Financial Transactions

What this chapter covers

Units 12 to 15 carry 30 marks between them — about 7.5 marks for this chapter.

LEARNING OBJECTIVES: After studying this chapter, you should know about the mechanism and processes related to financial transactions in case of mutual funds: Application form and Transaction slip · Purchase and Redemption Cycle · Statement of Accounts and Consolidated Account Statement · Concepts of Entry and Exit Load · Switches and Systemic Transactions · Timelines for Various Financial Transactions · Role of RTA in Calculation of Commission

Mutual funds involve large number of financial transactions on daily basis. These are: Purchases by investors (fresh/ additional) · Redemptions (repurchases) and Switchovers · Dividend pay-outs (Pay-out of Income Distribution cum Capital Withdrawal) · Payment of commission to the mutual fund distributors · Systematic Registrations.

Five kinds.

14.1 Application form versus transaction slip

The application form provides required information about an investor of a mutual fund. The information captured in the application form is entered in the RTA records. The investor is then assigned a folio number by the AMC. A folio is like a bank account number, created for a fund house and its investors. Investors can hold units under multiple schemes of a fund house, in a folio.

The third sample question asks who records the information — the R&T agents.

An investor fills out the details in the application form and signs it. In order to verify subsequent transactions from the investor, the investor's signature is scanned and maintained in the RTA system. For subsequent purchase transactions, if the folio number is quoted, several fields in an application form need not be filled up again.

The fields in the application form are largely standardized across mutual funds, because of the mandatory information requirement. There are however, minor differences in the presentation, detail and font sizes.

The mandatory fields:

Investor status in terms of resident/non-resident · Details of bank account (pay-in and pay-out) · Complete address of first holder · Date of birth and guardian details for minors with documentary proof for DOB and relationship · PAN/PEKRN details · Signature of applicants · scheme, plan and option · Nomination or declaration of Opted Out · Other declarations such as FATCA/CRS, UBO, NPO · Declaration on Email/Mobile · Any other documents mandated by SEBI/AMFI/SID from time to time.

Note "Signature of applicants" — plural. The first sample question asks who must sign a fresh purchase application: all joint holders. (Contrast the transaction slip, which has to be signed according to the mode of holding of the folio, to be valid — so under either or survivor, one signature can suffice for later transactions.)

The application form should then be checked and validated for these fields before accepting it.

Transaction slip

The application form is designed to capture all investor information for the first time. Investors can use a transaction slip for subsequent transactions. A transaction slip has the pre-printed folio number to identify the investor in the system.

The second sample question follows from that — a transaction slip is used when the investor knows his own folio number.

The transaction slip is designed to capture multiple transaction type requests. Investors use it for carrying out redemptions, additional purchases, switches and even non-financial transactions such as change of address or change of bank details. It has to be signed according to the mode of holding of the folio, to be valid.

Most AMCs provide transaction slip as a counterfoil to the account statement sent to the investor. The transaction slip has the folio number and account number of the investor, pre-printed. An investor can either use a pre-printed transaction slip form or he can use a blank transaction slip, which is available with AMC branches, distributors and ISCs and write the folio number in the space provided.

14.2 Purchase transactions

Mutual fund units can be purchased during NFO or after the scheme opens for on-going offer (if open-ended) after allotment of NFO units. When a new investor applies for units either during NFO or during continuous offer, it is called fresh purchase.

Seven checks on a payment instrument. When one is received it has to be ensured that: (a) scheme name is mentioned on the instrument, and is same as on the application form; (b) short name or abbreviation used for scheme name is one of valid alternatives as per offer document/AMC instructions; (c) the cheque date is current or valid (not stale or more than 3 months old); (d) the cheque is not post-dated; (e) amount in words and figures matches with the investment amount; (f) cheque is signed by the investor/ guardian in case of a minor investor; (g) cheque is not mutilated.

After the fresh purchase, every subsequent purchase by the unit holder is called additional purchase. Additional units can be purchased by using a transaction slip. An existing investor may decide to make additional purchases under a new folio. This will be considered as fresh purchase.

The sixth sample question follows — for an additional purchase in the same scheme, the transaction slip is the preferred mode.

