SEBI's recent consultation paper proposing tougher, tighter and more rigorous IA (Investment Adviser) regulations is a breath of fresh air. The points proposed in the paper clearly underscore the regulator's commitment towards creating a cleaner, more ethical sales environment for Financial products in India. By tightening the RIA noose, SEBI has clearly signalled that the future of Advisory is fiduciary and fee based and not commission oriented; either create enough value to get your client to write a fee cheque in your name, or perish.
It's not a secret that Indians investors have been ravaged by mis-selling for the past several years. Banks have mis-sold ULIP's, advisers have pitched mutual funds as guaranteed return products, and equity advisers have pushed futile propositions such as 'buy today, sell tomorrow'; all with a singular intent: to maximize commission incomes. SEBI has rightfully made it part of its mission to put an end to these unethical practices once and for all.
Sudipto Roy, Managing Director, Principal Retirement Advisors, echoes the view that the practice of paying fees for advice will have long term benefits for the financial advisory ecosystem. "It is in the interest of RIAs and all other distributors in the financial markets to make customers aware about the benefits of paying fees for good advice", he voices.
SEBI's preamble states: "...to protect the interests of investors in securities and to promote development of, and to regulate the securities market and for matters connected therewith or incidental thereto". It's always a tricky affair when a regulator plays a dual role of protecting investor interest and promoting market breadth and depth! Unfortunately, there is no simple solution that creates a perfect balance between the two.
Take Mutual Funds, for instance. With Rs. 15 trillion in assets, they represent a fair chunk of India's household savings. They also represent one of the lower cost, higher return potential investment avenues available to retail investors today. The annual cost of investing your money in a mutual fund through an intermediary would range from 0.5 per cent to 2.5 per cent, depending on the type of fund. If you choose to go direct with the AMC, it's even lower. Compare this with Life Insurance (the darling of the Indian investment community) - traditional plans are non-transparent and costly, sometimes paying out exorbitant sums that go up to half your first-year premium as commissions. Even ULIP's, recent reforms notwithstanding, represent a lower performance/ higher cost option compared to Mutual Funds.
It's fair to say that some of the more 'ethical' distributors have taken to recommending mutual funds over life insurance and trading in equities over the past few years; often at the cost of their own earnings. The commissions earned from the sale of Mutual Funds tend to be thin; but the benefits that accrue to the client over the long term are significant.
The recent paper now proposes that the 'incidental advice' that Mutual Fund distributors (IFA's) could earlier give be done away with, and that pure play distributors only be allowed to 'list products and their features' on their websites without advising clients or hand holding them through the process of investing. In other words, per the newly proposed norms, distributors cannot advise, and advisors cannot distribute; a time window of three years has been provided for the so intended transmogrification.
"SEBI intends to withdraw the exemption given to MF distributors to give advice incidental to their work and thus force them to register as RIA", says Dhruv Mehta, Chairman of FIFA (Foundation of Independent Financial Advisors). "Earlier, SEBI had decided to exempt all such persons who are licensed by another authority and have to abide by that authority's code of conduct. So, apart from MF distributors and insurance agents, even Chartered Accountants and Lawyers were exempted from the purview of RIA regulations."
There's little need to establish that as a product, Mutual Funds probably represent the best chance at long term wealth creation that most retail investors have. If their ability to provide incidental advice while continuing to earn commissions is dispensed with, will it have a net positive impact on the distribution ecosystem?
In a sense, that would depend upon if SEBI pushes the norms with an iron fist. If executed loosely, most distributors will merely create an 'advisory' subsidiary and 'migrate' their advisory function to it; while keeping their 'execution' functions separate. Unfortunately, no concrete definition of 'arm's length distance' or 'Chinese walls' exist that can create a material impact, if this were to be the case. The advisory company would earn fees, and the execution company would earn commissions - rendering the whole point of trying to create fiduciary advice moot.
If the regulator were to clamp down hard, the impact could be a lot more marked. Stripped of the ability to earn commissions and forced to earn fees, we could see more and more MF distributors becoming Life Insurance agents (the IMF structure is still a gaping grey area) to keep their incomes intact. Considering that the lion's share of mis-selling led client losses have happened in Life Insurance in recent years, this may end up creating a bigger problem in the endeavour to solve a smaller one.
For those distributors who choose to remain in the fray and adhere to norms without implementing creative solutions, there's another problem at hand. It's likely that their high net worth clients (their best chance of maximizing their fee incomes as a percentage of assets) will, by and large, take flight to the direct mode of investing. These distributors will be left to milk the hapless retail client for fees, and the poor lot could end up paying more for advice than they did in commissions! Mehta echoes this concern when he says: "There is clear evidence in the U.K that such a move move has benefited large investors at the cost of the small retail investor".
Unfortunately, there's no real solution to this problem in sight. SEBI's intended outcome (making financial advice fiduciary in nature) is fantastic. However, it could end up killing MF distribution as we know it, thereby depriving HNI's of quality advice and retail investors of a quality product. As Ranjeet Mudholkar, Vice Chairman and CEO of FPSB India believes, it's important to take a long-term view and proceed systematically by 'enabling, facilitating and then controlling' rather than working things the other way around.
SEBI will need to think creatively in order to get this right. Although none of them represent a complete solution, some potential workarounds are: getting Insurance Agents and PF Advisors under the IA purview (to create a level playing field), giving clients the right to choose between distribution and IA (while continuing to allow incidental advice) or even making it compulsory for clients to pay a minimum fee (say, of 1 per cent) while investing through a RIA.
As the distributor community holds its breath, it'll be interesting to observe how RIA will change MF distribution over the next five to ten years.
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