Greater mutual fund transparency in India: enhanced disclosure protection for India's mutual fund unitholders in a time of market volatility.

• Author: Smith, Stephen P.

ABSTRACT

India has been one of the darlings among emerging market economies over the past decade. It has experienced dizzying economic growth that has lifted great numbers of Indians out of poverty and changed the economic outlook of much of its populace. For the first time, many Indians have excess funds to save or invest, and the Indian mutual fund industry has enjoyed an explosion in popularity as a result of this economic boom, particularly among first time mutual fund investors.

One of the most important mechanisms for investor protection in any capital market is the provision of information to investors by market participants. The Securities and Exchange Board of India (SEBI), India's mutual fund regulator, has developed an information disclosure regime that, for the most part, has evolved along with the industry's explosive growth. However, SEBI'S requirements have failed to keep pace with the industry's torrid growth in certain key areas. Changes to this regime are particularly important given the market turmoil that has occurred in India recently, the likes of which many first time Indian mutual fund investors have likely never have experienced before. To that end, this Note proposes substantial modifications to the Indian mutual fund regulatory regime's information disclosure requirements in certain key areas in order to maximize protections for Indian mutual fund investors, as well as to assuage their collective concerns.

1. INTRODUCTION II. BACKGROUND A. India's Economic Rise and Its Results for India's People B. Structure of Indian Mutual Funds C. History of the Mutual Fund in India D. A Rapid Increase in Popularity E. More Room to Grow? F. Regulation of Indian Mutual Funds III. THE USE OF INFORMATION TO PROTECT INVESTORS: INDIA'S MUTUAL FUND DISCLOSURE REQUIREMENTS A. Specific Disclosure Requirements 1. Disclosures Prior to and at the Time of the Initial Investment 2. Annual Reports 3. Half-Yearly Disclosures 4. Other Disclosures IV. A CRITICAL EVALUATION OF INDIA'S MUTUAL FUND DISCLOSURE REQUIREMENTS A. Praise for Indian Disclosure Requirements in Practice B. Criticism and Other Issues V. SPECIFIC RECOMMENDATIONS FOR ENHANCED MUTUAL FUND DISCLOSURE IN INDIA A. Initial Considerations B. Specific Recommendations for Enhanced Disclosure in India 1. Disclosure and Independent Verification of the AMC's Annual Returns 2. Ban Assured Return Schemes 3. Increased Standard of Adequacy 4. Increased Enforcement 5. Enhanced Risk Disclosures 6. Greater Fee Transparency 7. Increased Data Access 8. Language Issues 9. Large Shareholders VI. CONCLUSION I. INTRODUCTION

   The Indian economy has enjoyed unprecedented explosive economic growth since the late 1990s and, at least thus far, has not been nearly as badly impacted by the world's current economic situation as some other emerging markets. (1) This rapid growth has resulted in an increased standard of living and greater material prosperity for many of India's billions of people. (2) This economic surge has also changed the monetary outlook of many Indians and the uses to which the Indian populace has begun to put its savings. (3) Formerly content to let their savings accrue nominal rates of interest in a bank account, an increasing number of Indians have turned to other avenues in their search for greater returns than a savings account can provide. (4) The result has been a large rise in the level of assets under management in the Indian mutual fund industry and a new wave of enthusiasm for and interest in Indian mutual fund products.

   For the most part, the Indian regulatory scheme has evolved at a steady pace along with the increased popularity of mutual funds among Indian citizens. The Indian mutual fund regulator, the Securities Exchange Board of India (SEBI), was created in 1988. (5) The first set of comprehensive regulations governing the mutual fund industry were promulgated by SEBI in 1993 and substantially revised in 1996. (6) SEBI has continued to periodically modify and streamline those regulations in an attempt to keep the investor protections that are at the heart of the Indian regulatory framework current as the industry continues to evolve and become more complex. (7) For the most part, SEBI's efforts to maintain the maximum level of investor protection possible have been well-thought out and effective. However, there are several areas in which the Indian securities regulatory apparatus needs substantial modification and improvement, particularly in light of the ownership structure and nature of the Indian mutual fund industry.

