Experts CornerPramod Rao

Cryptocurrencies or crypto assets continue to evoke mixed reactions among the knowledgeable and the lay public.

Do they portend a new world order and which would reshape the entire financial system? Or are they a new form of “tulip mania” or a South Sea Bubble or other mass belief suspending hysteria[1] and just a financial scam awaiting a damning expose?

In this context, stablecoins — a form of crypto assets — appears to present a halfway house, and deserves a closer review and a deeper understanding.

 


What are “Stablecoins”?


Stablecoins are a class or type of crypto assets that are backed by a commodity, a currency or an asset. Accordingly, the value of the stablecoins are pegged to, or derived from, the value of such underlying commodity, currency or assets.

Having such an underlying commodity, currency or assets serves to reduce the price volatility of stablecoins (or manages to peg it to the volatility that one observes in the prices of underlying commodity, currency or asset) as compared to other crypto assets. Crypto assets by contrast have shown wild swings in their prices, driven more by speculative forces rather than any practical or real world application (though always spoken as if they do).

Having such an underlying commodity, currency or assets also distinguishes stablecoins from other crypto assets which have no intrinsic worth or value and cannot be redeemed into anything.

Furthermore, any number of stablecoins can be created (subject to availability of the underlying commodity, currency or assets and its acquisition) unlike bitcoins or other crypto assets which are quite so often, by design, limited to a specific number that can be mined and create an artificial scarcity (while projecting the same as an anti-inflation measure).

The (relative) price stability of stablecoins (compared to the volatile prices of other crypto assets) is intended to provide a comfort to investors and merchants in anchoring the prices of goods, services or even other crypto assets.

Stablecoins draw upon the technology and protocols of crypto assets and are backed by or exchangeable into the designated underlying commodity, currency or asset, and hence are considered to represent best of both the worlds: of an important, emergent technology, and of being anchored in real world assets with intrinsic worth that is realisable on demand.

Popular stablecoins and how they describe themselves[2]


Costs, Income and Risks


Stablecoins are usually expressed in round numbers. Fresh issuance requires the stablecoin issuer to purchase an equivalent value of the commodity, currency or asset that backs such stablecoin.

Given the underpinning of the commodity, currency or asset for stablecoins, one needs to factor in the following costs:

  • Transaction costs for acquisition or sale of the commodity, currency or asset in form of brokerage, fees, costs, charges and/or stamp duty.
  • Assayers fees, charges and costs when the commodity or asset is in a physical form for verifying and validating the quality and quantity of the underlying commodity or asset.
  • Storage, custody and insurance costs when the commodity or asset is in a physical form.
  • Bank, depository or custodian charges for holding the currency or financial assets.
  • Auditors fees, charges and costs for verifying and validating the underlying.

Separately, for a holder of stablecoin, there could be costs for purchasing or acquiring stablecoins, storage costs (in a wallet), or transaction costs when making or receiving payments via stablecoins. There are marginal income generation opportunities, for instance by lending the owned stablecoins (with attendant risks).

On the income front, certain underlying assets could generate income for the issuer (akin to but not the same as central banks earning seigniorage[3]), and help offset its costs. Such income streams can include:

  • When commodity or physical assets are the underlying: can be lent to earn interest income.
  • When financial assets are the underlying: these could generate dividend or interest income.
  • When currency is the underlying asset and has been placed with a bank: interest on deposit.
  • When the underlying significantly appreciates in value: capital gains.

Such income earning opportunities bring their own commensurate risks.

When the commodity or physical asset has been lent, the risk of borrower failing to return such commodity or asset in a timely manner or failing to service the interest payment obligation or both. Risk of financial assets failing to generate any income. If such financial assets are bonds, debentures or commercial paper of corporations, the risk of such corporations defaulting or failing. When the financial asset is a bank deposit, there is the risk of bank failure[4]. Price appreciation of an underlying could also mean a later day price correction: if gains have been realised through sale, the issuer may need to purchase the underlying afresh to preserve the equivalence assured for the stablecoin.

 


Perspectives for a Stablecoin Holder


Acquiring stablecoins closely resembles keeping money as a bank deposit or investing in a liquid mutual fund scheme. The fact that there is an underlying of a commodity, currency or an asset backing the stablecoin and its redeemability inspires enormous confidence.

Apart from the perception of lower transaction costs, stablecoin holders should also evaluate the nature and quality of the income generated from the underlying commodity, currency or asset, even if they are not entitled to the same. This is because any such income brings commensurate risks. Hence, while the income stream may belong to the issuer, when the risks materialise, it could be the stablecoin holders who are left holding the can, and who would have to face the permanently diminished value of the stablecoins.

A further factor to consider is the expectation of quick, simple and ready redemption of stablecoins. Depending on the commodity, currency or asset underlying the stablecoin, unusual high levels of redemption could cause the collapse of the stablecoin. This is akin to how usually high levels of withdrawals of bank deposits can cause a run on such a bank and even lead to its collapse.

Bear in mind that banks have obligations to maintain statutory or cash reserves, are subjected to regulatory supervision and inspection and which is subject to prudential standards for capital adequacy, income recognition and provisioning.

