The coming Sebi storm for fintechs

The man had been sent by a senior bureaucrat who wanted to invest ₹26 crore in mutual funds through the fintech arm of the mutual fund distributor. But the investment was stuck—and the refunds were not forthcoming. “It was nerve-wracking. I pulled as many strings as possible to get the bureaucrat’s investment sorted. Only when his refund was processed did this man stop turning up at my house," says the officer.

Behind the stalled investment was a change in rules by the Securities and Exchange Board of India (Sebi). Last month, distributors and brokers had to transition from executing mutual fund transactions through their own fintech platforms to exchange platforms – either the BSE Star Mutual Fund or the NSE NMF—throwing the sector into a tizzy. Customers were left fuming, and sellers in panic as units were not allotted for almost 30 days.

That’s not the only reason why Sebi is making fintechs nervous.

Last month, Sebi issued two discussion papers that aim to bring a semblance of standardization on how fintechs are peddling regulated products. According to people aware of the matter, another discussion paper is in the offing on bridging the gap between research analyst and advisors which will tackle issues around digital platforms that recommend equities or stocks.

For fintechs in the business of selling and advising securities, the message is clear: The referee wants to tighten the rules of engagement. And a host of grey areas are in its crosshairs—from research analysts peddling model portfolios to fintechs selling corporate bonds and accountability for finfluencers. Mint examines the implications of the coming Sebi storm. The regulator did not respond to queries emailed to it.

To model or not

First up, the regulator is likely to issue a paper “on bridging the gap between who is a research analyst and who is a registered investment advisor" this month, said an official with direct knowledge of the matter. Discussion papers are usually the first step in a change in Sebi regulations.

This will have implications for a large investment strategy platform like smallcase. Started in 2016, it now has a 4.52 million user base. One of its offerings is the curated portfolio—baskets of funds created and recommended by the fintech’s research analysts as well as investment advisors—which investors can choose from.

Typically, brokerage firms offer model portfolios through smallcase, most do so under Sebi’s research analyst norms. “The regulator has observed that many fintech firms were advising on equities in the garb of acting as an analyst," said the official cited above.

In the last two years of unprecedented growth in first-time equity investors, quite a few red lines have been crossed. “As a rule, research analysts can offer research on stocks but many fintech firms are offering model portfolios— they not only recommend a portfolio, they also suggest ways to rebalance it. In short, they are running a mini-PMS (portfolio management service) without a licence and in some cases straight up acting as investment advisor," said a person with direct knowledge of the matter.

For the regulator, the worry is that research analysts (RA) dispensing such advice are not accountable to the investor, unlike registered investment advisors (RIA) who have to comply with stricter norms. Sebi has constituted a working group to see if the difference between RA and RIA norms is being exploited. The former are more disclosure-driven and require keeping a distance between research and other activities. In contrast, RIA norms require post-graduate qualification, a cap on fees and a contract between the client and RIA to ensure accountability.

“The regulator is looking at three major aspects— whether there should be a minimum and maximum fee threshold for RAs, whether their qualification criteria should be raised, whether Sebi should bar the bundling of equity (model portfolios) or ensure strict norms such as no weightage recommendations, no customising, no portfolio rebalancing," said the official cited above.

In some ways, research analysts use loopholes not only to do the work of a PMS but also behave like a mutual fund, says the founder of a fintech firm. “Why do you need a highly audited mutual fund industry, if anyone can create a basket and trade it?" he says.

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But another founder of a large online broking firm disagrees. “The current confusion started due to a settlement order issued against a RA. The work of a RA is to recommend stocks based on their research, if that is not allowed, then what is? But if they are offering customised portfolio based on the profile of the investor, there could be a problem," the founder says. He is referring to a Sebi settlement order issued in May this year against Amit Jeswani, a Sebi-registered RA, in which it said RAs cannot offer model portfolios or advisory services.

A spokesperson for smallcase said it was not worried about any change in regulation. “The smallcase platform supports various modules—RAs providing just the list of securities, RAs providing list and weights of securities, and comprehensive investment advisory module for RIAs. Regulatory changes increasing the safeguards for investors are always welcome, as they help the ecosystem grow in a healthy manner. This is not expected to have any business impact on the platform," said a spokesperson for smallcase in an emailed response.

Bracing for a change in regulatory stance, however, some firms are changing tack. For instance, IIFL Securities which offered portfolios is going to launch a ‘grow box’. “This will simply be a copy of a mutual fund portfolio. The investor can choose which one they like," said Suvajit Ray, head product and distribution, IIFL Securities.

Selling mutual funds

On 6 July, Paytm Money said it’s giving up its RIA license and will work only as a mutual fund distributor to comply with new Sebi norms. Consequently, all ongoing SIPs (systematic investment plans) and mutual fund transactions had to be routed through BSE Star MF, a mutual fund platform of the BSE, from 25 July.

