Investors and the Investing Process:
- Who can Invest?
- Investors eligible to invest in securities markets include individual investors and institutional investors.
- Individual investors can be residents, minors, HUF, NRIs and FPIs.
- Institutional investors include companies, trusts, charitable organizations, financial institutions, pension funds, insurance funds and banks.
- Institutional investors follow a formal process for making and executing investment decisions.
- Investment decisions must adhere to the approved pattern and be executed by authorized signatories.
2. Client Onboarding Process
- Investors must fulfill mandatory requirements to be eligible to invest in various investment products.
- Pre-requisites may be imposed by regulations or specific to investing in a particular product.
- Specific conditions with respect to the instrument must be completed, such as making an application during a specific period.
- Payment for applications made in a public issue must be made using the ASBA facility.
- SEBI has introduced the use of UPI with the ASBA facility as a new payment mechanism for retail investor applications submitted through intermediaries.
3. Terms of Offer
- The offer document of a financial product specifies the conditions to be fulfilled by a prospective investor and the documentation needed to support this.
- Conditions may be laid down in terms of who can invest and how much can be invested in the scheme.
- Some products may exclude a certain category of investors from investing.
- A product may also be launched for a specific category of investors, and investment instruments may have a certain minimum threshold amount for investment.
4. Regulatory Requirements
- Investors must have a PAN issued by the Income Tax Authorities to be eligible to invest in most financial products in India.
- Capital market investments made through a demat account or in physical mode require PAN card details to be provided.
- Investments in deposits with the Post Office Savings Bank, Post Office Savings Schemes and Savings Certificates have to be classified as medium and high risk, with balance in all other schemes not exceeding Rs. 10 lakhs.
5. Mandatory Investor Information:
When an investor applies to buy a financial product or service, there are certain mandatory fields that must be completed in the application form, without which the application may be deemed invalid and rejected. This note explains the different mandatory fields in the application form.
The financial product or service is held in the name of the investor who is identified by name. In case of mutual funds, shares and bonds, demat account, post office savings bank accounts and most company deposits a purchase application can be made by a maximum of 3 joint holders. In others, such as a fixed deposit with a bank or the senior citizens savings scheme and the NSC, there can be a maximum of two holders.
The signature of the investor is the identity of the investor in the records of the issuer. It is verified for every transaction. In case of a joint application, the form must provide for signatures of all joint holders irrespective of the holding pattern.
The address of the first holder is mandatory in order to enable physical identification of the investor’s location. Address of the investor must match with the address and proof of address provided while completing the KYC formalities.
- Bank Account Information:
The application form may require the investors to provide bank account details of the sole or first holder at the time of purchase. Account number, bank and branch details, type of account, IFSC code, and MICR code has to be provided. This is the account in which the interest, dividends and redemption proceeds will be credited.
- Permanent Account Number (PAN):
PAN has been notified as the single identification number for all capital market transactions. Barring some exempted small value transactions, it is compulsory for all categories of investors to quote PAN in the application form.
- KYC Compliance:
KYC completion status of the applicant must be provided in the application form, and proof of being KYC compliant also needs to be provided at the time of making the investment.
- Risk Profiling:
It is mandatory for an investment adviser to undertake the process of risk profiling of the investor. This gives an idea about the position of the investor and the kind of risk that they are able to take.
6. Investor Folio or Account:
A folio number or account number, customer identity number or certificate number is allotted to the investor at the time of the initial purchase or investment or account opening. It is created by the investment product or service provider or their agent, such as the registrar and transfer agent, on receipt of a valid application. The information provided in the application form is captured to create a unique customer record.
The investor folio or account number is used to record all transactions pertaining to the investment, financial or non-financial. The identity number assigned to the investor must be quoted at the time of initiating any transaction pertaining to the investment.
Information of the investor used to create the account or folio includes name, status, contact details and bank account information if it is mandatory for the particular product or service. The mode of holding and operating the account, in case of joint holders, is also recorded. The nomination of persons entitled to receive the investment in the event of the death of the holders is also recorded.