Stablecoins and their issuers have no such obligations or supervisory or regulatory requirements governing them. This can make the issuers of stablecoins susceptible to errors, mistakes or even fraud, which may go undetected for long periods of time. The aspect of underlying commodity, currency or asset if incorrectly valued, not adequately safeguarded or if is uninsured or underinsured may serve to bring operational risks that issuers of stablecoins may not be properly equipped to evaluate and address, but with risks and losses having to be borne by the stablecoin holders.

Given the digital only nature of stablecoins, an investor should be mindful of cyber risks – of hacking, security breaches or compromises of credentials[5] – that can result in theft or loss of the stablecoins whether at the investor’s end, at any platform where these are traded, at the issuer’s end or at the service providers engaged by the issuer.

Finally, to a large degree, ambiguity over the legal status of crypto assets and of stablecoins should dissuade an investor from putting her hard earned money into such a class of assets. Once there is clarity on the legal status of stablecoins, confidence that one will not run afoul of laws, rules or regulations, and clarity on several aspects mentioned in this paper, is when one could consider making such an investment[6].

 


Perspectives for Policymakers, Legislators and Regulators: More Questions than Answers


Stablecoins (or as many a central bank or even  Bank of International Settlement (BIS)  are known to say: “so-called stablecoins” perhaps with a latent fear of endorsing such coins or tokens as indeed being stable) have projected a halfway house between crypto assets and tokens (which display high volatility and price fluctuations) and local currency and payments systems (which are construed as slow or costly or both).

However, a much stronger look at the following aspects is necessary for stablecoins:

  • Is the issuer “fit and proper”?
  • Is the underlying duly acquired, and acquired on an arm’s length basis?
  • Is the underlying duly validated and verified both at the time of its acquisition and at periodic intervals?
  • Are the costs incurred by the issuer of the stablecoin fair and appropriate for acquisition, storage or custody, insurance or other related costs and charges? Are the arrangements with such service providers arrived at on an arm’s length basis, and are they regulated or inspected and audited at periodic intervals?
  • Are the underlying assets available in a risk free (or at least, low risk), liquid, easily convertible to cash basis, and can meet redemption requirements?
  • If the underlying assets are risky, illiquid and difficult to convert to cash when needed, then has there been due disclosure of such risks to the holders of stablecoins?
  • Can there be avoidance or reduction of the moral hazard of income belonging to the issuer (who, in all fairness it should be said, quite so often also bears some or all of the costs), while the risks are allocated to the stablecoin holders?
  • Inasmuch as stablecoins resemble bank deposits (or even liquid mutual fund schemes) albeit with features of being digital, transferable and redeemable, should its issuers or its issuance or its holders be regulated? If so, should the regulator be the Reserve Bank of India (if treated akin to bank deposits, with appropriate reserving for the liability and prudential norms for the assets apply) or Securities and Exchange Board of India (SEBI) (if treated akin to liquid mutual fund schemes, with due offer document, disclosure and investments in financial assets, arm’s length and caps on costs) in either situation after the issuer has passed muster with either regulator as “fit and proper”?
  • Given the projected utility of stablecoins in facilitating payments, should it and its issuers be regulated as a payment and settlements system and its operators respectively?
  • In case of existing stablecoins issued outside India, what should be the approach? Is such purchase by a holder compliant with foreign exchange remittances limits[7]? Should the overseas issuer be required to hold or store the underlying in India to the extent Indians hold the stablecoin? Can the underlying be ring fenced? Is localisation and ring fencing desirable, feasible and necessary?
  • Given the key and material factor of stablecoin requiring or having an underlying commodity, currency or asset, is it collective investment scheme, or a “derivative” and a “securities” in terms of the Indian securities law[8]? Do its issuers adhere to the securities law on creation of stablecoins? Do stablecoins as a derivative or as securities or both, require being listed and traded only as contemplated in the securities law? Do holders of stablecoins need to hold it only in demat accounts or can they hold it in crypto wallets?

 


The American View


On 1-11-2021, the President’s Working Group on Financial Markets (PWG), joined by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), released a report on stablecoins[9].

The press release[10] notes that: “To address the risks of payment stablecoins, the agencies recommend that Congress act promptly to enact legislation to ensure that payment stablecoins and payment stablecoin arrangements are subject to a federal framework on a consistent and comprehensive basis. Such legislation would complement existing authorities with respect to market integrity, investor protection, and illicit finance, and would address key concerns:

  • To address risks to stablecoin users and guard against stablecoin runs, legislation should require stablecoin issuers to be insured depository institutions.
  • To address concerns about payment system risk, in addition to the requirements for stablecoin issuers, legislation should require custodial wallet providers to be subject to appropriate federal oversight. Congress should also provide the federal supervisor of a stablecoin issuer with the authority to require any entity that performs activities that are critical to the functioning of the stablecoin arrangement to meet appropriate risk management standards.
  • To address additional concerns about systemic risk and concentration of economic power, legislation should require stablecoin issuers to comply with activities restrictions that limit affiliation with commercial entities. Supervisors should have authority to implement standards to promote interoperability among stablecoins. In addition, Congress may wish to consider other standards for custodial wallet providers, such as limits on affiliation with commercial entities or on use of users’ transaction data.”

