or NRE subtype) of the applicant • Portfolio Investment Scheme letter of approval for the NRI issued directly by the Reserve Bank of India. A Demat account in India for an NRI attracts charges: Account opening fee, Annual maintenance charges, Debit transaction charges and other charges. (Brokers fees) NRIs do not require permission IP and Asset Management – India Specific Page 78

from the RBI (Reserve Bank of India) to open a Demat account. However, there is a limit to the number of shares that can be sold by NRIs. There exists a restriction or repatriation up to a maximum of USD 1 million during a calendar year. Use of Power of Attorney and other Agreements A general Power of Attorney is just an authority document issued by the Guarantor to Grantee to perform certain acts on his/her behalf and is also required to be registered as per respective state provisions but convey any ownership right or title of the property to the guarantor. A power of attorney can be executed by any person who is competent to enter into a contract. There are two kinds of power of attorney viz., \"General Power of Attorney\" and \"Special (or limited) Power of Attorney\". A durable Power of Attorney is effective immediately after one signs it (unless stated otherwise), and allows the appointed agent to continue acting on one’s behalf in case the principal becomes incapacitated. Special Power of Attorney: A special power of attorney is one by which a person is appointed by the principal to do some specified act or acts. In this type of power of attorney, an agent is conferred with a power to do specific act in a single or specified transactions in the name of the principal PoA derives its legal authority as per the provisions of the Power of Attorney Act of 1822, under which you can appoint another person as your agent or attorney to act on your behalf. It is possible to issue a PoA with all general or special powers or specific powers to your named attorney for carrying out the work on your behalf as enumerated in the PoA, which may relate to operating bank accounts, investments in specific demat accounts, collecting rent or generally attending to the work which you were doing. The PoA may be made for a limited or indefinite period of time. The PoA should state if the attorney can sub-delegate the powers delegated to him or her to another person and that the PoA shall be valid even in the event you are incapacitated due to ill health NRIs may find it useful as they may not be physical present to execute a lot of routine legal documents related to their assets in India when they are abroad. The assets can be both physical (non-moveable) as well financial. PoA is generally revocable. If executed in India, it will require to be executed on a non- judicial stamp paper and notarized, and in a format which is generally acceptable. However, if it is related to empowering the agent to sell, mortgage and/or deal with an immovable property, then this PoA will be required to be stamped and registered. IP and Asset Management – India Specific Page 79

Operational aspects of managing account folios Nominations, Addition/deletion of name or bank account A registered and valid nomination allows a nominee to access the investments of a deceased investor in a hassle-free manner. Mutual funds make it mandatory to register nomination at the time of making the first investment. One can nominate up to three individuals with shares of each nominee specified in the nomination form. Following are features of valid nomination: • The statement of account should highlight the need to nominate if the account does not have the nomination. • The nomination should be maintained at the folio or account level and should be applicable for investments in all schemes in the folio or account. • Where a folio has joint holders, all joint holders should sign the request for nomination/cancellation of the nomination, even if the mode of holding is not “joint”. The nomination form cannot be signed by Power of attorney (POA) holders. • Every new nomination for a folio/account will overwrite the existing nomination. • The nomination shall be mandatory for new folios/accounts opened by individuals especially with sole holding and no new folios/accounts for individuals in single holding should be opened without nomination. • Even those investors who do not wish to nominate must sign separately confirming their non- intention to nominate. • The nomination form/section in the application form should also have a provision for the signature of the nominee (or guardian of the nominee), though this may not be mandatory. It should be not allowed in a folio held on behalf of a minor. Consolidation, Transmission and Lien Consolidation While making fresh investments in an existing mutual fund, if the existing folio number is not mentioned as a reference, a fresh folio is created for the same holder(s). It is possible to merge all folios into one to get a consolidated view of the investments. Consolidation can be carried out only if the following conditions are met: • Names of holders and holding pattern of investments is identical across all folios. • Mode of holding is same across folios (joint/either or survivor.) • Tax status of all investments is identical (NRE/Resident Indian/Corporate). • Signature, address, PAN and social status of investors is same. IP and Asset Management – India Specific Page 80

All folios held in the fund should be mentioned in the application. The target folio into which all other folios into which all other folios need to be consolidated should as mentioned. Folio consolidation can be done only at a mutual fund level. Folio can hold across different mutual fund houses cannot be merged. If the folio being merged is under lien or pledge, prior consent of the financier is required to be enclosed with the application. Transmission Units of a mutual fund are transferred to a surviving member in case of an untimely demise of the first holder, it is known as ‘transmission’ of mutual funds. On the other hand, a ‘transfer’ is said to happen when all the unit holders are alive. But both words are often used interchangeably. The following paragraphs list the documents required for transmission under various situations: a) In case of death of one or more unit holders: • Letter from surviving unit holders to the Fund / AMC / RTA requesting for transmission of units, • Death Certificate in original or photocopy duly notarized or attested by gazette officer or a bank manager, • Bank Account Details of the new first unit holder as per Annexure 1 along with attestation by a bank branch manager or cancelled cheque bearing the account details and account holder’s name. • Bank Account Details of the new first unit holder as per Annexure 1 along with attestation by a bank branch manager or cancelled cheque bearing the account details and account holders’ name. • KYC of the surviving unit holders, if not already available. b) In case of death of one or more unit holders: • Letter from claimant nominee/s to the Fund / AMC / RTA requesting for transmission of units, • Death Certificate/s in original or photocopy duly notarized or attested by gazette officer or a bank manager, • Bank Account Details of the new first unit holder as per Annexure 1 along with attestation by a bank branch manager or cancelled cheque bearing the account details and account holder’s name, • KYC of the claimant/s. c) Transmission to claimant/s, where nominee is not registered, in case of death of Sole or All unit holders. Letter from claimant nominee/s to the Fund / AMC / RTA requesting for transmission of units, IP and Asset Management – India Specific Page 81

