RELC - Textbook

Chapter 2: Role of Regulators You will learn the various roles performed by the regulators in Indian financial system & how these regulators protect the interest of consumer, intermediaries and the govt. The financial regulators in India have their roles spread over an array of complex functions. In their function of subordinated legislation they have been assigned powers to frame regulations and laws in their respective areas of expertise in order to administer the legislative requirements pertaining to those sectors. Thus, they have quasi-legislative functions, executive and to a large extent judicial functions. In their micro-prudential regulation, they maintain the supervision of the financial endurance of the constituent financial institutions and entities. All regulators have consumer protection at the center of all regulation. In fact, it is the primary motivation of all regulation-making. Financial inclusion is aimed at maintaining equity on one hand and spreading and developing industry on the other. As the industry develops, regulators have an objective to ensure a level playing field for the participants. A credible framework of resolution lends stability to the financial sector, and constitutes an essential function of respective regulators. There are few roles which regulators perform in close coordination with the government, such as capital controls or public debt management. Monetary policy falls within the ambit of RBI, which performs this role fairly in an independent capacity. Regulation-Making The regulation-making sets the standards of conduct amongst various stakeholders of the industry; how they interact with the regulator, with their peer bodies and the consumer. The regulatory guidelines also include the conduct of financial activities and the supervision of financial markets. Such supervision and/or adjudication can be performed only after clear and explicit terms have been laid down for the required behavior by the stakeholders. This is akin to a system governed by the rule of law or the known standards against which the action of the regulated entities should be judged. Some regulators in India have adopted a structured consultative process of regulation-making lately. In the absence of a well laid down process of rule-making or a defined set of instruments, a regulator may use guidelines, circulars, master circulars, notices, press notes, etc. which might have the intended outcomes. The whole idea of the exercise is that the regulations should become more responsive to the needs of the financial system, and should aid rather than impede the development of the industry. Executive Functions The executive functions of a regulator include issuance of licenses or permissions, enforcement of orders, processing of complaints, inspection of regulated businesses, investigation, alleged violations of CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 97

the law, etc. The exercise of supervision and monitoring powers is fundamental to the effective enforcement of laws by the regulator. Under the extant legislations in India, the executive functions of regulator do not have standardized statutory checks. Though on one hand the exercise of executive function may place an undue burden on regulated entities and financial markets, on the other hand the manner of their exercise could have a downside for the businesses. It may create uncertainty for businesses. The confidentiality issues may lead to loss of reputation for financial firms. The injunctions imposed during investigations may have economic implications if they are extended over a long period. Hence, it is desirable to have strong executive powers balanced with greater transparency and accountability. All executive actions should adhere to the two principles of the rule of law; a substantial reduction in discretion, and a duty to explain the reason behind any executive action. Administrative Law Functions Regulators in India also have an administrative law function. In a quasi-judicial function, they have powers to award appropriate penalties and punishments in exercise of their supervisory and enforcement powers, if any breach in compliance with the provisions of financial laws by any regulated entity is detected. These wide ranging executive powers given to regulators akin to a State capacity have a balancing mechanism in the form of proper systems governing the application of administrative law. There is a mechanism to review the actions taken by regulators in exercise of their quasi-judicial functions. In one such efficacious procedure the appeal against the orders written by SEBI, IRDA and PFRDA can be made to the Securities Appellate Tribunal (SAT). These processes uphold the rule of law and ensure fair play in the investigation, prosecution and quasi-judicial functions. These are good governance procedures and create for regulators the pathway to the higher levels of State capacity. Consumer Protection The function of consumer protection is at the heart of all financial regulation. The financial regulatory structure in India is divided along sectors. The regulatory treatment of financial products and services as also the protection that consumers afford therefrom is therefore defined by sector-specific guidelines and laws. Similar financial products under two different regulators may have inconsistent treatment, giving rise to the regulatory arbitrage. Moreover, the doctrine of caveat emptor, or let the buyer beware largely prevails over the Indian financial sector. Consumers are left to themselves to decipher financial products beyond the customary disclosures which regulators deem necessary for the industry and the intermediaries of products. At best, consumers can have recourse to financial frauds by going through a detailed legal process. The basic protection which is professed by the regulatory commentary across sectors is: fairness, confidentiality, disclosure, complaint redress, professional diligence and conduct, and allegiance to contract. What however gets camouflaged is the conflict of interest of the intermediaries pushing the products and the real advice which is in the sole interest of the consumer. Prudential regulations ought to have good preventive and curative instruments. The regulator through sound regulation-making can have measures built in the system to prevent grievances. There is however requirement of an equally robust curative mechanism in the form of redress agencies, either CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 98

independent or extended arms of the regulator. In India, there exist sector-specific ombudsman systems. Two such ombudsman mechanisms having regional access across India are the banking ombudsman and the insurance ombudsman. SEBI has a well-functioning online system of SCORES (SEBI Complaints Redress System) where complaints against a listed company or intermediary registered with SEBI can be filed. The pension regulator PFRDA has appointed a Stipendiary Ombudsman who oversees timely and effective resolution of grievances of subscribers under NPS. Besides, retail consumers have the option to approach other available forums, such as the consumer courts established under the Consumer Protection Act, 1986 and regular courts. Micro-Prudential Regulation – Manage Systemic Risk The micro-prudential regulation in India is conducted by the sector-specific financial regulators. This poses the problem of regulatory gaps. Some unscrupulous financial firms can design products tweaking certain features to escape regulatory oversight. Also, conglomerates specializing in more than one service may be difficult to be categorized under sector allocation. One important task of micro-prudential regulation is to ensure that the financial obligations made by a firm to the consumer under a contract are upheld. One vital construct of regulations is to constrain the behavior of a financial firm to take lower risk, or never to take disproportionate risk, so that the probability of failure is reduced. A micro-prudential framework therefore seeks both quality and comprehensiveness of regulations and their effective enforcement to thwart the specter of a systemic risk to the industry. Micro-prudential regulation must be distinguished from ‘systemic risk regulation’, also called macro- prudential regulation. Sound micro-prudential regulation is, of course, an essential ingredient of reducing systemic risk. Yet micro-prudential regulation focuses on one firm at a time, while systemic risk regulation involves the financial system as a whole. Micro-prudential regulation sees the proverbial trees to the forest surveyed by systemic risk regulation[7]. (FSLRC; vol.I, chap 6, p.57) Before we approach prudential regulations, there are a few functional forms that need to be addressed, viz. the financial market conduct and integrity regulation, retail consumer protection, and competition regulation. We finally have prudential regulations which deal with the safety and soundness of the financial system. Radhika Pandey and Ila Patnaik in their working paper, Financial sector reforms in India, have said, “…..Market conduct considers how persons involved in the financial sector conduct themselves and their businesses in relation to clients, customers, and each other, with a focus on fairness and integrity”.[8] (Radhika Pandey and Ila Patnaik; NIPFP Working Paper Series, No 267, 10-May-2019). Some of the challenges in the realm of market conduct are: opaque and complex fee structures that undermine product comparisons; poor disclosure of risks in complex products such as securitized assets; incentives and inducements reduce consumer scrutiny of core product features and distort decision-making; conflicted commission-based remuneration structures of intermediaries; and tick-box compliance, or disclosure documentation meant to merely fulfill regulatory requirements. Regulation CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 99

oriented towards consumer protection aims at ensuring that retail consumers have adequate information, are treated fairly and have adequate avenues for redress. General market conduct regulation is not sufficient to protect the interests of retail consumers. There is information asymmetry which makes it difficult for consumers to evaluate how well a financial service provider will perform, or is performing. There is noise in the information along with obvious limitation to process and to react to the market information. The complexity of financial products increases the probability that the consumers could be misled about the nature of financial promises particularly the risks attached to such products. Further, the regulations have to guard against the anti- competitive behavior where large financial institutions may exert significant influence over prices leading to the potential exclusion of other willing participants. Finally, prudential regulation strengthens the safety and soundness of the financial system by adding an extra layer of oversight beyond regulation of disclosure and market conduct. The micro-prudential regulations seek to seep through and isolate financial promises that are difficult to honor, difficult to assess, and that pose grave consequences for system if breached. Regulators have five powers through which they can pursue the micro-prudential goal: regulation of entry, regulation of risk-taking, regulation of loss absorption, regulation of governance/management, and monitoring/supervision[9]. (FSLRC; vol. I, p. xix) Resolution Financial Sector Legislative Reforms Commission (FSLRC) in their report, volume I, states that: Consumer protection, Micro-prudential regulation and Resolution are tightly interconnected. Consumer protection deals with the behavior of financial firms towards their customers in periods of good health. Micro-prudential regulation aims to reduce, but not eliminate, the probability of the failure of financial firms. Resolution comes into the picture when, despite these efforts, financial firms fail. (FSLRC; vol. I, p. xxi) The failure of large private financial firms can be highly disruptive for households that were customers of the failing firm, and for the economy as a whole. As India increasingly opened up entry of several large private financial firms into finance, it became important to create mechanisms to deal with failing firms. With the promulgation of the Insolvency and Bankruptcy Code (IBC) Act, 2016 India had its first law to deal with the resolution of assets of insolvent entities. The preamble of the Act reads: An Act to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 100

