In this article I wish to throw light on the hidden world of master data repositories in the securities market. A master data repository – of which there are presently four – are the two depositories (NSDL and CDSL) and two QRTAs (Qualified Registrar and Transfer Agents, presently only CAMS and KFin). For convenience I will refer to them all as “Recordkeepers”. The core role of a Recordkeeper is to be the single source of truth about an investor’s securities transactions and holdings.
NSDL and CDSL between them hold the demat share holdings of every account in the Indian equity market (circa ₹400 trillion). Since they are only two, they each hold a very large percentage of Indian holdings. Furthermore, many investors have a single demat account – with either one of the depositories – unlike banks, where most of us have multiple bank accounts. A similar situation prevails with CAMS and KFin in respect of Mutual Fund holdings (circa ₹55 Trillion).
For ease of understanding, let us assume that NSDL and CDSL each have a 50 per cent equity market share, and CAMS and KFin each have a 50 per cent MF market share. Contrast this with banking (circa ₹200 trillion) where the largest bank of comparable vintage — HDFC Bank — has an under 10 per cent market share.
Let us also say that about 15 crore investor accounts participate in the securities market — in equity, mutual funds etc. For these participants it is likely that the greater share of their financial assets are held in the securities market than in banks.
Let us also consider the retail participation in Indian securities market that has, as widely reported, increased massively in recent times, and yet the market is underpenetrated. It is likely that the approx. 15 crore number may double in the next few years and perhaps ultimately reach a level of 50-60 crore accounts, which means the data load will treble or quadruple soon.
We are therefore looking at a confluence of factors:
* Massive expected growth in volumes that will require huge effort and investment in technology and infrastructure on the part of these institutions.
* A huge dependence by the investing class on these four institutions
* A double duopoly in this marketplace, meaning that the effort that say 30-40 banks will collectively do to meet comparable growth will need to be made by just these four institutions.
All the Recordkeepers have done an outstanding job over this last decade of capital market growth and must be commended as the engines that work silently in the background to keep the markets functioning. I believe the next decade will be unprecedented in terms of absolute growth, taking these platforms to nation-scale.
Having laid the context, I would like to set out my views on what the Recordkeepers should be doing in this next phase of the markets, and also on the manner they must be supervised by their Regulator.
Role Difference - Depository vs. QRTA
Trading and settlement of equity shares originates at a broker and is executed by the Exchange and the Clearing Corporation. The role of a depository – an independent principal - is simply to hold the settled balance records basis electronic uploads from DPs. It is like many rivers flowing into the sea - the sea just holds; it doesn’t flow.
And the work of account opening, customer service, the odd off-market transaction etc. is pushed out to several thousand DPs. From a depository perspective, their IT imperative is to have a scalable data container, and to ensure cybersecurity, disaster proofing and of course to supervise their DPs.
These are relatively simple challenges that have been met in the past and I am sure will be met in future. Therefore, I am focusing more on the challenge before the two QRTAs.
QRTAs are fundamentally different in that they have twin roles:
First Role:
They bundle in one entity the roles of the exchange, clearing corporation, depository and a DP in the equity market. Whereas an equity customer would never be able to transact directly with a depository or an exchange, MF customers can and do – in large numbers – transact with the QRTA and their several hundred branches. And of-course there are several thousand third party front ends that feed into the QRTA.
Let us deconstruct the MF transaction process.
* A customer walks into a QRTA office or to her advisor’s office with a Buy/Sell order and payment. The advisor may key in the order or she may just physically pass on the order to the QRTA to key in. In either case the order reaches the QRTA order queue – In an equity trade this is activity that a Broker would do.
* Meanwhile, the payment has been credited to the Fund Bank and QRTA receives a confirmation of the payment – In an equity trade this is an activity that would be done by a Clearing Corporation
* Basis the receipt of the payment within cutoff time the relevant order is processed overnight by applying the price and fees – In an equity trade this would be done by the Exchange
* The units would be created and credited to the customer’s account. – In an equity trade this would be done by a DP and aggregated by the Depository.
* A statement is sent to the customer, her advisor and the Fund itself - In an equity trade this is activity that a Broker would do.
Owing to regulations surrounding “Point of Transaction Acceptance” the existence of a QRTA front office in a town was vital to opening it up to sales. With proliferation of online platforms that dependence has been mitigated to an extent.
In terms of the role of the QRTA, this is the simpler part. To understand the more difficult part, I will take a minute to explain a conceptual difference between the equity and mutual fund markets.
Equity shares are issued by a Company ABC Ltd. in order to fund its core business which, for example could be manufacturing widgets. The retail shareholders of ABC Ltd. typically do not add any value to the core business of ABC Ltd. Whether the retail shareholder sells or holds is largely a matter of indifference to ABC Ltd.
Mutual Funds unit issuance is actually the CORE BUSINESS of the Mutual Fund. The person buying the units is a customer of the MF in the same way that you are I are Airtel, Samsung or Flipkart customers. It is in the great interest of the Fund that we hold and buy ever more of their units. A sale by a unitholder is potentially like surrendering an Airtel connection. Mutual Fund units are just FMCG products that happen to be securities.
This conceptual difference plays into the transaction and service models that, as you have seen above, are fundamentally different between the two products.
