Here is the note given by the popular advisors forum to SEBI on the regulation of distributors
SEBI's Concept Paper on Regulations for Investment Advisors
The following are some "ground realities" that we would urge SEBI to please take note of while formulating its regulations for investment advisors. In line with these ground realities, we have also taken the liberty to outline what we believe will be a more inclusive and comprehensive approach to deal with the issues outlined in the concept paper.
Dealing with conflict of interest
The preamble of the concept paper says that it is meant to deal with conflict of interest that exists in an intermediary's business model - where he earns his revenues from one source (manufacturer) but is supposed to serve the interests of another (investor).By suggesting that an intermediary has a choice of either becoming an advisor or remaining an agent, are we saying that SEBI is happy for conflict of interest to remain so long as you call yourself an agent? If mis-selling based on commissions is the key concern, is SEBI saying that it does not want to protect an investor who goes to an agent but is keen on protecting an investor who approaches an advisor?
Just as the transaction fee proposal met with a resounding no from the distribution community, we strongly believe that only a miniscule proportion of distributors will opt to become advisors under the stipulations envisaged in this concept paper. SEBI would then have dealt with conflict of interest only in a tiny fraction of investment transactions executed by investors across the country and will then be trying to figure out what next to do to more effectively deal with this issue of conflict of interest.
Why should an intermediary become an advisor?
Once these regulations become a reality, an intermediary will be asked to make a choice of a business model. Please put yourself in the shoes of an IFA and consider the options. For the benefit of calling himself an advisor and therefore positioning himself better in a client's mind (which every intermediary would love to), he is being asked to give up his entire existing revenue stream (upfront plus trail commissions) in the hope of building a new revenue stream of fees from clients. There is a certain loss on one hand and an uncertain gain on the other. The loss that hurts the most is losing trail commissions on AuM that one has built up painstakingly over the years. Please also keep in mind that ever since entry loads were abolished in Aug 2009, MF distributors have tried introducing a fee based model - but with only limited success. The fear of not earning sufficient revenues solely from clients is therefore a very real one. If the fear of loss of income motivates even the best of advisory oriented intermediaries to opt to remain as agents and not become "investment advisors", what purpose will this concept paper achieve? Would SEBI have achieved its objective of dealing with conflict of interest and therefore protecting investors from mis-selling?
We need to understand and appreciate that entrepreneurs will gravitate to what they perceive is a viable business model. Finding ways to make the advisory model a viable proposition is in the best interests of all stakeholders - the investors (as they will receive better guidance), the manufacturers (whose products will not be mis-sold), the regulator (whose primary interest is investor protection) and of course the intermediary, who can build his business on a sustainable platform. This concept paper ignores the business viability aspect completely. We have seen that NPS, with its utopian business model (utopian from a cost perspective) has achieved precious little penetration. Have retail investors truly benefited from access to NPS? Couldn't a wider set of investors have got access to NPS if the fund management and distribution models were more practical? We fear that investment advisory - which is a critical need for this country - will go the NPS way if we completely ignore business viability.
Trail commissions do not represent conflict of interest
There is merit in the argument that upfront commissions can influence an intermediary to sell certain products, which sometimes may not be in the best interests of their clients - the investors. But, we fail to understand how trail commission from previous transactions can influence an intermediary to mis-sell a new product. Trail commissions are paid to intermediaries to incentivise them to offer an after sales service - by way of fund updates, response to queries and ongoing advice to clients. Where is the logic of asking an intermediary to give up trail to prove that he does not have a conflict of interest?
Interestingly, the IRDA Chairman recently observed that he is considering changing insurance commissions to an entirely trail based model, to eliminate conflict of interest. He did not talk about doing away with commissions - he specifically spelt out that high upfront and low trails act as a dis-incentive for agents to continue servicing the policies they have sold. A full trail commission structure he believes will check mis-selling based on upfront commissions and at the same time provide sufficient incentive to agents to service the policies they have sold.
