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What's your decision, Mr. SEBI Chairman?

Vijay Venkatram, Managing Director, Wealth Forum

16th August 2017

Lets say you (my reader) are the SEBI Chairman for a day and the key issue in front of you today is a decision on a proposed new regulation that will impact what mutual fund distributors can and cannot do in terms of guiding investors. When you were given this job for a day, you were briefed that investor protection is the paramount objective of the organization you head.

Your faithful Executive Assistant Rahul places in front of you the proposed amendments to the Registered Investment Advisor (RIA) regulations, and some of the feedback that has come in from the consultative process that's just ended. You skim through the papers and reflect for a moment. Here's how your conversation then proceeds with Rahul:

You: So presently, mutual fund distributors are supposed to guide their investors to suitable products and not doing so is a punishable offence.

Rahul: Yes

You: And registered investment advisors are also supposed to guide their investors and not doing so is also a punishable offence.

Rahul: Yes

You: And the main difference currently is higher standards of guidance for advisors and ban on commissions for advisors to eliminate conflict of interest

Rahul: Yes

You: And as these industry responses suggest, we have indeed implemented higher levels of commission disclosures and AMFI has actually implemented commission caps on upfront commissions to try and reduce conflict of interest that can result in mis-selling

Rahul: Yes

You: And you are now proposing to enforce a new regulation where distributors - who happen to constitute 99.5% of the total intermediaries today will be actively debarred from offering guidance to their existing 2 crore investors, and only permit such guidance related activities for registered investment advisors - who today constitute 0.5% of the total and serve today a proportionate amount of investors?

Rahul: No its not like that, we expect many distributors to register as RIAs as a consequence of this regulation

You: But why have only 0.5% taken up an RIA licence in the last 4 years? If it is a superior proposition, surely there should have been greater appetite for it.

Rahul: Well, the proposition is no doubt superior, but many intermediaries somehow believe that they will earn far less as fees compared to the amount of commissions they make currently. They say the business model is not viable.

You: So, in the proposal you have placed before me, in what ways are you proposing to make the RIA business model more commercially viable?

Rahul: Er, we haven't really suggested any changes on that front. But we have lowered the fees and educational qualifications to allow more distributors to register

You: So, if we enforce this regulation, we have to ensure that most if not all distributors do in fact migrate to the RIA model, otherwise we run the risk of reducing investor protection for upto 2 crore investors - is that correct?

Rahul: Not really - those investors who want advice can go to an RIA and those who don't want can invest in direct plans, which we have made much cheaper

You: And there is no guidance in direct plans?

Rahul: Yes

You: And direct plans have been around for more than 3 years and yet there are 2 crore investors who go to distributors

Rahul: Yes

You: So, for these 2 crore investors, we must ensure that there is an alternative where they can get guidance?

Rahul: silent

You: What gives you the confidence that many distributors will in fact take up the RIA license? How do we draw comfort that we are not doing a disservice to these 2 crore investors?

Rahul (brightening up): Because the distribution proposition is being made so uncompetitive that they will have no choice but to register as RIAs

You: But you say we haven't done anything to make the RIA model more commercially viable

Rahul: No

You: So you are betting that you will make their current business model unviable so that they come towards another model that they always found unviable?

Rahul: silent

You: What is at the core of our issue with the way distributors are currently serving investors?

Rahul: Well unlike the RIA model, there is really no accountability for distributors. Only the largest distributors get audited - most don't. We have suitability guidelines in place but anecdotal evidence suggests that many distributors don't really bother about it. Nobody has any oversight on whether they are mis-selling based on commissions. We tried to bring in accountability through a proposal to set up a Self Regulatory Organization (SRO) under SEBI's guidance, but that proposal is caught up in legal tangles and is therefore now in cold storage. We are really worried that gullible investors are being misled by distributors who may be placing their own interests ahead of their investors'.

You: I get it. Give me some time to think.

Rahul exits, leaving you in a pensive mood. You pick up a phone and call me. (Me? Why me? Well, if you can imagine being SEBI Chairman for a day, why can't I imagine that you will call me?)

Here is what I tell you are my two-bit thoughts on the best way forward:

  1. SEBI's objective should be that every individual who seeks out an intermediary - by whatever name called, and with whatever revenue model the intermediary chooses, should be given appropriate guidance that empowers him to make an informed investment decision. Every investor who chooses to invest through direct plans must similarly be offered online guidance to determine suitability of products/asset classes (which he can waive if he thinks he doesn't need it). That is what will truly serve SEBI's goal of investor protection.

  2. SEBI's current proposals will make it the first market regulator in the world to actively lower the bar on investor protection, by disabling distributors from conducting risk profiling and goal planning. The world over, regulators have been consistently focusing on increasing the bar, never lowering it.

  3. Present suitability guidelines for distributors need to be enforced rather than dismantled. There is a mechanism in place for due diligence audits for large distributors. This needs to be expanded to cover all distributors. It also needs to be strengthened with inputs from SEBI's team that currently audits RIAs. Anecdotal evidence suggests that SEBI's team seems to be doing a much more thorough job than some of the external auditors appointed for distributor due diligence.

  4. When distributors are asked to document the process through which they made fund recommendations for each client - which will be liable for audit, and with commission disclosures already in place, there is enough being done to minimize conflict of interest coming in the way of appropriate guidance.

  5. Wealth Forum's recent WF Advisor Alpha Report 2017 (
    ), clearly demonstrates the value that an intermediary can add, if he actually delivers on all the suitability standards laid out in current regulations. The report establishes the value of good advice at 4.95%. That's the incremental return that good advice can get for an investor, over what a typical Indian investor gets from his present asset allocation across financial products. The report highlights how a mutual fund intermediary can enhance the average return of India's middle class saver by upto 80% through judicious advice on mutual funds and ongoing behavioural guidance to keep investors on track through bouts of market volatility.

  6. While the MF industry has over 2 crore investors in the country today, there are at least 20 crore more who can invest in mutual funds and get upto 80% higher returns on their hard earned savings. Somebody needs to reach out to them, guide them into appropriate asset classes within mutual funds based on their needs, circumstances, risk capacity and risk profile, and then walk with them through the journey of investing in market linked products, which can often be gut-wrenching for the uninitiated. Towards this end, SEBI's key priority should be to enable growth of all intermediation models - distribution, RIA, online - to facilitate this task, while remaining cognizant of its responsibility to ensure that whichever mode an investor chooses, he must be offered appropriate guidance to help him make an informed investment decision.

  7. Best practices that serve investors well like risk profiling, goal planning and asset allocation guidance must be promoted vigourously. A roadmap should be drawn up for a time-bound implementation of these processes mandatorily by all intermediaries.

Well, you heard me out patiently and put down the phone. Now, you need to make a decision, Mr/Ms SEBI Chairman. What's it going to be? Do let me know by posting your comments below - its YOUR forum!

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