In short, the recommendations appear to place the issuance of stablecoins with banks, and ensuring banking level of supervision extends to such issuance, wallet providers and requiring arm’s length treatment.


Concluding Remarks


The halfway house approach of stablecoins — in providing low volatility, being speedy and low cost —  can bring broader acceptance and adoption, and even provide a playbook or a template for central bank digital currency (CBDC) to follow. These require the questions posed above being satisfactorily addressed.

What also requires being evaluated is that in a country where digital payment tools and technologies such as Unified Payments Interface (UPI) (value across rising volumes of which have crossed USD 100 billion in a single month[11]), Immediate Payment Service (IMPS), National Electronic Funds Transfer (NEFT), Real Time Gross Settlement (RTGS) being available at a low cost and 24×7 basis and which are within the regulated domain requires stablecoins or crypto assets? These stablecoins or crypto assets could bring risks that are still not fully understood by the lay public, have unaddressed moral hazards, lack of transparency and could be inherently unstable.

Asking that such stablecoins be regulated requires also an understanding and acceptance by the crypto ecosystem that the legal and regulatory framework will bring its scrutiny of fitness and propriety of the players, their dealings and bring additional compliance costs, impose all too necessary fetters (which creators of crypto assets quite so often decry), and perhaps take away the relative cost advantages currently enjoyed over the regulated financial services sector.

For those who already own or hold crypto assets and particularly stablecoins, it is perhaps time to take a closer look at what are the terms of such crypto assets and stablecoins: are these terms fair, appropriate and does the underlying exist, with sufficient assurance that whenever required, redemption will happen. It should not be that in times to come that we discuss and describe these as “so-called stablecoins” or as unstable coins.


 Pramod Rao, Group General Counsel at ICICI Bank. Views are personal. 

[1]Recommended reading: HERE and HERE.

[2] Source and a recommended read: HERE accessed on 12-11-2021.

[3] See HERE.

[4] While the last risk may seem remote, bank failures have been known to happen. Take Northern Rock in the UK, umpteen bank failures in the US where FDIC undertakes an orderly dissolution (which does not necessarily translate to depositors receiving higher than the insured limit in all situations) and closer home where many a cooperative banks have failed (while commercial banks have been by and large rescued by way of forced or voluntary mergers or recapitalisation, and with moratoriums of varying lengths being specified until such rescue took effect).

[5] There are even incidents of an investor forgetting the password to the wallet resulting in losing access to the crypto asset HERE.

[6] Read here for views of a SEBI registered investment advisor HERE

[7] See HERE for RBI posted FAQs on liberalised remittance scheme.

[8] See definition of “derivatives”, “commodity derivatives” and “securities” in Securities Contracts (Regulation) Act, 1956 (SCRA): Ss. 2(ac), 2(bc), and 2(h); additionally, legality of transactions in derivatives requires such transactions to be in adherence of S. 18-A or of S. 30-A of SCRA.

[9] See HERE.

[10] See HERE.

[11] See HERE.

Experts CornerPramod Rao

The advent of Covid-19 brought home the fragility of life in a way that none in living memory had considered. Both the first wave and the second wave, and the impending third wave, make it all too clear that taking safeguards (masks, frequent hand wash or use of sanitisers) and precautions (taking both the doses of the vaccine) are all too necessary lest life or health will be in severe jeopardy.

 

It is also a time that compels contemplating taking “precautions” to reduce the impact of what the survivors, successors and legal heirs may face after the death of an individual in relation to personal finances and financial assets of such individuals. Nominations have long been considered the panacea both for the individuals and their survivors/successors, and for the institutions that provide nomination facilities. Another initiative often considered is opting for the joint ownership of financial assets, so that the surviving joint owners can access financial assets notwithstanding untimely demise.

 

Both these approaches serve to bypass the daunting and time-consuming process of obtaining succession certificate or court orders (in case of intestate succession) or probate or letters of administration [in case of the testamentary instrument (will) being available], and to reduce, remove or eliminate submission of cumbersome paperwork for enabling access.

 

Your columnist examines the legal and regulatory regime governing nominations and joint ownership of three popular financial assets and their nuances.

(a) Current accounts, savings accounts and fixed deposits with banks.

(b) Safe custody and safety lockers with banks.

(c) Depository or demat accounts.

(d) Mutual funds holdings.

 


Nomination facility in current accounts, savings accounts and fixed deposits with banks


The aggregate of balances in current and savings accounts, as well as fixed deposits in India stands at Rs 153.1 trillion as of 31-3-2021, and represents a sizable amount of money saved or in transit (to be saved or spent). It also represents the most safe savings instrument (barring rare exceptions) in the country.

 

Nomination facility is encoded in a statutory provision viz. Section 45-ZA of the Banking Regulation Act, 1949, added in 1985 to ease the release of deposits to the nominee specified by the depositor upon death of the depositor. The section governs credit balances in savings accounts and current accounts, and to fixed deposits with banks. The norms for access to articles kept in safe custody with banks[1] and safety lockers[2] also follow principles and norms applicable for deposits (unless otherwise noted).

 

Individuals who jointly own and operate bank accounts or deposits are also permitted to make nominations. Nominations can only be made when the deposits are held in an individual capacity, and not in a representative capacity (including as a holder of an office or otherwise).

