Despite a rising market and more reforms, mutual fund inflows declined and redemptions went up to a massive Rs6,741 crore in September. The regulator and fund companies seem clueless to stem the tide
SEBI has just come out with draft regulations for investment advisors. Unfortunately, the proposed regulations will be of little consequence. It will mean little to investors and mis-selling may continue as before and with appropriate disclosures! An analysis of the proposed rules…
Investment advisor regulations have been discussed on and off for the past five years. In 2007, the Securities and Exchange Board of India (SEBI) published a consultative paper on “Regulation of Investment Advisors”. In 2008, the Swarup Committee re-examined the issue and submitted its report in 2009. The report was revolutionary in its thinking prescribing all financial products have to become “no load”. Opposition to this report was vociferous. After much heat and dust, including dharnas and morchas by a section of soon-going-to-be-affected persons, the report was buried deeply and quietly. In September 2011, SEBI published another concept paper on the regulation of investment advisors, which led to much debate. And now, in September 2012 the draft regulation on investment advisors in India has come out. How significant are these draft rules? Will it change the way people buy and sell financial products? Will conflict-of-interest be reduced?
SEBI’s concept paper had explained passionately the causes of conflict-of-interest, lamenting lack of financial literacy “in a country like India” and uselessness of disclosures when investors are financially illiterate. The concept paper proposed to set the things right by portraying work qualifications such as Chartered Accountants and Master in Business Administration-Finance as free from conflict-of-interest. SEBI highlighted the low level of financial literacy in India and the consequences thereof. It also mentioned about inherent conflict-of-interest in the prevailing agent-cum-advisor model of business practice. The concept paper advocated very strongly, the setting up of a Self-Regulatory Organisation (SRO) to regulate investment advisors. This writer participated in the debate actively and sent detailed comments to SEBI. The draft regulations appear to be a skeleton of what the concept paper set out to achieve. Here are some facts that come out:
SEBI has avoided turf war by restricting the licensing requirements of securities products, excluding insurance, real estate, commodities and pension products. If you look at any upper middle-class household, a chunk of savings is compulsory through employment (provident fund and superannuation fund). Next, big commitment is towards house purchase/construction and this area is not going to be covered through this regulation. What finally gets covered is a very small part of the savings—investing in riskier assets. So, on a weighted average basis, the effect of this regulation on a typical upper middle-class household is minimal.
The regulation appears to be enabling and not disabling. No one is going to be affected negatively and they may continue to do what they are doing. However, this negates the very object of the regulation—that of removal of conflict-of-interest involved in financial advisory and product sales—as the focus is very narrow and limited to the act of giving advice.
Most of the clearly identifiable conflicted practices are left untouched. So this regulation is not applicable to a host of financial service providers such as stockbrokers, mutual fund advisors, pension advisors, insurance agents or brokers. It is also excludes advice givers who are advising in good faith, free of cost.
In a complete turnaround, this regulation now tries to remove the conflict-of-interest through a mere disclosure. Look at the following wording: An Investment Advisor shall try to avoid conflicts of interest, and when they cannot be avoided, should ensure that appropriate disclosures are made to the clients and that the clients are fairly treated.
In another major effort at watering down, an investment advisor may have the cake and eat it too. Just read this provision—“An investment advisor shall disclose all consideration and rewards that it will receive if the client chooses the recommended security or investment.”
Financial planners, fund managers who are employees of mutual funds and asset management companies (AMCs) and alternative investment funds (AIF) are covered under the regulation. Entities other than an individual have to set up “Separately Identifiable Department or Division”. It is not a “Chinese Wall” but only an internal department or division.
Qualification of advisors now also includes post-graduate degrees or diplomas in most of the related areas such as finance, accounting and so on. Certification requirement is expanded to include “CERTIFIED FINANCIAL PLANNER” awarded by Financial Planning Standards Board India. A two-year time is also given to obtain these certifications including the one offered by NISM.
Capital adequacy for body corporate is set at Rs25 lakh and Rs5 lakh for individuals. Young professionals may feel the entry barrier is high. It would be advisable if the capital adequacy is waived off for individuals.
Registration fee is a steep Rs10,000 for individuals and Rs100,000 for body corporate for a period of five years. This will hurt many two-person dejure body corporates created by husband-wife, father-son, friends and relatives, which then work as de facto individual-run organisations.
Till such time an SRO is set up, SEBI will handle the licensing process. Does it have the bandwidth for this?
Who will be afraid of this regulation? None, because this regulation does not stop any of the existing practices, with perhaps financial planners being the only exception.
There is a saying in my mother tongue which when loosely translated means that “one caught a small rat after digging a big hill”. I have the same sense about this draft regulation. The list of excluded services is much longer than the included ones. If these provisions are gazetted as they are, the regulation would remove none of the existing conflicts-of-interest. Body corporates would be glad that they can now have one more vertical to attract investors—a mere “separate department” and ‘disclosure’ is sufficient to run the racket.
Not being a super-regulator, SEBI has restricted the applicability of this regulation only to a small sub-set of existing players and clearly precluded any future turf-wars. At the end, all are happy continuing to do what they are doing at present. From intention of the concept paper to the draft regulations, a lot of regulatory zeal has evaporated.
Those who are practicing as fee-only financial planners/advisors would be moderately elated to realise that they now have a regulatory framework to lean on. But they will be frustrated after knowing the costs involved in complying with the regulation in toto. They will not have any ‘exclusive’ tag as other so-called conflicted entities can also be investment advisors.