• Death Certificate/s in original or photocopy duly notarized or attested by gazette officer or a bank manager, • Bank Account Details of the new first unit holder as per Annexure 1 along with attestation by a bank branch manager or cancelled cheque bearing the account details and account holder’s name. • KYC of the claimant/s, Letter from claimant nominee/s to the Fund / AMC / RTA requesting for transmission of units, i. Death Certificate/s in original or photocopy duly notarized or attested by gazette officer or a bank manager, ii. Bank Account Details of the new first unit holder as per Annexure 1 along with attestation by a bank branch manager or cancelled cheque bearing the account details and account holder’s name. iii. KYC of the claimant/s • Indemnity Bond from legal heir/s - Annexure-II. • Individual affidavits from legal heir/s - Annexure III. • If the transmission amount is below Rs Two Lakhs: any appropriate document evidencing relationship of the claimant/s with the deceased unit holder/s. • If the transmission amount is Rs Two Lakhs or more: Any one of the documents mentioned below: i. Notarised copy of Probated Will, or ii. Legal Heir Certificate or Succession Certificate or Claimant’s Certificate issued by a competent court, or iii. Letter of Administration, in case of Intestate Succession. Lien Lien is the right given to the lender over a security to recover the money in case the credit given to the borrower is not repaid as per the terms agreed to. In the case of loan against mutual funds, the lien is marked by the lender on the units offered as security. The lien is marked on the units and not on the amount. The value of units marked under lien can keep fluctuating. Lien can also be marked in online mode. “For online marking of lien, the investor visits the financier’s web portal and provides consent to borrow against mutual fund units and the financier digitally submits the lien marking request against the said number of units in the investor’s folio. After marking of lien, the lender will part with the loan amount with the investor. IP and Asset Management – India Specific Page 82

Minors as Investors Minors can invest in Mutual Funds through a guardian. The minor willing to invest in mutual funds can do so in his name and he will be first and sole holder in such a folio. This means that there can be no joint holder in this fund. The guardian can be either of the parents or a court appointed legal guardian. Minors can invest in Mutual Funds through a guardian. Changes in investor status, residency status (NRI to RI, RI to NRI) Investor Status & Minor to Major Mutual Funds send a notice to the guardian and the minor for submitting necessary documents in advance. Guardian needs to apply for changing the status to Major along with Minor’s signature duly attested by a bank official. The bank account registration form and KYC of the Minor also need to be submitted along with the application. The tax implications will now have to be borne by the sole account holder (Major). Until the child is a minor, all incomes and gains from the child's account are clubbed under the parent/guardian's income and the parent/guardian pays the applicable taxes. In the year, the Minor attains Majority, he/she will be treated as a separate individual and will pay taxes for the number of months for which he/she is a Major in that year. NRI to RI On becoming a resident investor, NRIs cannot operate the NRO/NRE/ FCNR (B) accounts. The change of status must be intimated to the bank and a resident rupee account must be opened. The authorized dealer and the depository participants must be informed of the status change. A new Demat account with 'resident' status will be opened and the balance held in the NRI account will be transferred to the new one. If the NRI had an online trading account, the broker needs to be informed about the change. The trading account with NRI status will have to be closed and a new trading account with resident status will be opened. A KYC form with new details must be sent to the KYC registration agency for updating the change of status, address, and bank details. Mutual funds need to be informed of the change too. RI to NRI • Mutual Funds: A letter to individual AMCs with folios no stating the change of status from NRI to RI and attaches the cancelled cheques of the old NRE/NRO accounts and the new resident account. IP and Asset Management – India Specific Page 83

• PPF Account: An NRI cannot open a PPF account, but if held an account when he was a resident Indian, he/she can hold that account till its maturity. He/she can invest amount in it as an NRI using funds in NRE/NRO account. • NPS Account: A Resident Indian will have to close the NPS account when his residency status changes. He/she can open the account ends if he as Aadhaar or PAN card or he/she can download the NRI NPS form, complete it and submit it to the bank branch. The amount will have to be remitted through the resident savings bank account. Change in Nomination (NRIs) At the time of investing in a mutual fund for purchasing units, the ‘Nomination’ section is provided in the account opening application form, where an investor can furnish the nominee details. Individual investors holding accounts either singly or jointly can make a nomination. In a mutual fund, investor(s) can also have multiple nominees and specify the percentage to be given to individual nominees as per their preference. However, in the event of the death of any of the holders, the benefits will be transmitted to the surviving holders. The nominee will be entitled to the benefits only in the case of the death of all the unit holders. A non-resident Indian (NRI) can also be a Nominee subject to the exchange control rules in force. Nomination can also be done in favour of the Central Government, State Government, a local authority, a religious or charitable trust, or any person designated by his/her office The nomination once made by an investor can be changed/added/subtracted anytime subsequently and any number of times. A new nomination request will automatically cancel the existing nomination and replace the same with the fresh nomination. Cancellation of nomination can only be made by unit holders who made the original nomination, singly or jointly. On cancellation of the nomination, there shall not be any obligation on the part of the Mutual Fund to transmit the units in favour of any of the nominees. Mandate of a Bank account A bank mandate, or account signatory, is a person in your business who is authorized to manage your bank account. Most banks offer a broad range of options dependent on whether you are a business or commercial banking customer. Account signatories can: • View all balances and transactions, • Set up payments, • Sign up for new financial products and services, • add or remove other bank mandates. You can add users to your account without making changes to your bank mandate, provided you are a commercial banking customer. As a regular business banking customer, you can only add more people to your bank account by making them an account signatory IP and Asset Management – India Specific Page 84

