What should have been a battle against mis-selling turned into a squabble between the Securities and Exchange Board of India (Sebi) and the Insurance Regulatory and Development Authority (Irda), now amplified by the way the government has stepped in to legislate on the matter. But let’s go back to the original concern.
Sebi has, over the last year, made mutual funds extremely transparent and relatively low cost. These funds cannot levy any front-end fee and any fee over 1% at the time of the customer’s exit goes back to the scheme to benefit the fund’s remaining customers. Further, if an intermediary wishes to charge a fee to the customer, it needs to be billed directly and transparently. As a result, mutual funds have to now squarely focus on performance and good distributors who don’t rely on mis-selling.
Distributors have long thrived on high fees from mutual funds for every new sale. It was profitable, therefore, to periodically convince the same set of investors to switch schemes. Mis-selling such as this is now less rewarding.
However, much of this good began to get negated as the mutual fund distributors turned to sell the more profitable unit-linked insurance plans (Ulips) regulated by Irda. Under the hood, both mutual funds and Ulips are investment products.
Therefore, the lack of coordinated action by Irda and Sebi resulted in a suboptimal outcome from Sebi’s actions on mutual funds: One slipped away, even as the noose was tightened on the other. This is what probably forced Sebi to issue an order in April, concluding that Ulips sold by insurers required that they register with Sebi for their investment portion.
The ensuing chaos resulted in a government ordinance on 18 June. This has now taken the shape of a Bill in Parliament. While the Bill deals with regulatory squabbles, it does nothing to address mis-selling. That seems to have been left to the regulators.
To its credit, Irda recently mandated a five-year lock-in for Ulips, making them medium- to long-term products—ensuring that investors aren’t duped to switch products within the short term. It has also disallowed premature withdrawals in the case of pension and annuity products—making it difficult for agents to sell pension plans as any other investment scheme. The expenses on Ulip funds have been lowered and spread out more evenly across the scheme tenure. This would help calibrate agent commissions and stop Ulips from being the only item on their menu.
However, insurance companies still have room to pay high front-end agent fees compared with mutual funds. Besides fees, Sebi has also been more stringent with mutual funds when it comes to disclosure.
Further, pension products under Irda can also be pure investment schemes without any insurance element. It will be interesting to know what the Pension Fund Regulatory and Development Authority (PFRDA) thinks of this.
All this shows that creating a level playing field for competing investment products seems to be an essential ingredient to curb mis-selling. Else, distributors will practise regulatory arbitrage: moving to that sector least regulated. This means bringing about identical regulatory environments, greater product standardization, transparent and low fees and effective enforcement.
PFRDA has managed to achieve this to a great extent in the New Pension System, or NPS, where a basket of standard products is offered at standard fees. A customer can choose them from any pension fund, the products competing only on performance.
But getting regulators on the same page isn’t all. Incentives for all the parties involved matter too.
Consider that despite its more rigorous outlook on regulation, PFRDA has not managed to get many customers in the last 14 months for NPS. Similarly, despite all the good work by Sebi, mutual funds are now finding it tough to attract retail customers.
Under NPS, like any other investment product, the distributor is still the main cog to move sales. If he can make more money by selling pension plans offered by insurance companies then whatever may be NPS’ merit, he will do what is in his interest. This is very similar to mutual fund agents switching over to peddling Ulips.
The truth is that financial products are, at the end of the day, usually sold by a distributor. Unless the incentives of the manufacturer and distributor are aligned with the interest of the customer, there will always be mis-selling. This is the key missing ingredient to curb mis-selling.
For investment products such as mutual funds and Ulips, a percentage fee for the distributor and manufacturer based on the value of the customer’s investment portfolio can achieve this. High portfolio growth equals high fees. This would require the distributor to do homework and sell the product best suited to the customer. It also requires ongoing extra services to ensure that the customer does not get poached once the investment portfolio grows.
This model is already gaining favour among mutual funds. Mutual funds now offer distributors a higher fee based on the value of the client’s portfolio. Here, both the mutual fund and the distributor stand to gain if the client profits.
These examples already exist in our economy. Regulators don’t have to go that far in finding insights that will help them.
Ashish Aggarwal is executive director, Invest India Micro Pension Services.
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