KN Vaidyanathan on MFs, FIIs & Life at SEBI
KN Vaidyanathanís two year term as Executive Director at market regulator SEBI is coming to an end. Vaidyanathan joined at a time of big reforms in mutual fund industry- the abolition of entry loads. Under his charge, the move towards more transparency has gathered momentum. The most recent and landmark decision was to ask mutual funds to disclose their voting policies and actions regarding investee companies. But the disclosures have come late, are patchy and show neglect of fiduciary duty. CNBC TV18ís Menaka Doshi asked Mr KN Vaidyanathan if he was disappointed with the tick-box attitude of mutual funds.
Vaidyanathan: Simple answer I am not disappointed. I will agree there is work to do but it is important to spend a minute to understand why we went the way we did upon this. Couple of years ago, we had few issues in this country around corporate governance. The two primary questions that people asked what were Independent Directors doing and what were Institutional Investors doing?
The first was a big subject which is being addressed by a whole slew of issues between SEBI, Ministry of Corporate Affairs and others. The second- which is what were institutional investors doing- that is what stuck with us and I look after mutual funds. When we spoke to fund managers to moot the issue Ė is it a good thing to get you guys to vote and tell us how you vote and more importantly tell your unit holders how you vote- a good number of fund managers thought it was a good idea but you did have a few who have this very clichťd approach that fund managers vote with their feet. So when we debated that inside, we believe that here is a country which has created an institutional framework, rules, policies, laws which is thrown in a number of tax concessions for the mutual fund managers to do a legitimate business. So it is not unfair to ask them to play a responsibility in this area. It was with that premise that we set up on to say we will do this.
If you look at regulatory reforms in our country, it always starts with disclosure. So that is the first step we have taken- disclosure. What are we saying in this disclosure? We have said voting policy- and thanks to you we discovered that lot of people had hidden it in different areas- so just to standardize, we told them to put that link on the homepage of their respective website. The policy has to cover three parts, the first is Principle, the second is Process and the third is Particulars. When I talk about Principle- what we mean is what are the guiding principles based on which they vote. Yes there is a standardized statement- we vote to protect shareholder interests but can you go a little further to explain how do you address issues of conflict, how do you uphold fiduciary responsibility. So for me Principle has to disclose these areas.
The second part of it is the Process. What is the internal process that a fund manager, the company or an asset management company has with respect to deciding on to vote or not to vote and if they decide to vote, then vote for or against? That process is extremely important because that shows the rigor with which this is implemented in the system and the third are the particulars. We wanted them to disclose their actual track record of voting with every company that they have held shares in, and where they were invited for AGM. When I look at the data that has been put out, when I look at the policies that have been put out, I think the first step to do is to get everybody on the same page.
So what we are going through is the process of review in terms of the details which they have disclosed. For example not enough funds have disclosed the internal process. Who are the people who get involved? Is there a Committee? Who decides? How is it exercised? Who is actually sent for the meeting? The level of granularity in that disclosure is not enough.
The second, some people have not disclosed in the Particulars, the actual company in question. If they have, they havenít disclosed enough about the subject on hand. Some of them have not disclosed what the management recommendation was. I think we will go through the next process to just get all of them to have consistent common disclosure pattern.
Our belief is disclosure is like sunshine to treat bacteria. Start with that, get it out in the system, let it be transparent out there and then hope that a number of people who are aware will start questioning, will start challenging and that automatically raises the bar.
Doshi: To take your analogy further, this is a rare solar eclipse. I am really sorry to say this and I donít share the kindness with which you are looking at this disclosure, simply because I think that right from the beginning when SEBI put this out, we waited till November-December to see any voting policies go up. The reason why this perturbs me is that the disclosures were asked for now; the voting has been expected all through. Mutual Funds cannot be telling their unit holders that yes we invest in companies on your behalf, using your money but we choose not to participate at all to the extent that a shareholder can with regards to functioning and governing of that company. So I wonít believe that they have started voting only last year because they have been asked to disclose voting last year- that is one. Secondly, till November-December no policies were up. Thirdly, all of them took advantage of some loose wording in SEBI notification which said that you had to publish this for the fiscal year 2010-11 and also in your annual report. To me, it read as you go through these voting actions, you have to publish it. To them it read, I have till June-July next year- which is 2011- to be able to publish it. Thirdly, they hid it all over and fourthly now you have spoken very kindly of how some of them have not mentioned company names. I think that is blindly copying SEBI format that was offered to them which was also a miss on part of SEBI because you should have mentioned that specifically- knowing fully well that these guys donít do anything until you asked them to mention specifically- so they didnít mention company name. In several columns, when the management recommendation means what the management of the investee company is recommending, they have managed to put in their own management recommendations which I find absurd. I am going to go on with this litany because itís a litany.