PAN and KYC Process:
Permanent Account Number (PAN):
- Issued by Income Tax authorities for identification purposes
- Form 49A is the prescribed form to apply for a PAN, which requires proof of identity and proof of address
- Mandatory for most financial market transactions
- Attested copy of PAN card is maintained by Registrar and Transfer agent
- Certain micro investments and exempt from PAN requirement
Know Your Customer (KYC) Process:
- KYC norms ensure illegal funds are not routed into Indian markets
- Applies to opening bank, trading, demat accounts, and various financial transactions
- Involves verification of proof of identity and proof of residence of the customer
- Mandatory for all investors wishing to invest in mutual funds to complete KYC formalities with a KRA
- E-KYC services of the UIDAI have also been recognized as valid process for KYC verification.
Centralised KYC Registration Agencies (KRA)
Introduction: Centralised KYC Registration Agencies (KRA) are entities authorized by the government to maintain and manage KYC records of customers. In India, CERSAI is the Central KYC Record Registry that performs the functions of KRA under PML Rules 2005.
- Electronic storage, safeguarding, and retrieval of KYC records.
- Dissemination of updated customer information to reporting entities.
- Issuance of a unique KYC Identifier to each client.
- De-duplication of KYC records received from reporting entities.
- Availability of services on payment of a prescribed fee.
- Minimizing duplication of customer information submission.
KYC Template: The KYC template for individuals has been finalized by CERSAI and must be used by registered intermediaries for all individual accounts opened on or after August 1, 2016, where KYC is required to be carried out.
KYC Identifier: Each client is issued a unique KYC Identifier, which can be submitted to reporting entities for accessing KYC records from the Central KYC Registry. Reporting entities can download KYC records using the KYC Identifier and not require customers to submit documents again unless there is a change in customer information, current address verification is required, or enhanced due diligence is necessary.
Dematerialisation and Re-materialisation of Securities
- Depository is an institution that holds securities of investors in electronic form
- The Depositories Act passed in 1996 allows companies and investors to issue, hold and transact in securities through a depository
- Securities can be dematerialised at the time of issue or subsequently
- Currently, there are two depositories in India, National Securities Depository Ltd. (NSDL) and Central Depository Services (I) Ltd. (CDSL)
- Dematerialisation is the process of converting physical securities into electronic form
- Steps involved are: investor hands over the securities along with Dematerialisation Request Form (DRF) to the DP, DP sends the request through the electronic system to the issuer/R&T agent and the depository, and R&T agent mutilates the physical certificates once the process of dematerialisation is complete
- Dematerialised securities are fungible, i.e., once a share is dematerialised, it does not have a distinctive identity in terms of share certificate number or distinctive numbers or folio numbers
- Categories of securities eligible for dematerialisation are shares, scrips, stocks, bonds, debentures, debenture stock or other marketable security of any incorporated company or other body corporate, units of a mutual fund, rights under a collective investment scheme, venture capital funds, certificates of deposit, commercial paper, money market instruments, government securities and unlisted securities
- Re-materialisation is the process of converting electronic securities into physical form
- The process is similar to dematerialisation but involves the investor requesting the DP to convert electronic securities into physical securities
- The DP sends a request to the depository, and the R&T agent issues physical certificates after verifying the request
Power of Attorney: Easy-to-Understand Notes
Individual investors can empower someone they trust to do transactions on their behalf by granting and executing a Power of Attorney (PoA).
What is a Power of Attorney?
A Power of Attorney has two parties: the grantor and the attorney. The grantor grants the rights, and the attorney is authorized to execute an agreed set of actions on behalf of the grantor.
Who uses Power of Attorney?
This facility is generally used by non-resident investors who stay in a foreign country and are thus unable to manage their financial transactions, or by investors who like their brokers or advisors to manage their investments on their behalf.
What can the attorney do?
