Simplification of KYC norms for the Securities Market

Are the KYC norms a deterrent for retail investors in opening a securities account vis-a-vis a bank account? Are the retail investors shying away from the Securities market because of cumbersome processes in demat/trading account opening and multiple regulations? Is it possible to converge the KYC norms of various regulators so that it becomes simple and easy to implement? Union Minister P. Chidambaram, on Saturday on Saturday, 09th February, 2013 asked the regulators to simplify procedures, especially the integration of KYC (know your customer) norms, to attract more people to invest in financial products rather than gold and real estate. Launching the Rajiv Gandhi Equity Savings Scheme (RGESS), Mr. Chidambaram said, There are too many regulations. KYC under single regulator must converge in the first phase and, thereafter, there should be convergence of KYC under different regulators in the market.

Evolution of KYC norms in India:In India prevention of Money Laundering Act was passed in 2002 and it has been aligned with Financial Action Task Force (FATF) recommendations in 2009. Further, India became a member of FATF in 2010. The Reserve Bank of India introduced KYC guidelines for all banks in 2002. In 2004, RBI directed all banks to ensure that they are fully compliant with the KYC provisions before December 31, 2005. Subsequently various updates from time to time are being issued by RBI to Banks on how to frame their KYC and AML- PMLA Policy. Recently the regulator has also asked the Banks to introduce Unique Customer Identification system to track all facilities availed, monitor transactions in a holistic manner and to have better risk-profiling of customers. This will consolidate the KYC of a customer within the Bank and perhaps Inter Bank consolidation will be the next step. SEBI, being the regulator for securities market has been issuing necessary directives, since 1993, covering issues related to Know Your Client (KYC) norms, Anti- Money Laundering (AML), Client Due Diligence (CDD) and Combating Financing of Terrorism (CFT). In 2007 PAN was made the sole identification number for all transactions in the securities market. In 2011 SEBI came out with homogeneous norms on KYC for all intermediaries under its control including Stock Brokers, Depository Participants, Mutual Funds, AMFI, Portfolio Managers, Collective Instrument schemes, Venture Capital Funds. It also initiated the setup of KYC registration Agencies (KRAs) so that the investor is not required to undergo multiple KYC by different intermediaries. Five KRAs have been set up but interoperability/connectivity between them is not yet fully functional. The ultimate goal in this direction is to have a centralized KRA registry that will store the KYC data of all investors including Bank customers.

Comparison of the KYC regulations RBI v/s SEBI

RBI, which issues guidelines to the Banks and SEBI, that directs the Financial Institutions registered with it, base their guidelines on KYC upon the following:Anti- Money Laundering (AML) Standards Combating the Financing of Terrorism (CFT) Standards Prevention of Money Laundering Act, 2002 Barring few differences, Banks as well as Financial intermediaries have to follow similar set of guidelines and take almost identical measures to comply with KYC norms. The KYC process typically includes:Client/customer acceptance policy The identification procedure Monitoring and reporting of transactions From the Banks customer or the Security Market Investors perspective, there are about four requirements that he is required to fulfill. Any inconvenience to him will emanate from one of these. A comparison of KYC requirements for individuals between the SEBI and RBI regulations is given below:RBI Proof Of Identity (POI) (i) Passport (ii) PAN card (iii) Voter's Identity Card (iv) Driving licence (v) Identity card (subject to the bank's satisfaction) (vi) Letter from a recognized public authority or public servant verifying the identity and residence of the customer to the satisfaction of bank SEBI 1. Unique Identification Number (UID) (Aadhaar)/ Passport/ Voter ID card/ Driving license. 2. PAN card with photograph. 3. Identity card/ document with applicants Photo, issued by any of the following: Central/State Government and its Departments, Statutory/ Regulatory Authorities, Public Sector Undertakings, Scheduled Commercial Banks, Public Financial Institutions, Colleges affiliated to Universities, Professional Bodies such as ICAI, ICWAI, ICSI, Bar Council etc., to their Members; and Credit cards/Debit cards issued by Banks.