The ten steps of a purchase transaction:

Investor transaction is accepted by ISCs/AMC · Transaction is intimated to RTA back office · Units are added (purchase) on realisation of funds or reduced (redemption) in the folio of investors · Inflow and outflow resulting from transactions is reported to the AMC Treasury · Units issued and redeemed for the day are consolidated · Unit capital is updated for increase/decrease due the transactions · Unit capital is communicated to AMC fund accounts · Portfolio is valued by fund accounts/custodian · NAV computation is done using the portfolio value and updated unit capital · NAV is communicated to RTA for applying to investor transactions.

Note the circle — the RTA gives the unit capital to fund accounts, and gets the NAV back.

14.2.1 Entry load

Entry load is a percentage of the NAV of the unit. In an NFO, load is charged as percentage of the face value. Entry load increases the price at which an investor buys units. Hence, for the same amount invested, units allotted to investors paying a load are lesser, as compared to units allotted without load.

It may be noted that SEBI has abolished entry load vide its circular SEBI/IMD/CIR No. 4/ 168230/09 applicable from August 1, 2009. However, the candidate should be familiar with the concept.

The ninth sample question asks about entry load — it has been abolished by SEBI.

14.3 Redemptions and IDCW payouts

After the NFO, when a scheme re-opens, the continuous offer is for both purchase and redemption of units. Redemption refers to investors' request to return their investments in a fund.

In case of open-ended funds, on redemption, the units are extinguished or cancelled and are not re-issued. Redemption alters the unit capital of an open-ended scheme. Therefore, outstanding unit capital is communicated by the RTAs, after processing all purchase and redemption transactions for every business day.

In case of closed-end funds, redemption of units happens only on the maturity date of the scheme. Redemption may be allowed during specified periods under the Interval Funds before maturity date or at a cost as specified in the offer document.

Investors can specify the redemption of units held in a folio either in terms of number of units or as amount in rupees. Where redemption is specified in amount, the investor must ensure that the value of their holding is sufficient to meet the amount.

Investors can redeem all or part of the units in a folio; or they can redeem all or part of the amount in the folio. The redemption request has to be equal to or more than the minimum amount or units specified in the offer document. Mutual funds may specify the minimum balance to be maintained in a folio after redemption.

How the money is paid. Mutual fund investors are required to indicate in the application form, their preference for receiving redemption proceeds. The proceeds can be paid by cheque or through direct credit as indicated. As per SEBI mandate, the account holder's bank account and bank details have to be printed on the redemption cheques, to prevent fraudulent encashment. PAN card is compulsory for all redemption transactions.

Redemption cheques drawn are payable to the first holder in a folio. Mutual funds cannot issue third party payments. If the AMC's paying bank is not present in the location where the investor is, redemption proceeds are paid by demand draft. If the investor redeems units purchased on multiple dates, redemption will be made on a 'first-in-first-out' basis.

FIFO — the oldest units go first, which matters for capital gains.

AMCs may also use instruments or payment channels such as RTGS, NEFT, IMPS, direct credit, etc. or any other mode allowed by RBI from time to time, for payments including refunds to unitholders in addition to the cheque, demand draft or dividend warrants.

Delays cost the AMC. Redemption proceeds have to paid to unit holder within the time stipulated by SEBI. Dividends have to paid to investors within the time stipulated by SEBI. Delays attract a 15 percent p.a. penal interest to be paid by the AMC.

The workbook's footnote records the then-current periods — redemption proceeds have to paid to unit holder within 3 working days (earlier 10 working days). Dividends have to paid to investors within seven working days from the record date — while adding that candidates are advised to read the latest circular for the latest stipulated time period. The turnaround table later in the chapter states dividends within 15 days from the record date under the 2021 amendment regulations.

Instant Access Facility (IAF) helps credit of redemption proceeds in the bank account of the investor on the same day of redemption request, subject to prescribed limits. IAF is offered for Overnight and Liquid schemes of the mutual funds for resident individual investors only through the website or mobile app of the AMC.

Overnight and liquid only; resident individuals only; website or app only.

NRI redemptions

Redemption proceeds have to be paid to NRI investors as per the RBI regulations in force. The general rule to remember is that redemption payments have to be paid according to the source of funds of the purchase transaction.

Those investments that have been made from NRE or FCNR accounts or by remittance of foreign exchange from abroad can be paid on a repatriation basis. If the investor mandates, such payment can be made into a non-repatriable account. If the investment has been made from a rupee account, or an NRO account, redemption cannot be paid into a repatriable account. Capital gains arising on redemption have to be deducted at source for NRI investors.