The forms as prescribed are part of the Banking Companies (Nomination) Rules, 1985.[3]

 

If the nominee is a minor, the depositor can choose while making the nomination to appoint another individual (who is a major), to receive the amounts on behalf of the nominee (during the minority of the nominee) in the event of the death of the depositor.

 

A depositor can vary or cancel the nomination during the tenure of the deposit. Banks are required to provide acknowledgment of nominations to the depositor, and register the nomination, cancellation or variation in its records.

 

The key benefit that nominations provide to banks is that they receive a full discharge of the liability in respect of the deposit on making payment of the monies to the nominee[4].

 

It is important to note that while the nominee is legally entitled to receive the money from the bank, the nominee does not constitute the successor or inheritor of such sums. The successors or legal heirs (either in terms of the will executed by the depositor, or as per the personal laws of succession governing the depositor who dies intestate) are entitled to claim their rightful share from the nominee[5].

 

Many a time one sees claimants (claiming to be legal heirs or successors of a deceased depositor) serve notice of their claim or interest to the bank. As such[6], a bank is not bound to receive such notice nor is bound by such notice even when it has been expressly delivered to it. Only and only if a decree, order, certificate or other authority from a court of competent jurisdiction relating to such deposit is notified or served on the bank, is the bank required to take due note of such decree, order, certificate or other authority[7].

 

Table 1: Current and savings accounts, fixed deposits, safe custody and safety lockers

In the event of: Transmission in favour of:
Nomination provided Nomination not provided
Death of single holder Nominee Legal heirs (as per succession certificate/probate/letters of administration)
Death of one of the joint holders Surviving joint holder(s) Surviving joint holder(s)
Death of all the joint holders Nominee Legal heirs (as per succession certificate/probate/letters of administration)

 

A further element which bears consideration is that in terms of the current law, the nomination by a bank depositor is limited to a single individual[8]. This is in contrast to several other financial assets which permit multiple nominees and/or even specification of allocation (in percentages) among such multiple nominees.

 

Hence, it appears that almost by design the bank or the nominee, or both could be placed in a situation of having to deal with the legal heirs, successors and claimants, and which could also lead to litigious situations.

 

It is your columnist’s view that Section 45-ZA of the Banking Regulation Act (and consequently the Rules thereunder) should be amended to facilitate depositors being able to specify multiple nominees (together with percentage allocation of the money among them). This would help bank deposits keep pace with the approach adopted for other financial assets. Such a change would allow the depositors to specify, as far as possible, their legal heirs as nominees together with the percentage allocation among them. It would help reduce or remove possible friction and burden that the nominee carries in having to deal with the legal heirs, successors and claimants.

 

A separate thought is for banks to facilitate nominations being done on their internet banking sites or mobile banking apps. There has been a (mis)apprehension on account of the prescribed forms requiring signatures (construed as wet or physical signatures): this has led to banks hesitating in digitalisation of the nomination process.

 

In fact, the provisions of the Information Technology Act of 2000 and the various mechanisms specified therein for concluding contracts, can extend to the nomination forms being completed and submitted through authenticated means (such as internet banking or mobile banking apps) and will be legal, valid and effective (just as the transactions conducted over such internet banking sites or mobile banking apps). Adoption of such means – Aadhaar-based eSign, or OTP-based confirmation or simply undertaking the nomination after authentication of credentials of the internet banking site or mobile banking app – would also mean that requirement of witness if any can be dispensed with.

 

In respect of articles kept in safe custody or kept in the safety lockers, one item worthy to call out as a difference (from treatment of deposits) is that the bank, before returning any articles to the nominee or prior to removal of contents of the safety locker by the nominee, is required to prepare an inventory of such articles. The nominee is required to sign a copy of such inventory, and is entitled to receive a copy of the inventory.

 


Joint ownership and operation of current and savings accounts, fixed deposits, articles in safe custody and safety locker


Almost all financial assets are capable of joint ownership. One critical aspect, especially relevant for ease of access to financial assets, is the treatment of joint ownership and of joint operation of such financial assets on the death of one of the joint owners.

 

One key benefit is the rule of survivorship, which specifies that the surviving joint owners get the legal title to the asset. It would of course beg the question then why is nomination permitted and encouraged for jointly owned accounts: it is for the remote contingency of all the joint holders perishing simultaneously or together, that nomination becomes relevant.

 

In terms of practicality, in case of current or savings accounts, it is the mode of operation which also determines the ease.

 

For instance, specifying “either or survivor” or “anyone or survivor” enables any one of the account holders jointly owning an account to access the account even upon death of any of the account holder/s. Specifying “former or survivor” allows the first account holder to operate the account during her lifetime and upon her death, the survivor to operate the account. “Latter or survivor” works in pretty much similar way, where the second account holder operates the account in her lifetime and upon her death, the first account holder can operate the account.

 

If however, the mode of operation has been specified as joint, then it requires all account holders during their lifetime to jointly provide the instructions or sign cheques. Upon death of one of the account holders, the right to operate such a joint account will stand revoked or suspended. Such surviving account holders would need to establish a separate account to receive the proceeds from the joint account.

 

Accordingly, the choice of mode of operation is highly important, and certain choices, as above, can provide ease of access to the survivors and allow the continuing operation of an account upon death of one of the account holders.