(The Insolvency and Bankruptcy Code, 2016; No. 31 of 2016; Ministry of Law and Justice, The Gazette of India; May 28, 2016) The Code outlines separate insolvency resolution processes for individuals, companies and partnership firms. The process may be initiated by either the debtor or the creditors. A trustee is appointed to liquidate the company's assets and the money is used to pay off the debt, which may include debts to creditors and investors. The owners are last in line to be repaid if the company fails. Bankruptcy laws determine the order of payment. At present, India has a deposit insurance corporation, the Deposit Insurance and Credit Guarantee Corporation (DICGC). It deals only with banks, to the extent of insuring amount up to Rs. 100,000 in respect of savings, fixed, current, recurring, etc. per customer ownership across all her accounts across all branches of a failed banking entity. All commercial banks including branches of foreign banks functioning in India, urban cooperative banks and regional rural banks are insured under the DICGC. The deposit insurance premium is borne by the insured bank. Financial Inclusion and Market Development Apart from strict regulatory framework, there are certain functions in which the State role vests, such as ensuring an equitable distribution of financial services and fostering the development of market infrastructure and processes. Financial inclusion imposes costs on society as a whole while benefiting a certain class. Opening bank branches in rural areas and providing rural population credit at reasonable cost is one such initiative. The development includes modernization of facilities, embracing technology and absorbing international best practices. The outreach to a large percentage of population and encouraging their participation with a view to social enrichment is one important regulatory goal. The incentives extended to mutual fund asset managers to absorb costs and to compensate intermediaries for reaching out to towns and cities beyond the top thirty cities is one step to increase market penetration. Capital Controls India’s current account is fully liberalized. However, the movement of capital across borders is still under controls, as is with the majority of nations. The Foreign Exchange Management Act, 1999, codifies the existing approach to capital controls. It differentiates between current account transactions and capital account transactions. The Central Government makes rules in consultation with RBI for current account transactions, and the RBI in consultation with the Central Government makes regulations in relation to capital account transactions. Presently, there are difficulties[10] due to existence of multiplicity of regulators, laws and investment vehicles. For instance: The institutional bodies regulating capital flows include the RBI, SEBI, IRDA, and PFRDA. (FSLRC, Vol. I; chap 8, p. 82). Within the Central Government, the Ministry of Finance houses the Department of Revenue, the Department of Economic Affairs, and the Department of Financial Services. The Department of Economic Affairs hosts the Foreign Investment Promotion Board which CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 101

approves Foreign Direct Investment (FDI) into the country, on a case by case basis for those investments which require prior approval under the regulatory framework. The Ministry of Commerce and Industry hosts the Department of Industrial Policy and Promotion which is responsible for promulgating policy on FDI into the country. Besides, there are multiple laws as per the asset classes like equity, quasi-equity, debt, listed and unlisted securities, and multiple vehicles like Foreign Institutional Investors (FIIs), the Foreign Venture Capital Investors (FVCIs), the Qualified Foreign Investors (QFIs), and Foreign Portfolio Investors (FPIs). Moreover, the legal processes, judicial reviews, clear and consistent drafting requires a lot to be desired. Public Debt Management The public debt management in India is a market driven process with well-developed market infrastructure having varied instruments, developed institutions and intermediaries for market making. Market borrowing is the primary source of financing of Gross Fiscal Deficit (GFD) of the Central Government as well as State Governments. The internal control mechanism is able to address the operational risk, legal risk, security breaches, reputational risk, etc. Some functions of public debt management are divided between the Government and RBI. Market borrowing program of the Central and State Governments is managed by RBI while the external debt is managed directly by the Central Government. The debt management is carried out by the RBI’s Internal Debt Management Department (IDMD), which is functionally separate from monetary policymaking. The debt management strategy (DMS) is formulated by the Monitoring Group on Cash and Debt Management, which is the apex coordinating body between RBI and the Ministry of Finance. The primary objective of DMS is to secure the Government’s funding at all times at low cost over the medium and long term while avoiding excessive risk. The low-cost objective is attained by duly notified and planned issuances of Government Securities and Treasury Bills, taking into account market conditions and preferences of various investor segments. Contrary to the popular perception of a conflict between monetary policy and debt management, there exists a strong confluence of interest in these two activities that RBI undertakes. RBI also provides short-term credit up to three months to both Central and State Governments in the form of Ways and Means Advances (WMA) to bridge temporary mismatches in cash flows. R Gandhi mentions in his paper, Sovereign Debt Management in India - Interaction with Monetary Policy, that… “Two landmark developments have shaped India’s public debt management framework, namely (i) the March 1997 supplemental agreement between the RBI and the government and (ii) the 2003 Fiscal Responsibility and Budget Management (FRBM) Act. The supplemental agreement discontinued the issuance of ad-hoc treasury bills by the government to the RBI to finance the fiscal deficit, while the FRBM Act prohibits the RBI from participating in the primary auctions for government loans. Together, these measures prevent the fiscal deficit from being monetized”[11]. Outstanding liabilities of the Government as a percentage of GDP are at 68.1 at end-March 2019 and are foreseen to decline to 67.7 at end-March 2020. This is in line with the aim of attaining a Central Government debt to GDP ratio of 40 per cent and the combined Government debt to GDP ratio of 60 per cent by 2024-25. External Debt as at end-March 2019 is 19.7% of GDP[12]. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 102

Monetary Policy The Monetary Policy Committee (MPC) of India, which came into being on June 27, 2016 fixes the benchmark interest rate in India. The committee comprises six members - three officials of RBI and three external members nominated by the Government. The Governor of RBI is the chairperson ex officio of the committee and has the casting vote in case of a tie. The committee is answerable to the Government. The meetings of the MPC are held at least 4 times a year. The monetary policy is the instrument which RBI uses to manage the supply of money in the economy by its control over interest rates. The price stability or an environment of stable inflation is maintained to sustain the value of money over a time period. The other objectives of the monetary policy are to ensure financial stability and adequate availability of credit for growth, e.g. the allocation of loans among different sectors. Thus, the triumvirate of supply of money, cost of money and the availability of money to achieve specific objectives is sought to be achieved through the application of monetary policy. The two components to this instrument of monetary policy by RBI are the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR). CRR is the ratio of total deposit that banks need to keep as a reserve with RBI in form of cash not earning them any interest. This is a powerful tool to control the flow of money in the market. A high CRR decreases the capacity of banks to lend, thereby tending the interest rate to increase. This is how CRR ratio helps to reduce inflation. SLR is the ratio of a bank’s net time and demand liabilities which it has to maintain in the form of cash, gold and other securities prescribed by RBI. This ensures that banks will have an adequate portion of liquid assets which can be used to handle a sudden increase in demand of amount from the depositor. It is used by RBI to limit credit facility offered by banks to borrowers in order to maintain the stability of the banking system. RBI uses the Liquidity Adjustment Facility (LAF), an indirect instrument for monetary control. It controls the flow of money through repo rates and reverse repo rates. The repo rate is actually the rate at which commercial banks and other institutes obtain short-term loans from RBI. Conversely, the reverse repo rate is the rate at which the RBI parks its funds with the commercial banks for short periods. The reverse repo rate is maintained slightly lower than the repo rate, e.g. currently at 25 basis point below the repo rate of 5.15% (MPC Committee meeting on October 4, 2019). RBI maintains these rates over medium to long term to manage the flow of money in the market according to the economic situation. The banks can also borrow overnight funds from RBI equal to 1% of their net demand and time liabilities at a rate which is pegged 100 basis points above the repo rate called marginal standing facility or MSF rate. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 103

CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 104

Chapter 3: Acts Relevant to Corporate Entities, Securities & External Trade You will learn some of the most prevalent acts such as Contracts Act, Companies Act, Partnership Act, FEMA Act, Negotiable Instruments, SCRA etc. There are certain Acts the knowledge and understanding of which is pertinent to practicing finance, though these Acts may not be directly applicable to personal finance or financial planning. Some of these may be central to defining certain entities such as Companies and Trusts; instruments such as Securities and Contracts; and functions such as Foreign Trade and Partnership. It is important to understand in general the impact of these various subject matters on the finances and dealings of clients. The Insolvency and Bankruptcy Code, 2016 is applicable to the corporate and banks, but it is a landmark Act in financing discipline of the corporate sector. It was a missing link till recently which puts paid to a plethora of toothless laws and regulations in the function of turning around and rejuvenation of sick units. It is equally important for an adviser to be well aware of what constitutes as well as amounts to money laundering. Banks which deal with large monetary transactions as well as the manufacturers of financial products and instruments like mutual funds and insurance companies have to make their employees well aware of identifying monitoring of activities that deter money laundering. Many of these Acts lay down the rights and responsibilities of investors. The Companies Act, 2013 The Indian Companies Act 2013 (which replaces the Indian Companies Act, 1956) is a profound legislation to govern all listed and unlisted companies incorporated in India. It is replete with comprehensive provisions to empower shareholders, to drive corporate governance, and to rationalize compliance, audit and accounts. It provides greater power in the hands of shareholders in terms of approval that companies are required to seek for various significant transactions. The Act formalizes class action suits whereby any class of members or depositors in specified numbers may initiate proceedings against a company and its directors if they are of the opinion that its affairs are being carried out in a manner unfairly prejudicial to the interests of the company. It stipulates appointment of at least one woman director on the Board for certain class of companies. It stipulates the constitution of corporate social responsibility (CSR) committee for companies having a net worth of at least Rs. 5 billion, or a turnover of at least Rs. 10 billion, or net profits of at least Rs. 50 million, with utilization towards CSR at least 2% of the average net profits during the three immediately preceding financial years. The Act introduces National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT), the quasi-judicial bodies specializing in the function of adjudicating issues related to companies in a speedy manner. The entire rehabilitation and liquidation process of the companies in financial crisis has been made time bound. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 105

