Last Updated on January 28, 2020 at 11:17 am
Fee-only Registered Investment Adviser (RIA) S. R. Srinivasan explains why SEBI must encourage individual fee-only financial planners and why their proposed regulations are clearly favourable to established entities who have both distribution and advisory practices. Readers may recall Srinivasan from his popular article, How I achieved financial freedom and became an Investment Advisor! You can approach him for your financial needs via srinivesh.in. You can write to SEBI to help the cause of fee-only financial planners! Many readers have done so already. Thank you! Details are available at the bottom of the post on how to contact SEBI
Context Any regulation is made with an intent to make the system better. It could have some adverse effect on existing players. Usually, they are given time and/or support to adapt to the changes. The regulations can also spur newer players with different business models to enter the space. If these people add value to the end-user, then this is a very positive outcome from the regulations. The RIA regulations in 2013 definitely enabled individual, fee-only advisors to provide a valuable service to the end-users – investors in this case.
The regulations get amended from time to time, and this is usually a welcome move. The amendments have to be fair to all the stakeholders, including the new entrants who have abided by the letter and spirit of the regulations. Amendments that overtly or covertly favour the earlier business models, and punish the newer entrants, would often have the undesirable effect of making the regulation ineffective. The guidelines under public review clearly fall in this category. They clearly make it unviable for individual, professional, fee-only planners to enter and succeed in this space. An earlier article critiqued the guidelines from the perspective of investors. This article includes an additional critique from the perspective of fee-only advisors. (Note: The words advisor and planner are used interchangeably in this article.)
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Fee-only model vs Asset-based model
Compensating financial advisors for their effort has been a complicated matter in India, and in fact, many countries. The benefits of good financial advice, by definition, are realized over the long term. There is a strong view that clients do not want to pay upfront for advice. This view resulted in models that use commissions – the advisor is compensated over the length of the investment. While this model can work, it has inherent conflicts of interest. Commissions also reward ‘distributors’ in the value chain who may not provide suitable advice.
In India, almost all financial products have been designed to have some or more rewards for the distributors. It was easy then for advisors, including those that create strong financial plans and provide the right advice. to use a commission-based structure. She can spend the effort upfront to create a suitable financial plan but get compensated over time. (You would be shocked to know that even a strong company like Bajaj Finserv pays commissions up to 1.65% – no it is not a typo – for distributors!)
Distributors played a major role in the early spread of mutual funds. The largest distributors earn 100s of crores in annual revenue. Spurred by regulatory changes – abolition of entry loads, capping of commissions, availability of direct plans – some of the players adopted the fiduciary standards required by the IA regulations. They found it useful to continue with a ‘percentage’ compensation model. Instead of commissions (which are a percentage of the assets under management), they charge a percentage of Assets Under Advice (AUA). Many, not all, of them, are also corporates – they have many advisors, customer contact officers, backend staff, and a reasonably process-driven approach. This article has no argument with this business model – if the clients get a transparent, clear view of their expenses, and see value in the service, any business model is appropriate.
The introduction of direct plans in mutual funds, and the Investment Advisor regulations, provided a viable model for fee-only advisors to emerge. The space created by the regulations enabled individuals to enter the profession and succeed.
- Mutual funds are versatile instruments and are one of the largest parts of the financial portfolio for most investors
- Salary earners have EPF and/or NPS mandated for them and can build a sizeable amount with discipline
- Other commission-free products like PPF, SSA, etc. can be used for portions of the corpus
All these together made it feasible to create the right financial plan and, more importantly, build the required corpus using commission-free products. While such fee-only advisors still number only a few dozens, they have been able to offer fiduciary, ‘advice-only’ services to a large number of discerning clients. Please refer to the fee-only India website for a clear articulation of such planners. It is pertinent to note that these planners, together, have many hundreds of clients; and not a single complaint or grievance has been raised with SEBI on any of them! It is also interesting to note that, for some unexplainable reasons, corporates have not implemented a fixed fee approach.
Specific issues with the proposal
For brevity, we refer to the specific sections of the Consultation Paper. The entire paper is available here: https://www.sebi.gov.in/reports-and-statistics/reports/jan-2020/consultation-paper-on-review-of-regulatory-framework-for-investment-advisers-ia-_45685.html An earlier version of this list of issues appeared as a blog post in MorningStar
- Section 3.5.1.9 mandates both the experience and educational qualifications. The current regulations require either of them. The minimum experience is set as 5 years. Existing advisors are given 3 years to comply with the requirements. Any lateral entrant to financial advisory from the second half of 2018 would be very adversely affected by this new guideline. There is no rationale provided on why both experience and education requirements are necessary.