The attorney can do normal transactions such as purchase, payment for purchase, sale, settlement of transactions, and redemptions. The rights of the holder depend on what the grantor is willing to delegate under the power of attorney and what is allowed for PoA transactions by the investment or service provider.
How to Make a Power of Attorney Valid?
To be valid, the PoA must be typed on a non-judicial stamp paper, stamped according to the rules applicable in the state in which it is executed, signed by the grantor on all pages, signed by the grantor and the holder of the power of attorney on the last page, and notarized by a notary public.
General Power of Attorney
A General Power of Attorney gives the agent the authority to handle all the affairs during a period of time when the investor is unable to do so. General Power of Attorney is typically very broad, giving the agent extensive powers and responsibilities.
Specific Limited Power of Attorney
A Specific Power of Attorney gives the agent the authority to conduct a specific act or acts on the investor. Because this type of Power of Attorney is limited to the act or acts designated in the document, it is especially important to be very clear about the powers one wishes to give to the agent.
Account Opening Process for Non-Residents-
- A non-resident Indian (NRI) is an Indian citizen or person of Indian origin who is not a resident of India.
- The residential status of an individual is determined under Section 6 of the Income Tax Act.
- NRIs can invest in India, but repatriation norms vary depending on the source of the funds.
II. Definition of NRI
- An NRI is a person who is a citizen of India but resides outside of India.
- A PIO (Person of Indian Origin) can also be considered an NRI if he or she has held an Indian passport, is a grandchild of Indian citizens, or is the spouse of an Indian citizen.
III. Repatriation of Investment Proceeds
- NRIs can earn income in rupees or foreign currency.
- Investment proceeds from NRI investment depend on the source of funds.
- Rupee investment proceeds are non-repatriable because the rupee is not fully convertible on capital account.
- Funds remitted from abroad into the Non Resident External (NRE) Account or Foreign Currency Non Resident (FCNR) Account can be freely repatriated back.
IV. KYC for NRIs
- NRIs must be KYC compliant to invest in India.
- The KYC form is widely available online and must be submitted along with necessary documents to a point of service (PoS).
- NRIs must submit additional documentation, including a certified true copy of their passport, overseas address, permanent address, and PIO Card (for PIOs).
- All documents must be submitted in English and can be attested by the Consulate office or overseas branches of scheduled commercial banks registered in India.
Process of Consolidating, reorganising and folio keeping/Maintenance of Investments-
Investor accounts and folios require maintenance for changes to the details provided at the time of opening an account. The following are the steps involved in the process of consolidating, reorganizing, and folio keeping/maintenance of investments:
- Change of Address and Contact Details
- KYC process establishes the identity and address of the investor.
- Change of these details must be carried out in the KYC records.
- Uniform KYC process is done through the KRA for capital market transactions.
- KYC details change form can be used to carry out such changes.
- The KRA will update the records and communicate the change of address to all the entities with which the investor has holdings.
- In case of other financial products and services, the change in address has to be intimated to the provider for updation in the records.
- Self-attested documentary proof of the new address such as passport, current utilities bill, and ration card must be provided.
2. Change in Name
- The letter requesting the change in name should be supported by the name change certificate issued by a regulatory authority, an official gazette copy announcing the new name and a copy of marriage certificate, if applicable.
- A form specified for this purpose can be used, such as the form S2 prescribed by the NPS or the KYC details change form specified by KRAs or a form specified by the concerned bank, insurance company or other intermediaries.
3. Change in Status
- A change in status can be recorded with the capital market companies and intermediaries by using the KYC details change form to register these changes in the records of the KRA.
- Insurance companies have to be intimated of the change and the new address and mode of premium payment details provided in an NRI questionnaire that is prescribed by the company.
- Bank accounts held as resident should be re-designated to NRO account through an application signed by all the holders.
- New bank account details have to be provided.
- Marking a Lien:
- Investors pledge their investments as collateral to borrow money from banks, financial institutions, or NBFCs.