The Act provides the formation of a company for a lawful purpose by seven or more persons to be a public company, two or more persons to be a private company, or one person to be One Person Company. It shall be a company limited either by shares, or by guarantee, or an unlimited company. The memorandum of a company shall thus appropriately have in its last word/s, ‘limited’ or ‘private limited’. The memorandum shall mention the objects for the proposed incorporation, and the liability of members of the company, whether limited or unlimited. The articles of a company shall contain the regulations for management of the company and the provision for entrenchment. Towards governance, the maximum number of directors in a company is increased to fifteen, with no director holding directorships in excess of twenty (ten in respect of public companies). Minimum seven days’ notice is to be provided for Board meeting. Every director has to attend at least one meeting in twelve months, or else will have to vacate office. Participation through video conferencing is also considered for valid quorum. One board meeting in each quarter is mandated with two meetings not more than 120 days apart. A director, if resigning, shall forward a copy of resignation to the Registrar of Companies with detailed reason for resignation. Independent directors should constitute at least one-third of the Board of all listed companies, and no independent director shall hold office for more than two consecutive five-year terms. The roles, functions and duties including fiduciary duties of a director towards a company have been prescribed. There are provisions to prohibit forward dealings and insider trading by the directors and key managerial personnel having access to price-sensitive information. The public limited companies have to have audit committee, nomination and remuneration committee. Investors can claim damages against directors, auditors or experts (an engineer, a valuer, a chartered accountant, a company secretary, a cost accountant, etc.) who are legally authorized to issue a certificate. Exit option to dissenting shareholders is provided in case of mergers and amalgamations and in case where a company changes the objects for which the capital was raised. The number of shareholders in a private company can now be up to 200 as per the new Act, from maximum 50 earlier. A private company can accept deposits only from its members subject to certain compliances. The Act provides for the issuance of equity shares with differential rights as to voting or dividend, and that the voting rights of equity shareholders shall be related to total capital including preference share capital. The manner of fund raising shall be through private placement, bonus issue, rights issue for private companies, and additionally through a public issue for public companies. All preferential allotments shall require shareholder consent as also further issue of shares and stock options. Loans, investments, sale of undertaking and borrowings also require shareholders’ approval. To improve compliance, audit and accounts in companies, it is mandatory to timely file financial statements, the cash flow statement is made an essential part thereof, along with annual returns. The Company Secretary is required to provide a report to the Board that compliances under all applicable laws have been made by the company. Director’s responsibility statement shall reveal the adequacy and effectiveness of systems and compliance with all applicable laws. The related party transactions cover almost every contract for supply of goods, materials and services including property by lease or sale and require an approval from the Board of Directors and in certain cases special resolution. Two- third of the Board of Directors is liable to retire by rotation in public limited companies. Mandatory auditor rotation for listed and other prescribed companies is now every five years with the auditing CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 106

partner and team to be rotated at regular intervals. The Act prohibits auditors from performing non- audit services to the company to ensure independence and accountability. An auditor will be required to immediately report to the Central Government upon reasonable suspicion of any offence involving fraud. The Act proposes a fast track and simplified procedure for mergers and amalgamations of certain class of companies such as holding and subsidiary companies. It permits cross border mergers, viz. a foreign company merging with an India company and vice versa with prior permission of RBI. The calling of creditors meeting is dispensed with if 90% in value agree and confirm to a scheme of amalgamation, though the prior notice of such scheme must be given to the Central Government, RBI and SEBI. The Indian Trusts Act, 1882 A trust is a structure created by way of a legal arrangement to hold assets on behalf of a beneficiary. The legal ownership of a trust is vested in a trustee, who may be a person or an institution and to whom the assets are transferred to hold the same in the trust structure. A trust must have lawful purpose, i.e. the premise on which a trust is created should not be prohibited by law or should not defeat any of its provisions, a public policy, an immoral or fraudulent act. The purpose of a trust should not be injurious to a person or an institution or the property of another. A trust which has any of its purposes unlawful, shall be void. The Indian Trusts Act, 1882 defines a trust as: “a trust is an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner.” (Interpretation clause “trust”; Indian Trusts Act, 1882; p.1). A trust may be created by any person who is competent to contracts, and has the subject matter of the trust, called trust property, which he/she reposes to a trustee, who accepts the same for the benefits of another person, called beneficiary. A trustee acts in a fiduciary capacity and takes all required steps to preserve the trust property, maintains and defends against law suits. A trustee protects the trust property and its title in the interest of the beneficiary, including a beneficiary who is not competent to contract, and in that a trustee may do all reasonable acts for the realization, protection or for the benefit of the trust property. A trustee cannot normally renounce the trust unless provided with such power in the instrument of the trust, or with consent of the beneficiary who should be competent to the contract, or with the permission of a principal Civil Court of original jurisdiction. A trustee cannot delegate the trust office in normal circumstances to a co-trustee unless provided for such arrangement in the instrument of the trust, or with consent of the beneficiary who should be competent to the contract. A trust which has been created by Will can be revoked by the testator. A trust which is created on revocable basis has a provision towards the same expressly reserved to the author of the trust. In all other cases a trust can be revoked only by the express consent of all the beneficiaries who should all be competent to contract. A trust which is created for the payment of the debts of the author can be revoked at the pleasure of the author of the trust, provided that the creation of the trust has not been CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 107

communicated to the creditors. According to the Indian Trusts Act, 1882, “No trust can be revoked by the author of the trust so as to defeat or prejudice what the trustees may have duly done in execution of the trust.” (section 79; Indian Trusts Act, 1882; p.27). The Securities Contracts (Regulation) Act, 1956 The Government of India, in order to prevent undesirable transactions in securities and to regulate the working of stock changes in the country, enacted the Securities Contracts Regulation Act (SCRA). The Act defined marketable securities which broadly include shares, stocks, bonds, debentures, government securities, similar securities of an incorporated company or a body corporate, derivatives on shares and debt, and units issued by collective investment schemes to the investors in such schemes. A stock exchange assists persons, individuals as well as institutions, to enter into transactions and/or perform any contracts in securities in a regulated market environment. It constitutes an efficient channel for the providers of capital and the users of capital. Thus, a stock exchange helps in the vital activity of capital formation in the economy. SCRA mandates that only recognized stock exchanges function which have public holding essentially of at least 51% of its paid-up equity share capital, with not more than 5% held by either a person resident in India, or a person resident outside India. However, this holding can go up to 15% in case of an Indian stock exchange, a depository, or public financial institution. Similarly, the 15% maximum holding is also prescribed in case of a foreign stock exchange, a foreign depository, a Government of India approved bilateral or multilateral financial institution, provided that the combined such foreign holding shall not exceed, at any time, 49% of the total paid up equity share capital of any recognized stock exchange. All these holdings shall be considered to have been held directly or indirectly, either individually or together with persons acting in concert. SCRA further mandates that the recognized clearing corporation should be held to the extent of at least 51% of its paid-up share capital by one or more recognized stock exchange(s), provided further that no recognized stock exchange shall hold more that 15% of the paid-up equity share capital in more than one recognized clearing corporation. SCRA mandates that the infrastructure of a recognized stock exchange shall have: an established connectivity with the depositories, clearing banks, other stock exchanges and clearing members; the scalability of systems with a reasonable average load handling and peak load capacity during stress situations; the business continuity plan and the disaster recovery plan; and the mechanism towards arbitration and disputes resolution for issues among clearing members, their constituents and trading members. Every recognized stock exchange shall utilize the service of a recognized clearing corporation, and their agreement will determine the terms for securities to be admitted towards clearing and settlement, and in that respect, charges, margin mechanism, infrastructure of delivery, payment and settlement. The agreement shall entail detailing of mutual rights and responsibilities and other matters concerning risk management, safeguards against market manipulation, constitution of committees including a core settlement guarantee fund (SGF) committee, etc. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 108

The recognized stock exchange as well as the recognized clearing corporation shall establish a Code of Ethics to be followed by their directors and key management personnel. The code will focus on fairness and transparency in dealing with all matters relating to the respective entities and the investors. Additionally, the code will ensure complying with all rules established internally by the respective entities as well as with the regulations and other laws stipulated by regulatory agencies; exercising due diligence in the performance of duties; avoiding of conflict of interest between the respective entities and investors, and between self-interest of directors and key management personnel and the respective entities. A committee constituted specifically for the oversight shall monitor implementation of this code. SEBI is empowered to make or amend by-laws of recognized stock exchanges and recognized clearing corporations, issue directions in the interests of investors or securities market, or to any company whose securities are listed or proposed to be listed in a recognized stock exchange. Persons who intend to engage in the business of dealing in securities shall do so only after securing authority of an appropriate license from SEBI. The persons and companies with listed securities on the recognized stock exchanges shall comply with the conditions of the listing agreement with that stock exchange. SEBI notified the listing obligations and disclosure requirements (LODR) regulations in 2015 applicable to a listed entity, or the entity which has listed any of the designated securities on recognized stock exchange(s). They will comply with the governing principles which include making disclosures of relevant information that is equal, timely, cost efficient, adequate, accurate and explicit to the investors; refraining from misrepresentation; abiding by all the provisions of the securities laws and other applicable laws; complying with all event based filings and other periodic reports, statements, documents, etc.; and implementing the prescribed accounting standards. The Foreign Exchange Management Act, 1999 The Foreign Exchange Management Act (FEMA) seeks to maintain the foreign exchange market in India, ensure its growth, make and amend laws governing foreign exchange with a view to facilitate transactions and external trade. The foreign exchange is defined in FEMA to be foreign currency which includes deposits, credits and balances payable in any foreign currency. It also includes drafts, travellers cheques, letters of credit or bills of exchange expressed or drawn in Indian currency but payable in any foreign currency. Conversely, it also includes drafts, travellers cheques, letters of credit or bills of exchange drawn by banks, institutions or persons outside India, but payable in Indian currency. (Chapter 1 - Preliminary; Section 1, clause ‘n’; FEMA; p.4). A foreign security includes shares, stocks, bonds, debentures or like instrument denominated in foreign currency, and also includes such securities where cashflows and redemptions are made in Indian currency. The current account transactions include virtually all transactions other than those on capital account, e.g. payment due to foreign trade, banking and credit facilities, etc. The dealing in foreign exchange is only with general or special permission of RBI. Moreover, such dealings have to be through an authorized person, which can be an authorized dealer, a money changer, an off-shore banking unit, etc. registered with RBI and compliant with applicable guidelines. Thus, without RBI approval or without the channel of authorized person, no payments to any resident outside India can be made CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 109

