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Moneylife » Investing » Regulations » Investment Advisor Regulation I: SEBI’s ideas are, as usual, far from reality; may increase mis-selling!

Investment Advisor Regulation I: SEBI’s ideas are, as usual, far from reality; may increase mis-selling!

Moneylife Digital Team | 27/09/2011 06:35 PM | 

If SEBI’s new norms on investment advisors come into force, mutual fund sales will decline even further and mis-selling of insurance products will increase!

When UK Sinha took over as the chairman of the Securities and Exchange Board of India (SEBI), small distributors were elated. As the head of Unit Trust of India, he had after all felt the impact of a series of harebrained decisions by SEBI under the previous regime relating to mutual funds (such as abolishing upfront commissions abruptly). Small distributors hoped that Mr Sinha would reverse the previous decision or at least make sure that distributors are incentivised in some way. He stunned them by coming out with a more harebrained idea-a small charge to first-time investors. Polite criticism pointed out a simple flaw-how do you define "first-time"? It was no surprise that SEBI had not thought about it. It usually doesn't.

SEBI under Mr Sinha has now a gone a step further which would create major headwinds for the fund industry, especially after an 22nd August circular which asks mutual funds to implement a segregation between an agent and an advisor. SEBI now wants to regulate investment advisors and that too through the completely failed concept of Self Regulatory Organisations (SROs). No matter that its grievance redressal system is not exactly pro-investor, no matter that there is no surveillance worth talking about and market manipulation is rampant, no matter that its consent order system allows crooks to get away, investment advisor regulation seems to be a priority for Sinha.

SEBI has just released a concept paper, which lays down how an SRO would be formed to regulate investment advisors who will be registered under SEBI. The crux of the regulation is: "No financial incentives/consideration would be received from any person other than (an) investor seeking advice". What does this innocuous-sounding rule mean?

First, distributors simply cannot provide advisory services for a commission; they will have to sell for a fee. This means that if one wants to earn a commission and not a fee (since investors don't want to pay fees) he would have to identify himself as an 'agent'. Unfortunately, this means getting a letter signed from an investor that he is buying the product out of his own free will and that the agent has not done any due diligence. Few investors are willing to give such letters. No distributor is asking for it, either.

Second, the only mainline investment product that comes under SEBI is mutual funds. Issues related to other financial products will be dealt with the respective regulators. As such, there would be no single body regulating investment advisors. Is there mis-selling of mutual funds? Well, there has to be selling first! Mutual funds are struggling to add assets-SEBI's August 2009 decision has ensured that interest in mutual funds has totally waned.

In August 2009, SEBI had banned entry load for mutual fund investments. Investors were free to decide the upfront commission to be paid to the distributor/agent, based on factors like assessment of the service of the distributor. The effect has been disastrous. From the time of the ban till August 2011, there has been huge outflow of money. SEBI simply was out of touch with reality when it assumed that investors and distributors would negotiate for the service. Even the healthiest financial services don't sell by themselves. That's the lesson from all around the world. It takes a lot of hand-holding and convincing to get someone to invest in volatile products like mutual funds. Devoid of upfront commissions, the agents simply did not want to take the trouble to sell mutual funds after August 2009. Many distributors were happy to push insurance products, which earned them higher commissions.

Under the new proposal of SEBI, this would not change. This would get aggravated. While very few people would be interested in selling mutual funds for a fee, an "investment advisor" selling only insurance products does not come under the proposed Investment Advisor Regulations. Therefore why would an existing advisor pay for a certification to become an "Investment Advisor" when he is "better off" selling ULIPs (unit-linked insurance plans) as investment products?

The media is full of stories of mis-selling of insurance products. From those nearing their retirement to 80-year-olds have been sold retirement products where they would have to pay a substantial amount for annual payment across 10 years. Sadly, even if the proposal of SEBI comes into force, such cases would continue. Incidentally, the biggest mis-sellers are large banks and SEBI's regulation will not affect them one bit.

Of course, one could argue that the intermediaries would find a way to get around these rules. That is the subject of part two of this series.

