On 2 January, the Securities and Exchange Board of India (Sebi) came out with a consultation paper—the third so far—on mutual fund adviser guidelines, taking another step in demarcating advice and selling. The guidelines said that a Sebi-registered investment adviser (RIA) cannot offer mutual fund distribution services, and added that a distributor cannot offer investment advisory services.
Despite the Sebi (Investment Advisers) Regulations, 2013 being in place since 2013, until now your investment adviser or mutual fund distributor would have typically done both—advised you on what to buy and when; followed by a sale transaction where you bought a mutual fund from her to execute the advice given.
Remember, the original 2013 guidelines had allowed distributors to set up a separate division (commonly known as separately identifiable departments or SIDDs) to offer advisory services. Then, the two consultation papers (October 2016 and July 2017) said that mutual fund distributors would need to set up subsidiaries and offer investment advisory services through them.
The third consultation paper goes a step further and now tells advisers and distributors to choose—either to become advisers or distributors. They cannot be both. The latest consultation paper gives time till 31 March 2019 to distributors and advisers to make the choice. But a final circular will most likely come before that.
Here’s what the third consultation paper from Sebi means for investors.
Advisers may not be able to distribute
Many advisers, despite getting registered with Sebi to be able to give advice, used to sell mutual funds. To be fair, investors needed someone’s help to complete the transaction. And advisers were happy to help: partly because it was an additional service that kept their clients happy, and partly because advisers could earn a trail fee. Fund houses pay trail fees to distributors for as long as the investor stays invested; the longer she stays invested, the more commission income there is for the distributor.
Although many advisers had segregated their advisory and distribution activities into separate divisions or companies, as per Sebi Guidelines of 2013, many such companies or divisions were headed by family members or people close to the advisers.
Sebi’s latest consultation paper tells advisers and distributors to choose between one of the two. Further, it says that if a person’s immediate relative (spouse, parents, sibling, child; as per Sebi’s definition) runs either of the two businesses, the person cannot be the other. For instance, if the spouse is a distributor, the person cannot be an adviser, and vice versa.
That could be easier said than implemented. “I wonder if this can hold legal ground. If my brother—who is an independent person—chooses to be a mutual fund distributor, why should that prevent me from being an adviser? Aren’t we living in a democratic country and allowed to follow the professions of our choice?" asks Rohit Shah, a registered investment adviser, and founder and chief executive officer of Getting You Rich, a financial planning firm.
Sebi’s paper also talks about banks being asked to choose. Some banks like HDFC Bank Ltd would have to close down their investment advisory division and continue only their distribution business. “These banks will give up their RIA licenses because they hardly had fee-only clients. Most of these banks have a sizeable chunk of their income coming from commissions earned from selling third-party products," said the head of one of India’s largest distributor, which is also a brokerage firm, on the condition of anonymity.
As per the mandatory commission disclosures of India’s largest distributors, six of the 10 highest commission-earning distributors are banks, having earned Rs1,487 crore in 2016-17, according to Prime Database’s mutual funds data. With so much money, it’s only to be expected that any RIA licence that banks would have got, would most likely be surrendered, if Sebi’s consultation paper becomes law.
Sadique Neelgund, founder, Network FP, a firm that trains aspiring financial planners, said: “For a financial planner to be charging fees to customers and at the same time earning commissions from mutual funds is morally and ethically wrong. However, ensuring that there are no common customers between the two outfits (advisory and distribution) would have sufficed."
Migrate to direct plans
Direct plans have got a further push. If Sebi’s consultation paper becomes law, in all likelihood advisers will switch to offering direct plans. These are essentially meant for investors who invest directly with fund houses, bypassing distributors. Since sellers don’t earn any commission from selling direct plans, it makes sense for more and more advisers to offer direct plans to their customers in order to provide both advice and execution services.
Sebi allows registered investment advisers to get details of their clients’ investments in direct plans; customers get served and they save on cost.
Suresh Sadagopan, founder, Ladder7 Financial Advisories, a financial planning firm said, “We are suggesting only direct plans to our clients now. As far as our older clients are concerned, we have been slowly migrating them to direct plans and then charging them an advisory fee. This shift was already on, but after Sebi’s latest paper, we will accelerate."
While a large chunk of debt investments go through the direct channel, just about 8% of the industry’s equity-oriented assets (equity and balanced funds) lie in direct plans, according to Prime Database.
But there are side-effects. Shifting to direct plans is not easy. Many advisers who we spoke to said that getting details of customers’ direct plan investments has teething problems.
Some experts, like the national distributor quoted above, told us that “many advisers would surrender their RIA license and go back to being distributors, since it is very difficult to get customers to pay an advisory fee."
Distributors cannot advise but...
In keeping with Sebi’s intention of keeping separating advice from distribution, the paper suggests that distributors would not be allowed to undertake investment or financial planning.
But they must ensure that the product category the distributor suggests to investors would need to be ‘appropriate’. What is appropriate? As per Sebi’s paper, distributors would need to decide which category of funds is suitable for investors and then give out the list of schemes that she sells in that category and lay down the facts about the client.
Sebi has invited feedback from the public on this consultation paper and you can send in yours till 23 January.