towards acquisition of assets and property, etc., and similarly no such payments can be received without a corresponding inward remittance from any place outside India. In respect of capital account transactions, RBI specifies the permissible classes, the admissible limits, and conditions for such transactions. However, RBI may prohibit, restrict or regulate the issue/transfer of any foreign security by a person resident in India, or any security by a person resident outside India, or issue/transfer of any security or foreign security by any branch, office or agency in India of a person resident outside India. Such restrictions and regulations will also apply to deposits between persons resident in India and persons resident outside India, export, import or holding of currency or currency notes, transfer of immovable property outside India, acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a person resident outside India. Such restrictions however do not apply to holding, owning, transferring or investing in foreign currency, foreign security or any immovable property by a resident in India while he/she was resident outside India, and to a foreign resident in India vice versa. In respect of export and import of goods and services, every exporter shall furnish to RBI a declaration in the specified form containing true and correct material particulars and their full export value or realizable value, and actual repatriation to India of such foreign exchange equivalent to the value subject to market conditions without delay. The contravention of FEMA or any of its provisions, rules, regulations, notifications, directions or orders will make the person doing so, or persons in charge of the conduct of business of a company in such default, liable to a penalty up to thrice the sum involved in such contravention. Such penalty will be imposed upon a process of adjudication. Where such penalty is not paid within ninety days from the date of the notice, the defaulter may be liable to civil imprisonment as well. The decision of the adjudicating authority can be appealed before a Special Director (Appeals) or an Appellate Tribunal. The Prevention of Money Laundering Act, 2002 (PMLA) Money Laundering generally involves tactics adopted to legitimize currency and assets acquired through illegitimate activities, often referred to as transmutation of illegal acquisitions. In some cases, this leads to setting up business streams to finance the very means which generated such illegal proceeds, thus building a chain. In most jurisdictions, money laundering includes other financial and business malpractices such as obfuscation of the source of illegitimate money and/or the mode of its generation. The transfer of money outside the banking system to other jurisdictions to avoid scrutiny by the State, is generally outright illegal. India, given a long history of bureaucratic red-tapism, is palpably susceptible to money laundering. India is recovering her position from a high-risk zone as per Anti Money Laundering (AML) Basel Index. Attempts have been made at the level of every regulator as well as at the legislative and administrative levels to identify and counter money laundering activities. Various legislative measures towards anti- money laundering laws have been initiated from time to time, the major ones being: The Unlawful Activities (Prevention) Act, 1967; The Code of Criminal Procedure, 1973; The Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974; The Narcotic Drugs and Psychotropic Substances Act, 1985; The Benami Transactions (Prohibition) Act, 1988; The Prevention of Corruption CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 110

Act, 1988, etc. leading finally to the enactment of the Prevention of Money Laundering Act, 2002 (PMLA) which came into force on July 1, 2005. The PMLA deals with the issues of money laundering, prevents and controls the same apart from confiscating and seizing the assets created out of laundered money. The adjudicating authority for PMLA is appointed by the Central Government with powers to decide confiscation or attachment of assets involved in money laundering as well as powers to regulate its own procedure including inter- connected transactions. It shall not be bound by the procedure laid down in the Code of Civil Procedure, 1908. PMLA defines the offence of money laundering as, “whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering”. [PMLA; Chapter II, p.8]. PMLA has the nature of criminal legislation. The presumption of guilt has precedence and a person who is accused of having committed the offence has to prove that alleged proceeds of crime are in fact lawful property. The punishment under money laundering shall be rigorous imprisonment for a term of minimum three years, extendable to seven years and a fine too. Further, if the offence also relates to the Narcotic Drugs and Psychotropic Substance Act, 1985, the punishment may extend to 10 years. It is essential to track the movement of money and identify the ultimate beneficiary of laundered money. In case entity involved is a company, the beneficiary considered one or more the juridical person having controlling ownership interest directly or through other means. The PMLA further has provisions pertaining to reporting entities which include banking company, financial institution, or specifically designated intermediaries such as Registrars/Sub-Registrars, or persons such as real estate agents, dealers in precious metals, precious stones and other high value goods, or those engaged in carrying on activities for playing games of chance for cash or kind, in safekeeping and administration of cash and liquid securities. PMLA requires reporting entities to perform certain functions which extends from maintenance of records and furnishing the pertinent information to even identifying beneficiary and verifying the identity of its clients through due diligence process. The information on suspect financial transactions need to be furnished to the Financial Intelligence Unit – India (FIU-IND), which coordinates intelligence, investigation and enforcement for the related crimes at the national and global level. The Insolvency and Bankruptcy Code, 2016 (IBC) The Insolvency and Bankruptcy Board of India (IBBI) was established on 1st October, 2016. It is responsible for implementation of the IBC, a code that has consolidated all laws relating to the insolvency resolution. IBC is applicable to the corporate, partnership firms and individuals as well. It seeks to balance the interests of all the stakeholders in the ecosystem and incorporates feedback to amend the IBC. The central proposition is to conduct the insolvency resolution in a time bound and unbiased manner in order that the value of assets could be protected for a possible turnaround, and for ensuring the availability of credit in the ecosystem. IBBI shall oversee the functioning of infrastructure of IBC which includes insolvency professionals, insolvency professional agencies, information utilities, valuers and like institutions. The information utilities are tasked to build a CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 111

storehouse of financial and other information on the corporate that will be supplied to the financial institutions providing credit to the corporate, to the insolvency professionals and the adjudicating authorities, and to the businesses themselves. IBC enforces the statutory rights of creditors and follows a quick and systematic pathway to revive a debtor company. It differentiates between financial creditors, whose relationship with the company is a pure financial contract, from the operational creditors, who provide goods and services to the company. A company which is unable to pay its creditors, can as well approach the National Company Law Tribunal (NCLT) to avail the mechanism of revival or liquidation. As per the IBC, the property includes land and every description of property situated in India or abroad; present interest, vested or contingent interest arising out of or incidental to property, money, goods, etc. The security interest includes a charge, a mortgage, a hypothecation, an assignment or an encumbrance provided for a secured creditor which conveys a right, title, interest or claim to property. It also includes all transactions which secure either a payment or performance or any other obligation related to the property, however it excludes a performance guarantee. (IBC; Section3; clause 27 & 31; p.4, p.5) The process under IBC can be initiated by a financial creditor against a corporate debtor on the occurrence of default. The process can be initiated jointly also with other financial creditors. The Adjudicating Authority, being National Company Law Tribunal (NCLT) shall, within fourteen days of the receipt of the application towards corporate insolvency resolution, ascertain the existence of a default from the records of an information utility or on the basis of other evidence furnished by the financial creditor. Once the resolution application is admitted at NCLT, a moratorium follows on the continuation of all legal proceedings against the debtor, as well as opening of fresh lawsuits towards debt recovery. The Board of the corporate debtor is suspended and it is restrained to create a charge on any asset, or sell any asset. An interim resolution professional (IRP) is appointed by NCLT who takes the charge of the management and all the assets of the corporate debtor. IRP assesses the financial position of the debtor by collating all information on assets and liabilities, operations, as well as all claims of creditors. IRP also determines a fair value as well as the liquidation value of the corporate debtor. A resolution professional (RP) is appointed to take over the proceedings and a committee of creditors (CoC) is constituted towards adopting a cohesive approach towards resolution over individual pursuit of credit recovery. The CoC decides by a majority of voting share. The appropriate strategy would revolve around the repayment of the debts of the corporate debtor, while at the same time maximizing the prospects of survival of the corporate debtor as a going concern. If it is not viable to strike resolution of debts, NCLT may direct to initiate the process of dissolution of the corporate debtor. The liquidation process involves a complete assessment of the inventory of all assets of the corporate debtor. Within a period of thirty days, a list of all claims by the creditors is prepared, such claims verified before a decision is taken to admit them. The repudiation of claims, if any, can be appealed against. A secured creditor always has the option to withdraw from the process and enforce their security to recover its debts. The liquidator, however, is empowered to sell the corporate debtor as a going concern. IBC establishes the priority of settlement of outstanding claims after first deducting the fees and costs incurred in the insolvency resolution process. The secured creditors who prefer their claim through the resolution process are given priority, followed by workmen’s dues, employee wages CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 112

