Regulating financial intermediaries: Needs to cover all gaps

Rajendra Kalur

SEBI recently released a revised consultation paper (dated  22^nd June 2017)on regulation of financial intermediaries, thus stirring up a hornet’s nest across the distributor community. This unexpected development not only took the distributor community by surprise but also proposes a far shorter timeline for implementation than the earlier paper (dated 7^th October, 2016).

On most steps, the regulator cannot be faulted including its key measures to segregate the advisory role from that of execution role. It also proposes to relax the net worth criterion thus making it convenient for those having difficulties coming up with the stiff Rs 25 lacs required to corporatize. However, while SEBI has taken onus to protect investors’ interest, promote transparency and reduce product fees through this measure, there still are quite a few gaps both within the consulting paper and outside that may still end up damaging the interest of the clients it seeks to protect.

SEBI in its endeavour to increase the number of licensed RIAs has drastically altered the provision for certification of RIAs in the revised proposal. The deletion of the qualification criterion for rendering advice would drastically lower the competency bar for advisors and is short of the best practices that a regulator must seek to promote. In fact the guidelines in the earlier paper proposing advisors to be certified as CFPs / CFAs was a more desirable suggestion and would have ensured advice being rendered by committed set of people and enhanced the quality of such advice.

Another instance where SEBI’s revised consultation paper has fallen short is in the requirement of suitability & appropriateness criteria for a distributor. Paradoxically, the paper proposes that the distributor ensure suitability without a Risk Profile or the Objectives of the client in mind.

While the regulator has not spelt out the proposal in detail, it is quite an onerous task for any distributor to ensure suitability of a product without being guided by the risk profile, objectives and time horizon of investments. One way to ensure this is that all execution is guided by recommendations from an RIA. In such cases, the fiduciary role performed by an advisor would ensure that the distributor offers products suitable to the client and mitigate any kind of mis-selling.

However, these good intentions by SEBI aren’t enough. While the stringent regulations with respect to MF distribution has capped commissions and instilled far greater amount of transparency than earlier, there are a lot of other products which have fairly lax regulations and far lesser transparency.

These too need to be similarly regulated else the distributors may just yield to the temptation of regulatory arbitrage. Products under the Portfolio Management Schemes & Alternate Investment Funds have far less transparency with regard to expense ratios and commissions and there’s a danger that these products may be misused.

The revised paper has advised RIAs to register with other regulator for products falling outside the ambit of SEBI. However, this is easier said than done as other regulators have only provisions for distribution and not for advice. Thus, a fee only RIA would have difficulties registering unless separate advisory guidelines for such products are introduced.

A more practical approach to regulating intermediaries who advice across products spanning  multiple regulators / jurisdictions would be to adopt the approach used by ICAI. The ICAI is both a certifying as well as a regulatory body and ensures that its members are competent as well as ruled by a code of ethics.