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Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

We need Investment Adviser Regulations version 2

The current regulations is not clear about what kind of segregation is permissible

Financial advisers were sought to be brought under regulatory oversight through Investment Adviser (IA) Regulations, 2013. The intent of the regulation seemed to be to avoid conflict of interest, as much as possible. To that end, segregation of the activities and arms length dealings were central to the regulation. Also, the regulation sought to raise the bar with certain basic level of education and experience (graduation with five years of experience or a post-graduation, for example) and an appropriate certification such as being a certified financial planner (CFP). The regulation also wanted advisers to understand clients’ situation enough to enable them to select suitable products through proper procedures, after doing risk profiling.

Advisers were now expected to be fiduciaries. They were to collect their fees only from the clients they advice, and any perceived conflict needed to be conveyed to the clients.

It also wanted the adviser to maintain records properly, do yearly audits for compliance, and be prepared for inspection by the market regulator. In essence, the regulations have tried to create a new class of advisers, who are better than the existing crop.

So, what went wrong? Why are there just about 200 investment advisers in the system, even after two years? Is it that the regulations are so onerous that people are getting scared? Is it that the compliance costs are too high while the potential benefits of registering as an IA too little? Is it that collecting fee from the clients is an idea whose time has not come?

The answer is partially yes to all the three questions above. But these are not the only reasons.

The regulations were not clear about what kind of segregation is permissible, what is the definition of “arms length", or which are the structures that are kosher in terms of effecting proper segregation. Companies are struggling with issues such as what constitutes a separately identifiable division, what kind of Chinese Wall needs to be erected, who can be a compliance officer, and many more. Most people are grappling with these issues. Those who contact the regulator for clarification have been getting different answers from different people, which adds to the confusion. Hence, many financial advisers are sitting on the fence.

Apart from being ambiguous, the regulations expect advisers and their representatives to be compliant with certain education, experience and certification requirements. Also, the data collection and record keeping rigour in terms of following processes and keeping a record of advice given require a lot of work, which pushes up the cost. Various processes need proper software support—for research on products advised, risk profiling, record keeping, planning, and others. For all these efforts, what do they get? Most reckon, it may not be much since most clients may not have still heard of these regulations and may not know enough to appreciate the higher standards that the new advisers have to comply with.

Though the market regulator’s intention was to bring in a new class of advisers, the intended results are just not forthcoming. There is another reason for that—income.

Most people coming into advisory are from the independent financial adviser community. They are used to getting commissions or brokerages from their principals. Many have built significant businesses around that model.

Also, most feel that collecting fees from clients is not easy, and would prefer to retain their brokerages. But, at the same time, they also want the respect that an adviser gets. So, they would like to keep the income and also become advisers.

In this context, many are finding the regulations difficult as the meagre fees they may be able to collect does not justify the cost and efforts incurred to segregate the business. This is the one principal reason that deters potential candidates from becoming advisers.

Then there is the issue of credibility. Quacks abound in this business. There are very few who have registered and are complying with the regulations but thousands who brazenly purport to give advice without being registered. A cursory search on the Internet would produce hundreds of hits. But the market regulator is not pursuing them and enforcing its own regulations. So, is it any surprise that the number of those choosing to be registered advisers is this low?

The regulations allow segregation and tries to avoid conflict of interests. This creates situations where there are two related entities, kept apart. But conflicts remain. Take the case of banks. They have supposedly erected a Chinese Wall, but the “advisory" given is passed on to the other division for “execution". Mostly, the niceties are managed by punching in some very basic data on a computer software which generates a list of products to invest in. This is how banks and corporate entities give “advice"—distribution and advisory stay within the same entity.

Also, banks share client data with their relationship managers, including transaction history, which shows where the money is going. Armed with this data, relationship managers call banking clients and start pestering them to buy products, even questioning why they are doing some investment with someone else!

If the intention of the regulation is to ensure the best for clients, it is not happening now. And it will not, as long as there is potential of conflict. The current regulations were a good first step. But the best way to avoid conflict of interest and ensure that clients get good service is to abolish commissions across all products. The UK, Australia and the Netherlands have done this. It has worked wonderfully in the UK. Over 60% of advisers claim that they have grown after regulations.

When such a regulation is introduced, it is likely that no one will welcome it. But, they will adjust to it, over time. This needs to be done in the best interest of investors.

Suresh Sadagopan, founder, Ladder7 Financial Advisories.

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