Why should SEBI not think likewise? If SEBI were to allow trail commissions to be paid to all intermediaries (whether called agents or advisors) and ask MF intermediaries to seek upfront fees from their clients, there is likely to be a much better and more enthusiastic response to these regulations and a greater desire to acquire the new accreditation.
On a more philosophical note, as mentioned in point 1, what is the logic of allowing conflict of interest in one intermediation mode (agent) while eliminating it in another (advisor)? Why not take a leaf out of what IRDA is thinking - make all commissions trail based - regardless of the type of intermediary. We would suggest this has a better prospect of effectively dealing with conflict of interest rather than introduce a new category of intermediaries which few would opt for.
Piecemeal investor protection is not in the best interests of investors
We would strongly urge SEBI to please come up with a comprehensive set of regulations that in your view can effectively deal with mis-selling and protect investors. Right now, we have an Aug 22nd circular from SEBI which imposes a set of sales process guidelines on large distributors (about 600 ARN holders out of 45,000). If an investor goes to any of these 600 distributors, he is supposed to be advised appropriate products that are best suited to his personal risk appetite and circumstances. If he goes to any of the remaining 44,400, there is no such investor protection envisaged.
Even before the dust settles down on this, we have the concept paper which again proposes a bifurcation - between agents and advisors. If an investor goes to an advisor, he will get similar needs based advice (as what the top 600 are mandated to give) while if he goes to an agent, he does not benefit from this process. At a fundamental level, how can SEBI distinguish one investor from another - based on the intermediary he approaches? If we were to take both these sets of regulations (one actual and one proposed) together, is SEBI saying that it will only protect those investors who either go to a big distributor or to an advisor? And it will not offer similar protection to an investor who goes to a small agent? Isn't a small agent the most likely person who a first time investor in a small town would go to?
Insurance is a far more retail oriented product than mutual funds - and has many more agents involved in this business than mutual funds. Yet, there is a basic level of needs analysis that is mandated before each sale, to ensure at least a basic due diligence and appropriateness of product being offered. Similarly, the benefits and costs statement are mandatorily signed off by the investor and the agent.
Regardless of whether an intermediary is called an agent, advisor or anything else, there must be a basic level of sales process regulation in place that ensures that the intermediary conducts at least a basic level of due diligence before offering an investment product. And that regulation cannot be based on size of the intermediary - it has to be applicable to all.
When will an investor actually pay the intermediary?
The current regulatory stance seems to be that intermediaries should be able to seek fees from their clients based on the quality of their advice and service. There is no doubt on that in principle, but there is a serious flaw in its execution.
In a market like US, where fee based advisors are in substantial numbers, and work alongside commission based advisors, apart from the quality of advice, there is another important reason why they are able to command fees: they offer cheaper versions of the same product as opposed to commission based advisors - due to the presence of multiple share classes. When a client sees that the same fund is offered in a cheaper version because intermediation cost has been stripped off, he understands readily the need to pay his advisor an agreed fee. In UK, once the new regulations get implemented, there will be no commission based agent - so there is a level playing field automatically. The need for multiple share classes is less felt when all intermediaries don't earn any commissions.
In the proposed concept paper, we expect an advisor to sell the same fund that an agent would, which gives the investor no cost benefit, and then expect the investor to pay the advisor a fee over and above the in-built costs (from where an agent derives his compensation but an advisor is denied any compensation). In a value conscious society like India, this puts the advisor in an extremely difficult position. If at all SEBI insists on this agent versus advisor differentiation, the least that needs to be done is introduce a different share class for advisors with a lower expense ratio (which strips off the commission element from the expense ratios) and allow a situation like US to come into India. Fee based advisors will then offer low cost versions of the same products and will then negotiate an agreed fee for their services.
What should be the qualifications for an investment advisor?