and then unsecured creditors. A feature of IBC which overrides the provisions of the Companies Act, 2013 is that government dues come to be settled only after unsecured creditors. After yet discharging any other outstanding debt, the balance proceeds are distributable among preference equity shareholders and then ordinary shareholders. Negotiable Instruments Act, 1881 Negotiable instruments are of substantial advantage in commerce as they have several features to facilitate commercial activity, e.g. the advantage of negotiable instruments being used as a substitute for money, facilitates the very logistics of trade in size and turnover apart from sheer convenience and safety. Hence, they serve as a medium of exchange. Other important characteristic is the very negotiability which confers an absolute and good title on the transferee. Also, the transferability by delivery, in case of bearer instrument, or by endorsement and delivery, if it is an instrument payable to order, makes a negotiable instrument amenable to indefinite transfers within the prescribed maturity period. The rule of evidence confers indebtedness, unconditional transfer and requires that negotiable instruments must be in writing and also signed by the maker or drawer. Negotiable Instruments Act which came into force from 1st March 1882 is still largely valid. It defines negotiable instruments to mean “a promissory note, bill of exchange or cheque payable either to order or to bearer.” (The Negotiable Instrument Act; Chapter II, Section 13; p.10). A promissory note is an unconditional undertaking, in writing and signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument. The bill of exchange however has the above feature except that it contains an unconditional order directing a certain person to pay a certain sum of money. The maker of a bill of exchange is the drawer and the person directed to pay is drawee. The drawer of a bill of exchange or cheque is bound in case of dishonor by the drawee, to compensate the holder. Every person capable of contracting may bind himself and be bound by the making, drawing, acceptance, endorsement, delivery and negotiation of a promissory note, bill of exchange or cheque. (The Negotiable Instrument Act; Chapter III, Section 26; p.12). The person who endorses and delivers a negotiable instrument before maturity without expressly excluding or making conditional his own liability, is bound to compensate every subsequent holder for any loss or damage caused in case of dishonor by the drawee or maker of that instrument. The endorsee on delivery of the negotiable instrument is transferred the property therein with the right of further negotiation, unless expressly restricted or excluded thereto in the endorsement. Every maker, drawer, payee or endorsee of a negotiable instrument who is in lawful possession or is holder of the instrument, may endorse and negotiate the same, if the negotiability of such instrument has not been restricted or excluded. The maker, acceptor or endorser of a negotiable instrument is discharged from liability if a holder of that instrument cancels the acceptor's or endorser's name; releases the title; or makes the underlying payment to all parties thereto. A promissory note, bill of exchange or cheque is dishonored by non-payment when the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon being duly required to pay the same. The holder of the instrument must give notice of such dishonor to some party it seeks to make liable, or to all parties to make them severally liable thereto. The Act maintains that if any CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 113

cheque is returned unpaid by a drawer bank due to insufficient funds maintained by the drawer of the cheque, provided that the cheque was presented within its validity period and the payment was towards any money owed to the payee towards a legally enforceable debt or other liability, deems the drawer of the cheque to have committed a cognizable offence. (The Negotiable Instrument Act; Chapter XVII, Section 138; p.27). The payee shall be required to give a notice in writing of such non- payment of the cheque to the drawer within thirty days of the receipt of information from the bank towards such non-payment. The court of jurisdiction will take cognizance of such an offence on a written complaint filed by the payee within one month of the expiry of the fifteen days afforded to the drawer by way of a written notice to make good the payment. If the person committing such an offence is a company, every person in charge of, or responsible for, conduct of the business of the company at the time the offence, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly. The offence if so adjudicated, shall be punishable with imprisonment for a term which may extend to two years, or with fine which may extend to twice the amount of the cheque, or with both. The Forward Contracts (Regulation) Act, 1952 The Forward Contracts Regulation Act (FCRA) provides for the regulation of commodity futures markets in India. It proposed setting up of a commission, the Forward Markets Commission (FMC) for the purpose of exercising specific functions and discharging duties assigned under this Act. It was considered vital for the development of futures trade. The Act sought to benefit various stakeholders including the farmers to take advantage of the price discovery in the commodities and manage the risk associated with price fluctuations. Several amendments have been carried out in the FCRA in the 2000s which included facilitating the entry of institutional investors, introducing Options, and permitting trading in these commodity derivatives, i.e. contracts that derive their value from the prices or indices of prices of underlying goods or in respect of such goods, services, activities, rights, interests, etc. The Act proposed giving recognition to associations, being a body of individuals, whether incorporated or not, constituted for the purpose of regulating and controlling the business of the sale or purchase of any goods or classes of goods with respect to which forward contracts may be entered into between members of such association or through any such member. As per the Act, forward contract means a contract for the delivery of goods and which is not a ready delivery contract, i.e. a contract which provides for the delivery of goods and the payment of a price therefor, either immediately or within such period not exceeding eleven days after the date of the contract. (FCRA: chapter I, section 2c; p.3). The goods mean every kind of movable property other than actionable claims, money and securities, and the option in goods means an agreement for the purchase or sale of a right to buy or sell, or a right to buy and sell, goods in future, and includes a call or a put and call in goods. Under the Act, the Central Government retained the power to declare, by notification, all forward contracts for the sale or purchase of any goods or class of goods as illegal for such time as specified in the notification. The Act defined “non-transferable specific delivery contract” to mean a specific delivery contract, the rights or liabilities under which or under any delivery order, railway receipt, bill CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 114

of lading, warehouse receipt or any other document of title relating thereto are not transferable. (FCRA: chapter I, section 2f; p.3). The provision of the Act would not apply to such category of goods and services. Also, no person shall organize, or assist in organizing, or be a member of any association in any area which provides facilities for the performance of any non-transferable specific delivery contract. The Central Government however retained the power under the Act to regulate such class or classes of non-transferable specific delivery contracts, if it is of opinion that in the interest of the trade or in the public interest it is expedient to regulate and control such area, and may also specify the manner and extent of applications of the provisions of the Act. (FCRA: chapter IV, section 18; p.14). The Indian Contract Act, 1872 A contract in many jurisdictions is a legally enforceable agreement made between two or more parties towards providing of a product or service, or towards performance of an act. The offer being made and accepted are critical elements of a contract, as well as the consideration involved in the contract. As per the Indian Contract Act, a person who makes a proposal to another signifying his/her willingness to do or to abstain from doing anything, with a view to obtain the assent of that other person is called a promiser; and if such proposal is accepted by that other person, the subject matter becomes a promise and the accepter, a promisee. The acceptance must be absolute and unqualified for a proposal to be converted into a promise. Such act of doing is called a consideration for the promise. Every promise or a set of promises, forming the consideration for each other, is an agreement. Promises which form the consideration or part of the consideration for each other are called reciprocal promises. An agreement enforceable by law is a contract, and otherwise is said to be void. An agreement which is enforceable by law at the option of one or more of the parties thereto, but not at the option of the other or others, is a voidable contract. A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable. (Indian Contract Act; preamble, interpretation clause; p.9). If the proposal prescribes a manner in which it is to be accepted, the proposer may enforce the same for its acceptance, but if not insisted he/she is deemed to have accepted the acceptance. Likewise, the deemed acceptance may also be construed by the performance of the conditions of a proposal, or the acceptance of any consideration for a reciprocal promise. An express promise is conveyed by way of words in the proposal or its acceptance, otherwise it is said to be an implied promise, e.g. inference drawn from circumstances. A contract shall necessarily be an agreement made with free consent of the parties who are competent to contract, is for lawful consideration and lawful object, and is not expressly declared to be void. A person competent to contract shall have attained the age of majority, shall not have been disqualified from contracting by any law, and shall be of sound mind, i.e. he/she should be capable of understanding the subject matter of the contract and forming a rational judgment when he/she enters into the contract. A contract consisting of reciprocal promises to be performed simultaneously should begin only after the promise is ready and willing to perform his/her reciprocal promise, and those reciprocal promises shall have to be so performed in the order in which they are expressly provided for in the contract, or in the order commanded by the very nature of the transaction. In such a case, if one party to the contract is prevented by the other from performing CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 115

his/her promise, the contract becomes voidable at the option of the party so prevented, with entitlement to compensation for any loss due arising therefrom. The Act defines a contingent contract as a contract to do something, only in case of happening of a collateral event. Such contracts cannot have legal enforceability unless and until that event has happened, and in case of the event becoming impossible, such contracts become void. (Indian Contract Act; chapter III, section 31; p.18). In case a contract is altered, rescinded or substituted by a new contract with agreement from the parties to the original contract, the promises thereof need not be performed. (Indian Contract Act; chapter IV, section 62; p.23). If a contract is rescinded by a party who deems the contract as voidable, the other party thereto need not perform any promise, and if the party rescinding voidable contract received any benefit thereunder from another party to the contract, he/she should restore such benefit to the party from whom it was received. The similar restoration of benefit to the parties to a contract be made if an agreement is discovered to be void, or when a contract becomes void. If a contract is broken, the sum stipulated in the contract by way of penalty towards such breach, whether or not actual damage or loss is proved to have been caused thereby, is receivable from the party breaking the contract. The contract of indemnity is defined where a promiser in a contract promises to save the other from loss to be incurred in the performance of the contract. (Indian Contract Act; chapter VIII, section 124; p.28). A contract of guarantee however is to perform the promise or discharge the liability of a third party in case of the promiser’s default. The promiser is called the surety, the promisee is called the creditor. The liability of the surety is co-extensive with that of the third party, unless otherwise provided in the contract. The surety has the right to revoke a continuing guarantee in respect of future transactions by due notice to the creditor. The Act defines contract of bailment as the delivery of goods by the delivering person, called bailor, to the person who is delivered, called bailee, in the course of a defined purpose which once accomplished, mandates that the goods be returned to bailor or otherwise disposed of according to the bailor’s direction. (Indian Contract Act; chapter IX, section 148; p.32). The bailment of goods as security for payment of a debt or performance of a promise is called pledge. The Act defines agent to be a person who is competent to contract and is employed to do any act for another or to represent another, called principal, in dealings with third party. (Indian Contract Act; chapter X, section 182; p.37). The relationship of agency may or may not have a consideration. The authority of an agent may be expressed or implied, but confers on him/her to carry on a business and to do every lawful thing necessary for the purpose of conducting such business, while being responsible to his/her principal according to the provisions in that behalf, or according to the custom which prevails in doing such kind of business. Contracts entered into through an agent and the acts undertaken thereto would have the same obligations and legal enforceability as if the contracts had been entered into and the acts done by the principal in person. An agent, however, cannot personally enforce contracts entered into by him on behalf of his principal, nor is he personally bound by them. The principal shall indemnify an agent against the consequences of all lawful acts done by such agent in exercise of the authority conferred upon him/her. Any untruthful representation as an authorized agent of another and dealing in that garb with a third party, shall make such agent liable to make compensation of any loss or damage which the alleged principal has incurred by his/her such dealing. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 116