Also, in the future, this would completely shut out people from outside the financial services industry. This is not necessarily bad. However, most of the financial services in India use commission-based models. A person with experience in such structures is more likely to follow an AUA model rather than a fixed-fee model. It takes far more emotional quotient and maturity to adapt a fixed-fee model. This statement in the article that introduces fee-only planners (https://freefincal.com/list-of-fee-only-financial-planners-in-india/) can’t be more true: “I think it takes guts and confidence to choose a different path and say ‘no’ to product distribution.”
- Section 3.5.2 imposes new net worth requirements for Investment Advisors. There is no specific rationale provided for the higher net worth requirements. Further, other sections that force a corporate model ensure that a fee-only advisor would have to significantly scale up net worth. This results in higher expenses and higher client fees.
- In a bizarre fashion, Section 3.5.2.6 imposes an arbitrary upper limit on the number of clients and AUA (Assets Under Advice) an individual or partnership firm can handle. There is no rationale provided for this. There has not been any analysis done to see if such limits are even needed. In the absence of these, it is difficult to attribute any charitable motive for the new restriction. This section can be seen as blatantly favouring body corporates at the expense of individual and partnership firms.
- Section 3.7.3 removes the usage of Continuing Professional Experience (CPE) credits. CPE is a global practice followed in many fields. There is no reason to remove it and require periodic ‘re-certifications’.
- Section 3.4.5 uses specific language to refer to ‘advance fees’. The language seems disconnected with the reality of fee-only advisory. In this model, a vast majority, even upto 90 per cent, of the effort is spent upfront by the advisor. The language in the section seems to assume that the effort is spread over an year. This could be the case for distribution services, wealth management services, etc. But it is strange to apply this language to Investment Advisory as defined by SEBI. (Of course, this could be based on the reality that most of the corporate IAs are acting like ‘Wealth Managers’.)
- Section 3.4.2 clearly gives the context on the issue of fees. There have been instances where IAs, of the rogue variety, have charged fees that are clearly exorbitant. A regulator then would have to use ‘hard hands’ and come up with caps on fees, and Section 3.4.4 does that. The section could be more flexible for the fixed fee model and provide periodic revision of fee caps. (In an AUA model, the fees naturally increase as the assets increase in value!)
- Section 3.3 is a welcome move. It provides a list of ‘standardised terms and conditions’ for IA services. Adherence to the new guideline would greatly reduce the friction in the advisor-client relationship.
- Section 3.1 takes a nuanced stand on the separation of advisory and distribution services. It is a major departure from the previous consultation papers where the regulator favoured a clear separation of these services. The current proposal allows even individual planners to provide both advisory and distribution services, albeit to different clients. The discussion in this section does not say why this change was felt necessary. The dilution of the stand on this important issue is clearly favourable to established entities who have both distribution and advisory practices.
Conclusion
Comments 1,2,3 and 8, taken together, can be seen as a clear tilt by the regulations in favour of established, multi-business, AUA based entities and against committed, individual, relatively new fee-only planners. It may be acceptable for the regulations to provide some advantage to one business model. However, favouring one model while almost eliminating alternate models is very problematic. Particularly so if the eliminated model is practised by individuals who intend to follow the regulations in letter and spirit and charge affordable fees for the service.
Disclosure: S. R Srinivasan is a ‘lateral entrant’ to financial advisory. He switched from a very lucrative career to enter this field. See Factors that helped me achieve financial freedom. In a few months, he has provided meaningful value to a number of clients. Many of his clients have clearly expressed their desire to work with an individual planner rather than a corporate entity. Sections 3.5.1.9 and 3.5.2.6 would force him to corporatize and increase the fees or exit the business altogether.
What you can do to prevent SEBI from implementing these changes
SEBI has sought feedback from the general public on or before Jan 30th 2020. Please write to [email protected]
in the following format (the proposal number refer to the text in the consultation paper.
Format to be used for sending feedback to SEBI (with sample response, you can copy and paste this format in your email and replace the text underlined). You can also add any other point or modify this as you please.
Email subject: Feedback on Consultation Paper on Review of Regulatory Framework for Investment Advisers (IA)
3.6.3. The record of interactions with the client could be, inter alia, in the form of: a. Physical record written & signed by the client, b. Telephone recording, c. Email from registered email id, d. Record of SMS messages, e. Any other legally verifiable record.
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
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