Repatriable money can go either way; non-repatriable money can only stay.

14.3.1 Exit load

Exit load has the effect of reducing the redemption price for the investor. If the investor has specified the redemption in unit terms, the redemption value comes down because of the load. The exit load of an open-ended mutual fund scheme shall not exceed three per cent of the Net Asset Value of the scheme.

The fourth sample question — exit load has the effect of reducing the redemption amount.

The worked example: at a NAV of Rs. 20 per unit, redeeming 1000 units will get the investor Rs. 20,000. However, if the exit load is 1 percent, the redemption price is Rs. (20 - 0.20) = Rs. 19.80. Therefore, the redemption proceeds are Rs. 19,800 for 1000 units.

And the other direction: if the amount to be redeemed is specified, the number of units that has to be redeemed goes up after applying the exit load. In the above example, the investor has to redeem 1010.10 units to get a redemption amount of Rs. 20,000.

Equal treatment is mandatory. Loads are charged to investors at the discretion of the AMC and are mentioned in the offer document. However, they are subject to an overall limit imposed by SEBI. SEBI does not permit exit loads to be charged on the basis of the type of investor. AMCs cannot have differential exit load structure for different types of investors or based on transaction amount. All investors must be treated equally in regard to exit loads.

And redemption is always at a NAV-based price — the fifth sample question answers Net Asset Value.

14.4 Account statements

14.4.1 Statement of Accounts

Statement of Accounts (SoA) is a proof of investment for the investor. A SoA is sent when an investor makes a fresh purchase transaction. The amount, price, and units are shown. For subsequent transactions, apart from these details, the balance units in the folio and their current market value are also shown in the SoA. RTA on behalf of mutual funds, despatch SoAs to investors, whenever there is a transaction in a folio.

As per SEBI regulations, the dispatch date should not be later than 5 working days from the date of the transaction. In case of NFOs, the SoA has to be sent within 5 working days of closure of NFO/ or from the date of receipt of the request from the unit holders. Statement of Accounts (SoA) is issued every month if there is a transaction in a folio during the month. If there are no transactions in a folio in a six month period, a SoA will be sent annually, giving the latest closing balance. Alternately, soft-copy of the account statements is sent to the investors' registered e-mail address, instead of physical statement, if so mandated.

In case of systematic transactions, mutual funds dispatch the SoAs to the unit holders once every quarter ending March, June, September and December within 10 working days of the end of the respective quarter. The first SoA is, however, issued within 10 working days of the initial transaction.

Mutual funds also provide SoAs to unit holders within 5 working days, without any charges, if specific requests are received from the investors. Further, if so mandated, a soft copy of the SoA is sent through e-mail to the unit holders on a monthly basis.

14.4.2 Consolidated Account Statement

Pursuant to the Interim Budget announcement in 2014 to create one record for all financial assets of every individual, AMCs/ RTAs share the requisite information with the Depositories on monthly basis to enable generation of CAS. The depositories and the AMCs/ RTAs have put in place systems to facilitate generation and dispatch of single CAS for investors having mutual fund investments and holding demat accounts.

Consolidation of account statements are done on the basis of PAN. In case of multiple holding, PAN of the first holder and pattern of holding are considered. Based on the PANs provided by the AMCs/RTAs, the Depositories match their PAN database to determine the common PANs and allocate the PANs among themselves for the purpose of sending CAS. For PANs which are common between depositories and AMCs, the Depositories send the CAS. In other cases (i.e. PANs with no demat account and only MF units holding), the AMCs/ RTAs continue to send the CAS to their unit holders.

Who sends it depends on whether there is a demat account.

If there is any transaction in any of the demat accounts of the investor or in any of his mutual fund folios, then CAS shall be sent to that investor through email on monthly basis. In case there is no transaction in any of the mutual fund and demat accounts then CAS with holding details shall be sent to the investors by email on half yearly basis.

The half-yearly calendar: the AMCs/MF-RTAs shall provide the data with respect to the common PANs to the depositories on or before eighth(8th) day of April and October every year. The depositories shall then consolidate and dispatch the CAS to investors that have opted for delivery via electronic mode, on or before the eighteenth (18th) day of April and October and to investors that have opted for delivery via physical mode, on or before the twenty-first (21st) day of April and October.

8th → 18th → 21st.

