Globally, financial advisors make money in two ways: either by way of commissions built into products, or through fees charged to clients. Common sense dictates that the former approach houses intrinsic conflicts of interest that might orient advisors towards ‘recommending’ higher brokerage investment products that are detrimental to client interests. Since commissions really represent a fraction of the client’s own money; the more they give away to intermediaries, the less they have left for themselves.
In a watershed development earlier this year, the Obama administration unveiled, amidst much controversy, its new ‘fiduciary standard’ rule, effectively disallowing brokers from charging commissions on close to $15 trillion in retirement assets. Brokers in the US can now only operate ‘fee based’ retirement accounts for their clients.
The Securities and Exchange Board of India (SEBI) had issued a notification about the investment advisor (IA) regulations in January 2013, with the stated objective of “addressing the conflict of interest arising due to the dual role played by distributors of financial products”. Registered Investment Advisors (RIA) are subject to stringent professional standards and regular audits by SEBI. Says Sudipto Roy, managing director, Principal Retirement Advisors: “The proposed RIA guidelines are definitely good steps in nurturing a vibrant capital market, for which interests of investors are paramount.”
Three years later, the entire framework is at risk of being written off as a damp squib — only 500-odd RIA licenses have been issued to date. According to sources, bureaucratic inefficiencies have left even well-meaning advisors wringing their hands in despair.
As if to stem this rot, SEBI recently released a consultation paper proposing significant amendments to the previous regulations. For instance: under the existing framework, a mutual fund distributor can sell mutual fund products and also provide ‘incidental advice’ on mutual fund products. It has now been proposed that this auxiliary advice be disallowed altogether, essentially allowing distributors to simply ‘list’ products on their websites, e-commerce style. A window of three years has been provided to distributors who also intend to advise clients, after which they will be needed to register as IAs, and make do with fees alone.
The paper also proposes that financial planners, wealth advisors, independent financial advisors and ‘robo advisors’ be brought under IA regulations. Further, by mandating that such persons obtain an RIA license, SEBI is rightfully aiming to clamp down on unregulated and unqualified stock tippers. Notably, the paper seems to have exempted life insurance agents from the need to obtain a license.
“As products become more complex, it’s vital that advisory takes the centre stage compared to the mere selling of products,” says Ranjeet S. Mudholkar, vice chairman & CEO, FPSB India. “However, it’s critical that SEBI implements these regulations in degrees; starting off by enabling, and then moving on to facilitating and subsequently, controlling.” According to him, implementing such regulatory changes in the reverse order may prove to be damaging to the overall ecosystem.
It’s unarguable that the IA regulations, if implemented, will represent the gold standard for investor protection and will lead to a cleaner, more investor friendly ecosystem. However, the 360-degree impact of a full-fledged implementation is unlikely to be quite so obvious.
First, the propensity of Indian investors to pay fees is questionable. In the short run, fee incomes could be measly. In such a situation, we are likely to see distributors spending more energy seeking ‘creative solutions’ to circumvent the fall in income.
Second, by exempting insurance agents from the fold, SEBI may be risking a flight of advisors to the camp of life insurance agents. The Aegon Retirement Readiness Survey 2015 estimates that 63 per cent of Indians park their retirement savings into life insurance. The IA regulations may indirectly exacerbate this problem.
Third, it’s likely that high net worth individuals (HNI) will be averse to paying fees as a percentage of assets, and will therefore choose to self-manage their investments. With the cream skimmed off, mobilising enough fee incomes to build a sustainable business may prove to be a serious challenge for RIAs. The small investor might just end up overcompensating for the exodus of HNIs by paying more in fees than they would have paid as commissions!
Dhruv Mehta, chairman of FIFA (Foundation of Independent Financial Advisors), believes that investors should be given a choice between RIAs and distributors. “The regulations, as proposed, are aimed at killing the distribution model of sales in mutual funds,” theorises Mehta.
Is the RIA push a well-intentioned overextension on SEBI’s behalf that will lead to ‘overpaid advice’ for smaller clients and ‘no advice’ for HNIs? Or is it the first step towards a shift to fiduciary advice that will destroy misselling and create widespread value for retail and HNI investors alike? While the question uncomfortably hangs in the air, we can only hope that the regulator doesn’t end up throwing the baby out with the bathwater. A balanced and phased approach is the need of the hour.
aniruddha@businessworld.in
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