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Sebi gives a stronger push to advisory practice

LiveMint logoLiveMint 24-07-2017 Suresh Sadagopan

The Securities and Exchange Board of India (Sebi) has made a move towards ensuring that investors receive appropriate advice and their long-term goals are met. This deliberate move has been happening for a decade now, precipitated in 2008 by the global financial crisis. Financial product manufacturers made arcane products whose structures were difficult to understand even by finance professionals, and distributors sold them widely.

In the aftermath of the meltdown, there was a sudden realisation for regulators across the globe, that they need to regulate more aggressively and ensure that intermediaries don’t run roughshod over investors. 

India has been among the countries in the forefront of investor protection initiatives. Towards this end, regulators started modifying the framework for financial intermediaries to bring in responsibility and accountability, following appropriate processes to ensure the right outcomes, cost control and documentation or trail. 

But an important piece was missing—conflict-free advice. The only option available earlier was advice from distributors. The advice was shallow as it was free and incidental to product sale. Also, most times, the distributor was not equipped to offer advice as she did not have the necessary qualifications, knowledge and experience. But there was no one else investors could turn to.

Realising the importance of providing access to quality advice, Sebi had brought in its Investment Adviser Regulations in 2013. The endeavour was to create a new class of Registered Investment Advisers (RIAs) who would offer advice for a fee and not distribute products. The regulation specified a number of requirements—education, experience, certification, conduct of advisers, net worth and other eligibility requirements; various responsibilities including advising in a fiduciary capacity; proper processes for offering advice; and documentation requirements. These advisers also had to get audited annually for processes and compliance. 

This was a watershed regulation in terms of bringing in fee-based advisory in India. But it also allowed many exemptions, which obliquely indicated that exempted parties may give incidental advice (which was being interpreted loosely). This was a grey area due to which many chose not to register. The RIA regulations also allowed both advisory and execution functions to be within the same entity, though with segregation; but that’s not the optimal way to engender conflict-free fiduciary advice.

There were a couple of consultation papers to amend the regulations; one in October 2016 and another in June 2017.

In the June 2017 paper, Sebi is proposing clear segregation of advisory and distribution services. It suggests creation of a separate subsidiary or entity for investment advisory services. This would enable watertight containers carrying out the two functions, instead of segregated divisions with Chinese walls.  

It also suggests that RIAs who provide advice across multiple categories should take necessary permissions and ensure compliance with respective regulators. However, regulators register those who distribute products under their jurisdiction, and not those who offer advice. RIAs are not product sellers and hence may not be eligible to register with various regulators. This is going to present a problem.

Since RIAs have appropriate certification for advisory functions, they should be allowed to offer fee-only advisory without being registered with various regulators.

As per the proposal, the exemption for mutual fund distributors (and others) to offer incidental advice without registering would no longer be an option. From now on, mutual fund distributors can explain the features or material facts of the product and ensure suitability, but not offer investment advice or financial planning services. If they want to offer advice, they will need to register as fee-only advisers.

There is, however, some relief to RIAs. Representatives of investment advisers can now be graduates in any stream. It was difficult to find employees with 5 years of experience after graduation, which was the condition before. Also, the net worth requirement for body corporates has come down from Rs25 lakh to Rs10 lakh. Application and registration fees for body corporates has come down to Rs10,000 and Rs1 lakh, respectively. But the re-registration fee after 5 years is Rs5 lakh, which is inexplicable.

Agencies and entities that provide ranking of mutual fund schemes are sought to be brought under the regulatory ambit under Research Analysts Regulations, 2014. However, if they provide the same on public media like a newspaper or a website, they are excluded from registering under this regulation. Again, there was no need for this exemption because widely circulated information through a newspaper or website has more impact on the public and should, therefore, be under regulatory ambit.

Overall, the consultation paper sharpens the distinction between distribution and advisory and is clearly pushing people to choose either advisory or distribution as their vocation.  

This consultation paper also puts all the choices before the investor. Sebi has made its intention clear—to have a true-blue advisory community to assist investors. It is now strengthening that framework further.  

It also gives investors an option to engage with distributors, who are very much a part of the ecosystem. For those investors who want to do it on their own, there are platforms of regular or  direct plans.  

Frequent changes can be unsettling. It would be good to have a stable regime for some time, to allow the participants to settle. Apart from that, the changes suggested are mostly positive and welcome. Investors’ hands are strengthened and they will have more choices.

Suresh Sadagopan is the Founder of Ladder7 Financial Advisories.

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