An agent cannot further delegate generally, except if the nature of the business or the agency so require to appoint such sub-agent. The agent would be responsible to the principal for the acts of the sub-agent. A sub-agent would act under the control of the original agent, but would not be responsible to the principal except in cases of fraud perpetrated by the sub-agent. However, where a sub-agent is properly appointed, the principal is bound by and be responsible for his/her acts to third party as if he/she were an agent originally appointed by the principal. The Indian Partnership Act, 1932 Partnership is the contractual relationship among persons who agree to share the profits of a business. They are individually referred to as partners, and collectively a firm. The partnership does not arise out of a status, e.g. family business, or holding of a joint or common interest in a certain property or assets. The partnership determines whether a person is actually a partner in a firm, or the group of individuals is actually a firm. Owing to this, the consideration received by an outgoing partner due to sale of his/her own share or goodwill, does not render him/her a partner. By the same logic, the receiver/s of annuity out of business proceeds by the dependent/s of a deceased partner does not render them partner/s with the persons carrying on the business. The same premise is extended to a minor and a transferee. However, a transferee has entitlement to the share of the assets of the firm to which the transferring partner is entitled when the firm is dissolved. The property of a firm may be all property, acquired initially and in the course of business, and includes all rights and interests in the property as well as goodwill acquired or created by the business. The property of a firm shall be exclusively held and used for the purpose of carry on the business to the greatest common advantage. The contract determines the mutual rights and duties of the partners of a firm, but would at the foremost include: to be just and faithful to each other; and to render true accounts and full information of all things affecting the firm. The partners have rights to take part in the conduct of the business and have access to the books of the firm. The implied authority of any partner can be extended or restricted by the contract. All partners’ consent is required before any change in the nature of business is made. The partners are entitled to share equally the profits of the firm after deduction of any interest on capital subscribed. Every partner is liable, jointly with all the other partners and also severally, for all acts of the firm done while he/she is a partner. A firm is liable to the loss/injury caused to any third party, or to any penalty incurred, to the same extent as the partner, if a wrongful act or omission is done by the partner acting in the ordinary course of the business, either solely or with the authority all the partners. A partner may not be expelled from a firm by any majority of the partners, except in extraordinary case prescribed in the contract itself. An insolvent partner ceases to be a partner on the date of the order of adjudication, irrespective of the firm’s dissolution. The estate of a deceased partner is not liable for any act of the firm done after his/her death. The estate of a deceased partner is entitled to the share of the profits made by the firm if it is not dissolved pursuant to the death of the partner and the surviving partners carry on the business of the firm. A firm may be dissolved with the consent of all the partners or in accordance with a contract. Notwithstanding such dissolution, the partners continue to be liable as such to third parties for any act done by any of them which would have been an act of the firm if done before the dissolution notice. After dissolution, every partner may restrain from carrying on a CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 117

similar business in the firm name or from using any of the firm’s property, if the contract does not provide or unless the goodwill is bought, until the affairs of the firm have been completely wound up. The Limited Liability Partnership Act, 2008 A limited liability partnership (LLP) is a body corporate formed for carrying on a lawful business with a view to profit, and incorporated in the Act as a legal entity separate from that of its partners. It shall have perpetual succession in that any change in its partners shall not affect its existence, rights or liabilities. The LLP shall have at least two partners, who can be individuals or body corporate. The contribution of a partner may consist of tangible (movable or immovable) or intangible property or other benefit including money, capital, or agreement to contribute the same, and contracts for services performed or to be performed. Each partner’s monetary value of contribution shall be accounted for and disclosed in the accounts. The nominee of a body corporate shall be the designated partner, who is responsible for the doing of all acts, matters, things, etc. in respect of compliance of filing of any document, return, statement, etc. At least one of the designated partners of an LLP shall be a resident in India. An incorporated LLP shall, by its name, be capable of suing and being sued and do all acts in respect of acquiring, owning, holding, developing and disposing of tangible (movable or immovable) or intangible property. Every limited liability partnership shall conclude its name by such words or the acronym LLP. Every partner of a LLP for the purpose of its business is the agent of that LLP, but not of other partners. If the number of partners of a LLP is reduced below two, and the only partner carries on business, he/she/it shall be liable for the obligations and all liabilities of the LLP beyond a period of six months. The LLP is liable in the same way as its any partner for any wrongful act or omission on his/her part of the partner in the course of its business or with its authority. The liabilities of the LLP shall be met out of its property. An obligation of the LLP whether arising in contract or otherwise, shall be solely the obligation of the LLP. A partner is not personally liable, directly or indirectly for an obligation solely by reason of being a partner of the LLP. This however shall not affect the personal liability of a partner for his/her own wrongful act or omission, but a partner shall not be personally liable for the wrongful act or omission of any other partner of the LLP. The LLP shall maintain proper books of account in the prescribed manner relating to its affairs for each year, and within a period of six months from the end of each financial year, prepare a Statement of Account and Solvency, duly signed by its designated partners for the said financial year. Such statements duly audited shall be filed with the Registrar every year. There is provision to be converted to a LLP by a firm, an unlisted public company, or a private company by applying to the Registrar. All tangible (movable or immovable) and intangible property vested in the firm or the company and all assets, interests, rights, privileges, liabilities, obligations relating thereto, and its entire undertaking shall be dissolved of its erstwhile status and transferred to and shall vest in the LLP without further assurance, act or deed. A Foreign Limited Liability Partnership can also be registered in India being an LLP formed, incorporated or registered outside India and which establishes a place of business within India with applicable provisions. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 118

Chapter 4: Consumer Grievances Redressal You will learn the rights which a consumer has & how a consumer is entitled to a fair redressal of his grievances in the financial services environment. The consumer protection is at the core of all regulation-making. Financial products and services are typical and to a great extent intangible in the sense that the outcome is difficult to distinguish from a desirable one, and is usually after a fair length in time or in the long-term. A vast majority of consumers are not trained in finance, hence it is difficult for them to discern the outcome in a financial transaction from what is desirable in their individual best interest. The outcome in certain financial products and services cannot be defined at the time of transaction. In other cases, it can be camouflaged in a financial terminology which serves the minimum regulatory requirement and can be the screen to disallow consumer grievances, if they arise at a later stage. It is a challenge for regulatory agencies, arbitrators and courts to establish mechanisms which should resolve consumer grievance cases in principle-based manner, keeping the consumers’ interest uppermost. It is to be kept in the perspective that the consumers are not organized which comes in the way of a structured stance developing and being considered in regulation-making. Although, consumers affect all economic decisions, they being the agents for two-thirds of all spending in the economy, it is ironic that consumers get affected the most by those same economic policies which they directly or indirectly help evolve. Regulators make analogies about consumer interest and afford protection within considered parameters at a point in time. This protection available to consumers in the regulations has to be reviewed constantly and updated in a progressive exercise. The effective regulations of entities in the market should coexist with an easily accessible and credible mechanism to resolve disputes timely between consumers and the regulated entities. This is essential for promoting consumer confidence which is the pedestal of financial stability in the markets. Many jurisdictions try to ensure that consumers have recourse to a dependable mechanism to redress grievances. Such systems have to be time bound, easily accessible, independent and fair and should involve least financial burden. Towards accomplishing this objective, the banking and insurance sector regulators in India have well-structured ombudsman schemes which help resolve consumer grievances. There are other online mechanism of registering and monitoring of complaints and grievances. Additionally, a comprehensive law, being the Consumer Protection Act can also be utilized to settle financial grievances. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 119

Redress in Banking – The Banking Ombudsman Scheme The Banking Ombudsman Scheme was notified by RBI in 1995 under Section 35 A of the Banking Regulation Act, 1949 and has been revised over time, the last being in July 2017. The scheme covers scheduled commercial banks, urban co-operative banks, regional rural banks, apart from small finance banks and Payment banks. RBI administers twenty-one offices of banking ombudsman across India and bears the entire cost of running the scheme. A total of 163,590 complaints in the year 2017-18 were received which were 25% more than the previous year. The disposal rate of 96.5% was maintained. Nearly two-thirds of maintainable complaints were resolved by agreement i.e., through mediation. The major grounds of complaints received during the year were non-observance of fair practices code, ATM, debit and credit card issues, failure to meet commitments, and mobile and electronic banking. The total cost during the year 2017-18 incurred towards handling complaints was Rs. 572 million[13]. The awareness campaigns, events and advertisements were organized by the offices of banking ombudsman in their respective rural and semi-urban areas. RBI also implemented in April, 2019 the ombudsman scheme for deposit taking Non-Banking Financial Companies (NBFCs) and those non- deposit taking NBFCs having customer interface, with assets size of Rs. 1 billion or above. Public grievances and complaints which are not covered by the Ombudsmen Schemes are managed by the Consumer Education and Protection Department (CEPD) of RBI and by such cells in its regional offices. CEPD focuses on reducing the information asymmetry while expanding disclosures and meting out fair treatment to the financial consumers. Moreover, the Charter of Customer Rights [RBI; December 2014] lays down broad guidelines and principles for banks towards protecting consumers from unfair treatment and conduct. The internal ombudsman mechanism implemented in 2015 in all public sector banks, select private sector and foreign banks serves as the first level to resolve customer complaints, before they could be escalated to the banking ombudsman. RBI has also implemented a technology enabled Complaint Management System (CMS) which will integrate the entire mechanism of Ombudsmen for banking and NBFCs, its nodal department CEPD and regional cells. Investor Grievance Redress Mechanism – SEBI Complaints Redress System (SCORES) platform SEBI notified ombudsman regulations in August 2003 which contained guidelines for appointing ombudsman. In March 2007 the proposal to introduce an ombudsman for capital markets was scrapped. SEBI reckoned that the then prevailing system of addressing investor grievances by stock exchanges was working. The bourses in their self-regulatory capacity were regarded as the first level of regulators for the corporate, and only unresolved complaints were escalated. SEBI issued a circular on December 18, 2014 regarding redressal of investor grievances through SEBI Complaints Redress System (SCORES) platform[14]. This sought to strengthen the centralized web-based complaint redressal system launched in June, 2011 for investors whose grievances pertaining to securities market remain unresolved by the concerned listed company or the registered intermediary, all of which were mandated to obtain their SCORES authentication. The complaints against stock brokers, sub-brokers and Depository Participants continued to be routed through the platforms of the concerned Stock Exchange or Depository. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 120