Payment instruments, transformation to digital payments Traditional Payment Cash: Cash is one of the most common ways to pay for purchases. Both paper money and coins are included under the larger category of \"cash.\" While cash has the advantage of being immediate, it is not the most secure form of payment since, if it is lost or destroyed, it is essentially gone. Cheque: A cheque is a document that orders a bank to pay a specific amount of money from a person's account to the person in whose name the cheque has been issued. The Reserve Bank of India (RBI) has introduced a new rule for cheque payments from January 1, 2021. It is called 'positive pay system' for cheques, under which re-confirmation of key details may be needed for payments beyond Rs 50,000. Availing of this facility would be at the discretion of the account holder. However, banks may consider making it mandatory in case of cheques for amounts of Rs 5 lakh and above. Demand Draft: A demand draft is a negotiable instrument like a bill of exchange. A bank issues a demand draft to a client (drawer), directing another bank (drawee) or one of its own branches to pay a certain sum to the specified party (payee). A demand draft can also be compared to a cheque. Digital Payment: Credit & Debit Cards: Credit cards and debit cards typically look almost identical, with 16-digit card numbers, expiration dates, and personal identification number (PIN) codes. Both can make it easy and convenient to make purchases in stores or online, with one key difference. Debit cards allow you to spend money by drawing on funds you have deposited at the bank. Whereas Credit cards allow you to borrow money from the card issuer up to a certain limit to purchase items or withdraw cash. Internet Banking: Internet banking, also known as online banking or e-banking or Net Banking is a facility offered by banks and financial institutions that allow customers to use banking services over the internet. Customers need not visit their bank’s branch office to avail each small service. Not all account holders get access to internet banking. If you would like to use internet banking services, you must register for the facility while opening the account or later. You must use the registered customer ID IP and Asset Management – India Specific Page 85

and password to log into your internet banking account. UPI (Unified Payment Interface): UPI allows transfer of money from one bank account to another instantly via one's mobile phone. Payments can be made via app on mobile device only. The money transfer via UPI works on 24x7 basis. To use UPI, you must have a bank account with a member bank, i.e., your bank should allow you to use the UPI facility. It is an initiative of NPCI (National Payment Corporation of India Role of Digital Payments in prevention of money laundering and frauds In India, the payment and settlement systems are regulated by the Payment and Settlement Systems Act, 2007 (PSS Act) which was legislated in December 2007. The PSS Act as well as the Payment and Settlement System Regulations, 2008 framed there under came into effect from August 12, 2008. In terms of Section 4 of the PSS Act, no person other than the Reserve Bank of India (RBI) can commence or operate a payment system in India unless authorized by RBI. Reserve Bank has since authorized payment system operators of pre-paid payment instruments, card schemes, cross-border in-bound money transfers, Automated Teller Machine (ATM) networks and centralized clearing arrangements. RBI regulations based on payment systems are as follows: Paper- based Payments Reserve Bank had introduced Magnetic Ink Character Recognition (MICR) technology for speeding up and bringing in efficiency in processing of cheques. While the overall thrust is to reduce the use of paper for transactions, given the fact that it would take some time to completely move to the electronic mode, the intention is to reduce the movement of paper – both for local and outstation clearance of cheques. Electronic Payments Electronic Clearing Service (ECS) Credit The Bank introduced the ECS (Credit) scheme during the 1990s to handle bulk and repetitive payment requirements (like salary, interest, dividend payments) of corporate and other institutions. ECS (Credit) facilitates customer accounts to be credited on the specified value date and is presently available at all major cities in the country. The system has a pan-India characteristic and leverages on Core Banking Solutions (CBS) of member banks, facilitating all CBS bank branches to participate in the system, irrespective of their location across the country. National Electronic Funds Transfer (NEFT) System In November 2005, a more secure system was introduced for facilitating one-to-one funds transfer requirements of individuals / corporates. Available across a longer time window, the NEFT system provides for batch settlements at hourly intervals, thus enabling near real-time transfer of funds. IP and Asset Management – India Specific Page 86

Certain other unique features viz. accepting cash for originating transactions, initiating transfer requests without any minimum or maximum amount limitations, facilitating one-way transfers to Nepal, receiving confirmation of the date / time of credit to the account of the beneficiaries, etc., are available in the system. Real Time Gross Settlement (RTGS) System RTGS is a funds transfer system where transfer of money takes place from one bank to another on a \"real time\" and on \"gross\" basis. Settlement in \"real time\" means payment transaction is not subjected to any waiting period. \"Gross settlement\" means the transaction is settled on one-to-one basis without bunching or netting with any other transaction. Once processed, payments are final and irrevocable. This was introduced in in 2004 and settles all inter-bank payments and customer transactions above Rs 2 lakh. Other Payment Systems Pre-paid Payment Systems Pre-paid instruments are payment instruments that facilitate purchase of goods and services against the value stored on these instruments. The value stored on such instruments represents the value paid for by the holders by cash, by debit to a bank account, or by credit card. The pre-paid payment instruments can be issued in the form of smart cards, magnetic stripe cards, internet accounts, internet wallets, mobile accounts, mobile wallets, paper vouchers, etc. The use of pre-paid payment instruments for cross border transactions has not been permitted, except for the payment instruments approved under Foreign Exchange Management Act,1999 (FEMA). Mobile Banking System Mobile phones as a medium for providing banking services have been attaining increased importance. Reserve Bank brought out a set of operating guidelines on mobile banking for banks in October 2008, according to which only banks which are licensed and supervised in India and have a physical presence in India are permitted to offer mobile banking after obtaining necessary permission from Reserve Bank. The guidelines focus on systems for security and inter-bank transfer arrangements through Reserve Bank's authorized systems. ATMs / Point of Sale (POS) Terminals / Online Transactions Presently, there are over 61,000 ATMs in India, over five lakh POS terminals in the country, which enable customers to make payments for purchases of goods and services by means of credit/debit IP and Asset Management – India Specific Page 87

