Chemist or doctor: Sebi’s nudge to the industry
4 min read 22 Mar 2016, 08:23 PM ISTThe Sebi circular says that effective 1 October 2016, investors will see the total cost of investment in each scheme and how much commission in rupees their agent has got from their portfolio
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How much disclosure is good? The answer to this question will decide if the 18 March circular issued by the Securities and Exchange Board of India, or Sebi, (you can read it here: https://bit.ly/1pwzzTf ) is a good idea or not. The background first: Sebi has been trying to get mutual fund sellers to decide if they are chemists or doctors. If, as chemists, they simply vend the product, then they earn the commission from the product. If they choose to be doctors, they do not earn a product-linked commission, but take a fee directly from the investor. This neat view of the world was rolled out with the adviser regulation that encouraged sellers to choose between being a distributor and an adviser in January 2013. (You can read the regulation here: https://bit.ly/1RwpKBN . And three years later, with less than 381 people registered as investment advisers, Sebi has changed regulations one more time to force the industry into the two-bucket market structure.
Sebi hopes to achieve this by additional disclosures that tell the investor what she is paying as a sales cost. The disclosures that have upset mutual fund distributors are around the disclosure of costs and commissions. The Sebi circular says that effective 1 October 2016, investors will see the total cost of investment in each scheme and how much commission in rupees their agent has got from their portfolio. Remember, mutual funds are zero load—which means that your 1,000 goes to work fully—and have an overall cost cap. Commissions to agents are paid from this annual charge. Sebi now wants investors to know what their agent gets directly as commission and indirectly through gifts, trips and other ‘marketing charges’. Large corporate agencies, banks and some large distributors have been compensated above the industry standard by asset management companies (AMCs) via ‘gifts’, ‘trips’ and ‘other benefits’. Now, all such compensation will appear on the consolidated account statement that each investor gets twice a year.
The logic of this disclosure seems to be this: if I see value in the portfolio management services provided by my agent, I will continue routing my investments through him (this could be an online agent who simply makes it easier to transact in a flexible and smooth manner), else I will go direct. The investor may choose to go direct and engage the service of a financial planner who she compensates in the form of a fee. To help investors understand the difference between going direct and going through an agent, Sebi wants the total expense ratio for the direct plan and regular plan to be disclosed in the bi-annual statement. Direct plans are meant for the do-it-yourself investor who can trawl through thousands of schemes and build a portfolio, and they carry a lower cost. All others need to invest through an adviser.
Para C of the circular has not caused much noise, though I believe there is huge disquiet within the fund industry. This para mandates disclosure of AMC management remuneration. The name, designation and remuneration of the CEO, CIO, COO will now be disclosed on the website under the head: ‘Remuneration’. All employees who earn more than 60 lakh a year join this list. The ratio of the CEO’s remuneration to the median remuneration of the employees will also be disclosed. The idea behind this seems to be to bring Indian disclosures at par with those in the West where such disclosures are made. The US, Canada and some European Union countries are in various stages of implementing this disclosure.
Which brings me to the question I began with: how much disclosure is good? More is good. Maybe not for the investor who will get buried in paper, but for third-party analysts (like this paper) who can use the data to come up with league tables and analysis that the investor can consume. The circular does well to make it mandatory to get data disclosure standardised and machine-readable, paving the way for making it downloadable and comparable.
But I cannot let this question of how much disclosure is good, go, without looking over the shoulder at the other regulator in the system, who also oversees retail investment products, but is going in the other direction from Sebi. While Sebi is going down the path of tighter regulations and more disclosure, the Insurance Regulatory and Development Authority of India (Irdai), is going in the other direction. A January 2016 draft (https://bit.ly/1RlmiJ9) has hiked commissions and ‘rewards’ payable to insurance intermediaries with a peak rate of 70% of the first year premium. Not just hiking commissions and rewards, Irdai has lowered standards over the past few years. On 11 February 2014, the regulator did away with a minimum persistency metric of 50% for renewal of agency licence (https://bit.ly/1MyVC14) . The guideline allowed each company to fix their own persistency metric. A five-year persistency metric of less than 50% for the industry as a whole, shows that the insurance industry is unable to hold on to its long-term business for more than five years, while charging upfront the high costs for a long-term product.
Investment-linked life insurance plans and mutual funds compete for the same investor funds. How then can the government allow such different governance and consumer protection standards? This is clearly a case that the joint regulatory form, the Financial Stability and Development Council (FSDC), needs to solve. Similar disclosures must be made mandatory for sellers of insurance policies and for senior management of life insurance companies as well.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at expenseaccount@livemint.com