- The lender creates a lien or charge on the securities pledged and informs the investment provider of the lien through a letter.
- The lien or pledge is recorded by the investment provider in the investor’s records and can be for all or part of the securities in a folio.
- An investor cannot redeem or transfer the securities under lien until the lien holder provides a written authorization to revoke the lien or pledge.
- Once the investor repays the loan, the securities become free from lien and are unmarked.
- The lien holder can invoke the lien, which means redeeming or selling the pledged securities, and receives the proceeds by selling/redeeming the securities.
- Dividends and other benefits from the securities under lien will go to the investor unless specifically barred by the lien holder.
- Transmission means passing on investments on the death of the investor to another person.
- The investment provider does not take responsibility for the equitable distribution of the investments among the heirs of the deceased investor.
- The eligibility of claimants to get the investments transmitted in their name on the death of the first holder will depend upon the way the investment account was held.
- If the investment account was held jointly and did not have nominations, then the investments are transmitted to the joint holders in the same order.
- If the folio was held jointly and had nominations, the right of the joint holders to transmission supersedes the right of the nominee.
- If the investment account was held singly and had a nomination, then the investments will be transmitted to the nominee.
- If the investment account was held singly and there was no nomination, then it would be transmitted to legal heirs or other claimants where there are documents to establish succession.
- Transmission is completed by removing the name of the investor from the investment records and transferring the investment to persons entitled to receive them.
Notes on Change in Status of Special Investor Categories
- Minors, NRIs, and investors investing through a constituted attorney are special categories of investors.
- Additional documentation and process are required due to their differential status with respect to taxation, mode of operation of investments, or restrictions on certain components of investment activity.
- Minors as Investors
- Minors are investors who are less than 18 years of age.
- Financial transactions are conducted by adults on their behalf, and those transacting on behalf of the minor child are called guardians.
- When investments are made on behalf of minors, additional documents need to be submitted with the application form.
- The guardian has to provide all details and complete the KYC formalities.
- The guardian signs the application and payment instruments on behalf of minors.
- The new guardian could be a natural guardian or a court-appointed legal guardian.
- The signature of the new guardian in the bank account of the minor attested by the bank as such needs to be submitted.
2. Minor Turned Major
- Once the minor becomes major, financial transactions are disallowed in their account.
- KYC process has to be completed by submitting proof of identity and address.
- Banks will ask for proof of age and an application to attest the signature of the minor-turned-major.
- The PAN issued to a minor will have to be resubmitted to the Income Tax authorities for issuance of a new card.
- Demat accounts of minors can be held only on a single-name basis, and a new demat account has to be opened.
- Securities held in the old demat account with minor status are transferred to the new demat account.
- In the case of mutual fund investments, notification to the registrars with a copy of the banker’s attestation of the signature is adequate.
- NRI to Resident Indian (RI)
- A returning NRI needs to carry out certain procedures regarding investments and bank accounts
- NRO/NRE/FCNR(B) accounts cannot be operated anymore
- Inform the bank about the change of status to resident Indian and open a Resident Rupee Account
- Open a Resident Foreign Currency (RFC) account to transfer balances from NRE/FCNR(B) accounts
- Inform the DP with whom he/she has opened a demat account to transfer all the balances held in the NRI demat account to the new ‘Resident’ demat account
- Inform the broker about the change if the NRI was operating an online trading account
- Send KYC change form to respective AMC with whom the NRI holds mutual fund investments to change status, address, and bank details
4. Resident Indian to NRI
- Different rules apply to a Resident Indian when the status changes to an NRI
- Resident savings account cannot be operated anymore
- Open an NRE/NRO account with the bank and route investments only through NRE/NRO account
- Convert bank fixed deposits to NRO fixed deposits and submit original fixed deposit receipt for a new deposit confirmation advice
- Open a new depository account with NRI status and transfer all balances held in the account with ‘Resident’ status
- Regularize physical securities by submitting a letter addressed to the issuing company along with the Demat Request Form
- Open a new trading account for future investments with higher brokerage rates compared to resident investors
- Inform relevant AMCs about the change of status, address, and bank details with respect to mutual fund investments
- Send KYC change form to the KYC registration agency for change of status, address, and bank details
5. Addition or deletion of name in an account
- Add or delete a name from the bank account by applying for the purpose of either the addition or the deletion
- Collect necessary documents from the person being added and complete KYC
- Update specimen signature card with new account holders
- Mutual funds do not usually allow for the addition of a name as it amounts to a transfer of the units being held
- Open a new folio with the desired holdings and get the units in that folio after closing out the existing holding
6. Addition or deletion of a bank mandate
- Bank mandate consists of authorization given by an account holder to operate a bank account
- Add or delete a bank mandate by making a request to the bank with necessary documents
- In case of joint accounts, all account holders need to sign the new mandate form
- In case of death of the account holder, the legal heir can submit the necessary documents and request a change in mandate
I. Traditional Modes of Payment
- All payments for capital market transactions should be routed through the first holder’s bank account.
