A handbook for regulators and cracks in the wall

The Financial Sector Legislative Reforms Commission (FSLRC) has written the grid of a brand new regulatory structure. With 16 Acts of Parliament to be repealed and 50 Acts to be amended for the Indian Financial Code (IFC) to become a reality, the political journey ahead is complicated. The ministry of finance took a pragmatic view and used the meeting ground of regulators, the Financial Stability and Development Council (FSDC), to build consensus about implementing those parts of the IFC that need no legislative changes. The eighth FSDC meeting, held on 24 October 2013, approved 12 areas that each regulator will work on to make them IFC-complaint. These include consumer protection, framing regulations, notices, transparency in board meetings, reporting, approvals, investigation, adjudication, imposition of penalties and capacity building. They agreed that these should be implemented quickly. Two months later, on 26 December 2013, the ministry uploaded a handbook that gives guidance to the regulators to help implement these steps with the idea that there should be regulatory harmony so that market failures that occur due to regulatory blind spots, regulatory arbitrage and turf wars are reduced.

Though there is a lot to chew on in the handbook, the part that I am keen to see on the road is the one where a new category of consumers will be created. Individuals and small and medium enterprises that buy financial services below a certain value will be considered “small consumers”. They will have an additional layer of protection to prevent them from getting cheated since they have the least ability to navigate the technical world of financial products. Small consumers will have the right to receive “suitable” advice that takes into consideration the individual circumstance of the person or firm. Additionally, there will be products that will need advice irrespective of whether the consumer fits into this “small consumer” category. I’d like to see all home loans, life and general insurance products (other than term insurance) and mutual funds (other than broad market index exchange-traded funds) and the National Pension Scheme fall under the advice-needed category.

The IFC says that in case of a dispute between a small consumer and the financial service provider, preference will be given to the consumer. Additionally, small consumers will get easy access to a consumer grievance redressal mechanism.

My fear is that one way to kill this special category will be to set the threshold so low that most of the products fall out of the reach of this protection for the people who actually use them. For example, if the regulators were to look at the 13,000 average ticket life insurance premium for 2012-13 and fix this as the threshold to define a “small consumer”, a large part of the market will get left out. The urban mass affluent Indian is earning well and the outlay on financial products is rising. The threshold of who is a “small consumer” must be done keeping in mind such investors and not the national average.

Then there will be the tricky issue of deciding whether each transaction will decide who a “small consumer” is or will it be the annual financial transaction in that product. Common sense points towards a per transaction rule; the annual road is messy.

If the regulators get this right with a sensible threshold established for “small consumers” and the list of products that need advice at the time of sale includes the products mentioned above, the mass market will be an advised market with do-it-yourself investors opting out by signing a declaration that they are investing at their own risk. Once this happens, and there is harmony across various regulators, we’ll see big ticket investments in pan-India advisory and distribution businesses. This has not happened yet due to the different regulatory requirements and the pace of regulatory change in the past few years, with uneven expectations from the manufacturers and the sellers. I believe we’ll see a lot of action in this space. But then let’s wait for the regulations first.

End note: The artificially created walls between various types of corpus-building products are beginning to come down. The Insurance Regulatory and Development Authority has released the draft guidelines for investment by insurance companies into exchange-traded funds (ETFs) on 9 January 2014. These allow insurance companies to invest in ETFs run by mutual funds. About a decade ago, sharp lobbying by an insurance chief executive officer, who wanted asset management as part of the insurance company mandate, had got the wall constructed that prevented insurance companies from using the asset management services of mutual funds. A sensible regulation would have allowed those who wanted to outsource investment to do so and others to do it themselves. Over time, different parts of this wall have been crumbling. I’m hoping to see the rest of the wall break too and the choice left to insurance companies.

The reporting of mutual funds is far superior than that of insurance companies where benchmarks are not known and return comparison remains extremely difficult. It would encourage portability as well—allowing investors in bundled policies to exit funds performing poorly while retaining the risk cover.

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