However, where an investor does not wish to receive CAS through email, option shall be given to the investor to receive the CAS in physical form at the address registered with the Depositories and the AMCs/MF-RTAs.

Accountability is split. AMCs/RTAs are accountable for the authenticity of the information provided through CAS in respect of MF investments and timely sharing of such information with Depositories. The Depositories are responsible for the timely dispatch of CAS to the investors serviced by them and the demat account information.

A proper grievance redressal mechanism is put in place by the depositories and the AMCs/RTAs and details of the same are communicated to the investors through CAS.

Opting out: if an investor does not wish to receive CAS from Depositories, an option is given to the investor to indicate negative consent. Where such an option is exercised, the concerned depository informs the AMC/RTA accordingly and the data with respect to the said investor is not shared by the AMC/RTA with the depository.

RTAs also issue a consolidated account statement covering all mutual fund investments of an investor, across all AMCs, across all RTAs. Investors can also get a consolidated statement of account for all family members having common email ID.

14.5 Switch

A switch is a redemption and purchase transaction rolled into one. A redeeming scheme is called source scheme from which money is switched out; the purchasing scheme is called target scheme, into which the money is switched in. This is known as inter scheme switch. Switch can also be done from one option to another. An investor who has chosen a growth option can switch to a pay-out of income distribution cum capital withdrawal option, for example. A switch saves both time and effort for an investor.

What it replaces — five days of work:

Fill a redemption request and submit it (Day T) · Receive redemption cheque and deposit it in bank (Day T+3/T+4) · Receive cleared funds in bank account (Day T+5) · Fill a purchase request for the desired scheme and submit with a cheque (Day T+5)

The above steps spread across five days can be crunched into a single transaction in switch request. The transaction will be put through by the RTA in the books and the funds will be credited to the scheme's account.

AMCs may or may not charge loads to switch transactions. Generally, no exit load is charged for switching within options of the same scheme. For inter-scheme switching, the AMC may specify an independent load structure, which may differ based on the nature of the source scheme and the target scheme, whether it is liquid, equity, or debt fund.

Switch transactions always have two legs – the switch-out leg and the switch-in leg. Switch-out leg is treated as redemption and switch-in leg is treated as purchase. Both options are processed at the respective applicable NAV of the scheme. The procedure to determine the applicable NAV for switch transactions is similar to the process for individual purchase and redemption transactions.

And the tax point that catches investors out: switch is a facility that is allowed to investors for ease of transactions. However, each switch transaction is subject to long term / short term capital gains in the hands of the investor based on holding period and type of scheme.

14.6 Systematic transactions

Systematic Transactions are of three types: Systematic Investment Plan (SIP) · Systematic Transfer Plan (STP) · Systematic Withdrawal Plan (SWP).

The systematic transactions are executed at the applicable NAV... on the date of transaction. In case of transfers, each leg of the transfer (redemption and purchase) are executed at the applicable NAV for each scheme.

SIP

Most mutual funds offer the investors Systematic Investment Plan (SIP), a facility to make periodic or recurring purchases in mutual fund schemes. SIP is like a recurring deposit with a mutual fund. SIP can be viewed as a series of purchase transactions. SIP serves the purpose of accumulation and growth of capital.

Table 14.1 — lump sum versus SIP:

Investors commit a periodic investment over a chosen length of time. AMCs offer specific intervals in which SIP investments can be made and the period or tenure of the SIP. These can be monthly, quarterly, half yearly or annual. SIPs are to be made on specific dates, for example - 5th, 15th or 25th of a month. SIPs can be committed for six months, one year, or even more as defined by the AMC.

SIPs can be made along with an NFO. The first instalment is at the NFO purchase price and is allotted like an NFO. The second instalment begins after the scheme reopens for purchase transactions.

SWP and STP

Systematic Withdrawal Plan (SWP) is a facility for periodic or recurring redemptions. This facility allows unit holders to withdraw sums from an existing scheme at periodic intervals.

Systematic Transfer Plan (STP) is a facility for periodic redemption from one scheme and investment into another scheme of the same fund. STP allows unit holders to transfer fixed sums from an existing scheme to another scheme of the same mutual fund at specified intervals.

The seventh sample question asks which facility moves funds periodically from one scheme to another — STP.

STP is used either as a variation of SIP or to periodically book profits. SWP is usually used by retired persons to get a regular income.