cards. To facilitate customer convenience the Bank has also permitted cash withdrawal using debit cards issued by the banks at POS terminals. Directions require that the funds received from customers for such transactions need to be maintained in an internal account of a bank and the intermediary should not have access to the same. Further, to reduce the risks arising out of the use of credit/debit cards over internet/IVR (technically referred to as card not present (CNP) transactions), Reserve Bank mandated that all CNP transactions should be additionally authenticated based on information not available on the card and an online alert should be sent to the cardholders for such transactions. Corporate Actions Dividends, Stock Split, Rights and Bonus A company initiates several actions, apart from those related to its business that has direct implications for its stakeholders. These include sharing of surplus with the shareholders in the form of a dividend, changes in the capital structure through the further issue of shares, buybacks, mergers, and acquisitions and delisting, raising debt, and others. In a company that has made a public issue of shares, the interest of the minority investors must be protected. Dividends A company pays dividends to its shareholders from the profits made by the company during the year which are paid on a per share basis. It is not mandatory to pay out dividends every year. SEBI has mandated that listed companies shall declare dividends in rupees terms on per share basis as against the earlier practice of declaring dividends as a percentage of the face value. This is to avoid confusion among investors while comparing dividends on various shares of different face values. For instance, if a company having a face value of Rs 5 declares a dividend of Rs 30, the dividend pay-out ratio is said to be 600% (30/5). The price falls to the extent of dividend paid as the amount paid out no longer belongs to the company anymore. The dividends are not paid right after the announcement. This is because the shares are traded throughout the year, and it would be difficult to identify who gets the dividend and who does not. The following timeline would help you understand the dividend cycle. Dividend Declaration Date is the date on which the AGM takes place, and the company’s board approves the issue of dividend. Record Date or RD is when the company decides to review the shareholders register to list down all the eligible shareholders for the dividend. Usually, the time difference between the dividend declaration date and the record date is 30 days. The Ex-Dividend date or XD is normally set two business days before the record date. Only shareholders who own the shares before the ex-dividend date are entitled to the dividend. Save for IP and Asset Management – India Specific Page 88

market supply and demand for a share, the price should correct by the amount of dividend per share on the XD. The Dividend Pay-out Date is when the dividends are paid out or credited to the bank account of the shareholders on the register of the company on the Record Date the shares are said to be cum dividend till the ex-dividend date. Stock Splits A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the shares. Although the number of shares outstanding increases by a specific multiple, the total value of the shares remains the same as prevails prior to the split. The split does not add any real value. A stock split is usually to encourage more retail participation by reducing the value per share. The equity capital of the company and the market capitalization does not change post-split of a company’s shares. Consolidation Consolidation is the reverse of a stock split. In a share consolidation, the company changes the structure of its share capital by increasing the par value of its shares in a defined ratio and correspondingly reducing the number of shares outstanding to maintain the paid-up/subscribed capital Bonus Issue The purpose of bonus shares for a company is the capitalization of its reserves into the fresh equity of the company. It changes many ratios of the company as the outstanding number of shares increases post-bonus as also the equity capital. The shareholders seem to be rewarded, although at the time the deal is benefits neutral. The share price would correct in the market post bonus to reflect the same value of outstanding number of shares as pre-bonus. The dividends paid out in the future years would also adjust to a trend the company follows in declaration of per share dividends. However, in a lot of ways the bonus has a great sentimental value for shareholders as well for the company’s accounts. For sentiments, the company’s financial health is good as is reflected in sound reserves position. On the market parameters the turnover and liquidity of the company’s shares increase and the same trend of increase may be experienced with regard to the market capitalization of the company as the stock IP and Asset Management – India Specific Page 89

continues its upward journey. However, on ex-bonus date, the market capitalization of the company remains, more or less, the same depending on market sentiments and other factors. The following table indicates this: Rights Issue A company may offer rights shares to its shareholders to raise extra funds to pay off its debts or to fund its expansion plan, etc. The rights are issued generally at a discount to the ruling market price, primarily to benefit the shareholders, and secondly to make the issue attractive enough for subscription. The rights shares can be renunciated, wholly or partly, by a shareholder who does not wish to avail of the offer. As Rights share have some intrinsic value, by virtue of its discount to the prevailing share price, they can be traded in the market. Equivalently, those who wish to apply for extra rights shares may do so. Depending on the level of subscription of such Rights issue, such shareholder may get more Rights shares allotted in their account. Rights issue increases a company’s outstanding shares, equity capital and the market capitalization. Let us understand the intrinsic value (or theoretical value) of a Rights share by the table below: Alternatively, the theoretical value of a Rights share is given by the following formula: (Share Price - Rights subscription price) / (Number of rights required to buy one share + 1) (500 – 350) /(2 +1) = 150 / 3 = 50 Buy-back, Delisting of Shares, Mergers & Acquisitions Buy Back of Shares A buyback can be seen as a company’s method to invest by buying shares from other investors in the market. Buybacks reduce the number of shares outstanding in the market to expand the business and grow or reduce its liability by paying back/reducing its borrowings or distributing to the shareholders. Buyback of shares can be done only out of the reserves and surplus available with the company. The shares bought back are extinguished by the company within the stipulated time frame and that leads to a reduction in its share capital. To be eligible for a share buyback, a company should not have IP and Asset Management – India Specific Page 90