 

In terms of the rule of survivorship, the surviving account holders (under all modes of operation) get a legal title to the balance in the account, and the bank gets a good discharge from such surviving account holders.[9] Nomination, if any made, for such joint accounts has no relevance, unless all the joint account holders are no more.

 

It is all too necessary to call out that just as in the case of nominees, while the surviving account holder/s are legally entitled to receive the money from the bank, the survivors may not constitute the successors or inheritors of such sums. The successors or legal heirs (either in terms of the will executed by the deceased account holder, or as per the personal laws of succession governing the deceased who dies intestate and subject to the arrangements among the joint holders) are entitled to claim their rightful share from the survivors[10].

 

It is your columnist’s view that the choices in the mode of operation that bank accounts provide is worthy of emulation across other financial assets. Several of the financial assets straitjacket the joint ownership, and hinder the ease of access to joint owners and survivors.

 

Summary of reforms recommended for current accounts, savings accounts, fixed deposits, articles in safe custody and safety lockers

Permit multiple nominees (doing away with current limitation of one nominee).
Permit specification of allocation of percentage of among multiple nominees.
Facilitate e-nominations (over internet banking or mobile banking apps).
Placing a deadline for all holders of current accounts/savings accounts/fixed deposits that are presently without nominations to provide nominations.

Nomination facility in depository or demat accounts


 

With a growing number of investors in the equity markets, or those holding bonds and debentures or even sovereign gold bonds, having a depository account (more popularly referred to as “demat account”) with a depository participant (which in turn are linked to either of the two securities depositories[11] licensed by the Securities and Exchange Board of India SEBI) is a given. The total count of demat accounts stood at 55 million plus as of 31-3-2021[12], with Rs 518.83 trillion constituting the total value of securities held in such demat accounts.

 

Nomination is possible for demat accounts. There is flexibility to specify up to three nominees, and in case of multiple nominees, the demat account holder/s can specify the percentage of share of each nominee. In the event percentage allocation is not specified, the presumption of equal division among the nominees applies.

 

Individuals who jointly own demat accounts are also permitted to make nominations. Nominations can be made only by individuals, and only individuals/natural persons can be specified as nominees[13].

 

A minor can be a nominee, subject to the name and address of the guardian being provided.

 

The prescribed forms require photographs of the nominee and other details to help identify and give effect to the nomination. Additionally, the form requires a witness for nomination.

Nominations can be varied or cancelled and fresh nominations made.

 

The key benefit that nominations provide to depositories and depository participants is that they receive a full discharge of the liability upon the transmission of the securities balances in the demat account to the nominee.

 

It is important to note that while the nominee is legally entitled to receive the transmission of the securities balance in the demat account, the nominee does not constitute the successor or inheritor of such securities. The successors or legal heirs (either in terms of the will executed by the demat account holder, or as per the personal laws of succession governing the demat account holder who dies intestate) are entitled to claim their rightful share from the nominee[14].

 

Table 2: Depository or demat accounts

In the event of: Transmission in favour of:
Nomination provided Nomination not provided
Death of single holder Nominee(s) Legal heirs (as per succession certificate/probate/letters of administration)
Death of one of the joint holders Surviving joint holder(s) Surviving joint holder(s)
Death of all the joint holders Nominee(s) Legal heirs (as per succession certificate/probate/letters of administration)

 

As can be noted, the demat accounts permit more than one nominee (though imposes a limit of three nominees). It permits percentage allocation among the nominees for all the securities held in demat account (in the aggregate and not individually).

 

One reform to consider would be to do away with the limitation of three nominees. It would facilitate demat account holders being able to specify multiple nominees without limitation (while continuing with the percentage allocation of the money among them). Such a change would allow the demat account holders to specify, as far as possible, their legal heirs as nominees together with the percentage allocation among them. It would help reduce or remove possible friction and burden that the nominees carry in having to deal with the legal heirs, successors and claimants. Nonetheless, flexibility of having up to three nominees is certainly better than one.

 

Another limitation is the manner in which nominations along with the percentage allocations takes effect: such nominations and allocations apply across the securities balances held in the demat account, and securities-wise nominations or allocation are not currently possible. Hence, if there are multiple sets of shares and securities held, the nomination and percentage allocation uniformly cuts across all the shares and securities. A potential reform to consider is facilitating nominations and percentage allocation at the level of each security held in the demat account. Such a possibility, it must be noted, exists for physical shares and securities.

 

A few recent changes[15] that have been made by SEBI which regulates depositories and depository participants that provide demat accounts, in respect of nomination, are important to consider:

 

  • On and from 1-10-2021, investors opening new demat accounts have a choice of providing nomination or opting out of making a nomination. Due formats have been prescribed for either course, and for changes to or cancellation of nominations made.

Indeed, while the regulator has provided a choice of making nomination or opting out of making a nomination, it is your columnist’s view that it would be particularly foolish and indeed downright mean for demat account holders to not use the nomination facility. It would leave the survivors and successors facing a needless, time-consuming and daunting process of obtaining a succession certificate or court orders (in case of intestate succession) or probate or letters of administration, with attendant costs and efforts. Having chosen to invest and open a demat account, it would be prudent and practical to utilise the nomination facility.