   Information disclosure figures prominently in the Indian mutual fund regulatory regime in a variety of forms. Every Indian mutual fund is required to file an offer document with SEBI before selling units to the public and every mutual fund scheme is required to make a number of mandatory yearly and half-yearly disclosures. (8) SEBI has specifically prescribed disclosure of a number of important pieces of information and characteristics by every mutual fund in an Annual Report. (9) Among these requirements is a report by the fund trustees on fund performance and expenses over the course of the year. (10) SEBI has received praise from a number of quarters for its disclosure requirements, but has also faced criticism from several constituencies for not mandating enough of the right kinds of disclosure of information crucial to Indian investors.(11)

   SEBI has not fully utilized disclosure as an effective tool for investor protection. SEBI has failed to utilize disclosure as effectively as is necessary, particularly considering the fact that India has so many first time mutual fund investors. (12) Although the economic turmoil currently occurring in India is less pronounced than in other markets, even the muted economic downturn in India is likely causing considerable anxiety among novice investors who are completely unused to market downturns. SEBI should immediately begin to take steps to provide for an enhanced Indian mutual fund disclosure regime. Several additional disclosure requirements are needed in order to maximize the effectiveness of disclosure as a method for protecting Indian investors. This Note will advocate nine essential reforms to the Indian mutual fund regulatory regime that should be immediately enacted by SEBI.

   Part II of this Note describes India's economic history in the second half of the twentieth century and notes its impressive economic growth towards the later stages of that period. Part II also provides background information on the Indian mutual fund industry, describing the structure and characteristics of Indian mutual funds, reviewing their rapid increase in popularity during the past twenty years and some of the reasons for that increasing popularity and then describing the Indian mutual fund regulatory framework. Part III describes the specific disclosure requirements with which Indian mutual funds must currently comply. Part IV provides a critical evaluation of these disclosure requirements, and Part V provides nine specific recommendations for enhanced mutual fund disclosure in India that should immediately be enacted by SEBI. Those specific recommendations are (i) disclosure and independent verification of the asset management company's (AMC) annual returns, (ii) the banning of assured return schemes, (iii) an increased standard of adequacy, (iv) increased enforcement, (v) enhanced risk disclosures, (vi) fee transparency, (vii) greater data access, (viii) greater use of languages other than English for fund disclosures, and (ix) mandatory disclosure of large fund shareholders. Part VI concludes by offering some remarks on the ease and utility of adopting the nine specific proposals that are presented in this Note.

2. BACKGROUND

   1. India's Economic Rise and Its Results for India's People

      After gaining independence from Britain in 1947, India had a centralized, highly controlled economy with particularly onerous exchange and capital controls that enabled the government bureaucracy to retain tight control over the country's economy for many years. (13) As is often the case in the developing world, a financial crisis in 1991 precipitated the Indian government's decision to liberalize its formerly stringently planned economy. (14) A balance of payments crisis became so severe that India was forced to request an emergency loan from the International Monetary Fund (IMF). (15) The stringent conditions imposed on the loan eventually led to the adoption of much-needed extensive liberalization measures. (16) Many consider the 1991 restrictions imposed by the IMF as the starting point of a revolutionary series of reforms that led to India's economic boom (17)--reforms that included cutting taxes and scrapping a system of industrial controls known as the "license raj." (18)

      As a result of the structural reforms introduced in the early 1990s, India has experienced an economic rise that has been nothing short of miraculous. While it experienced an annualized gross domestic product (GDP) growth of just 1.25% in the thirty years after it gained independence in 1947, India has witnessed a dizzying rate of growth in GDP ever since, with a growth rate of 7.5% as late as 2007. (19) This explosive growth has shown little sign of slowing down, with several commentators predicting that growth could exceed "5% for the next 30 years and close to 5% as late as 2050 if development proceeds successfully." (20)

      Even the onset of a global recession seems to have barely affected the Indian economy's rapid growth rate. (21) Indeed, some commentators believe that the country will hardly be affected by current economic conditions as compared with the rest of the world, due largely to the fact that the Indian bureaucracy's iron grip over the economy, operating in conjunction with the country's protectionist policies, have largely shielded the country from the economic disaster that has devastated much of the rest...