Simplifying the norms further, RBI has recently permitted a single document to be used as POI and POA if it contains the current address. Proof of Address (POA) (i) Telephone bill (ii) Bank account statement (iii) Letter from any recognized public authority (iv) Electricity bill (v) Ration card (vi) Letter from employer (subject to satisfaction of the bank) (any one document which
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Passport/ Voters Identity Card/ Ration Card/ Registered Lease or Sale Agreement of Residence/ Driving License/ Flat Maintenance bill/ Insurance Copy. Utility bills like Telephone Bill (only land line), Electricity bill or Gas bill - Not more than 3 months old. Bank Account Statement/Passbook -- Not more than 3 months old. Self-declaration by High Court and Supreme Court judges, giving the new address in respect of their own accounts. Proof of address issued by any of the following: Bank

provides customer information to the satisfaction of the bank will suffice)

Details

(Different Banks design their own application forms with the required KYC details.) (Banks are free to design their own means of customer identification as per the general guidelines given by RBI. For natural persons of course this also entails personal visit to the Bank.)

Managers of Scheduled Commercial Banks/Scheduled CoOperative Bank/Multinational Foreign Banks/Gazetted Officer/Notary public/Elected representatives to the Legislative Assembly/Parliament/Documents issued by any Govt. or Statutory Authority. 6. Identity card/document with address, issued by any of the following: Central/State Government and its Departments, Statutory/Regulatory Authorities, Public Sector Undertakings, Scheduled Commercial Banks, Public Financial Institutions, Colleges affiliated to Universities and Professional Bodies such as ICAI, ICWAI, ICSI, Bar Council etc., to their Members. 7. The proof of address in the name of the spouse may be accepted (A one page Uniform KYC details form specified by the regulator is used by all intermediaries. The details required are bare minimum to comply with the various regulations of AML/PMLA/CFT.) i. It shall be mandatory for all the intermediaries to carry out IPV of their clients. ii. The intermediary shall ensure that the details like name of the person doing IPV, his designation, organization with his signatures and date are recorded on the KYC form at the time of IPV. iii. The IPV carried out by one SEBI registered intermediary can be relied upon by another intermediary. iv. In case of Stock brokers, their sub-brokers or Authorised Persons (appointed by the stock brokers after getting approval from the concerned Stock Exchanges in terms of SEBI Circular No. MIRSD/DR-1/Cir-16/09 dated November 06, 2009) can perform the IPV. v. In case of Mutual Funds, their Asset Management Companies (AMCs) and the distributors who comply with the certification process of National Institute of Securities Market (NISM) or Association of Mutual Funds (AMFI) and have undergone the process of Know Your Distributor (KYD) can perform the IPV. However, in case of applications received by the mutual funds directly from the clients (i.e. not through any distributor), they may also rely upon the IPV performed by the scheduled commercial banks.

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In the comparison above it can be seen that the KYC requirements for an individual are not much different between the two regulators. SEBI in fact is one step ahead in that it has already gone for convergence for intermediaries registered with it. By giving a larger choice whether in POI, POA or IPV it has tried to make it more convenient for the client. Conducting the IPV may be a bit costly and cumbersome for the intermediary but that does not necessarily add to the investors inconvenience.

Hurdles in the KYC process for Retail Investors

The journey from framing a policy to its implementation springs few hurdles on the way to make the KYC process a bit cumbersome for a new client wishing to enter the securities market. The reasons can be attributed to the following:1.

Requirement of PAN becomes mandatory for demat account or for investing in mutual funds over Rs 50000.00, because the PAN number acts as a unique code for the client. Obtaining a PAN is still considered a costly and time consuming process for the retail investor. In case of Brokers or mutual funds their reach is limited and after the preliminary interaction for opening the account there is not much interaction on a day to day basis with the clients. For existing accounts where the KYC is deemed incomplete since implementation of Uniform KYC norms by SEBI, some investors have been facing hardships in completing the formalities. The norms also put a lot of additional burden in terms of cost and manpower on the intermediary. On the other hand, the reach of the Bank Branches and their frequent interaction with the customers ensures that IPV is not an onerous task either for the customer or for the Bank. In case of any change in client details or change of address the whole process has to be repeated. Again for a Bank customer it is easy to approach the nearest Branch but this may not be the case for financial intermediaries. The uniform KYC and KRA norms have brought about some fresh problems because the system is still new and the full infrastructure is not in place. There are five KRAs as on date and ideally they should have connectivity and a common platform for sharing of data. This is lacking and the task of movement and updation of the existing accounts to the new platform seems a herculean task. The securities account and products are usually sold by third parties like Distributors, Agents, Sub Brokers.. Their interaction with the prospective investor is usually one time while selling the product or opening the account. Their endeavor is to follow the KYC norms in letter to avoid any Regulatory repercussions to their organizations in case of a lapse. The unique circumstances of any particular case will not be handled with any discretion. The Banks in contrast are directly dealing with their clients and can provide solutions for unique circumstances. The mutual trust and understanding built up over a long term of regular interaction also ensures KYC formalities pose a lesser challenge.