  • All existing eligible demat account holders are required to make a choice of providing nomination or opting out of making a nomination on or before 31-3-2022, failing which no debits can be made to the demat account, effectively freezing trading of securities held therein.

Such a missive is a much-needed measure. Lack of nomination impacts both the survivors, successors and inheritors as well as the depositories and depository participants. Both bear the burden of having to arrange for (and receive) duly notarised copy of succession certificate or an order of a court of competent jurisdiction (when the demat account holder has not left a will) or duly notarised copy of probate or letter of administration (when the demat account holder did execute a will). Either course is a daunting court process, which the survivors, successors or inheritors face. For the depositories and depository participants, when there is no nomination, then good discharge can be achieved only by receiving such documents.

  • A key change has been dispensing with the witnessing of the nomination form in the following circumstances:

(a) Nomination form signed under wet signature of the demat account holders.

(b) Online nomination form signed using e-Sign facility.

Witness signature is however required when the demat account holders affix thumb impression (in lieu of signatures).

It is your columnist’s view that such a measure is quite laudatory and appreciable: it removes the friction of the depository participant or the investor having to arrange for an independent witness, and provides due privacy to investors affixing wet signatures or using e-Sign facility. In respect of investors affixing thumb impressions, perhaps if could be nudged instead to use e-Sign facility (which also relies on biometric identification), would also have the same benefit. Notably, most other financial assets also do not require witnessing of the nomination form and this measure brings demat accounts in line with the same.

 


Joint ownership and operation of demat accounts


Individuals can jointly own demat accounts, subject to a limit of three joint owners. A minor cannot be one of the joint owners[16].

 

In keeping with the recommendation of lifting the limit of number of nominees, it would be appropriate to also recommend lifting the limit of number of joint owners of a demat account.

 

In case of death of any one joint owner, the rule of survivorship will be applicable. To briefly recap, this means that the surviving joint owners get the legal title to the balances in the demat account. It is noted that while the surviving account holder/s are legally entitled to receive the securities balances in the demat account, the survivors may not constitute the successors or inheritors of such securities. The successors or legal heirs (either in terms of the will executed by the deceased demat account holder, or as per the personal laws of succession governing the deceased who dies intestate and subject to the arrangements among the joint holders) are entitled to claim their rightful share from the survivors[17].

 

When the surviving demat account holders provide a notarised death certificate of the deceased account holder, the depository participant would proceed to freeze the demat account, and transmit the balances to the demat account of the surviving demat account holders.

 

This presumably preserves the record of holdings, transactions and of the demat account holders (including the deceased account holder) in the records of the depository, and fresh records are created for the surviving demat account holders and their transactions.

 

This perhaps is a key difference between joint bank accounts and joint demat accounts: the former is a running account, capable of being operated (subject to the mode of operation) even upon the demise of one of the joint holders, while the demat account is closed upon death of one of the joint holders. A reform worthy of consideration is treating the demat account as a running account, the way bank accounts are: so demise of a joint owner should not mean closure of the demat account (with attendant transmission of the balances to the demat account of the surviving demat account holders). Rather, the surviving demat account holders should be allowed to continue operations in the same demat account.

 

Jointly owned demat accounts also have a very limited scope on mode of operation: the depositories require that all joint holders authorise the transactions.

 

Practically, the first holder or main holder could be conducting the transactions, especially in case of online transactions. Additionally, reliance is possibly placed on a letter of authority or power of attorney given by all the joint owners of the demat account holders.

 

As mentioned earlier, the multiple choices in the mode of operations that bank accounts provide is worthy of emulation for demat accounts. Limiting the mode of operation to only jointly by all the demat account holders, and allowing practices to develop wherein parties rely upon a letter of authority or a power of attorney from all the demat account holders can be thought of as an inefficient and poor workaround. Rather, just as banks facilitate different types of modes of operations, the two depositories could upgrade their systems to provide the same or similar facility.

 

Summary of reforms recommended for depository or demat accounts

Permit multiple nominees (doing away with current limitation of three nominees).
Permit ability to specify nominations and percentage allocation at the level of each security held in the demat account (from current account level nomination and allocation being feasible).
Removal of choice of opting out from making nomination.
Permit multiple joint owners (doing away with current limitation of three joint owners).
Permitting jointly held demat accounts to become a running account by surviving demat account holders after the death of one of the joint holders (doing away with closure of demat account and transfer of balances to demat account held by surviving holders).
Permitting multiple modes of operation for jointly held demat accounts

(either or survivor, anyone or survivor, former or survivor, latter or survivor, joint).


Nomination facility in mutual funds


 

Investments in mutual fund schemes have grown by leaps and bounds, and particularly post demonetisation. The current corpus under management of mutual funds is at Rs 31.4 trillion as on 31-3-2021.

 

Nomination is possible for mutual fund holdings. Nomination made by a mutual fund investor is applicable for units held in all the schemes under the respective folio/account and gets rescinded on redemption of such units or its transfer.

 

There is flexibility to specify up to three nominees, and in case of multiple nominees, the mutual fund investor can specify the percentage of share of each nominee with such allocation/share being required to be in whole numbers without any decimal. In the event percentage allocation is not specified, the presumption of equal division among the nominees applies.