Vaidyanathan: Let me just stop you there because I think we will miss the woods for the tree if we adopt this approach. I want you to understand that regulatory actions are two-fold broadly-one which is for long-term good and second which is fire fighting or crisis management. In our view, what we have done with respect to disclosure of voting policies is for long-term good. Regulators around the world understand and accept that it takes a little while to get this implementation to running at a pace you would like it to.
Doshi: Why would it take time to recognize that you need to mention the name of the company on whose resolution you are voting? What time or experience do you need an industry to go through? So thatís purely paying lip service to compliance requirement without appreciating the spirit.
Vaidyanathan: If somebody is addressing Ė I think you are were flattering at the beginning about landmark changes- I think everybody understands SEBIís stance with respect to Mutual Funds and how we get everybody to get focus on the spirit of reforms and which we will do in these instances as well. So I donít want you to think that we will be lax or accommodating.
Doshi: Thatís what I am concerned about?
Vaidyanathan: I am very happy that people like you are very alert in picking these up.
Doshi: And anguished.
Vaidyanathan: Rightfully so. Because this is something that is if it happens the right way will do a world of good. But my only request to you is if something has not happened in several years, it may take a few more months for it to happen but it will happen the right way and we need to make sure that right goal is achieved and not get distracted by some aberrations in the middle.
Doshi: These are not aberrations. I am sorry to say but 3 out of the top 5 mutual funds in this country according to assets under management have not disclosed the companyís name the resolution on which they voted. To me, that seems like they are paying lip service to the compliance requirement without actually buying into the spirit of what SEBI is trying to do. Several of them have not made full disclosures. DSP BlackRock has shown 4 votes- are you telling me that the entire fund is invested in 4 or 5 companies? 4 out of those 5 are delisted. So I am guessing now that entire fund is invested in one company because those 4 companies went through the delisting. UTI Mutual Funds has disclosed I think 86 or maybe 90 resolutions. I am guessing that their money is invested in a lot many more companies.
Vaidyanathan: I donít think this discussion will be on specific mutual funds but I am not (interrupted)
Doshi: I am saying there is lack of sensible disclosure. I am not talking about an evolved voting policy.
Vaidyanathan: I will agree with you that the level of depth and breadth in the disclosure can leave a lot more than done.
Doshi: It has been consciously been left out. It is consciously been left out and you will admit to that this is not about evolving policy?
Vaidyanathan: I donít think we need to get too judgmental so early in the game. I think it is more important to make sure that you go through the process of getting that information more comprehensively, engaging with them and I donít think if I look back at the track record of SEBI versus Mutual Fund over the last few years- itís been direct, itís been forthright and it has been result oriented. That principle will continue.
Doshi: I donít expect you to comment on specific Mutual Funds. As a regulator, you cannot. I am using specifics to layout a broader hypothesis which is that yes, I am going to be judgmental because they have consciously neglected their duty. ICICI Prudential has abstained from every single resolution that they have to vote on, every single one of them with an exception of 4- 3 of which were government banks and I am just guessing that they were too scared not to vote on a government resolution and one was a group company which was the merger of Bank of Rajasthan with ICICI. Birla Sun Life has said yes to every single resolution. Bharti AXA- I think has abstained from all with the exception of 2 companies unexplained totally why those 2 companies. I think one was the Indraprastha Gas and other was Tata Group Company- why they chose to vote in those when they have abstained from everything else? You tell me how I can afford not to be judgmental when I expect Mutual Funds or Institutional investors in this country to play a slightly more active role than the retails shareholders who go and sing songs in AGMs?
Vaidyanathan: If I was in your shoes, I would react in an almost identical fashion. I believe that the reasonable adapts to the world, the unreasonable makes the world adapt to him and therefore all progress is caused by the unreasonable. To that extent, I completely agree with you.
