Seeking Clarity on SEBI IA Jan20 Consultation Paper

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  • Mr Market
  • 27-Jan-2020

SEBI came up with investment advisory regulations for the first time in Jan2013 and over the years has been trying to evolve it further. In relation to this, since 2017, SEBI introduced four consultation papers with the last one in Jan2020. The consultation paper is seeking public and expert comments before 30Jan2020. Though the efforts and intent of SEBI may be in the right direction, there are a lot of loose ends that require attention. These loose ends, if not corrected, may make the operating environment incredibly difficult even for the well-intentioned stakeholders and can thereby slow down the penetration of financial products at a mass level in India. In this regard, we highlight some of the points that where further thought may be required by the authorities. 

1) Confusion over incidental advice: Some terms used in the law are not well defined bringing in a lot of subjectivity and uncertainty. One such confusing term is “Incidental Advice”. Where does it come into question? The current law allows mutual fund distributors and stock brokers to give incidental advice to their clients even when they are not registered as investment advisors. However, it becomes difficult to understand which advice will be considered as incidental advice. To put it in a single question, the stakeholders require clear directions on this question. 


Can an entity involved in the business of mutual fund distribution & stock broking who also registers itself as a SEBI Investment Advisor help the client with the overall financial planning without taking any advisory fee but earning the distribution / commission income after disclosing the same to the client? Needless to say that the entity in question continues to follow all the procedural aspects including arm’s length of advisory and execution, disclosure to clients about commissions, maintaining suitability standards among others. 


To further illustrate the same point, here is the detailed workflow:
a) Entity is in distribution and in stock broking? Yes
b) Entity has also taken registration under IA regulation? Yes
c) Does the client understands that the entity provides execution services as well as advisory services through different departments? Yes
d) Does the client understands that entity cannot charge client under both services? Yes
e) Now what if a client chooses to take paid adviosry services; then execution can be provided by entity for free under the name of “implementation services”. 
f) But what if a client chooses to take paid distribution services; but wants to take "free holistic and detailed advice" from the same entity's advisory department? Can it be done? Can the entity provide “holistic financial planning and advisory services” to the client for free? Assuming this is subject to all other procedures of IA regulations being followed? 


2) More clarity on dependent parents and dependent children: India has a unique system of joint families. There are so many families in India where the financial decision making is individualistic but they still stay under the same roof. More so, with women now becoming an integral part of the working class, husband and wife take many financial decisions independently for themselves. Additionally, there are so many practical examples where parents and children take their financial decision by themselves even after staying under the same roof. In such an environment, the word "dependent" should be given more clarity in order to avoid unnecessary confusion. 


3) Investment Product vs Financial Product: Both these words were used in one of the consultation paper at different locations. As two separate words were used, it creates doubt as to the potential difference among them. Ideally, both are used interchangeably. So in case if SEBI does not have a different meaning for both of these, it would be better to use either one only or provide clarity. 


4) Commission where there are no direct plans: There are many financial products that do not have any non-commissions or direct code options. In such cases where direct code options are not available, the commissions received should be allowed to be adjusted to the fees net of taxes. In other words, anything extra over and above the fees received should be allowed to be refunded to the client net of tax impact, if any. This will benefit clients very well. 


5) Restricting the fee model may not be in investors’ interest: The current consultation paper restricts the fee models to either have a mechanism of "% of AUA" or have it in the form of a "fixed fee" with a maximum amount as Rs. 75000 per annum. In case if an advisor wants to offer a service that does not have any fixed fee (Zero fixed fee) but has a variable fee based on the performance of assets under advice, the proposals of consultation paper will not allow the same. That can have dis-advantage with the clients. In other words, what if the advisor says, “As an advisor, I will only charge you, if you make money; else my charges are ZERO. But when you make returns, I would like to charge you x% of profits." It may, therefore, be more sensible to categorize fee models as "Fixed Fee Models" & "Variable Fee Model". Within the variable fee model, advisors should be allowed to choose the mechanism of charging either as a % of AUA or performance fees as a part of sharing or any combination. To further protect the clients, a hard upper limit as a % of AUA between 2.5% to 4% should be kept as deemed fit by SEBI. 


6) Improving ease of collection: Additionally, restricting the fees charged up to 6 months looks too harsh at this point in time. Considering the increasing cost of compliance, tax management, record keeping, an adaptation of technology and associated spending, fee collection even after all services are rendered well is the most unproductive task and requires a lot of human effort sometimes. Additionally, multiple billings a year adds to the logistical efforts which are not really productive for the entire system. Additionally, today the mechanism of auto debiting the client, subject to services well delivered, does not exist, for the registered IA network. For people who are looking to go for a fixed fee model, this will act as one of the big deterrents to growth. Unless the regulatory view is that only large entities should prevail as against multiple quality advisors, this can act as a big disabler for many investment advisory boutiques.  A point to keep in mind is that unlike the broking industry, it may be a huge advantage for the country to have a large number of qualified IAs who may play a critical role in increasing the penetration of correct financial products in India.


In addition to the same, SEBI to enable debate and participation from multiple agencies for enabling the use of right technology where operational hassles for Investment advisors can reduce. Special note about this discussion could be mechanisms of allowing fees to be charged from respective client's broking account or bank accounts or similar other accounts after the confirmation of the clients. The moment such possibilities become reality, market forces will ensure that a lot of distribution led models may start thinking in terms of advisor led models. 


7) Engagement with relevant authorities for allowing fees as a part of tax deduction: Additionally, SEBI can also take up the discussion of allowing advisory fees to be deductible from the gains for payment of taxes on financial products. This is tricky, but an effort in that direction should be facilitated so that it can become a reality over a long period of time. Today investors are at a great disadvantage from this aspect.


Though the other pointers are easy to think clearly, the point about the incidental advice is a very tricky one. It is important to understand that it is a practical impossibility to draw a hard line between advice and appropriateness and just because there can be a potential conflict of interest, execution and advisory should not be completely bifurcated from each other. That may do more overall harm than a particular good. 


Note: These are the founder's personal views/opinions and are subject to change with additional clarity. Please do not assume these views to be static views. This note is being shared here so as to stir the right debate among the stakeholders. 



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