 

Individuals who are joint investors in mutual fund (irrespective of the mode of operation) are also permitted to make nominations, being required to do so jointly.

 

Nominations can be made only by individuals. Non-individuals including a society, trust, body corporate, partnership firm, karta of Hindu Undivided Family, a power-of-attorney holder and/or guardian of minor mutual fund investor cannot nominate.

 

Nominations can be in favour of individuals/natural persons, and also the Central Government, State Government, a local authority, any person designated by virtue of his/her office or a religious or charitable trust can be specified as nominees. This is an expanded set of eligible nominees (distinct from nominations permitted for bank accounts or demat accounts).

 

A minor can be a nominee, subject to the name and address of the guardian being provided.

 

Nominations can be varied or cancelled, and fresh nominations made.

 

Uniquely, there is a specification of consequences in case of death of a nominee. In the event of the nominee(s) predeceasing the mutual fund investor(s), the nomination is automatically cancelled. In case of multiple nominations, if any of the nominee is deceased at the time of claim settlement, that nominee’s share would be distributed equally amongst the surviving nominees.

 

Transmission of units in favour of the nominee(s) constitutes valid discharge of the asset management company, the trustee company and the mutual fund. It is important to note that while the nominee is legally entitled to receive the units, the nominee does not constitute the successor or inheritor of such units. The successors or legal heirs (either in terms of the will executed by the mutual fund investor, or as per the personal laws of succession governing the mutual fund investor who dies intestate) are entitled to claim their rightful share from the nominee[18].

 

To claim the units after the death of a unit holder, the nominee has to complete the necessary formalities, such as completion of KYC process, along with proof of death of the unit holder, signature of the nominee duly attested, furnishing of proof of guardianship in case the nominee is a minor, and such other document as may be required for transmitting the units in favour of the nominee(s)[19]. One key element, which appears to be excessive or contributing to avoidable friction is requirement of attestation of nominee’s signatures. When the transmission amount is up to Rs 2 lakhs, the attestation by a Bank Manager is required in a prescribed form, and when the transmission amount is more than Rs 2 lakhs, the attestation by a notary public or a Judicial Magistrate, First Class (JMFC) is required. Attestation requirements also extend to various documents including bank passbook/bank statement, death certificate and so on, all of which appear excessive and could be dispensed with.

 

It is also important to note that when units in mutual fund schemes are held in a depository or a demat account, the nomination details provided to the depository/depository participants will be applicable to such units and govern the transmission.

Table 3: Mutual fund folios/accounts

In the event of: Transmission in favour of:
Nomination provided Nomination not provided
Death of single holder Nominee(s) Legal heirs (as per succession certificate/probate/letters of administration)
Death of one of the joint holders Surviving joint holder(s) Surviving joint holder(s)
Death of all the joint holders Nominee(s) Legal heirs (as per succession certificate/probate/letters of administration)

 

As can be noted, the mutual funds permit more than one nominee (though imposes a limit of three nominees). It permits percentage allocation among the nominees for the units held in the folio/account (in the aggregate and not individually).

 

One reform to consider would be to do away with the limitation of three nominees. It would facilitate mutual fund investors being able to specify multiple nominees without limitation (while continuing with the percentage allocation of the money among them). Such a change would allow the mutual fund investors to specify, as far as possible, their legal heirs as nominees together with the percentage allocation among them. It would help reduce or remove possible friction and burden that the nominees carry in having to deal with the legal heirs, successors and claimants. Nonetheless, flexibility of having up to three nominees is certainly better than one.

 

One further reform to consider is doing away with a choice not to furnish a nomination. As previously noted, it is your columnist’s view that it would be particularly foolish and indeed downright mean for mutual fund investors to not use the nomination facility. It would leave the survivors and successors facing a needless, time-consuming and daunting process of obtaining a succession certificate or court orders (in case of intestate succession) or probate or letters of administration, with attendant costs and efforts. Having chosen to invest and create assets in form of units of mutual fund schemes, it would be prudent and practical to utilise the nomination facility.

 

Finally, enabling e-nomination facilities could greatly boost specifying nominee(s). Either the mutual fund industry and AMFI – the Association of Mutual Funds in India – could harness the provisions of the Information Technology Act of 2000 and the various mechanisms specified therein for concluding contracts, for completion of the nomination forms and submission through authenticated means and will be legal, valid and effective. Adoption of such means – Aadhaar-based eSign, or OTP-based confirmation or simply undertaking the nomination after authentication of credentials of the internet site or mobile app of the AMC – would also mean that requirement of witness if any can be dispensed with. Alternatively, SEBI could specify e-nomination norms for mutual funds akin to the norms specified for demat accounts.

 


Joint ownership and operation of mutual fund investments


Individuals can jointly own units in mutual fund schemes, subject to a limit of three joint owners.

 

In keeping with the recommendation of lifting the limit of number of nominees, it would be appropriate to also recommend lifting the limit of number of joint owners of units in mutual fund schemes.