At first look it appears that the many roles played by disparate entities in the equity market are concentrated in one hand in the MF market. This is a reflection of the fact that in the equity market, the issuer company ABC Ltd. Is entirely hands-off from its shareholders after issuance, which thereafter become high velocity instruments, so this role segregation provides necessary checks and balances and helps handle the high velocity.
In the low velocity MF market, checks and balances are provided by other regulated entities – The AMC is the principal in the QRTA relationship and has a legal duty of oversight, in addition to having a deep vested interest in the integrity of this process and in the happiness of their customer. Their Trustees have a major oversight role in this process. And the accuracy of all transaction and money flow is vetted in near real time by the Fund Accountants and Custodians on an aggregate basis. This architecture retains the checks and balances while facilitating massive economies of scale and a close and real time customer connect by the AMC for what is after all an FMCG product.
There have been discussions in the past about modifying the MF architecture to mimic the equity architecture, but the above arguments have prevailed.
Second Role:
This brings us to the second and more complex role of the QRTA, which is on the product side. Every FMCG company strives to increase its product offerings and differentiate them from competition; and so do Mutual Funds. FMCG products are differentiated in a factory under their control; MF products are essentially “virtual products” and their differentiation happens inter alia within the set of rules contained the QRTA’s systems.
The Mutual Fund unit is a collection of business rules involving pricing, fees, commissions, taxation, liquidity etc. Other differentiating features involve customer touchpoints and service features such as statements, analytics etc. Of course performance could be a differentiator, but oftentimes it is not under the funds’ control (fund manager changes, random events, market vagaries..). History has shown that dependence on returns as a differentiator will come back to bite the fund in times of bad performance. Whereas dependence on services and product features is in the funds’ control.
Many product differentiators (except performance) are enabled by changes and features of the QRTA system. In that sense the QRTA is the “factory” for the Fund. This enormous customer facing role that the QRTA delivers, is actually the most complex role of them all and has no parallel in the equity market.
A significant part of this role also encompasses business analytics to help the AMC analyze its own sales and redemptions and make data driven decisions on distribution, new branches, commissions and incentives etc.
Consequent to these two roles, CAMS and KFin are two competing ecosystems somewhat like Android and Apple. AMCs make a choice; having made one they typically do not change, as the cost of change is significant.
Supervisory Imperatives
Operational Oversight: The operations of the QRTA are overseen and audited at several levels. The Trustees carry out regular audits. SEBI carries out regulatory audits from time to time. Between Trustee audits and SEBI audits, there are probably dozens of audits carried out each year.
The scope of these audits has also expanded over the decades. In a paper world, the audit focus was on paper handling, KYC etc. As a hybrid (paper + digital) world emerged, the focus expanded to cover cyber security, access controls, system input-output accuracy etc. With decades of experience in process audits my assessment is that process assurance, as carried out by top audit firms, is of high quality and adds a lot of value to the QRTA.
IT application related audits are however still immature. We are in a digital first world where application dependence is close to 100 per cent and the application itself is slowly becoming a black box. In the present situation, IT application audit scope must expand to include the following with the same rigour followed for operational processes:
* To comment on the quality of IT staff, infrastructure that supports these business
* To comment on the documentation, change management process, bug rates etc.
* To comment on proposals for significant change in the underlying software, such as change in programming language, database, addition or collapsing of layers, major process redesign, major re-architecture, implementation of new-gen tech such as AI, LLM, Bots etc.
Bug fixes and System changes, in particular, are a source of vulnerability and need strong technical oversight by the likes of the Big Four.
Governance Oversight
SEBI has recognized the dependence on these institutions and has framed regulations that mandate their operation and strategic planning. I believe there is scope to go further in the area of governance.
As background to suggestions that follow, I would like to touch upon RBI’s supervisory model for banks. The depth of RBI supervision into banks is legendary. Of course they look into transactions, transaction related compliance (such as KYC, exposures..). But more importantly they play a very important role in assessing the quality of governance of a bank. Starting from approval of the MD, her compensation structure, variable pay and formula and performance assessments, to approval of each member of their Board, to detailed review of Board Minutes, detailed interviews with KMP, to reviewing the succession plan, they go the whole hog. The intention is to catch problems that may come in the distant future owing to today’s decisions by management – they do this by exercising effectively a veto on Board appointments and then by monitoring the decision-making process of the Board itself. RBI will not accept assertions by management that they are compliant; they will dig deep to find the true state. Their audits are just short of forensic in nature.
Absence of a “promoter” (being a long-term shareholder bearing financial and reputational risk) in a listed company with fragmented shareholding and professional management has the potential to induce short term thinking. Whereas what a financial infrastructure company needs is “decadal” thinking. It may be useful for SEBI to incorporate elements from the bank supervision framework into their supervision of QRTAs to cover this gap.
It will be useful for Trustees to internalize that CAMS and KFin are two competing but different ecosystems, somewhat like Apple and Android. There is a significant cost to making a change; so it is always better to invest in the existing relationship and make it a partnership. The good health of the ecosystem provider is obviously critical, so pending suitable regulations, it may be prudent for Trustees to start looking at governance aspects as part of their audit oversight.
As an interesting aside, both the QRTAs are diversifying into other regulated financial infrastructure segments, so national dependency and the consequent need for a comprehensive supervisory framework is made more relevant.
I am confident that there is a sound base that the industry has created and even with a phased acceptance of these recommendations the industry will easily absorb the increase in scale to come.
The writer is founder of CAMS, a listed QRTA