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UF says RIA paper is anti-investor, anti financial inclusion

United Forum - a forum of national, regional and local distributor associations

7th November 2016

In a nutshell

Even as SEBI announced the extension of time to file responses to its RIA consultation paper upto 30th November 2016, the United Forum has made its move by filing a detailed response to SEBI. UF believes the paper is anti-investor and anti financial inclusion - views shared completely by Wealth Forum, and expressed earlier by us in these two articles: RIA paper is completely anti investor, 3 recommendations on SEBI's RIA paper.

UF has also warned that the paper, if implemented, can likely see many banks withdrawing from the MF distribution business completely. The commercial implication of implementing the RIA paper will mean potentially maintaining two sets of RMs for a single customer - one who will sell banking products and another in a subsidiary who will sell MFs, insurance etc - this will make the business unviable. The alternative - of selling MFs at bank branches with no incidental advice will mean distributing MFs without any form of product suitability documentation at the bank branch level - which will likely run afoul most internal compliance norms of global banks. SEBI may well have to reconsider its stance on the RIA paper, if it can result in the fastest growing distribution channel of the last 10 years, now withdrawing completely.

Given below is the press release issued by UF on its response to SEBI.

About United Forum

United Forum is a forum of several national, local and regional associations of distributors and independent financial advisors (IFAs) like FIAI (Banks & national Distributors Association), FIFA (IFA Association) and 43 other Regional IFA across the country. Thus it represents almost the entire financial distribution Industry of the country. The various associations under United Forum have been engaged in undertaking various activities for the development of the mutual fund industry and distribution Industry.

Views on the paper

United Forum has written on behalf of its members in reference to the invitation for comments on the Consultation Paper on Amendments/Clarifications to the to the SEBI (Investment Advisers) Regulations, 2013 ("Consultation Paper").

While the proposals in the SEBI RIA Consultation Paper purport to bring in uniformity in the standards applicable to all intermediaries and address regulatory gaps, we believe that the many of the proposals would be detrimental to the interest of investors and not be in accordance with the orderly development of the securities market. It may appear that making registration under the IA Regulations mandatory, for all mutual fund distributors providing incidental advice, would help regulate them better. However, such a measure would not only unreasonably disrupt the activities of distributors (Independent Financial Advisors, national distributors and banks distributing financial products) and compromise financial inclusion, it would also be against the interests of investors. The ramifications of the Consultation Paper, if implemented in full, would be catastrophic for the growth of the financial products industry and largely defeat the financial inclusion agenda of the government and the regulator.

The proposal to remove the existing exemption granted to mutual fund distributors, under the IA Regulations, for providing incidental investment advice would gravely affect the service mechanism of distributors, and be harmful for investors. Firstly, it is pertinent to note that distributors perform several essential and critical functions in India. A distributor is not only responsible for marketing and selling mutual fund products, but also provides a range of services, both at the time of onboarding and on an ongoing basis, which greatly benefits investors, especially in the retail category. Distributors reach out to investors in small and large towns, make investors aware about their needs and goals, schemes of mutual fund houses and help them understand the effectiveness of mutual fund schemes for investments. Distributors help investors undertake transactions relating to switching, redemption and guide them periodically on the performance of their investments. Distributors monitor and review client portfolios to ensure that their investments suit their financial abilities and risk profile, and match with their overall financial goals. Further, distributors provide services to investors relating to their funds, such as aiding in nomination, calculation of taxation etc.

The nature of work of distributors entails an advisory component. We believe that the essence of incidental advice is very important for any financial distribution activity, lest the product may have harmful effects on the investor. Further, regulatory norms make it mandatory for distributors to sell only appropriate products after conducting the requisite process for assessing suitability of the products to the client's age, profile, pension aim and risk profile. A product appropriate for an upper middle class salaried person may be wholly unsuitable to a lower income person with a small shop. Pursuant to SEBI's circular dated August 22, 2011, distributors are duty bound to sell only suitable products to clients after a detailed profiling and assessment of the income, expenditure, wealth and risk appetite, retirement plan, time horizon for investments, taxation, goals etc. Removal of the advisory element would not only unreasonably limit the role of distributors but also expose investors to investments in unsuitable products. If distributors are not permitted to provide investment advice, as an activity necessarily associated with their distribution function, they may sell products without a check on the investor's risk profile. This move is clearly harmful to investors as the proposed regulation is reducing the obligations and level of service of the distributor. Further, as discussed, a distributor does not merely act as a courier for fund applications but provides several other critical services. Without the aid and advice of distributors, unsophisticated investors would make investment decisions that are unsuitable for them and expose themselves to market risks beyond their risk appetite or make inappropriately safe investments where inflation would eat away at their returns leaving an inadequate pension pot.