 

In case of death of any one joint owner, the rule of survivorship will be applicable. To briefly recap, this means that the surviving joint owners get the legal title to the units of the mutual fund scheme. While the surviving joint holders are legally entitled to the units of the mutual fund scheme, the survivors may not constitute the successors or inheritors of such units. The successors or legal heirs (either in terms of the will executed by the deceased joint holder, or as per the personal laws of succession governing the deceased who dies intestate and subject to the arrangements among the joint holders) are entitled to claim their rightful share from the survivors[20].

 

Akin to bank accounts, the folios/accounts and the units held in such folios/accounts continue to operate without any issue, and only the details of the holders – nominees in case of sole mutual fund investor, or the surviving joint holder/s – get updated.

 

Mutual funds permit “either or survivor” mode of operation when investments are jointly held, thereby providing flexibility for the investors in transacting. The exception is making nominations, which have to be jointly made.

 

Summary of reforms recommended for mutual fund investments

Permit multiple nominees (doing away with current limitation of three nominees).
Removal of choice of opting out from making nomination.
Permit multiple joint owners (doing away with current limitation of three joint owners).
Removal of attestation requirement for signatures of nominees or of documents submitted by nominees regardless of amounts that are to be transmitted.

 


Concluding remarks


As would be appreciated, there are very many similarities (and the differences are less apparent) in the nomination facilities, and joint holdings of financial products. These similarities and differences can have significance for orderly claim by nominee or survivors, and due discharge of the financial institutions. In many senses, the system may be efficacious, but quite tedious, time consuming, and also containing many pain points, friction and overall stressful to the nominees and claimants navigating the process. The financial institutions which have to process such claims also are hidebound to adhere to rules framed in a different era and time, running the risk of not securing due discharge and/or regulatory reprimands or penalties if deviate from such rules.

 

For anyone who has lost a loved one and is coping with an unfamiliar and difficult process, aggravated by the circumstances Covid-19 has brought, if financial sector regulators and financial institutions can consider reforms for further easing the pain, the friction and the efforts that survivors make in accessing the financial assets of the deceased, it would be highly commended and appreciated.

 

Adopting the best features regarding nominations or joint holdings as outlined above for each type of financial product would appear the easiest way forward.

 

Additionally, a few of the limitations – number of joint owners or number of nominees – most likely come from a technology system design perspective, where the record-keeping capability or capacity perhaps acted as the reason for the limits. In case of bank accounts, it is in fact coded into the statute. In real life and for assets such as real estate or physically held securities, such limits do not apply. The technology and systems should accordingly adapt and be upgraded to enable individuals and families to deal with financial assets in the mode, manner and extent that they desire.

 

It is time for society to be fair-minded to its financial consumers and their nominees, successors and survivors at the time they most need solace and support.


†  Group General Counsel at ICICI Bank. His Linkedin profile can be accessed HERE

Disclaimer: Views in this article are his personal views.

*Vanaj Vidyan, student of RMLNLU has assisted in the research of the article.

[1] Governed by S. 45-ZE of the Banking Regulation Act, 1949.

[2] Governed by S. 45-ZE of the Banking Regulation Act, 1949.

[3] See <HERE>; Vide Noti. No. S.O. 264(E), dated March 29, 1985, published in the Gazette of India, Extra., Part II, S. 3(ii), dated 29th March, 1985, pp. 10-18.

[4] S. 45-ZA(4) of the Banking Regulation Act, 1949.

[5] Proviso to S. 45-ZA(4) of the Banking Regulation Act, 1949; also specification in the will that the nominee is the beneficiary can obviate challenges or issues from arising.

[6] S. 45-ZB of the Banking Regulation Act, 1949.

[7] Proviso to S. 45-ZB of the Banking Regulation Act, 1949.

[8] In case of jointly operated lockers i.e. by two or more individuals jointly, such hirers may nominate one or more persons to whom, in the event of the death of such joint hirer or hirers, the bank may give, jointly with the surviving joint hirer or joint hirers, access to the locker and liberty to remove the contents of such locker.

[9] Banks as such do not take notice of any rival claimants to the monies even if notified though would take note of a decree, order, certificate or other authority from a court of competent jurisdiction relating to such money if is duly notified or served on the bank.

[10] Specification in the will that the joint owners or surviving joint holders are the beneficiaries can obviate challenges or issues from arising.

[11] NSDL: National Securities Depository Ltd., and CDSL: Central Depository Services (India) Ltd.

[12] 55,127,436 as of 31-3-2021 for the detail oriented.

[13] Akin to nominations for bank accounts excluding non-individuals.

[14] Specification in the will that the nominee/s is the beneficiary/ies can obviate challenges or issues from arising.

[15] See <HERE>.

[16] On account of minors incapacity to enter into contracts.

[17] Specification in the will that the joint owners or surviving joint holders are the beneficiaries can obviate challenges or issues from arising; one other potential challenge that should be considered is how the surviving joint holders get along (or do not), and hence segregating securities into distinct demat accounts with one joint holder each could be a better approach (unless securities level nomination is permitted).

[18] Specification in the will that the nominee/s is the beneficiary/ies can obviate challenges or issues from arising.

[19] See Here

[20] Specification in the will that the joint owners or surviving joint holders are the beneficiaries can obviate challenges or issues from arising; one other potential challenge that should be considered is how the surviving joint holders get along (or do not), and hence segregating the mutual fund holdings into distinct folios with one joint holder each could be a better approach.