Fundsgate: Is SEBI’s net worth barrier too high for investment advisers to vault?

It has taken more than seven years, four consultation papers and heaps of feedback it got, for the Securities and Exchange Board of India (SEBI) to finalise the direction with regards to the Investment Advisers regulations. It first came out with the norms way back in 2013. In over seven years since the SEBI first carved out this category of RIAs (registered investment advisers), only 1,277 are in this profession, of whom less than 900 are individuals and partnership firms. Will we now see more RIAs in this profession? The path looks difficult.

Raising the qualification bar

SEBI has raised the qualification criteria for RIAs. Earlier, a graduate degree with five years’ experience was enough. A post-graduate could straightaway become an RIA. In both cases, a certification in financial planning was necessary. Now, the principal investment advisor must be a post-graduate in finance or a related stream, have a certification in financial planning and five years’ work experience in investment management or financial advice. Relationship managers who meet clients – persons associated with investment advice – are also required to have the same qualification, but just two years’ work experience is good enough. Individual RIAs (except those over 50) and those working in a RIA firm must comply with these educational qualification within three years.

Hiring MBAs with work experience is going to be costly affair. Your RIA’s wage bill will hit the roof. One of India's largest mutual fund distributors who I had met long ago used to manage over 10,000 systematic investment plans that brought in inflows in excess of Rs 3 crore a month in those days. Over the years, he hired relationship managers who were mostly commerce graduates (but put through a rigorous 8-12 months of training). Although he isn't an RIA, his example suggests that having expensive MBAs to talk mutual funds and investments, may well not be necessary.

Other diktats for advisors

SEBI has mandated registration as non-individual advisors if investment advisors manage over 150 clients. Look at this in conjunction with the increased net worth requirement. Individual RIAs will now require a net worth of Rs 5 lakh. Non-individual RIAs now require a net worth of Rs 50 lakh, up from Rs 25 lakh before. So far, it was possible for individual RIAs to hire a large team of para-planners and run their firms, even if the number of clients exceeded 150. Now, not only will an RIA’s wage bill go up, she would need to cough up additional net worth if she crosses 150 clients. Why a high net worth?

Conventional wisdom say that RIAs who come with a net worth show commitment because they have put their funds on the table. Other than that, corporate firms also have a sense of continuity as they operate as a going concern. An individual planner may not have anyone after her time to hand-hold clients. But a high net worth doesn’t make much sense. Niche and small fund houses such as the erstwhile Benchmark mutual fund (MF) and Quantum MF who were advocates of smaller net worth did just fine. Crisis in the MF industry has struck fund houses not due to their net worth but because of their fund management calls. One way out is that individual RIAs could merge with one another to form a corporate RIA, thereby sharing their net worth burden.

Additional barriers are still fine but the challenge is how to incentivise commission-earning mutual fund distributors to become RIAs? If one set of advisors is scrutinised and the other set isn’t, it’s clear as to which way a large section of distributors would go. Asking RIAs to choose to between advisory and distribution is the correct course. But given the historical commission earnings she’s been used to getting from her distribution business and the requirement to go back to school and re-qualify (unless she’s over age 50) doesn’t make it convenient for her to choose the RIA path.

An incentive, here, for the RIA would have made her effort worth the while. Let us not forget, a large section of investors doesn’t like paying an advisory fee. But it’s not that investors don’t pay their distributors; they do, through embedded commissions in regular plans. It’s just that they do not know about it. But small-ticket investors would still find investment advisory costly and may want to continue availing distribution services with basic risk profiling. SEBI’s recent moves on expense ratios and a ban on upfront commissions have taken care of the distributor’s clients to an extent. Distributors have done well to aid penetration of mutual funds in India and their role is crucial. But the RIA community needs to grow as well; too high entry barriers may not work. As far as stock tippers are concerned, keeping them out of the RIA regulation is a better solution.