The proposal that individuals must either be professionally qualified (CA/MBA or similar) or possess 10 year experience has met with widespread criticism. Why can't a commerce graduate with 5 years experience as an advisor qualify to take the necessary tests and attain the accreditation? The proposals are somewhat arbitrary and non-inclusive.
The idea should be to encourage the widest possible set of people to take the necessary tests, and only accredit those who pass the tests and meet their continuing professional education requirements. NISM has a very good certification called Certified Personal Financial Advisor - which could well be used as the entry level test for the new accreditation. Just like many professional courses have levels (MBBS & MD for doctors), you could have various levels for advisors, which can in turn be based on higher level tests and more on-ground experience. The scope of CPFA can be expanded to introduce different levels - each signifying a higher level of professional competence. But, shutting out somebody with say 8 years on-ground experience as an advisor completely out of the system merely because he does not have 10 years experience, is arbitrary and against the principles of natural justice.
On this subject, the concept paper is ambiguous on an important point. For large banks and national distributors, the paper seems to imply that only two people from their central team need to meet the qualification criteria and the hundreds of RMs who actually interact with clients need not be appropriately qualified - and yet the organisation will receive accreditation as an investment advisor. I am sure that is not the intention as the regulator surely will not ask an IFA to meet all the stringent qualification parameters while sparing a bank RM from the necessity of doing so. It would be good if the final regulations clarify that any individual who interacts with an investor would need to individually possess the required accreditation (just like the MF and insurance distribution regulations require).
To conclude....
We would respectfully put forward the following as our recommendations, based on the ground realities described above :
1. Introduce a basic level due diligence for any seller of any financial product that ensures that at least a bare minimum profiling of an investor is done and that products are sold on that basis. This is already in place for insurance products - there is no reason why we cannot have a simplified profiling exercise for investment products. Ensure that all investors in the country benefit from a basic due diligence process - not just a chosen few who go to a handful of "investment advisors".
2. If conflict of interest has to be effectively dealt with across the entire spectrum of intermediaries and financial products, bring in regulations that mandate only trail based commissions and do away with upfront commissions. Don't just deal with conflict of interest for a tiny fraction of investment transactions - deal with it across the spectrum of all investment transactions. Let the intermediaries earn alongside their investors rather than before their investors have earned anything from their investment. Encourage an environment of trail based commissions for all financial products. Trail does not induce conflict of interest - on the contrary, trail inculcates a long term outlook - which is what we desperately need in this business. Over and above the trail commissions, all intermediaries should be free to negotiate and charge fees that they and their clients decide as mutually acceptable, based on quality of advice and service.
3. Expand the scope of NISM's Certified Personal Financial Advisor accreditation to cover different levels of qualification. Make Level one mandatory for anybody who wishes to call himself an advisor. Higher levels can be awarded upon passing higher level tests and having certain experience levels. Run a publicity and awareness building campaign to inform investors to ask their intermediary about his level of professional qualification - based on the NISM CPFA level that he has passed. This should induce more and more intermediaries to aspire for higher levels of CPFA accreditation - which is in the best interests of investors. Higher levels of CPFA can also be tied into more stringent sales process regulations (such as comprehensive profiling, record-keeping of all advice etc) which are envisaged in the concept paper.
The fundamental difference in this recommended approach is that we are not creating two categories of intermediaries - agents and advisors - in an attempt to deal with conflict of interest. We are recommending that you deal with this issue more firmly and in a comprehensive manner - yet keep the business viability of intermediation in mind. Once this is taken care of, and all investors are offered a higher level of protection, then encourage intermediaries to take up higher and higher professional qualifications by building an aspirational value to these qualifications. Let competition among intermediaries drive them to achieve higher professional qualifications in a bid to attract more customers. This approach can be a lot more inclusive - rather than creating a tiny exclusive club of investment advisors - who will serve only a miniscule fraction of India's investing population.
(Source: wealthforumezine.com)