The platform does not accept complaints against companies falling under the purview of other regulatory bodies viz. RBI, IRDAI, PFRDA, Competition Commission of India (CCI), etc., or under the purview of other ministries viz., MCA, etc. Such complaints may pertain to banks, NBFCs, Primary Dealers, insurance companies, insurance products and their intermediaries, pension products and their intermediaries, housing finance companies, unlisted companies, suspended companies, vanishing companies, sick companies, companies struck off from Registrar of Companies (RoC) or those under liquidation or insolvency proceedings. The platform enables online movement of complaints to the concerned listed company or intermediary and uploading of the Action Taken Reports (ATRs) by them, thus facilitating tracking of resolution status. SEBI retains the sole authority to close the complaints. The Board of Directors of the listed company or the registered intermediary, their proprietors or partners are made responsible for ensuring compliance including filing of ATR/reply. Any failure to file ATR within thirty days of date of receipt of the grievance is treated as failure to furnish information to SEBI and a deemed non-redressal of the grievance. Investors are required to register on the SCORES platform with necessary details like name, address, e-mail address, PAN and mobile number. They need to select the correct complaint category, provide entity name, the nature and full details of the complaint and upload supporting documents. In case the complaint has not already been filed with the concerned entity, it is first routed to the entity to elicit response/resolution within thirty days. The complainant has to indicate if the resolution by the entity is not satisfactory along with the reason, else the complaint is treated as closed. An appropriate supervising officer in SEBI is the next level of escalation. SEBI can act as a facilitator but cannot stand to judge, arbitrate in a matter or represent on behalf of investor or force the entity to resolve the complaint. The securities and other laws provide legal rights and remedies which investors can resort to in resolving grievances, i.e. by seeking intervention of consumer courts, the courts and arbitration, etc. SEBI has empowered stock exchanges to levy fine for non-redressal of investor complaints in respect of listed companies under the SEBI (Listing and Disclosure Requirements) Regulations, 2015. In case of default to redress, the exchanges can direct to freeze the entire shareholding as well as other securities held in the demat account of the promoter group. If non-compliance continues, the stock exchanges may refer such cases to SEBI for enforcement actions, if any. Insurance Ombudsman Scheme The Insurance Ombudsman was created in November, 1998 with the purpose of timely settlement of the insured’s grievances. In all, seventeen such ombudsmen spread geographically. An individual can approach ombudsman in the concerned jurisdiction for consideration of complaint/grievance against an insurer, the major grievances being a partial or total repudiation of claim, dispute with regard to premium paid in terms of the policy, misrepresentation of policy terms and conditions, dispute with regard to policy wordings of claims, delay in settlement of claims, non-issuance of any insurance document, etc. The powers of an ombudsman are restricted to insurance contracts of value not exceeding Rs. 3 million. The insurance companies are bound to honor the awards made by an ombudsman within three months. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 121

A complaint can be filed with an insurance ombudsman after a representation made to the concerned insurer is either not resolved or is not resolved satisfactorily within a month, but not beyond a year after the insurer had replied, provided that the same complaint on the subject is not be pending before any court, consumer forum or arbitrator. The ombudsman shall pass an award within a period of three months. A policyholder, not satisfied with the award of the ombudsman, can approach Consumer Forums and/or Courts of law. The Consumer Protection Act, 2019 The erstwhile Consumer Protection Act, 1986 sought to protect the interests of consumers by way of establishing consumer councils and other authorities for the settlement of consumer disputes. It provided for a three-tier system at the district, the state and the national levels along with detailed procedure for handling of complaints. It was felt in the 1980s that there was a drastic change in the perspective due to the industrial revolution and changed contours of commerce due to globalization. That resulted in a vast array of consumer goods and services including insurance, banking and finance. Hence, it became necessary to safeguard the interests of consumers and to protect them from exploitation and from adulterated and sub-standard goods and services. Similarly, the late 1990s and the following two decades have seen a sea change in the consumer goods industry and the nature of services offered to consumers. The digitization has been one single largest game changer. The ease and access to goods and services, the mechanisms to acquire/avail them, to pay for them and the accompanying perception of service has created its own challenges. The e-commerce has blurred geographical boundaries and with them the liability aspect of goods and services. The securities have been almost entirely dematerialized. There is information overload especially in digital mode, scientific processing of huge databases, algorithmic trading, etc. The fintech has its role in almost every sphere with machine learning, internet of things, etc. The revised Consumer Protection Act, 2019 enacted on August 9, 2019 seeks to address this aspect along with improvement in processes and the mechanisms of enforcement. The revised Act provides for a Central Consumer Protection Council (Central Council) with its objective to render advice on promotion and protection of the consumers' rights under the Act. The Minister-in- charge of the Department of Consumer Affairs in the Central Government shall be the Chairperson of the Central Council which shall meet at least once every year. Every State Government shall establish a State Consumer Protection Council (State Council) which shall have the objective to render advice on promotion and protection of consumer rights under the Act within that State. It shall meet at least twice in a year under the chairmanship of Minister-in-charge of the Department of Consumer Affairs of the State. The State Government shall establish for every District a District Consumer Protection Council (District Council), which shall meet as often as possible but at least twice in a year. The objects of every District Council shall be to render advice on promotion and protection of consumer rights under the Act within the district. There is provision in the Act of the establishment of the Central Consumer Protection Authority (Central Authority), a regulatory authority having enforcement powers to take suo moto actions, cancel licenses, recall products, order reimbursement of the price of goods/services, file class action suits, etc. The Central Authority shall regulate matters relating to violation of rights of consumers, unfair trade CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 122

practices and false or misleading advertisements which are prejudicial to the interests of public and consumers and to promote, protect and enforce the rights of consumers as a class. A Director General will spearhead the Authority’s investigation wing, which may conduct inquiry or investigation into consumer law violations. The Director General shall also exercise the powers of search and seizure. The State Government shall establish at least one District Consumer Disputes Redressal Commission (District Commission) in each district of the State. The District Commission shall have jurisdiction to entertain complaints where the value of the goods or services paid as consideration does not exceed Rs. 10 million. A consumer may file complaint in a District Commission if she works/resides in that district, or the cause of action, wholly or in part, arises in that district, or the opposite party ordinarily resides or carries on business or has a branch office in that district at the time of the institution of the complaint. Every complaint shall be disposed of as expeditiously as possible but within a period of three months from the date of receipt of the notice by the opposite party. Any person aggrieved by an order made by the District Commission may prefer an appeal against such order to the State Consumer Disputes Redressal Commission (State Commission) on the grounds of facts or law within a period of forty-five days from the date of the order. The State Commission shall have jurisdiction to entertain complaints where the value of the goods or services paid as consideration, exceeds Rs. 10 million but does not exceed Rs. 100 million. The State Commission will ordinarily dispose of the cases within a period of three months. A person aggrieved by an order made by the State Commission may prefer an appeal against such order to the National Consumer Disputes Redressal Commission (National Commission) within a period of thirty days from the date of the order. An appeal shall lie to the National Commission from any order passed in appeal by any State Commission, if the National Commission is satisfied that the case involves a substantial question of law, and the memorandum of appeal shall precisely state the substantial question of law. Such appeals will be normally disposed of within ninety days. The District Commission, or the State Commission, or the National Commission shall have the power to review any of the order passed by it if there is an error apparent on the face of the record, either of its own motion or on an application made by any of the parties within thirty days of such order. An appeal shall lie, both on facts and on law, from the order made by the National Commission to the Supreme Court of India within thirty days of such order. Every order made by a District Commission/State Commission/National Commission shall be enforced by it in the same manner as if it were a decree made by a Court in a suit before it. Whoever fails to comply with any order made by any of the Commission shall be punishable with imprisonment for a term which shall not be less than one month, but which may extend to three years, or with fine, which shall not be less than Rs. 25,000, but which may extend to Rs. 100,000, or with both. The Act maintains that a product seller includes a person who is involved in placing the product for a commercial purpose and includes e-commerce platforms and aggregators. The product liability covers within its scope, the product manufacturer, product service provider and product seller for any claim for compensation. The product manufacturers have an increased liability risks especially where the express warranty of a product is made. The Unfair Trade Practices also include sharing of personal information given by the consumer in confidence, unless such disclosure is made in accordance with the provisions of any other law. The celebrities who endorse products in advertisements as well as the brand ambassadors have increased liability under Unfair Trade Practices. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 123

CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 124

Chapter 5: Acts, Statutes & Regulations Relevant to Financial Consumers You will learn the various acts, laws, statutes and regulations which are there to protect a financial consumer in India. The financial consumer has recourse to certain statues and regulations which affirm protection to its interests. The information is power and the right information and practices go a long way in building confidence in the institutions, the manufacturers and dispensers of financial products and services, and in the public authorities as well, who are vested with powers to make rules and regulate industries. The right to information act or RTI is one gamechanger statute which empowers the general public to have access to the rightful information from authorities and institutions in the Central and State Governments. One positive offshoot of RTI is that it in stills accountability in the public institutions. Also, the compliance requirement and its time bound nature reinforce discipline of elaborate cataloguing and sequencing of records and data and their genuineness. Right to Information Act, 2005 (RTI) India is a democratic Republic. The democracy requires transparency of information which is vital to its functioning, notwithstanding the fact that the revealing of certain information may actually conflict with its very confidentiality and sensitiveness apart from other public interests and efficient operations of the governments. It is essential to manage these conflicting interests. RTI provides a mechanism for citizens to access certain information under the control of public authorities with the central purpose to infuse a degree of accountability in their functioning. Every public authority is required to maintain all its records systematically in order to facilitate the access to such records in a timely manner, and designate Public Information Officers in all administrative units to dispense information to persons seeking the same. A person who seeks information is not required to give any reason or details other than the contact details where the required information needs to be delivered. A request for information shall not be rejected unless there is reason to believe that the act of providing information would disproportionately divert the public resources or would be detrimental to the safety or preservation of the record demanded. In case a request for the information sought is rejected, the concerned Public Information Officer shall communicate the reason for such rejection, the period within which the appeal can be made against such rejection, along with details of the appellate authority. Certain information is categorized where the authorities shall not be under obligation to disclose. Such areas generally are the categorical records related to the security, strategy, economy, science and CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 125

technology, space and nuclear research, etc. This may also potentially include areas where the disclosed information and facts could prejudicially impact the sovereignty and integrity of the State or its relations with a foreign State, or the disclosure could lead to provocation in a certain community or in general could give rise to offence. Such forbidden information can be so specified by any court of law or tribunal; can be part of cabinet papers including records of deliberations of the Council of Ministers, Secretaries; can be a breach of privilege of Parliament or the State Legislature. Other areas where a request for information is denied are: information on intellectual property and trade secrets; information available to a person in his/her fiduciary relationship; personal information having no links with public service; information necessary to safeguard the life or physical safety of any person; information which if leaked could hamper an investigative process or prosecution; etc. However, even in these cases, part access may be provided to the record which does not contain any information which is exempt from disclosure. SEBI (Disclosure and Investor Protection) Guidelines, 2000 (DIP) The Disclosure and Investor Protection guidelines issued by SEBI in the year 2000 and amended from time to time are the most comprehensive compendium in respect of issuances to be made by companies and other corporate entities, the methodology to be adopted, the role and responsibility of various intermediaries such as merchant bankers and registrars, and most importantly the timely disclosures to be made at every stage for the benefit of investors and other financial consumers. Though it may seem that the guidelines in good part are applicable to the corporate and institutional entities in the ecosystem of securities market, the ultimate aim is to help discover the most appropriate market determined price that should be paid by the investor, who may have the entire channel to review and make an informed decision. The securities market regulator SEBI does not engage directly or indirectly in fixing the price of an issue or any formula to purport the same. However, the guidelines in this regard are elaborate which the issuer has to follow and come to a price band in consultation with merchant bankers. The full disclosure of parameters adopted and process followed in this regard is to be made. In the book building process, the issuer appoints a lead manager book runner who is responsible for preparing the draft red herring prospectus which is filed with SEBI, and which discloses a price band for the issue. The prospectus is sent to corporate investors and to the media to create awareness. The corporate investors and other syndicate members may act an interface between the issuer and the investors. The investors can access the entire chain of information and get their queries clarified with syndicate members. The risk factors from every foreseeable perspective are covered and explained for the benefit of investors, who in accordance with their risk appetite and risk capacity take calculated bets towards investment. The due diligence certificates are mandated by SEBI at various stages of an issue from the issuer as well as all the intermediaries in the entire process to ascertain the validity of information value chain; the accounts and valuation records, the promoters’ contribution, the assets and liabilities, the profit and loss statements, etc. There are certain restrictions imposed on the companies which are in the interest of investors. If a company has issued either fully convertible debentures or partly convertible debentures, it is restricted from issuing any shares by way of bonus or rights unless they reserve appropriate proportion of such CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 126

issues towards the benefit eligible to the holders of such debentures. In case, fully convertible debentures have been issued which bear interest at a rate less than the bank rate, the offer document shall contain explanation of that price, which would take into account the notional interest loss on the investment from the date of allotment of such debentures to the date of full conversion, in all stages, if relevant. And towards this activity investors can ascertain the price that would work the best in their favour, depending on their individual return expectation. In respect of rights issues, the issuer company may utilise funds collected only after satisfying the designated stock exchange that a minimum ninety percent subscription has been received. There are guidelines for the publication of research reports. The lead merchant banker shall ensure that the research report is prepared only on the basis of published information as contained in the offer document, and that no selective or additional information or information extraneous to the offer document shall be made available by the issuer or any member of the company management or syndicate to any particular section of the investors or to any research analyst in any manner whatsoever including at road shows, presentations, in research or sales reports or at bidding centres, etc. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 127

CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 128

Chapter 6: Regulation of Market Intermediaries in Financial Products You will learn the various regulations of SEBI which are there for Market Intermediaries of Financial Services in India. The advisers and distributors in various financial sectors need to comply with the respective sector regulations and guidelines including obtaining requisite licenses to practice. There is no single professional accreditation which authorizes advisers to practice across the segments of insurance, investments, retirement, etc. Advisers have to register with respective regulatory agencies and follow their code of conduct and recommended professional practices. It is therefore necessary to have a broad understanding of regulations around financial intermediation in India. SEBI (Intermediaries) Regulations, 2008 The intermediaries regulations of SEBI includes under the broad definition of intermediaries: stock brokers and sub-brokers, trading members of derivatives segment of a stock exchange, merchant bankers and underwriters, bankers and registrars to an issue, share transfer agents, depository participants, clearing members, custodians of securities, trustees of trust deeds, portfolio managers, investment advisers, foreign institutional investors, foreign portfolio investors, credit rating agencies, asset management companies, and such other intermediaries who may be associated with securities markets in any manner. Associates of an intermediary are persons/entities who are under common control with intermediary, either controlling the intermediary or being controlled by it, directly or indirectly, and include any relative, or companies under the same management. To carry on the activities of one or more intermediary activities, separate certificates need to be obtained. An intermediary is required to provide to SEBI every year a certificate of compliance with all prescribed obligations and responsibilities as well as fulfillment of the continued eligibility criteria, and maintain accounts and records as specified in the relevant regulations. A prescribed code of conduct needs to be abided by an intermediary and its directors, officers, employees and key management personnel, ensuring that sound good corporate policies and good corporate governance is in place. It shall redress investor grievances promptly (within forty-five days) and shall maintain records of all complaints received and redressed. It shall ensure that the recommendation made to a client is suitable, and that an investment advice issued in the publicly accessible media is with due disclosure of all interests. It shall refrain from engaging in price rigging, market manipulation, market distortion, fraudulent practices, self-dealing, front-running, and creating unfair competition or false market which may affect the smooth functioning of the market. It shall make adequate disclosures of all interests, resolve proactively any potential areas of conflict of duties CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 129

on an ongoing basis. An intermediary shall be transparent, fair, objective and unbiased in rendering services. SEBI (Investment Advisers) Regulations, 2013 SEBI adopted a consultative approach to construct Investment Advisers (IA) Regulations in January 2013. The investment advice as per these regulations is considered as advice towards all types of dealing in the securities or investment products, dispensed to a client either orally or in written form. The investment adviser engages with a client in a fiduciary capacity and seeks remuneration directly from the client advised, and not from any other sources. Financial Planning is considered to be investment advice as well. Intermediaries who are engaged exclusively dealing in insurance and pension products need not register as investment advisers, as also several other professionals who may dispense investment advice incidental to their main profession of tax, accounts, law and distribution of mutual fund products. In their subsequent consultation papers to amend the IA regulations, SEBI however proposed that such professionals offering advice for a consideration have to register as investment advisers as well. The proposals further recommended mutual fund distributors to choose between investment advice and distribution. The investment advisers as individuals cannot be on the execution side as well. The institutions and body corporate, which engage in both the activities of distribution and investment advice, are required to dispense investment advice through a separately identifiable department or division. In the subsequent consultation paper however, it was further proposed that such institutional entities would be required to provide investment advice through a subsidiary only. There are qualification and certification requirements from a registered investment adviser (RIA). They have certain obligations and responsibilities; like risk profiling of client, suitability norms which bind the advice being provided to the client’s analyzed risk profile, disclosure requirements on the services to be provided and the relevant fee structure, proactive disclosure of conflict of interest, and maintenance of records with respect to the advice provided. The RIA shall maintain an arms-length relationship between its other activities, if any, from the core investment advisory services. A prescribed code of conduct requires an RIA to maintain fairness and diligence in all dealings including the fees charged, to uphold a certain level of capability, to being compliant with regulations/laws, etc. SEBI (Self-Regulatory Organizations) Regulations, 2004 A Self-Regulatory Organization (SRO) defined in the above regulations would mean an organization of intermediaries which is representing a particular segment of the securities market and which is duly recognized by SEBI under these regulations, but would exclude a stock exchange. Such an organization intending to be recognized as an SRO may apply to SEBI by forming a non-profit company with objective to promote a useful activity including commerce. Such a company shall have its main object as discharging the function of an SRO, shall have a net worth of at least INR 10 million, shall have adequate infrastructure for the purpose, professional capability and experience. SEBI would ensure that grant of SRO status to the applying organization is in the interest of financial consumers and the securities market, in general. SEBI has mandated that overall governance and management of CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 130

an SRO shall vest in its Board of Directors, a majority of which shall be independent directors. After an SRO of specific segment of intermediaries is thus recognized, the registration and renewal of intermediaries who would be its members, shall be made only through the specified SRO. The SRO will treat all its members in a fair and transparent manner and in their respect, collect membership fees, organize awareness and training programs as well as screening tests/certifications, issue a code of conduct and monitor the same. It shall inform SEBI of any violations by its members of the provisions of the SEBI Act and rules and regulations, circulars and guidelines made thereunder, and shall take disciplinary action as directed. An SRO shall have approved governing norms to direct its various functions. CFP Level 1 - Module 3 – Regulatory Environment & Compliances – India Specific Page 131