In other words, entities with conflicts-of-interest would be very happy to know that life can continue as usual and in fact may get even better with an additional label to sport—“Investment Advisor”. After discarding the disclosure route in the concept paper, the regulation now requires mere disclosures to comply with.
Young graduates and post graduates whose hands are not yet bloody with legacy products and practices can think of setting up a free-of-conflict profession (from the regulatory point of view). However, this enthusiasm may yet be dampened with socialist era provision such as “Investment Advisors may charge fee subject to the ceiling specified by the Board, if any”. Even the existing conflicted service providers/intermediaries can think of redeeming themselves by complying with the provisions in letter and spirit.
My experience says that there are as many mis-buyers as there are victims of mis-selling. Pass-backs even when banned are demanded and received gleefully. There are investors who are well-versed about minutest options in their pads, pods and tablets but not their investments. The gap between general literacy and financial literacy is too wide for one advisor’s lifetime to bridge. Investor Protection Fund, instead of diminishing in size, is increasing. The existing IPF corpus is good enough to start at least half a dozen good universities in India.
Given the economics of becoming an investment advisor, what category of investors would benefit from this regulation is a question that will be answered by the behaviour of the investors. An investor who is willing pay separately for advice is the intended beneficiary of this regulation. How many such investors are there is anyone’s guess. I am not cynical though because there are small yet growing numbers of people who are willing to entrust their financial future to someone such as a “CERTIFIED FINANCIAL PLANNER”. They do trust but also test. They would be pleased with this regulation for sure.
Answer is yes and no. As a “CERTIFIED FINANCIAL PLANNER”, I comply with fiduciary responsibilities at much higher levels. But now to do it, I have to incur more cost and this is a negative. On the positive side, I have regulatory backing and can be regulatory-proud, if I can present as such to my clients. One thing, however, I am much pleased to notice is Annexure E—Comments. I am seeing for the first time that the regulator has listed down comments/feedback received in a summary format. Though it not on par with the efforts of countries such as UK and Australia, it is a good beginning. Also, Indian investors or a small set of them can be proud of the fact that they are now either on par or ahead of many developed countries when engaging an investment advisor.
There is absolute lack of coordination between departments whose goal should be to ensure no impediments in much needed power project executions. Do we want power or let the country suffer silently?
Power generating plants based on coal as the primary fuel source have a great number of obstacles to overcome if they have to run smoothly. First is the adequacy of quantity; second is the calorific value and its cost; third is the continuity of supply and fourth is the transport logistics. Hopefully, of course, a linked coal supplier does not have labour problems or heavy disruptive rains!
A brief study on the coal mining process shows that even after overcoming and meeting all requirements of the state government and the ministry of environment and forests (MOEF), and clean chit obtained for mining, it would still take at least six to seven years to achieve peak production. Labour trouble or heavy rains or transport logistics would still have to be overcome as these are variable factors from time to time.
Take for instance, the Essar Power plant at Singrauli in Madhya Pradesh, set up at an investment of Rs7,200 crore. The project is idling for want of coal.
It appears that the MOEF clearance has been given to mine coal at Mahan, as the power ministry has not sent its ‘proposal’ for tapering linkage, and that the matter cannot be put up to the “Standing Linkage Committee-long term” for approval. All this because everyone is standing on ‘formalities’ to be completed!
In other words, there is absolute lack of coordination between departments whose goal should be to ensure no impediments in much needed power project executions. Do we want power or let the country suffer silently? To read about how the government needs to reduce controls to induce imports, click here.
The coal ministry is involved in clearing the issue of tapering linkage for coal supplies from identified mines. It appears that the Mahan block is also assigned to Hindalco Industries and the coal ministry is not sure that adequate supplies will be available from this source. The major stumbling block is the MOEF clearance and only when this is obtained and mining starts, one should be able to assess if enough supplies will be forthcoming to meet both Hindalco and Essar’s demands. It looks like that work has not even started!
This is one of the many instances where the dog is chasing its tail in a never-ending circle. It is a pity.
It appears that the Essar Power project was to be included as a priority in The Twelfth Plan. But the progress, as we see it now, has been far from satisfactory.
We therefore, have to return back to our own pet theory. For those already approved projects, where fuel supply is the main obstacle, the government must move in with waivers to expedite commencement of work with a stipulated time frame given to the power generators to comply, without holding up the work. They may be given extended time to complete, if they face any new obstacles, but comply they must, all the requirements. Such interim relief is only saving much-needed time to expedite the issue, and not as an ‘exemption’ completely.
The second is more radical and out the box. The government must identify coal supply sources—dedicated mines of approved quality—and THEN invite tenders for power generators to put up their plants in such locations. Such a proposal must have clearances from all concerned departments and ministries and no foul play will be permitted at any stage.
Time is the essence of the contract; the successful bidder will have to undertake setting up the power plant, with the agreed time frame, and make available power at the pre-determined price per unit. If necessary, foreign direct investment (FDI) in this regard may be permitted from multinational companies which have proven experience and are operating successfully elsewhere.
We have had enough of this merry-go-round with various departments, ministries and a whole lot of others simply passing the buck. The buck stops here. Yes, right here, and let's get on to work. To read other articles by the same writer, please click here.
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce and was associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US. He can be contacted at [email protected].)