SEBI Board meeting - FE piece

I have a piece in today's Financial Express on the decisions by the SEBI board yesterday - yes that was quick (there is one error as this was written before the press release came out). Here is the full piece:

The Securities and Exchange Board of India (Sebi), in its board meeting yesterday, made several important modifications to the regulatory framework of the securities markets. Of these, the one that’s most significant would probably attract the least news coverage. That relating to regulation of investment advisors.

Sebi has, in the past, not once but twice, come up with draft regulations to register and regulate the huge number of people who are in the business of investment advice. With the regulations now passed by the Sebi board, anyone who gives investment advice for consideration must register with Sebi or a self-regulatory body and be subject to a deeper and wider Sebi jurisdiction.

So, if you give stock tips for money, you must first register with Sebi. Conversely, if you give free advice, then you are exempt from registration. In addition, anyone who is registered with Sebi and who provides investment advice which is incidental to their main business would be exempt from registration.

For instance, a stock broker who provides research reports or other advice would be exempt from registration. This exclusion is sound as the broker is already under the deep and pervasive regulation of Sebi and any misconduct by the broker is a short inspection of the broker away. Clearly, the broker must fulfil the substantive regulations which apply to the registered investment advisor. So, fraud by means of churning a portfolio would be prohibited by a broker as by a pure-play investment advisor.

With this regulation, the entire industry, which is involved in distribution of securities products and even financial products, is sought to be covered. Therefore, anyone peddling a security to an investor would be covered by the regulation and any wrong advice and misconduct would attract scrutiny and punishment by Sebi. Until today, Sebi was sceptical about introducing these regulations because just the number of distributors would run into hundreds of thousands and regulating such a large number would be outside the available manpower and bandwidth of Sebi. Many of the ills of the financial industry actually have their origin in distributors and advisors, some of whom are unscrupulous and would sell the worst product for a given investor merely because they get a higher commission from selling that product.

While the promise of Sebi’s reach beyond the securities markets and into the entire financial market with the help of other regulators is still some practical distance away, this is an important though difficult step forward for the investor population of the country.

The second decision by Sebi is related to mutual funds and here again Sebi has made the right choices. It has allowed a higher expense to the asset management company of the mutual fund if it is able to garner funds from smaller towns. Therefore, an asset management company would get a higher expense if it has the ability or takes the pains of going beyond the lucrative large cities.

This move has two impacts. One on the investor, and the other one on the asset management company. Investors will need to bear a larger burden because the higher expense will come from their pockets for compensating the asset management company. However, the amount of incremental expense is not substantial and is unlikely to substantially impact investors adversely. From the asset management company’s perspective, there are both costs and benefits involved.

Clearly, the large cities are the easy markets with higher disposable income. To go beyond them would require substantial expenses and consume time, though trying to tap this untapped market would come with the benefit of a higher expense ratio. Each asset management company will need to see whether it is able to generate more income compared to the costs incurred in penetrating the markets and try to move into the semi-urban and smaller urban market. While many smaller asset management companies will protest at not being offered the pie, the dessert is only available to those who are willing to put in that extra effort to go beyond the low-hanging fruit.

The other decision with respect to expense ratio of mutual fund asset management company is also a good move. Until now, the expenses an asset management company charged and could seek re-imbursement from the fund were capped. Not only that, Sebi prescribed how the expenses would have sub-caps. By making expenses fungible, Sebi has removed an area of pointless over-regulation within the overall regulation of capping of expenses. Similarly, charging the exit load back to the scheme instead of it going to the asset management company is an investor-friendly move which will insure that distributors who keep investors pointlessly churning by buying and selling mutual fund units would not indirectly be incentivised for committing fraud on the investors (Sebi regulations term churning as fraudulent). Every time a distributor makes an investor sell prematurely, an exit load goes to the asset management company, which, in turn, has more money to pass on to the distributor, thus incentivising illegal behaviour. The incentive now goes away and short-term investors will be penalised for the benefit of the longer-term investors.

On the third topic of IPOs, Sebi has enabled e-IPOs. While the fine print is not yet available, presumably it will permit applications being made from secondary market broker terminals. This would make applications more efficient and accessible from an existing network of exchanges. This will be good depending on how efficient the process is made in terms of processes and form-filling which could be a roadblock.

There are a catena of other announcements which are smaller and more incremental but are in the right direction.