Doshi: You called me unreasonable and complemented me at the same time.
Vaidyanathan: I am so happy that you are making this an important one from countryís standpoint, from investor standpoint.
Doshi: Donít take a name. Explain to me how is it that an institutional investor, in this day and age, gets away by abstaining from every single resolution that it has had to vote on? What voting philosophy on the world can explain that?
Vaidyanathan: Let me be honest and tell you that it was precisely some of these questions that triggered the entire discussion internally to say Ė we need to get these guys to become more accountable on this subject. This is extremely important.
Doshi: Then can I then understand that SEBI will ask them to explain why they have chosen to abstain from every single resolution?
Vaidyanathan: When we started off by saying- when I talk about principle, the principle for me is not just one sentence to protect shareholders interest or unit holder value. The principle to me is why is it important? How do you address conflicts? What are the kind of decisions that I would take a stance on, not take a stance on? What are the kind of decisions that you would make on an issue- that is important (interrupted)
Doshi: Are you going to ask them all these questions?
Vaidyanathan: I want those disclosed. (Interrupted)
Doshi: The disclosures have been made Ė we will abstain from all resolutions. Are you okay with that?
Vaidyanathan: Absolutely not. Different firms will be asked different questions. But for example one question will be asset management business is about discharging fiduciary obligations to your investors and thatís all that matters. You have not answered that question because the asset management company is a part of a conglomerate. So can you please explain out there how you will discharge fiduciary obligations in that context and that is not covered in your policy.
Doshi: 2 out of the top 5 have said - we will avoid conflicting interest. I thought that was laughable. I was surprised that any fund manager signed-off on that policy. Of 4000-5000 resolutions- thatís a ball park figure- that they have voted on, I think only on 3 cases they have voted against the resolution.
Vaidyanathan: Itís not a good thing. So we have to do something.
Doshi: I was hoping you would say that
Vaidyanathan: We have to do something about it but at least we know for a start today that there were 3 ĎNoí out of 4000; we had a black hole earlier.
Doshi: Let me come to the other part and the large other part of everything that you have done here in SEBI outside of this voting disclosure. Several landmark changes in the mutual fund industry; I am not going to recount all of them. I think everybody knows about that and the industry is also already facing the consequences. Let me ask you for what you consider the unfulfilled part of the regulatory agenda when it comes to both your charges Ė mutual funds as well as foreign institutional investors?
Vaidyanathan: If you go back to the concepts of, letís say the last few years of regulatory agenda with respect to mutual funds, principally the big mandate was to steer the ship which was looking towards distributors to investors. Have we done it? I think in terms of directional change we have done. But are we there? The answer is no. The ship has still to go a long way before it is completely investor aligned. Did we address systemic risk? I think we have done a fair part of the systemic risk whether it is valuation of securities, whether it is allotment of units only on sighting of funds, whether its intraday borrowing that a mutual fund can do. So in terms of systemic risk misuse, we have done a fair amount of it. Disclosures- we have done but I think there is lot more which needs to be done and some of that, you learn as you make those things.
For example performance disclosures- the level of granularity can do better but without making it too complex that a retail investor canít understand. This voting policy disclosure is one such thing. So there is a lot more that we can do with respect to disclosure because at the end of day, as a regulator, you believe that the more and more transparent the system is, the better it works for the interest of the investors. So we have done that. Development area we have made some start and there is some more that we can do in terms of investment awareness education.
Doshi: If one was to argue that the decline that we have seen in the mutual fund industry over the last year?
Vaidyanathan: The data is wrong. Your data is wrong. Decline of the mutual fund industry whether it is profitability, it has gone up 4 times over 2009, 3 times over 2008. Inflows is a function of market. To attribute anything to entry load- you look back and see the last few months. In the month of April, you have net outflow. In the month of May, you have net inflow; slightly higher amount than April. In both months there were no entry loads- what is the difference?
Doshi: Are you saying that the decline in the inflows we have seen, letís say for the last fiscal, can be attributed 95% to market factors and has nothing to do with the entry load situation?