- Cheques, demand drafts, and electronic payment modes are accepted.
- For mutual funds, cheque payment is the most common mode of payment.
- Local cheques and At-Par cheques are accepted, but outstation cheques and post-dated cheques (except for SIPs) are not.
- Demand draft is accepted for applications from centres where the producer does not have an office or collection centre.
- Systematic Investment Plan (SIP) allows investors to accumulate a target investment sum through periodic recurring investments.
- Payment for purchase of units through an SIP can be through post-dated cheques or through an ACH mandate.
II. Digital Payment Systems
- ACH (Automated Clearing House) mandate form should be filled up and submitted by the investor.
- ACH facility is available only in select cities as given by the AMC.
- ASBA (Applications Supported by Blocked Amount) is a facility extended to investors subscribing to securities.
- ASBA is an application containing an authorization to block the application money in the investor’s bank account for subscribing to a primary market issue.
- Only funds to the extent required for allotment of units are debited from the bank account.
- NEFT (National Electronic Funds Transfer) and RTGS (Real Time Gross Settlement) are electronic fund transfer modes.
- NEFT and RTGS are settled in batches at times defined by the RBI.
- RTGS is for transactions of Rs. 2 lakhs and above, while there is no minimum amount for NEFT transactions.
- Indian Financial System Code (IFSC) is necessary for performing NEFT or RTGS transactions.
- Debit cards issued by selected banks can also be used to make payments.
- NEFT/RTGS facilities benefit investors who do not have internet banking accounts with the designated banks specified.
- Prevention of Money Laundering Act
Prevention of Money Laundering Act, 2002 is a law passed by the Government of India to prevent money laundering and other financial crimes. SEBI has permitted cash investments in mutual funds to increase the reach of mutual fund products among small investors. However, these cash investments should be in compliance with the Prevention of Money Laundering Act, 2002.
- Cash investments in mutual funds are permitted up to Rs. 50,000 per investor per mutual fund per financial year.
- The asset management company should have sufficient systems and procedures in place for accepting cash transactions.
- Repayment in the form of redemptions and dividends is only permitted through banking channels.
- Third party payments or payments made through an instrument issued from a bank account other than that of the investor mentioned as the first holder in the application form will not be accepted for payment for investing in capital markets.
- Exceptions on the third party payment rule are made for grandparents/parents making payments not exceeding Rs. 50,000 (per transaction) on behalf of a minor, employer making payments on behalf of employees through payroll deductions and custodians making payments on behalf of FPIs.
- A third party declaration form must be provided stating the relationship with the beneficiary and details of the bank account through which payment will be made.
- The person making the third party payment must be compliant with the PAN and KYC requirements.
4. Prevention of Frauds
Prevention of frauds is a critical aspect of the investment process. There have been instances where investors gave cheques for investment in a fund, but the cheques went into the account of someone else who then encashed the amount and disappeared. To prevent such frauds, various measures have been taken.
