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Is suggesting suitability different from advising?

LiveMint logoLiveMint 03-07-2017 Kayezad E. Adajania

Your mutual fund distributor would like to be able to sell you a fund and advise you which fund to buy as well. But soon, she may not be allowed to do that.

On 22 June, the capital market regulator Securities and Exchange Board of India (Sebi) issued a consultation paper to define who is a registered investment advisor (RIA) and who is a mutual fund distributor (MFD). In October 2016, too, it had issued a paper that outlined the road map of distribution and advice. But in January, Sebi’s International Advisory Board suggested to the regulator to study the financial viability of the advisory business in India. Sebi is taking comments till 14 July on the latest paper. After that, it could modify the existing Sebi (Investment Advisors) Regulations, 2013. Let’s take a look at what Sebi aims to do.

At present, your distributor can assess your risk profile and also advise you across multiple products; in short, most of what an RIA does but without the strict controls of Sebi’ RIA guidelines. Also, while an RIA is paid by you, the distributor is paid by your mutual fund—with money that eventually impacts your fund’s net asset value. If your distributor were to register as an RIA, she would have to undertake stringent record-keeping and maintain a separate officer to ensure compliance with Sebi’s RIA guidelines. Besides, RIAs cannot sell mutual funds and earn trail fees without setting up a separately identifiable division. Thus, we have a little over 675 RIAs, with most distributors choosing to continue as MFDs.

And yet, many MFDs still offer advisory or financial planning services. The 2017 consultation paper wants this to stop. “The problem today is that when an MFD advises and sells a scheme, the investor doesn’t know whether it is genuine advice or a sales push driven by commissions,” says Munish Randev, chief investment officer, Waterfield Advisors Pvt. Ltd, a family office advisory. Randev also points out that the 2017 paper prevents MFDs from giving incidental advice; something that the 2013 guidelines allow.

The Sebi paper has also said that while MFDs cannot advise you, they need to ensure that the product sold is suitable for you. Further, every time an MFD sells you a scheme, she needs to take your signature on a document that gives you a list of all mutual funds that she sells and commissions she earns from them. The document should further certify that the scheme is suitable for you and carry a disclaimer that she may not be acting in your best interest. Experts say that here’s where it gets confusing.

Sebi has not prescribed what is product suitability and how an MFD would ensure its compliance. Gajendra Kothari, chief executive officer, Etica Wealth Management Pvt. Ltd elaborates how this ambiguity may play out if suitability required recommending a category. Let’s take a 50-year-old who goes to an MFD to buy a mutual fund for her retirement years. The MFD may give her a hybrid debt-oriented scheme, like a monthly income scheme, says Kothari. But even if that scheme was the worst-performer of its category, the MFD would have met the suitability criteria. “This (ensuring suitability) is still a grey area,” Kothari admits. Other experts say that ensuring product suitability cannot come without giving advice. Does suitability call for profiling customers or is it about offering a shortlist of pre-approved products that are universally valid for customers? “I think Sebi is talking about the latter. But, if Sebi says that MFDs must ensure product suitability, it runs afoul with its own rule that MFDs cannot do financial planning,” says Bindu Ananth, chair, IFMR Trust, a Chennai-based organisation focused on financial inclusion.

Many distributors refer to themselves by labels such as financial advisers and wealth managers. Last year, Mint had called up a sample of such distributors to check if they are registered with Sebi; read about it here. Most had not registered and a few said they were going to. Sebi’s 2016 paper proposed to give then up to 3 years to start calling themselves ‘mutual fund distributor’. The 2017 paper is silent on the time-frame but the proposal to change the nomenclature remains.

By restricting distributors from advising, and mandating them to disclose that they “may not be acting in the best interest of investor”, Sebi appears to be pushing MFDs to register as RIAs. MFDs and RIAs say that’s easier said than done. Thus, stand-alone MFDs would need to set up a separate company that takes care of distribution, assuming the MFD herself takes up the RIA license. Some advisers, who are RIAs, have made their family members as heads of the separate distribution entity. But industry experts claim Sebi has been selective in allowing this. “There have been cases where Sebi has not allowed this,” says Kothari. He adds that the current infrastructure is not enough to get customer to cut a separate cheque to pay fees. A portfolio management services (PMS) firm, for instance, mandates clients to open separate bank accounts from where it collects fees automatically through a power of attorney. But the minimum ticket size of Rs25 lakh in a PMS makes it look worthwhile to open a separate account just for that purpose, says Kothari. With smaller ticket sizes, an RIA may not be able to convince clients to open separate accounts and here’s where, Kothari says, it could be a challenge for advisers to ask clients for a separate cheque. A better idea, he says, would be to have more technology platforms where MFD-turned-RIAs could on-board their clients; and for paying the fees, RIAs could liquidate their clients’, say, liquid fund units in lieu of fees. “But Sebi needs to give guidance about such solutions. Merely saying MFDs cannot advise may not be enough,” Kothari adds. The coming months should be interesting for the distribution space that seems set for a big overhaul.

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