Investment advisor regulations – fourth time lucky

I have an opinion piece on the proposed amendments on the investment advisor regulations in today's @EconomicTimes where I argue that some of the proposals will be counter-productive and anti-competitive, not to mention unconstitutional:

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"The topic of investment advisor regulations and distributor regulations must be one of the toughest to crack from a cost benefit analysis. SEBI has now come out with its fourth concept papers for discussion. The latest one is a bit of a departure from the previous ones. It must be said that SEBI is one of the most thoughtful and open minded regulators willing to listen to criticism. Some follows in this piece. There would be few regulators in India or abroad which would not have by now implemented new regulations.

SEBI in its introductory paragraph says that the mischief it seeks to remedy is investor complaint with respect to assured returns provided, exorbitant fees charged from client, mis-selling, non adherence to risk profile, non disclosure of service or fees and imposition of random charges.

SEBI proposes broadly to introduce seven major changes to the current regulation of investment advisors or IAs. The hallmark of IAs is that they provide a non conflicted model of providing advice to investors. They are different from distributors, whose main task is to sell financial products, generating commissions not from the client but from the manufacturer of the product like a mutual fund. Both play an important part in the ecosystem of financial inclusion. With just over 700 IAs, most of the heavy lifting is done by the distributors who are regulated by AMFI a trade body of mutual funds.

The first area of proposed reform is to provide either distribution or advice, the segregation done client-wise. In other words, a person can act as either advisor or distributor, but for a particular family can provide only one of the two services. This makes sense but will certainly increase the cost of compliance because of an external audit requirement. Presumably, no audit is required if a person does only advisory work.

Secondly, it is prescribed, that an IA must recommend only commission free mutual fund products, known in industry jargon as direct plans. Additionally, the IA of its group/family may not get any fee or commission for execution of the investments except from the client.

Third, written terms and conditions must be entered into before starting advisory work and no fees are charged before such written agreement. So far so good. However, SEBI should clarify that the terms can be accepted through a click-wrap agreement rather than a printout and signatures. With robo-advisors providing exceptional and objective advise based on various inputs which measure a person’s risk appetite, it would be sad if unnecessary sand is thrown in the wheels of efficient and affordable advice. On the other hand, providing a clear roadmap with clear objectives and expectations, termination clause, conflict of interest disclosures and the like would be very useful both for the client and for subsequent enforcement action in case of mischief.

The fourth recommendation seeks to control the fees payable to the advisor. SEBI has stated that it has received complaints of excessive fees and thus has capped the fees at a reasonably generous Rs. 75,000 or 2.5% of the assets being advised. While this is not problematic by itself, it is a bit intrusive.

The fifth suggestion can be problematic on the ground. It recommends a professional qualification/post-graduation, experience and NISM certification for all client facing advisors. This is clearly unnecessary and will disqualify a large number of highly able advisors currently operating. Some of the best advisors I know are simple graduates. The problem would get aggravated once one looks at grass-root advisors operating in rural and semi-urban areas. Similarly, many advisors who work with robo-advisory firms will face problems, since much of the work is done by the automated algorithm sitting on the app. If each person who assists in this data entry and minimal level of hand holding is required to have a post- graduate degree, the universe of able and competent advisors will shrink, and not in a good way. SEBI’s focus should be on having at least ten thousand advisors across India providing reasonable and honest service rather than ten Nobel laureates providing world beating services to a hundred people.

The sixth requirement is simply wrong – having a networth requirement for IAs. Professions which require brains and skills should never ever have networth requirements. We need smart advisors with integrity, not super rich ones. To extend the figure of speech in the previous para, we will only have Nobel laureates with ten(s) of lakhs in the their bank account. This presumption of rich people being smarter is so absurd and it creates a wrong entry barrier, that it should be condemned in every non capital-intensive profession. Imagine putting a networth on a person before she can provide legal services or medical advice. Individuals are required to have a networth of Rs. ten lakhs and non-individuals fifty lakhs.

As if this wasn’t wrong enough, the paper suggests something not just wrong, but also probably unconstitutional. It suggests that an individual advisor whose clients exceed 150 or who advices assets exceeding Rs. 40 crores must de-register and re-register as a corporate advisor. So an able, accountable individual, with unlimited liability and low costs is sought to be banned if they do well. He must now hide behind a corporate veil, have limited liability to his clients, pay massive costs and spend 80% of his life complying with pointless corporate laws and filling DIN and SIN forms rather than providing honest, accountable investment advice. If implemented this will be a regressive self goal in regulation. SEBI’s goal should be to develop the under penetrated market for advice to over a billion Indians. As Shakespeare said “Striving to better, oft we mar what’s well”."