That opened a can of troubles. One, technical glitches dogged all distributors as they routed transactions to the exchange platforms. Two, the BSE Star MF requisite for a demat account led to more confusion—and ripples were apparently felt across fiduciaries.

According to one officer working with a regulated entity who invested via Paytm Money, the mandatory demat account rule put him in a spot. “Under staff regulations, I cannot trade/invest in equities or derivatives. Having a demat account and trading account with Paytm Money may, by mistake, result in stock or derivative trading—which will be a serious violation," he says.

According to people with direct knowledge of the matter, the very next Monday, Paytm Money officers went to the Sebi office in Mumbai, where the option of delaying the transition deadline to 31 October was discussed. That meeting threw up one possible solution. “The Paytm officers suggested that simple execution platforms might be a way out," said this person. Paytm Money denied this chain of events.

“We meet the regulator multiple times for discussions and guidance on different capital market products/new regulations/consultation papers. The deadline for migration was extended to 31 October by us to ensure our retail investors have sufficient time to adapt. We continue to offer execution services to investors in direct MF schemes," said a Paytm Money spokesperson.

Three weeks later, on 22 July, Sebi issued a discussion paper on execution-only platforms, which can act as intermediaries to help execute trade with reduced compliances. Such a carve-out option would benefit the likes of Paytm Money, Kuvera, ET Money, Groww and Zerodha Coin.

“Though platforms provided by stock exchanges enable the investors to transact directly, there are a considerable number of investors who may find it more convenient to avail the services of a technology/digital platforms for transactions in mutual fund schemes of different AMCs (asset management companies)," said Sebi in the discussion paper.

There was another set of complications. From 1 July, Sebi had discontinued pooling of funds by stockbrokers for mutual fund transactions. Earlier, a broker would collect money from individual investors in a pool account to buy mutual fund units. Sebi’s new rules ensure that money now flows from an investor’s account to the fund house (whose scheme the investor wants to buy) via the platform and the clearing corporation/ exchange platforms. “This increased our reliance on exchange platforms. But there were many glitches in issuing mutual fund units or refunds," said Nithin Kamath, founder and CEO of Zerodha.

As a result, transactions have been stuck for 30 days; in amounts ranging from thousands to crores of rupees, according to investors and brokers Mint spoke to. NSE and BSE say the backlog has been cleared.

“Currently, we do not have any pending transactions to be executed on our NSE mutual fund platform," said an NSE spokesperson in an emailed response. “There were some teething issues which have been addressed and resolved fully," said a spokesperson for BSE.

The debt question

The other area which has caught Sebi’s eye is corporate bonds. Typically, these are products favoured by high net-worth individuals. All the buying and selling is settled through clearing corporations to minimise third-party risks of defaults. But with the aim of democratizing the corporate bond market, many fintech firms have mushroomed in the past couple of years to offer corporate bond investments in small ticket sizes.

Firms like GoldenPi, Bonds India, Wintwealth, BondsKart, India Bonds buy the bonds and assume the risks associated with settlement. The role of clearing corporations was played by these bond platforms, which directly accepted funds from the client and processed the security settlement off-market.

“Some of these platforms seemingly operate in a manner similar to organized avenues for trading, especially stock exchanges, for executing trades in debt securities... But they do not come under any regulatory purview," said Sebi in a discussion paper issued on 21 July.

These platforms also were flouting rules—bonds were being sold within six months of the allotment, or they were split into smaller denominations, or both listed and unlisted bonds were being bunched together. Sebi will soon bring these platforms under regulatory purview.

Belling the social media cat

The one area the Sebi vigilance over fintechs is facing a hurdle involves finfluencers. A few years ago, the regulator mandated that anyone providing share tips against a fee needs to be registered with it. Finfluencers found a way out—they are empaneled with brokers and fintech companies, and offer stock tips under the garb of financial awareness videos. But the regulator can still act. “Sebi wants to police every social media influencer, but it cannot. But it can say that startups like ours cannot hire influencers as spokespeople. A simple regulation could be that a fintech company or financial company cannot advertise through influencers. This entire content industry will dry out," said the second fintech founder cited above.

As in all regulatory efforts, the trick is not to choke a sector, even while laying down the rules of the game. “Sebi has to play referee but it’s important to keep the process customer-centric. Empower the user, allow her the flexibility to decide on the viability of asset classes. Put in entry conditions, disclosure obligations and clear directives on mis-selling. As long as the user is making decisions, and the system is watching over supply of information that aids in such decision making, over-regulation of platforms can be avoided," says Shruti Rajan, partner, Trilegal. It’s a tightrope walk.

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