Unit holders can redeem or purchase units at the Applicable NAV on the respective SWP/ STP dates. However, if any of the dates on which the redemption / transfer is sought is a non-business day, the units are redeemed at the Applicable NAV of the next business day.

Two options: some funds give investors the choice of withdrawing or transferring a fixed sum over a defined period. This is known as the fixed option. And investors can also opt for withdrawing or transferring only the appreciation on the investment. This is known as the appreciation option.

Some funds also provide the facility of determining the amount to be switched from one scheme to another based on the pre-defined target value of the scheme to which funds are being transferred. In a transfer of income distribution cum capital withdrawal plan, investors are given the option of automatically transferring the dividend (IDCW) declared in a source scheme to an identified target scheme.

14.7 Turnaround times

Two figures for dividends in this workbook. A footnote in the chapter text says dividends are paid within seven working days from the record date; this table says IDCW is dispatched within 15 days from the record date. The workbook states both and tells candidates to check the latest SEBI circular. Answer with whichever figure the question's own wording points to — the table's 15 days is the turnaround-table figure.

On NFO refund delays: investors need to be paid interest at the rate of 15 percent p.a. for the period of the delay. This interest cannot be charged to the scheme.

The AMC pays, not the unitholders.

On the half-yearly CAS: where there are no transactions in a folio during any six-month period, a CAS detailing holding across all schemes of all mutual funds at the end of every such six-month period (i.e. September/March), shall be sent by post/e-mail on or before the 21st day of the month following that half year.

14.8 Role of RTA in commission payment

RTA has a significant role in Commission payment to distributors. Some of the activities where an RTA is involved are to:

Determine average assets for payment of trail commission · Determine if a transaction sourced from T-30 or B-30 locations based on pin codes · Determine claw backs and reversals, if any · Determine inflows from SIP transactions made by new investors to the mutual fund industry, identified by PAN, for calculating the amount of trail commission payable to distributors.

The eighth sample question asks who calculates distributor commission — the Registrar and Transfer Agent.

As per SEBI guidelines, mutual funds are required to adopt full trail model of commission in all schemes, without payment of any upfront commission or upfronting of any trail commission. However, upfronting of trail commission is allowed only in case of inflows through SIPs. Upfronting of trail commission means payment of expected future trail commission upfront at the time of the transaction.

The upfronting of trail commissions, based on SIP inflows, shall be up to 1 percent payable yearly in advance, for a maximum period of three years. Implementation of this, therefore, requires system integration at RTA's end.

With the existing trail commission structure, AMCs shall pay additional commission to distributors for on-boarding eligible new investors from B-30 cities and women investors from both B-30 and T-30 cities respectively. The incentive would be distributed through two modes, Lumpsum mode and SIP, provided the investor remains invested for a minimum period of one year. The additional distribution commission shall be paid from the 2 basis points on daily net assets, mandated to be set apart annually by AMCs for investor education, awareness and financial inclusion initiatives, subject to adequate claw back provisions.

The carve-outs for upfronting:

The upfronting of trail commission is applicable for SIP of up to Rs. 3000 per month, per scheme, for an investor who is investing for the first time in Mutual Fund schemes.

For a new investor, as identified above, only the first SIP(s) purchased by the investor shall be eligible for upfronting. In this regard, if multiple SIP(s) are purchased on different dates, the SIP(s) in respect of which the instalment starts on the earliest date shall be considered for upfronting.

The upfront trail commission to be paid from AMC's books.

The said commission to be amortized on daily basis to the scheme over the period for which the payment has been made. A complete audit of trail commissions from the AMC's books and amortization of the same to scheme(s) thereafter to be made available for inspection.

The said commission will be charged to the scheme as 'commissions' and should also account for computing the TER differential between regular and direct plans in each scheme.

The commission paid to be recovered on pro-rata basis from the distributors, if the SIP is not continued for the period for which the commission is paid.

The chapter's sample questions confirm that a fresh purchase application is signed by all joint holders; that a transaction slip is used when the investor knows his own folio number; that R&T agents record the application information under the folio; that exit load has the effect of reducing the redemption amount; that redemption is at a price based on Net Asset Value; that a transaction slip is the preferred mode for an additional purchase; that STP moves funds periodically between schemes; that the Registrar and Transfer Agent calculates distributor commission; and that entry load has been abolished by SEBI.