defaulted on its payment of interest or principal on debentures/fixed deposits/any other borrowings, the redemption of preference shares, or payment of the dividend declared. Delisting of Shares Delisting of shares refers to the permanent removal of the shares of a company from being listed on a stock exchange. Delisting may be compulsory or voluntary. In a compulsory delisting, the shares are delisted on account of non-compliance to regulations and the clauses of the listing agreement by the company. Involuntary delisting, the company chooses to get the shares delisted and go private. No minority shareholder can be forced to exit at the time of delisting of shares from the stock exchanges. Post delisting, any such shareholder would continue to be a shareholder in an unlisted business. Mergers & Acquisitions Mergers and acquisitions are corporate actions that result in a change in the ownership structure of the companies involved. In a merger, the acquirer buys up the shares of the target company and it is absorbed into the acquiring company and ceases to exist. For example, Microsoft and Skype, Walmart and Flipkart, Vodafone, and Idea, etc. The assets and liabilities of the target company are taken over by the acquirer. In an acquisition or takeover, the acquiring company acquires all or a substantial portion of the stock of the target company. Other examples, Sun Pharma’s acquisition of Ranbaxy, Disney's acquisition of 21 Century Fox, Amazon’s acquisition of Whole Foods, etc. Purpose of M&A: • Synergy: Each company may have distinct efficiencies that when combined may result in greater economic benefits. • Increased revenue and market share: If two competitors go through M&A, it would result in increased revenue and market share for the acquiring entity. • Geographical or other diversification: Acquiring Company in a different geography or complimentary business space may offer a significant competitive advantage to the acquirer. • Taxation: A profitable company can buy a loss-making company to enjoy a tax shield against the losses of the target company. Direct Investing A client who has fair knowledge of the products and skills required to operate in their respective markets may be equipped to make direct investment. However, mere possession of knowledge and skills may not be enough and a client may avail the services of professionals to make investments, e.g. by way of managed portfolios, mutual funds, collective investment schemes, etc. There is a sea change IP and Asset Management – India Specific Page 91

in the India marketplace over the last couple of decades from the days of holding and transacting in paper form (physical certificate) various investment products/avenues such as equity shares, bonds and mutual fund products. The electronic form of holding securities has done away with a unique number to identify a physical security certificate. The International Securities Identification Number (ISIN), a 12-character alphanumeric code assigned to a class or type of security by an issuer, serves for uniform identification of a security at trading and settlement. This has brought a revolution in the database management of registrars and transfer agents, which have digitized all issuances to the maximum extent, so much so that the securities market regulator SEBI mandated 31st March, 2019 as the last date after which the physical shares of listed companies would need to be necessarily dematerialized before their sale or transfer At the very root of dematerialization of securities are two depositories, the National Securities Depository Ltd (NSDL) and the Central Depository Services India Ltd (CDSL). They in turn have depository participants (DP), being banks, securities companies, stockbrokers, non-baking finance companies, registrar and transfer agents, etc. The DPs hold investor accounts in electronic form and maintain investor holdings for securities purchased and kept in such accounts. They also release securities sold by investors and collect the proceeds from clearing house to credit the investors’ registered bank accounts. A DP maintains records related to both depositories, NSDL and CDSL, which are respectively affiliated to the National Stock Exchange of India Limited and the Bombay Stock Exchange. The DPs receive requests from investors to dematerialize securities held in physical form. The reverse of the process is called rematerialization. All equity shares, bonds and debentures, as well as derivative products are held by DPs on behalf of investors in electronic form. Banks also have electronic investment accounts which hold mutual fund units purchased by their clients through them. Even the physical issue of fixed deposit receipts is gradually being done away with. An electronic record is maintained in a client’s bank account, while electronic fixed deposit receipts are e-mailed. Risk Management System in the Secondary Market There are risks at multiple levels when investing in stock markets. There may be company level risk, sector risk, operational risk, etc. In short, a risk is the probability of losing money while dealing in stock markets. Broadly, the investment risk is classified in two categories: Systematic risk: The variability in a security's returns that is directly associated with the overall movements in the general market or economy is called systematic risk. It is a non-diversified portion of the risk also known as market risk. All securities have systematic risk whether it is bonds or stocks because systematic risk directly encompasses interest rate, market, and inflation risks. IP and Asset Management – India Specific Page 92