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Steps towards making KYC hassle free for retail investors.

For further easing of KYC norms we may go no further than look at the recommendations of Damodaran committee that recommended for Banks the following measures:1) KYC for additional accounts opened in the same Bank should have relaxed conditions and need not be duplicated. 2) A third party Know-Your Customer (KYC) data bank may be set up and relied upon for KYC purpose. 3) Unique Identification number (UID) as KYC for No Frills account- with introduction of UID it is recommended that for opening of no Frills account, UID may suffice as KYC. Till the full implementation of the UID project self-attested photograph and address proof should be treated as sufficient KYC to open No Frills account. While the Banks may take up this recommendation for No Frills account, a similar initiative may be implemented for securities account with low value investments. There can be a separate relaxed set of KYC norms for low risk clients.

PAN is mandatory for demat accounts. The PAN number is used as a Unique code for trading in the securities market. There should be some relaxation in this especially for retail investors in the low risk category. An alternate to PAN, like UID can also serve as a Unique code for the clients. RBI has directed Banks to have Unique customer identification code (UCIC) for its customers. This will ultimately help in having a centralized KYC Registry across banks and Financial Institutions. Most of the Banks already have UCIC for their customers and the others like Primary Urban Co-operative Banks will soon follow suit. The UCIC can be used for Security market investors till the centralized KYC Registry is set up.

The suggestion to converge the regulations under one regulator and then under various regulators has been taken up by SEBI in 2011. It introduced Uniform KYC requirements in October 2011, for use by all SEBI registered intermediaries. The same KYC form and supporting documents are now being used by all intermediaries. Further it also introduced Guidelines for setting up of KRAs. The KRA enables an investor to invest through various intermediaries, after undergoing the KYC process only once through an intermediary. This helps in avoiding duplication of KYC process. Further, any subsequent changes in demographic details of an investor across various intermediaries can be updated by simply updating the record maintained with the KRA. Since there will be multiple KRAs they have to be interconnected and should share data for the system to work smoothly. This bit is still being threshed out. Also considering the huge task of uploading and updating the existing records on the new system and as per new norms, it will take some time to settle down.

RBI has asked the Banks to implement Unique customer identification code (UCIC) for its customers to reduce the duplicity in KYC process among various Branches of a Bank. The next step here would be to have convergence of KYC for customers of different Banks and then finally a centralized KYC Registry for the whole Financial market.

Other Hurdles for securities market

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A securities demat account will also entail opening a Trading and a Bank account raising the cost for the customer as well as requirement of filling up numerous forms, agreements, declarations, POA and indemnities. Since the operation of the Trading and demat account entails lots of standing instructions, the whole documentation may extend to about 50 pages or more. However SEBI in 2011 came up with a circular on simplification of Trading account opening process. It consolidated and made uniform documents available for use of the Brokers. This has reduced the paperwork to a great extent. Doing a transaction in securities market involves a certain amount of risk and there is a general fear and lack of trust in the securities market. The volatility in the market, some scams in the past and the recent persistent downturn of the whole economy have stoked these fears. There is also a lack of awareness due to which the common man either perceives it as a lottery or satta. Because of the enhanced perceived risk the investor also expects unreasonably high returns from the stock market and is disappointed when he sees it not giving those returns. Only an educated person who understands and is well conversant with the securities market will undertake to invest. The factors that cause movement in the value of securities is not easily understood or explained. Historically also the returns from the securities market have not been as consistent or unidirectional as real estate or Gold. The prime concern of the investor being protection of his funds he would rather put it in a Bank account or Gold where at least the value will not erode. Sale of Securities market instruments through third parties like Distributors, Agents, Sub Brokers also increases the chances of mis-selling. Plus there may be incentives on volumes which sway the salesman from giving a correct representation of the Risks and rewards in Securities investments. This has not helped the cause of gaining trust of the investors in the long run.

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Conclusion
Though it may still be possible to improve the KYC hassles for the individual investor, the regulations are not solely to be blamed for the situation. Use of technology for faster processing and data storing, avoiding duplication through convergence, following the KYC norms in spirit than just in letter may go a long way in making the process investor friendly. However the bulk of the problems lie elsewhere. Simplification of the documentation process, prevention of malpractices in the market to raise investor confidence, educating the uninitiated, providing Tax incentives to retail investment are some measures which will bring long term interest in this avenue of saving and investment.