Managing the investment advisors

Written by Sandeep Parekh | Tejesh Chitlangi | Updated: Dec 20 2011, 05:38am hrs
One comes across several entities rendering investment advice and distributing various financial products such as mutual fund units, insurance products, structured products, amongst others. An investor must decide whether to invest, if so for what quantum, what duration, and when to exit. These and other pertinent questions often need expert advice. The securities market regulator Sebi recently issued a concept paper proposing a broad framework for regulating any entity rendering investment advice in any manner.

Before listing out the proposals for regulating investment advisors, the paper puts forth norms to resolve conflicts of interest between the issuers of financial products such as banks, mutual funds, insurance companies, etc, and the distributors who sell their products. The conflict arises because distributors receive commissions from the issuer and also fees from investor. To eliminate this conflict, the paper suggests that a person who interfaces with the customer should declare upfront whether he is an advisor to the client or is an agent of the issuer. If he declares himself as an advisor, he would be subject to Investment Advisors Regulations requiring high qualifications, registration, compliances and would receive payments only from the investor. On the other hand, if he declares himself as an agent associated with issuer of the product, such person can receive remuneration only from the issuer.

Sebi has borrowed the above conflict resolution mechanism from the UK regulatory regime, but such application of foreign laws in India

appears inappropriate. For instance, the UK regime (effective from 2013) is applicable only

to distribution of retail products to retail

investors, much unlike the uniform application of the proposed law to all financial products and to all investors as proposed by Sebi. Also, the UK regime has basic advice exemptions (i.e. advice using pre-scripted basic questions and not detailed advice) wherein advisors would still earn commission from the issuer. No such exemption is contemplated in the Sebi paper.

The above proposal, if implemented, is bound to hurt markets, in particular mutual funds, for two reasons. First, the commission payments by mutual funds to distributors are already heavily regulated, coupled with the fact that distributors get little money from unit-holders as fee/commissions. Prescribing only either of such payments will further discourage distributors and hurt mutual fund business. Second,

distributors will be more interested in acting

as agents of the issuer as this will obviate the need to register as an investment advisor and provide scope to earn from the issuer (with

larger corpus and one-time negotiation), rather than agreeing on a fee with each investor. This will have serious repercussions for investors as they will not have access to even basic investment advice. This would be a concern even where issuers are banks or insurance companies. The basic advice exemption should hence be considered by Sebi.

With respect to regulation of investment

advisors the proposals in the paper sound

ambiguous. The following are the key concerns. First, the proposals seek to create a self-

regulatory organisation (SRO) framework to primarily regulate the investment advisors, who have to seek such SROs membership.

Till date no entity has registered under Sebi

SRO Regulations of 2004 because of onerous

provisions, accountability and compliances without any benefits. Even bodies like AMFI (mutual funds association) and AMBI (merchant bankers association) have not sought SRO registration for these reasons. Regulating investment advisors through an SRO may,

therefore, fail. Investment advisors are

regulated even today under Sebi portfolio

manager regulations but such provisions are not strictly enforced, as Sebi does not have the bandwidth to manage multitude of such

advisors. Trying to regulate such advisors across all financial products and across the width of the country under an SRO framework may be ambitious though well meant.

Second, a Sebi-registered SRO would be the first-level regulator of advisors of financial products coming under other regulators such as RBI and IRDA. Though the matters relating to

financial products other than securities shall come under the jurisdiction of the respective sectoral regulators, conflicts will arise as an SRO regulating advisors of the products falling under other regulators jurisdiction would still be accountable to Sebi. It is likely that this could cause pointless turf wars between regulators similar to what we saw last year.

Third, the definition of investment advisor under the paper is extremely wide and would cover any investment advice for which consideration is received. This would even cover all Indian private equity advisors which render advice to offshore managers managing overseas funds. Also, its unclear if the foreign advisors rendering investment advice to Indian residents would also be brought within the ambit of proposed requirements, even though the advice doesnt pertain to Indian financial products.

In an attempt to regulate the investors, their advisors, their markets and instruments, Sebi may end up regulating everything on paper but harming investments in the process. Proposing technical concepts and borrowing foreign regulations may not help in this context and are likely to hamper the growth of the financial markets and financial inclusion.

The authors are with Finsec Law Advisors