Unsystematic risk: The risk is specific to a particular company or security such as business risk, financial risk, liquidity risk, etc. This type of risk can be diversified. Total risk: Systemic risk plus unsystematic risk on an investment. Every investment has systemic risk (any risk carried by an entire class of assets and/or liabilities) and unsystematic risk (any risks unique to the investment). When making investment decisions, investors must account for the total risk to the investment. Total risk = Systematic Risk + Unsystematic Risk = Market Risk + Issuer’s Risk = General Risk + Specific Risk A sound risk management system is integral to an efficient clearing and settlement system. The clearing corporation ensures that trading members’ obligations are commensurate with their net worth. It has put in place a comprehensive risk management system, which is constantly monitored and upgraded to prevent market failures. It monitors the track record and performance of members in terms of their net worth, positions, and exposure with the market, collects margins. Thus, a multiplicity of risks may arise as follows: Capital Adequacy The capital adequacy requirements stipulated by the NSE are substantially more than the minimum statutory requirements as also as those stipulated by other stock exchanges. A person/entity seeking membership in the CM segment is required to have a net worth of Rs. 1 crore and keep an interest-free security deposit of Rs. 1.25 crore and collateral security deposit of Rs. 0.25 crore with the Exchange/NSCCL. The deposits kept with the Exchange as part of the membership requirement are taken as base capital to determine the member’s intra-day trading limit and/or gross exposure limit. Additional base capital is required to be deposited by the member for taking additional exposure. Margins and Settlement Guarantee Mechanism The transactions in the secondary market pass through three distinct phases, viz., trading, clearing, and settlement. Margin trading refers to the process whereby individual investors buy more stocks than they can afford to. Margin trading also refers to intraday trading in India and various stockbrokers provide this service. Margin trading involves buying and selling securities in one single session. While the stock exchanges provide the platform for trading, the clearing corporation determines the funds and securities obligations of the trading members and ensures that the trade is settled through the exchange of obligations. The role of each of these entities is explained below: IP and Asset Management – India Specific Page 93

Clearing Corporation: It is responsible for post-trade activities such as risk management and the clearing and settlement of trades executed on a stock exchange. Clearing Members: These are responsible for settling their obligations as determined by the NSCCL. They do so by making available funds and/or securities in the designated accounts with clearing bank/depositories on the date of settlement. Custodians: They are clearing members but not trading members. They settle trades on behalf of trading members when a particular trade is assigned to them for settlement. Clearing Banks: These are a key link between the clearing members and Clearing Corporation to settle funds. Every clearing member is required to open a dedicated clearing account with one of the designated clearing banks Depositories: A depository holds securities in dematerialized form for the investors in their beneficiary accounts. Each clearing member is required to maintain a clearing pool account with the depositories. He is required to make available the required securities in the designated account on settlement day. Fundamentally, there are two sorts of depositories in India. One is the National Securities Depository Limited (NSDL) and the other is the Central Depository Service (India) Limited (CDSL). Every Depository Participant (DP) needs to be registered under this Depository before it begins its operation or trade in the market. Professional Clearing Member (PCM): NSCCL admits a special category of members known as professional clearing members. A PCM is entitled to clear and settle trades executed by other members of exchange the exchange. They also undertake clearing and settlement responsibilities of the trading members. The PCM in this case has no trading rights but has clearing rights i.e., he clears the trades of his associate trading members and institutional clients. The settlement process begins as soon as member's obligations are determined through the clearing process. The settlement process is carried out by the Clearing Corporation with the help of clearing banks and depositories. The Clearing Corporation provides a major link between the clearing banks and the depositories. This link ensures the actual movement of funds as well as securities on the prescribed pay-in and pay-out day. NSCCL imposes stringent margin requirements as part of its risk containment measures. The categorization of stocks for the imposition of margins is as given below: a) The stocks, which have traded at least 80% of the days during the previous 18 months, should constitute Group I and Group II. IP and Asset Management – India Specific Page 94

b) Out of the scrips identified above, those having a meaningful impact cost of less than or equal to 1% should be under Group I, and the scrips where the impact cost is more than 1, should be under Group II. c) The remaining stocks should be under Group III Price-monitoring, Price Bands and Circuit Breakers The function of a proper price monitoring mechanism is to detect potential market abuses at a nascent stage to reduce the ability of the market participants to unduly influence the price of the Securities traded at BSE by taking surveillance actions like reduction of circuit filters, imposition of special margin, transferring Securities on a trade-to-trade settlement basis, suspension of Securities/ members, etc. These proactive measures are taken based on the analysis/ processing of alerts generated based on various parameters and other inputs like news, company results, etc. The broad parameters considered for generation and analysis of alerts are price movement, top 'n' turnover, Securities traded infrequently, Securities hitting new high/ low, Securities picked up for rumour verification, etc. The Securities picked up based on the preliminary analysis/inquiries are forwarded to the Investigation cell for further examination/ investigation The NSE and BSE have set price bands for all securities and serve as boundaries for the stock's trading; the exchange will not accept orders that are set outside the minimum and the maximum of the price range. The purpose behind price bands and circuit breakers is to control mass buying or selling of shares and send a market spiralling into one direction, and perhaps most importantly, to curb panic selling. Most stocks on the NSE and the BSE have an upper and lower price band. There are 5 categories of price bands: • If a stock has derivative products listed or if the stock is included on an index on which derivative products are available, it does not have an upper or lower price band. • A stock can have price bands of 20% either way, based on the previous day's closing price. • A stock can have price bands at 10% either way, based on the previous day's closing price. • A stock can have price bands at 5% either way, based on the previous day's closing price. • A stock can have price bands at 2% either way, based on the previous day's closing price. Similarly, a marked wide \"price band\" is implemented through the circuit breaker system. On the BSE, the Sensex is used while on the NSE, the Nifty. Whenever either triggers a circuit breaker, a coordinated trading halt is applied to all equity and derivative markets nationwide. IP and Asset Management – India Specific Page 95

