BackWhy IRDAI, RBI need to follow Sebi on Adviser guidelines
The final pending circular will pin down the finer details, but the broad strokes are clear
PremiumThe crucial lines between an adviser and an agent have finally been clearly drawn in the Indian capital market. This is as crucial as drawing a distinction between a doctor and a chemist. The process that the capital market regulator began in 2013 ended in July 2020 with the Securities and Exchange Board of India (Sebi) notifying the registered investment adviser (RIA) amendments that have gone through years of debate, consultation papers and introspection. Sebi began by asking a question to the mutual fund intermediary: who are you? Are you an agent of the mutual fund or are you an adviser to the investor? The answer to this will determine in whose interest you work. The agent gets his compensation from the mutual fund in the form of a trail commission (Sebi banned front commissions in 2009) and the adviser is compensated by the investor through a fee. You can read the way the debate moved over the years here.
The final pending circular will pin down the finer details, but the broad strokes are clear. Individuals have to choose between being an agent and an adviser, they cannot be both. An adviser can execute the investor’s buying and selling through the direct plan (the mutual fund option with no commissions, hence cheaper). There will be limits on what the adviser can charge. There will be net-worth and qualification thresholds for advisers. Non-individuals (firms, banks, corporate agents) can offer both distribution and advice, but to a client (identified by his PAN) it can only offer one of the two services. The client-level segregation solves many of the issues that the earlier version of this regulation suffered from. For the individual agent who wants to become an adviser, the trail commissions will continue, the new business will be on a fee-for structure. We’ll have to wait and see if these regulations prevent banks from churning and selling unsuitable products.
When you step back and look beyond the capital market to ask how the other regulators are solving this problem, you at once see how Sebi is generations ahead of both the Reserve Bank of India (RBI) and the Insurance Regulatory and Development Authority of India (Irdai), in its approach in creating a market that differentiates between distribution and advice. While Sebi has taken a first principle approach to sort this issue, Irdai is floundering around in a mess it has made that goes on hurting the household investor over and over. The insurance industry makes no difference between an agent and an adviser. The high commissions of the agent are built in on the premise that the investor needs advice. That makes the agent an adviser and builds a fiduciary (responsibility towards the client) relationship. But the insurance agent is there to maximize his commission and cares little what damage he does by selling toxic and unsuitable products.
Instead of solving this, in a weird move, Irdai, via a 14 December 2016 notification, split the market into agents and intermediaries. Intermediaries include brokerages, corporate agents, web marketing firms and are further split into two—those with less than half and those with more than half their income arising out of insurance. You can read about this here.
Irdai actually went ahead and formalized under-the-table payments made from insurance firms to agents and called them “rewards", bringing the total first-year commission to a huge 42%. Because the renewal commission drops to 7.5% for the rest of the life of the policy, what do you think the financial incentive for an income-seeking agent is? Churn, churn, churn investors out of their old policies into new ones. No wonder that less than half the policies sold don’t survive for five years in the investors’ portfolio. They are just hard sold, mis-sold and cheated into buying new policies that give the agent a huge first-year commission. Why Irdai exists, for whose interest is not clear.
RBI did its usual half-hearted one step in and two steps out jig with its 2016 notification, hoping to solve the problem of mis-selling by the banking channel by hiving off its advisory into a separate subsidiary that would be registered under Sebi’s RIA regulations. You can read about it here. By not fixing the responsibility on bank managements and boards of allowing incentives that lead to mis-selling, RBI has looked the other way from the way banks have sold toxic and unsuitable products. The clear demarcation between distribution and advice has not been put in place by RBI.
Sebi has shown the way and now we have a market place with very different rules of the game in the way insurance and mutual funds are sold across different channels. Other regulators must follow. Solving this is beyond individual regulators to work through and will need the intervention of the ministry of finance. The finance minister needs to get into this question and nudge both Irdai and RBI to implement the RIA regulations. The Financial Stability and Development Council (FSDC) was supposed to be the place where these issues would be hammered out, but that has clearly failed. Nirmala Sitharaman needs to understand this issue and sort it out in investor interest.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation
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