Secondly, the registered investment advisory model would not be feasible or workable for distributors. The Consultation Paper proposes that advisory services can be provided only through a separate subsidiary. If existing IFAs were to register under the IA Regulations, it would become impossible for such individual distributors to undertake both distribution and advisory functions as the current proposal will prohibit that. In addition, it would be a death knell to expect a small distributor say in Nagpur to set up two companies for advisory and distribution functions. Since, both entities would be run by the same person, even where such corporate entities are set up, the additional requirement does not solve any problems. Further, the IA Regulations prescribe a minimum net worth of Rs. 25 lakhs for body corporates to be registered as IAs. This is an excessively high threshold which numerous existing distributors may not be able to meet. Finally, today a distributor collects commission from the manufacturer. Even assuming, the split roles/entities are viable for some of the distributors, expecting an advisor to charge say Rs. 5,000 as advisory fees for the year would make little sense for a small investor who wishes to invest say a monthly SIP plan of Rs. 1,000. The advisory fee would be an astronomical number for such an investor and a rational small investor would abandon such a market altogether.

In the current paper the proposal may force most of the Banking players to close the MF Distribution business. Banking is a very strong Distribution channel for the growth and financial inclusion of investors in the MF Industry, Banks cannot provide Mutual Funds as an investment product without an incidental advice element which is being suggested in this paper. It is not practical for them to set up another subsidiary to run the distribution through incidental advice activity. Today the distribution of products is done by thousands of employees spread across the smallest district of India. Several branches may have only one or two employees, of which one may be engaged in multiple activities including distribution of financial products. To mandate a separate company to provide advice and one probably to provide distribution apart from the banking company, to mandate Chinese walls in a small two employee branch in a small district of UP, to mandate NISM certification from this employee, these will all effectively stop not just new businesses but even push banks to shut their distribution of mutual funds, as its neither practical nor cost effective.

Currently, there are approximately active 46000 ARN Holders in a population of 130 crores. The proposals if implemented would force a considerable proportion of the distributor community, at least 70-80 % out of the distribution business and the MF Industry would virtually vanish from the market. This will lead to large amount of disservice to existing investors who will be orphaned on their portfolios and also new investors will not be brought to the Industry. The existing assets of the Industry will also be at risk since they can go in other alternate products and investors may take irrational decisions given lack of advice. The skill India and Entrepreneurship push program of Government of India will also suffer since financial Distributors will more or less seem to vanish .

Thirdly, the proposals would compromise with the level of financial inclusion in the country. There is a huge and pressing need for expanding mutual fund investments, and as discussed, distributors are a crucial part of realising this potential. More than 85% of longterm funds in India are distributed through banks, national distributors and IFAs. The Sumit Bose Committee Report has highlighted the role and significance of distributors in educating the customer about modern finance and financial products, especially push products such as mutual funds. Investors typically lose money from bank fixed deposits post inflation and it is critical for the financial health of any person to invest in higher return products. The National Pension Scheme itself invests significant amounts in equity investments.

Most retail investors need help, guidance and service for savings and investing. Various surveys have indicated that Indian investors consider the role of distributors and advice as a key to their decision making process and do not have concerns regarding mis-selling, or pricing of products. In fact, with the intervention of distributors, investor savings and investments in financial products have gone up. There is a lot of hand holding that investors, especially retail investors, need from time to time for their investments. Hence, at this stage removing distribution in a meaningful role will be detrimental to the Indian investors. Retail customers may not seek advice from registered IAs because of the upfront advisory fees required under advisory model. While a Family Office with assets of more than Rs. 1 crore would engage an RIA, a person investing in an SIP of Rs 1000/- would not approach an RIA. By not permitting distributors to provide incidental investment advice without a separate IA registration and driving distributors away from their business, retail penetration in financial assets like mutual funds would suffer. Absence of a large distribution network will see households savings once again shift to unproductive physical assets like gold and result in a drastic fall in the reach of mutual fund products to households across the country, especially in B15 towns. The role of distributors is very important in educating and penetrating the retail customer base. Without proper regulatory structure, financial inclusion would be compromised.

The international experience in other jurisdictions viz. UK which moved towards only fee based advice is not encouraging from the point of view of retail investors. Specifically in UK after the implementation of RDR the following outcomes are clearly visible as the guidance gap for retail consumers has increased significantly for the following reasons. Firstly, it has lead to insufficient assets of retailers making advisory services /fees unviable for retail investors. Secondly, it has led to a huge fall in the number of advisers reducing the supply substantially resulting into several customers being orphaned. Thirdly, there has been unwillingness of customers to pay fees comfortable with embedded fees. Lastly, unbundling actually has increased the expense ratio of customers. The above outcomes are not all in favor of retail customers an\d the changes recommended in the paper are only leading towards such consequences which are not at all desirable or in the interest of investors.

We believe that the proposal to make registration mandatory for distributors providing any advice is based on certain misplaced assumptions, such as, financial intermediaries like distributors would not act in the interest of customers. It is also based on a fallacious premise that creating two corporate entities will solve some of the problems which plague the markets today. We are hoping that the proposed regulatory changes in the Consultation Paper are relooked in the interest of the investors, Distributors, Financial Inclusion and the growth of the Industry.

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