Online Monitoring and Inspection of books Online Position Monitoring System (OPMS) is the online position monitoring system that keeps track of all trades executed for a trading member vis-a-vis its capital adequacy. The system also tracks online real-time client-level portfolio base upfront margining and monitoring. The SEBI Act empowers the regulator to conduct inspection of any book, register or other documents and records of any listed company if it has reasonable grounds to believe that the company has been indulging in insider trading or fraudulent and unfair trade practices relating to securities markets. Mutual Funds Mutual Funds (MFs) in India are funds established in the form of trusts to raise money through the sale of units to the public or a section of the public under one or more schemes for investing in securities, money market instruments, government securities and bonds and other assets including gold and real estate. Erstwhile Unit Trust of India was established by an act of parliament in 1963 to encourage a savings culture among the public by investing the collected funds in securities and equity markets by allotting equitable units to the investors, called unit holders, in lieu of their money. Late in the 1980s, few public sector banks joined the fray by sponsoring their mutual funds. In 1993, the space was further opened to private sector mutual funds. Regulatory Framework With the notification of SEBI (Mutual Funds) Regulation, 1996, prudent guidelines were issued for creating a level playing field in the mutual funds industry, and for its growth. Each mutual fund is required to have a sponsor who should have a sound track record and general reputation of fairness and integrity in all its business transactions. The structure requires the sponsor to appoint a trustee company (trustees) which will act as trustee for the mutual funds and hold all its assets. The trustees appoint a custodian to keep the assets of all schemes in safe custody. The trustees, under an Investment Management agreement, appoint an asset management company (AMC) with the approval of SEBI. The sponsor will have at least 40% holding of the net worth of the promoted AMC, mandated to be at least Rs. 50 crore. The AMC will manage one or more schemes of the mutual fund and issue units to the general public (and other approved classes of investors) to procure their funds for investment as per SEBI guidelines. A compliance officer appointed will monitor the compliance of SEBI Act, Mutual Fund Regulations, notifications, guidelines, etc. issued from time to time. The compliance officer will report to the trustees, who will also design a compliance manual and internal control mechanism including internal IP and Asset Management – India Specific Page 96

audit systems. The trustees shall appoint directors on the board of AMC. They will have power over the continuance, or otherwise, of AMC, if substantial irregularities are observed in any of the schemes managed by the AMC. The Chief Executive Officer of the AMC shall ensure compliance with MF regulations and appoint key personnel to manage various aspects in a non-conflicting manner including appointing of a dedicated a fund manager to manage each scheme. The AMC will appoint registrar and transfer agents to manage unit holding accounts. The Association of Mutual Funds in India (AMFI), incorporated in August, 1995, is a nodal body of all the AMCs of SEBI registered mutual funds in India. It is a non-profit organization and promotes best business practices and code of conduct to be followed by its members, which are all the SEBI registered mutual fund AMCs. Process, Features and Benefits The funds of investing public are solicited by launching schemes which are approved by the trustees and a copy of their offer document is filed with SEBI. The offer document shall contain disclosures which will enable a prospective unit holder to make an informed investment decision. SEBI may, in the interest of unit holders, require modifications in the offer document. General features of the scheme such as its investment objective, asset allocation and investment strategies are part of the scheme information document (SID). It categorically mentions the risk profile of the scheme, which is important information for decision-making. The fees and expenses, the benchmark for investment performance and details of fund manager are other notable features. The other part of offer document is the statement of additional information (SAI), which has statutory information of the sponsor of the mutual fund. An abridged version called Key Information Memorandum (KIM) summarizes in a standard format the information that a prospective unit holder must take into account before investing. It has asset allocation, risk profile, various plans/options, unit price, minimum investment, dividend distribution policy, benchmark index, etc. The KIM needs to be revised at least once in a year, and as frequently when key changes are introduced in a scheme. The obvious advantage of investing through mutual funds is professional management of funds at a reasonable charge, which includes fund management and administrative fees. Mutual funds invest across the investment universe: equity stocks, corporate bonds, government securities, money market instruments, commodities, gold and real estate. IP and Asset Management – India Specific Page 97

At a very low-ticket size of a few hundred of Rupees, the investment in mutual fund scheme units gives a diversified exposure to one or more asset classes. One can have a balanced exposure to equity and bonds through hybrid funds; and can have high liquidity and very low risk through money market and liquid schemes. There are in-built tax exemption under section 10(23D) of Income-tax Act, 1961of all income earned by way of interest, dividend and capital gains by mutual funds established under SEBI (Mutual Funds) Regulation, 1996. The unit holders can have a long-term approach to benefit from this provision apart from several other tax advantages they individually have, like availing annual limit of Rs. 1 lakh for long term capital gains in equity schemes, a staggered withdrawal to qualify for lower capital gains than the high tax rates on income distribution in bond/debt funds. Other benefit of investing through mutual fund debt schemes is that we can have risk-diversified exposure with low amount of investment to bonds, government securities and money market instruments, which otherwise have high ticket size in the market. Net Asset Value and Investment Options The net asset value (NAV) is the performance barometer of a mutual fund scheme. In the new fund offering (NFO) a scheme offers units at par, generally at Rs. 10 per unit. Based on income and dividend received on invested securities, the capital appreciation thereon, and realized gains on churning investment, the value of assets in a scheme is likely to go up in due course. Per unit value of these assets across all created units in a scheme, as reduced by accrued administrative expenses and fund management fees, gives the NAV of the scheme. This NAV may not always move up. The market forces may erode partially the value of securities invested in a scheme, thereby depressing NAV from the levels at which a unit holder had invested earlier. There are open-ended schemes of a mutual fund which offer fresh investments and redemption on an on-going basis. They do not have a fixed tenure, and are perpetual in nature. The closedend funds generally do not take fresh investments after the initial offer, and they have a lock-in for redemptions, known as the tenure of the scheme. Interval funds are a combination of the above, in that, they have open periods at pre-fixed intervals during which redemptions, or even fresh sales are allowed. Each scheme has a dividend option and a growth option. The dividends are declared and distributed as per the dividend policy to unit holders exercising the ‘dividend’ option. On choosing a dividend reinvestment option (instead of dividend distribution option), the unit holder gets the dividend invested at the ex-dividend NAV of the scheme, and fresh units get allotted. The NAV of dividend option of the scheme reduces to the extent of dividend distributed (including taxes on dividend) per unit. In ‘growth’ option, the dividend is not declared, and the invested funds aim at compounding and long-term capital appreciation. A unit holder may exercise option to buy units in a IP and Asset Management – India Specific Page 98

