ETF rules stump bidders

Last Updated: Wed, Oct 03, 2012 19:42 hrs

Steep eligibility conditions and conflict of interest provisions have kept fund houses and merchant banks from bidding for the mandate to advise the proposed Exchange-Traded Funds (ETFs) of public sector undertakings (PSUs).

The Department of Disinvestment (DoD) has now diluted one of the conditions and has extended the deadline for submission of bids to October 19 from 8, hoping to get bidders.

Last month, DoD had floated request for proposals (RFP) “towards engagement of an advisor for creation and launch of a central public sector enterprise (CPSE) exchange-traded fund”.

  • Finance ministry calls for advisors to launch ETF on PSUs
  • Says advisors should have handled a Rs 1,000-crore fund launch
  • Not many Rs 1,000-crore funds launched in past three years
  • Ministry relaxes norm to include MFs that launched schemes that later grew to Rs 1,000 crore 
  • Conflict of interest provisions continue to be irritants

Under the RFP,“bidders should have advised or have been involved in a relevant capacity or have launched an equity ETF/equity MF/similar transaction during April 1, 2009 to June 30, 2012 of the size of Rs 1,000 crore or more.”

This condition was simply impossible to comply with, say fund houses.

Only one new fund offer (Reliance Infrastructure NFO in May-June, 2009, raised Rs 2,350 crore) meets this condition during this three-year window. Due to the market downturn and entry load ban in August 2009, NFOs have become few and far apart. Even the ones that hit the market were happy if they managed to collect a few hundred crores. Even fund houses that specialised in ETFs, such as equity Goldman Sachs (erstwhile Benchmark) and Motilal Oswal, would not have satisfied this condition.

After realising this, the ministry has now extended the eligibility period by seven years to April 2002. Thus, a bidder who has launched a fund during “the period April 1, 2009 to June 30, 2012, whose size at the time of launch was at least Rs 1,000 crore or its average AUM in any quarter subsequent to its launch have/had reached Rs 1,000 crore or more” would be eligible. This move will expand the number of eligible fund houses.

According to Valueresearch data, there were 48 equity schemes with AUM (assets under management) of Rs 1,000 crore or more as of June 30. None of these were ETFs. Thirteen fund houses, including Reliance, UTI, Birla Sun Life, DSP Blackrock, ICICI and HDFC managed these schemes.

But, the conflict of interest provision is a key irritant, say fund houses.

The department has laid out a two-stage process to get the ETF up and running. Accordingly, the department would first select an advisor through competitive bidding. This advisor would then give inputs on the favourable course of action. If the formation of an asset management company (AMC) is preferred at the end of this process, then the second stage kicks in.

Under the conflict of interest provisions, the advisor will not be eligible for participation in the second stage. “The entity appointed as advisor, or its sister concern or an arm thereof, will not be eligible to participate for selection as the AMC or ETF provider, so as to avoid any situation of conflict of interest,” the RFP said.

Under the existing industry practice, a fund house launching an ETF or an equity fund does not hire an external advisor such as merchant bankers or consultants. Structuring, marketing and distribution of a new fund offer is done in-house by fund houses. Therefore, there are not many consultants who can claim to have advised a fund launch of “Rs 1000 crore or more” like the DoD wants.

While this leaves out most of the merchant banks and consultants, a fund house which might have launched or managed NFOs of Rs 1,000 crore or more, as prescribed by DoD, does not have any incentive to become an advisor if it will be disqualified from bidding in the second stage.

Quantum Asset Management Company chief executive Jimmy A Patel said, “The conditions put out by the government like separate role for advisors and management, are difficult to implement.”

Patel also added the post-launch market making is another difficult requirement. “AMCs themselves don't do market-making but have to depend on third-parties like brokers.”

Amar Ranu, associate vice president-research and advisory, Motilal Oswal Wealth Management, said “It will be very difficult to sell this ETF. PSU stocks typically don't move in tandem with the market due to regulatory hurdles and other governance-related issues. A few PSU schemes that are there in the market haven't done well. Therefore, it will be difficult to convince the investor to invest in such a fund.”

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