About a year ago, in September 2011, the capital markets regulator, the Securities and Exchange Board of India (Sebi), issued a concept paper on regulation of investment advisers. In its board meeting in August 2012, Sebi approved the investment advisers’ regulations.
The regulator seeks to define the role of the investment adviser and bring clarity on an adviser’s responsibility towards the client, that is you. Now all “investment advisers", as defined by Sebi, will have to register with it and come under the regulation. While the fine print is still to come, let’s take a look at what the regulation means for you and the industry on the whole.
Sebi has defined an investment adviser as a person or entity that provides investment advice directly or indirectly for a consideration, which may be received directly from the investor, or who holds himself as an investment adviser.
Distinguishing your adviser from an agent: The foremost change is that if your investment adviser charges a fee, then he or she will be clearly distinguished from brokers/distributors/agents who sell products. To cut confusion, Sebi has said that investment advisers—financial planners, independent financial advisers (IFAs), other individuals and firms—will have to use the word “investment advisers" in their name.
Usually an agent is appointed by the manufacturer and derives livelihood by selling the manufacturer’s product. On the other hand, an adviser is someone who considers your overall financial requirements and is doing you a service for which you pay a fee.
Advisers’ code of conduct: The new regulations will lay down the code of conduct for advisers and other fiduciary duties. The fine print will have the nuances, but essentially it means that Sebi wants to protect your interest. Says Rajesh Saluja, chief executive officer, ASK Wealth Advisors Pvt. Ltd, “These directives are a positive step towards building transparency in the advisory practise to distinguish genuine advisers from product pushers."
Certification for advisers: This will enforce a minimum standard or qualification for an individual to qualify as an adviser. While it is not specified yet, the draft spoke about certification from the National Institute of Securities Markets (NISM), which was established by Sebi to promote securities market education and research.
Additionally, the market has the certified financial planner award by the Financial Planning Standards Board (FPSB) India. Says Ranjit Mudholkar, vice-chairman and chief executive officer, FPSB India, “While there is no mention yet, we are optimistic that the final regulation will include the CFP certificate for advisers."
Separation of commission and fee income: A significant change that the regulation will bring about is specifying that your adviser will not be able to receive remuneration from any person other than you. This means your adviser can earn a fee from you but no commission from the product manufacturer such as an asset management company or an insurance firm.
The press release goes on to clarify that banks or companies that are also distributors will need to create a subsidiary or separately identifiable department or division to offer investment advisory services. So this means if you are dealing with a bank-sponsored wealth management division, it will now have to separate the investment advisory division, which can charge you fees for handling your portfolio (if there is one) and pure distribution or selling of products.
The release, however, is silent on what this means for IFAs and financial planners, who advise clients in their own capacity rather than through a company.
What it means for advisers, banks
A lot has changed in the years since entry loads in mutual funds (MFs) were done away with. Says Dhruv Mehta, chairman, Foundation of Independent Financial Advisors, “At present, we are in a transition phase. Sebi was inclined towards a negotiated fee between the advisor and client after the ban on entry load. Now that the model has changed and advisers have struggled to negotiate a fee, there is this new regulation. Not earning commission income will definitely hurt." This is because while established financial planners derive a bulk of their income from fees, many agents who are still in the transition phase derive a higher percentage of their income from commissions.
Says Suresh Sadagopan, a Mumbai-based financial planner, “This will affect newcomers to a great deal and push them back towards pure distribution."
One may think that the solution lies in raising the advisory fee, but that too is not simple. Says Sadagopan, “We spend a lot of time with the client in fixing the initial fee and it’s hard to go back and ask for more without any significant change in our service."
The fact is that commission income is important to the independent adviser. Says Mehta, “This regulation could mean that the advisory model gets killed. Rather than banning, let the client decide what means of compensation is acceptable and make that transparent."
It works differently for banks and companies as earnings from fees and commissions simply needs to be separated. Says Prateek Pant, director, products and services, private banking, RBS India, “For private banks like RBS, there are specialists who advise clients on their investment portfolios and are designated as investment advisers. They are distinguished from the bankers who have holistic ownership of client relationships across all products and services. So the structure is in place but the framework will have to be looked at once the regulatory details are known."
Says Saluja, “We have a fee model in place but the industry is still trying to work out the details on implementation; how an adviser’s compensation gets structured will be known only once we have the detailed regulation."
So prima facie it seems that companies are better placed. Says Mudholkar, “The regulations are positive and can lead to further institutionalization of the industry."
Investment advisory is a fairly new concept and the industry is highly fragmented. With the introduction of regulation for advisers, the part of the industry that is getting more disciplined and organized can be clearly brought under one umbrella. But challenges will be there. Says Ashvin Parekh, partner, national leader (global financial services), Ernst and Young Pvt. Ltd, “In the short term, there could be some deterrence to the regulation but in the medium term, investors will benefit as quality and integrity of advice can be judged better."
What it means for you
Undoubtedly, the transparency is welcome and certain provisions such as recordkeeping for five years are in your interest. The press release from the regulator mentioned the setting up of a self regulatory organisation (SRO) for regulation of distributors, but did not specifically mention an SRO for investment advisers (as distinguished from distributors) which was mentioned in the concept paper. The release does say that initially Sebi will directly register and regulate investment advisers. This indicates the eventual setting up of an SRO for investment advisers to which you can turn to, among other things, for dispute resolution.
While the fine print is awaited, there is a section of the industry that is not happy with the separation of commission as advisory fee, maintaining that the regulation on how one earns fees is not favourable. The industry, however, is unanimous in welcoming transparency that this regulation introduces in favour of the client, which is you.