scheme directly from a mutual fund house, in a ‘direct’ plan. The other plan is ‘regular’ in which the commissions to mutual fund distributors is dispensed by schemes in all years of a unit holder remaining invested in the scheme. The NAV of ‘direct’ plan is higher than ‘regular’ plan due to this impact of commission or sales charge. The systematic investment plan (SIP) allows a unit holder to invest regularly on monthly/ quarterly rests as per convenience of income or investable funds. The investment mandate once exercised works on auto-mode with pre-determined amount of SIP deducted at defined dates of the chosen period, and invested at that date’s NAV. The best advantage of SIP investment is a disciplined approach to investments irrespective of market level or trend. It helps in Rupee Cost Averaging, which allow more units allotted for fixed investment in depressed markets and lower number of units purchased at high NAVs during bullish phase. It allows small size investments over long periods to ride out volatility and to give a power of compounding to the invested kitty. It is the best investment strategy to save for one’s retirement, especially in the absence of access to statutory retirement plans. The systematic withdrawal plan (SWP) allows the accumulated funds to be withdrawn in fixed amounts or fixed units over a period. It allows advantages of capital gains, especially due to indexed cost of capital taken into account in debt schemes for terms of investments longer than three years. It also permits withdrawal near a goal in meeting staggered expenses as well as in riding out high volatility or a steep fall in equity on reaching a goal term. The systematic transfer plan (STP) allows periodic redemption from one scheme, equity or debt or liquid/money market, with simultaneous investment in another scheme of the same mutual fund house. This is good strategy while changing asset allocation and in rebalancing asset classes. Mutual Fund Products Mutual fund schemes have broad categorization in equity, debt, hybrid and liquid/money market. The equity and equity-oriented schemes have a minimum of 65% assets invested in equity shares of Indian companies. Many hybrid funds keep this allocation to have equity categorization. The arbitrage funds as a rule keep this exposure to equity for offering tax advantage to its unit holders, while they generate returns which are, more or less, that of debt funds. The strategy adopted by arbitrage funds is to take advantage of mispricing or price differences of equity shares in the spot and futures market. A ratio of less than 65% to equity changes a scheme’s nature to debt scheme. Monthly Income Schemes (MIPs) are in this category where between 10% and 30% is usually invested in equity stocks. One can have passive exposure to stock markets by investing in index funds mapping Nifty-50 and BSE Sensex at very low management fee. Various ETFs are also available which present opportunity to trade at intra-day levels. IP and Asset Management – India Specific Page 99

With some risk and fund management costs, one can have access to schemes from well-diversified equity funds to themes like large cap, medium, small cap, and dynamic multi-cap funds; sector themes like banking, infrastructure, pharma, technology, IT/software, auto, FMCG/consumption, etc. There are also International Funds which invest in global securities. The Fund of Funds (FoF) invests in other funds, instead of securities. They are pooled investment funds, their portfolio consisting of different underlying portfolios of other funds. It is more apt to have exposure to bonds, debentures and other fixed income securities through mutual fund schemes. They diversify concentration risk and credit risk very well, besides managing the all- important interest rate risk. One can have accrual funds which invest in securities of short-and- medium-term maturity. They can be ultra-short term or short term in types. The credit opportunity funds that look for mismatches in the current rating of a bond and its fundamentals, as well as corporate bond funds are also in this category which generally carries low interest rate risk. The interest rate risk is also mostly avoided by investing in fixed maturity plans (FMP), wherein the term of the plan is matched with the outstanding maturity of invested debt securities. There is a category of dynamic bond funds which vary the duration of schemes to suit investment climate to offer better returns. For a pure play on interest rate, there is opportunity in long duration funds and government securities (G-Sec or Gilt) funds. In a falling interest rate cycle, the duration is increased by taking more exposure to long-dated bonds and government securities. As yields fall all across, these long-dated, higher-coupon underlying securities appreciate in prices leading to capital appreciation in units of such schemes. In contrast, in rising interest rate cycle it is better to reduce exposure to duration funds, though fund managers take evasive action by reducing duration of schemes. The Liquid Funds and Money Market Mutual Funds (MMMFs) are kind of risk free investment category. The underlying securities in such schemes are of below 90 days maturity, mandated for this category. Time, Value and Event-based Triggers in MF investing Investments are meant for a long and adequate horizon. They are not meant for perpetuity unless meant for succession. They should be liquidated are at the appropriate time. Some of such appropriate times are decided by the triggers for exit. Exit triggers could be routine or pre-set, review based, ad-hoc or event based. A pre-set trigger is a finite event, in the sense that the variable and the level of the variable is decided either initially or some time into the investment. It is not a subjective decision point for the investor or the adviser, as the decision has been taken earlier, based on an objective parameter. IP and Asset Management – India Specific Page 100