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JJN 4 years ago

Firstly, I agree with the following:
1. Financials advisors and intemediaries need to be better regulated in this country.
2. It is the job of the regulators/ SRO, such like to regulate them.
3. Preferably regulations should not be hasty and ill-thought, and the industry and stakeholders (investors, manufactuers & intermediaries) should be given sufficient time to make the changes required for them to work under the new rules – which will help in a smooth transition.
4. Proper education is required to be provided to all the stakeholders, on how to engage their partners under the new rules

However, having read through the draft paper, I feel it falls short in many respects and needs significant amends:
1. Though the concept paper says the Indian investors are not yet financially very literate (para 2.4), they expect them to understand and differentiate the services of the agent from the advisor – and thus feel the need to pay for the services of the capable advisor – an ideal situation, don’t you think? I feel the time has not yet come for this in India. It requires a lot more “financial literacy” – which the concept paper itself admits, we Indian mostly lack.
2. They quote the FSA in UK – like a benchmark – however, one must note that the FSA and other US bodies are making regulations for people who are used to living in a culture where children – from a young age – are trained to respect and pay for help rendered – like it is any other job. So culturally, the people in these advanced economies are used to paying for services that they use. Though this will come about as we progress, maybe it will take a while before the regular investor in India feels the same way, and appreciate the fact that he/she needs to pay for financial advice.
3. Why are Stock brokers being excluded from the rules of the concept paper? Aren’t they also financial advisers in every sense of the term – if they are going to recommend a stock to buy? Are they scared that liquidity will drastically drop in the equity markets if they do so?
4. SEBI says nothing yet about whether they will differentiate financial products/ schemes - whether mutual funds or others - that will give a benefit to advisors to market themselves – like mutual funds for agents and mutual funds for advisors. Obviously, we can expect “Investment Advisors” to put pressure on SEBI/ AMCs to create lower cost products for them… This is likely to play out. But SEBI has not given a mention about it.
One main amendment/suggestion to this concept paper is this –
1. Have rules / guidelines set for working as an agent and as an advisor, separately. Obviously, the rules for advisor will be more stringent with higher level of audit & eligibility requirements. This can be overlooked by an SRO / as well as respective regulators.
2. Give all agents/ advisors to choose and work in both capacities if they meet the requirements set - . Here, it would presumably start with being an agent, and then elevate oneself to being an advisor. Some may choose to remain only as an advisor or an agent also.
3. Every client should be compulsorily be registered only as either one - “agent- relationship” or “advisor relationship” and subsequent agreements on fees etc should be drawn up at the start. This cannot be changed for each transaction.
4. This gives leeway for the agent/advisor to work up the value chain, while the client has the freedom to choose what relationship he wishes to have with the agent/ advisor to start with.

I hope that this suggestion is taken up. I call on distributors to write their suggestions/ feedback to the email id given in the concept paper.

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Shrikant Kulkarni

Shrikant Kulkarni 4 years ago

The things were moving smoothly and the Industry was doing fine. Abolition of Upfront commission created a mess. Many people left the industry. Now SEBI wants to rectify the wrong but its ego hearts to reintroduce the entry load. They want to introduce the entry without it looking like an entry load. Funy,
what is wrong in accepting the wrong action and think to re-introduce the entry load. The rate may be brought down from 2.25% to 1.5% and close the chapter.

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seetharamank 4 years ago

a verywell said analysis

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srinivas chandolu

srinivas chandolu 4 years ago

first let grow mf industry substantially.then they can come with new drafts.when inflation is going high n commissions are not matching to inflation how can a ifa will survive?gont wants to handover the business to corporates majorly.

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Sweena Jain

Sweena Jain 4 years ago

There are innumerable regulations in our country.The more regulation higher are the chances for corruption.This new regulation seems for corruption only.
SEBI's one regulation is it is mandatory for all market intermediaries--COMPULSORY REGISTRATION.But many brokers looted public by appointing unregistered intermediaries which turned to be fly by night operators .There are no dearth of complaints with SEBI pending under this regulation.The stock exchange grievance resolution center are no better option.Most of the time Stock exchanges direct investors to opt ARBITRATION route at Investors cost and consequences.When there is break in any regulation the ACTION must be as per prescribed penalty in the said regulation.To sum up it is SEBI's act which are being opened for floodgate for corrupt and malpractice.And we should view SEBI's action in this scenario.

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