- The amount being invested should come from the investor’s own account and not a third party.
- A bank account linked with the investment ensures that dividends and redemption proceeds go to the right place.
- Cheques are printed with the account number to prevent them from being deposited into the wrong account.
- Electronic modes of payment reduce the risk of fraud by minimizing physical handling of money.
- Collection of various documents and matching the names of the investment holding and bank accounts while processing payment mode helps to reduce fraud.
Documentation for Financial Advice:
- The process of providing financial advice involves collecting information from the client, evaluating the investor’s situation, determining a realistic saving and investment plan, and executing the plan.
- Clear documentation of the entire process is important to exclude chances of information being misinterpreted and to avoid giving unsuitable advice.
Agreement with Client
- The financial adviser must enter into an agreement with the client laying out the roles and responsibilities of each party.
- The agreement should include the scope of work, agreed remuneration, and an undertaking to act in good faith.
- The adviser must take the client through all the clauses and make sure they understand the implications.
- A signed copy of the agreement must be available with both parties.
- The adviser must collect essential information on the client, including age, income, asset details, existing borrowings and liabilities, and needs and goals for which they wish to save and invest.
- This information is fundamental to making a financial plan, and it should be recorded and verified by the client before use.
- Risk profiling tools such as questionnaires can be used to assess the risk tolerance of the investor.
- The adviser must ensure that the investor understands the questions clearly, interpret the responses correctly, and see them in conjunction with the financial and personal situation of the client to arrive at the appropriate risk tolerance.
- The risk profile arrived at should be communicated and explained to the client, and all information should be maintained in records and periodically updated.
Investment Product Selection
- The investment adviser must document the process by which they short-list investment products for the client.
- The products recommended should be those that are suitable for the client’s goals and risk profile and their ability to understand the risk and performance of the investment.
- The reasons for the selection must be explained to the client and documented, and the key features of the investment product must be clearly laid out and explained.
Investment Advice and Pre-Investment Requisites
- The investment advice given on saving and investing for the goals must be recorded and maintained.
- The adviser must communicate it clearly and ensure that the implications are understood.
- There are pre-investment requisites that have to be met by the client, such as undergoing the KYC process and having a specific type of bank account and investment account.
- The documentation associated with all these must be maintained.
- Once the investments are made, documents such as proof of investments and account statements have to be maintained for which a system has to be in place.
- Regulations allow records to be maintained physically or in electronic form, and if maintained electronically, they must be digitally signed.
- All records must be maintained for a period of five years, and the regulatory requirements for maintenance of records and documents are discussed in detail in chapter 6.
Investing in Mutual Funds through Stock Exchange Platforms:
- What are Stock Exchange Platforms for Mutual Funds?
- Stock exchanges offer investors the facility to buy and sell mutual fund units through their platform.
- SEBI allows mutual fund distributors registered with AMFI to use the infrastructure for their clients.
- Investors can transact in a seamless manner and get units in their demat account.
- The BSE Star MF Platform and NSE NMF (II) platform are two examples of such platforms.
- The process, including pay in and pay out of money as well as the units, takes place through the stock exchange infrastructure, eliminating counterparty risk.
- Investors can undertake SIP, STP, SWP, and switch transactions.
2. What is the Role of Investment Adviser?
- Investment advisers can advise investors on using the online platform for mutual fund investments.
- The adviser guides the investor on the manner of investment and the process to follow.
- Advisers can construct portfolios and suggest the route for making the investment.
3. What Transaction Feed is Available to Investment Advisers?
- Investment advisers can see their clients’ entire mutual fund portfolio at a single place.
- The stock exchange provides details of holdings and transactions, making decision-making easier.
- The adviser can take an independent view of the portfolio and make decisions based on available information.
- There is almost no paperwork involved in the entire process, making the process smoother and allowing advisers to undertake more business and serve clients better.