Vaidyanathan: I would say 99% to market factors and I am very happy that investors are better demonstrating. Look at when did the inflows happened in mutual funds- in 2007-2008, the big inflow and retail investors hate to book losses. So 2008-2009 saw the lowest redemption because market was low. People hate to book losses. Evert time the market has bounced back and when itís riding high, people get out.
Doshi: Unfinished agenda Ė what do you see as the next few actions from SEBI?
Vaidyanathan: I think we have to look at distributor regulation. It is in the agenda.
Doshi: So new architecture or regulatory architecture for distributors. Then?
Vaidyanathan: To me, the other big area, where the maybe the regulator can work with the industry is technology. This industry works with 15 year old technology of recognizing an investor by his portfolio. Thatís archaic. Thatís self serving for some narrow commercial interest. Itís completely investor unfriendly. We need to move away.
Doshi: So specifically what can we expect SEBI on this?
Vaidyanathan: I think some of the realms of the KYC process- which I think the Chairman has spoken about- we need to simplify the KYC Process and thatís not limited to mutual fund industry, itís across securities market. You need to create more outlets for people to come into the mutual funds.
Doshi: Unfulfilled agenda when it comes to FIIs?
Vaidyanathan: There is a big report put out which the current Chairman headed. That would be a path breaking reform to foreign investment process.
Doshi: That is still dependant on the Finance Ministry deciding to go ahead with the implementation of important aspects of that report?
Vaidyanathan: A part of it has been implemented.
Doshi: Of the mutual funds?
Vaidyanathan: Correct. I think the crux of this report is to move away from a SEBI pre-registration to a market registration process. I think that is the hump we have to make.
Doshi: How has your time here at SEBI's been? We have seen the world change in your time here. We have seen SEBI change substantially in your time here. And may I say that maybe the winds have changed or blowing again- at least the outside perception is that there has been an increase in the intervention by the Finance Ministry in several regulatory bodies across the country, including SEBI?
Vaidyanathan: Let me put it in context. It is very interesting how market jumps to conclusions. Not even 3 year ago, the entire market- not just in India, around the world- expected all governments and regulators to work together to bail this great market out. When it suits them, government has to be extremely interventionist with market. When it doesnít suite them government has to be hands off.
Number 2, as a former SEBI Chairman said Ė it is the same market which once provoked the SEBI Chairman to say the route from the Dalal Street to SEBI is not via Delhi. Now you want the market start saying that SEBI should be independent. I think the right answers in all of these are far more calibrated. But the bigger point to me and I will say this - what the crisis demonstrated is that the regulators have been held captive by industry. I think over the last 3 years regulator across the world have worked very hard to pull themselves away. Regulator capture was one of the big cause of the crisis. I think in the last 2 or 3 years if there is a tough war that they have fought very hard, it is about extricating themselves and demonstrating their independence vis-ŗ-vis industry. That has been done by measures where some of them may not have been pleasant and therefore enemies or everybody thinks anything else. But the point is the big case study for regulators to write is about how they have extricated themselves from the regulatory capture. For me that is a big success story. That augurs well for the markets for the long-term.
Doshi: How do you recount or what do you remember most of the time that you have spent in SEBI? This is my final question to you Ė how will you remember it and will it mean that you will come back to the financial services industry thereafter?
Vaidyanathan: I will remember SEBI for 2 big learnings. I have enjoyed every day in this institution. 2 big learning from the market- a lot of people think the regulator has to be market friendly. I have understood the difference between market friendly and investor friendly and I have understood the downsides of the first. That has been a huge learning.
The second is- I think a lot of people want to do public good. My experience tells me that in life if you want to improve probability of success, then you are better-off trying to do the public good from inside the system. If ever you get an opportunity like I got to come and work in an environment like this- it does not always have to be SEBI, it could be any public institution- grab it with both hands. Because there is a lot that you can do.
Doshi: Are you apprehensive that this Committee that I understand internally within SEBI or your group of people that is studying what next to do with the mutual fund industry that it may go back on some of the moves that SEBI made 2 years ago with regards to doing away with entry load?
Vaidyanathan: This is like a P.S. to a completed letter since you said this is the last question and then you asked. Let me answer it briefly. Abraham Lincoln fought against slavery and he won. He was shot dead. After his assassination slavery didnít come back. I hope that rests the case.
Doshi: Thank you very much.