Impact of changes in Investment Advisers regulations

By Suresh Sadagopan

Early in July, the Securities and Exchange Board of India (Sebi) notified changes to the Investment Advisers Regulations, 2013.

The amendment to the IA Regulations has been long in the making – over seven years to be precise. The various proposals that came in the form of consultation papers in the past, have gone in different directions, adding to the confusion.

Now finally, the amendments have come in. There are good points for sure; but there are niggles as well.

The positives
One of the positive amendments is client-level segregation. This is a brilliant way of avoiding conflicts of interest at the client level and at the same time allowing the advisor to do distribution for some clients and advisory for others. This way, the existing businesses are not disrupted, while at the same time avoiding conflicts of interest at the client level.

This kind of client segregation is to be there at the family level for individual investment advisers, where say the wife can be an IA and the husband can be a distributor. They cannot work with the same client for both services. However, this provides the flexibility to conduct both businesses alongside.

Such client-level segregation is also permitted for corporate entities at their group level. However, an individual cannot do both advisory and distribution of products.

The other very good provision (details expected as a circular) is the comprehensive scope of agreement between the IA and the client.

Here is another positive – investment advisers can implement their advice in direct/ non-commissionable products but must not receive any kind of consideration at the family or Group level. Also, it plugs a loophole of trying to earn twice by first charging for advice and then again earning through commissions or other means.

Allowing implementation by IAs is a good provision as many clients are looking for implementation support from their advisers. Also, IAs should suggest only direct/ non-commissionable products wherever available.

The amendment also proscribes the use of the term Independent Financial Adviser, Wealth Adviser and other such similar terms by distributors of securities. This is again a good move, as such terms used by agents were misleading the public into believing that they were somehow dealing with an adviser, when in fact, they were dealing with a product seller.

The niggles
The qualification requirements for an IA has gone up to professional qualification or post graduate degree or diploma. Also, they now need to have five years of relevant experience along with an appropriate certification accredited to National Institute of Securities Markets (NISM).

Even persons associated with Investment Advice (PAA) should comply with the above, with a lower experience requirement of two years. The requirements for PAA can be a problem as getting compliant people as well as compensating them appropriately, will pose a problem for IAs. This will affect the growth of the advisory practice.

There is a sting in the tail – all certifications like CFP which are renewed using Continuing Professional Development (CPD) credits will not satisfy certification requirements needed by IAs.

This is going to be a big problem. Asking a person to again reappear for all exams hardly makes a person a better adviser. This is like asking a doctor to give all his/her exams every other year, to continue being a doctor.

What is truly required is to be abreast of new developments. This exposure was to be gained through CPD credits. This is an accepted global practice. This provision certainly needs a rethink.

Networth requirements have gone up from Rs 1 lakh to Rs 5 lakh for individuals. For corporates, it has gone up from Rs 25 lakh to Rs 50 lakh. Existing IAs are allowed three years from the date when the notification will come into effect to comply with this requirement. However, those registering newly would need to comply with this immediately, which would be a challenge especially for those applying for a corporate license.

An individual IA who has 150 clients should compulsorily corporatise. The provision to corporatise may be seen as being in the client’s interest. The argument that individual IAs cannot handle more than 150 clients is specious; they can also employ advisers under them, who are PAAs. This way there is no limit to how many clients even an individual IA can handle.

The revenue the IA may be earning on 150 clients may not be enough for the IA to be able to afford to corporatise (with a Rs 50 lakh networth and Rs 5 lakh fee requirement). At the ground level, this is going to be a major challenge.

Some of these IAs may choose to remain under the threshold of 150 by choice. Others who want to grow but cannot corporatise, will probably have to align with platforms for RIAs which will obviate the need to corporatise and also provide support in terms of compliances.

The other red herring is regarding the fees. The notification just mentions that fee will need to be charged in a manner specified by the board.

However, the board minutes specifies a fixed fee with a cap of Rs 1.25 lakh per annum or a variable fee of up to 2.5 per cent a year of the assets under advice (AUA). Only 50 per cent of the fees (or six months fees) can be charged and collected in advance. Both fixed and variable fee cannot run concurrently in a year.

The above structure would be fine for ongoing advice but not for discreet advice or one-time engagements, which are common in financial advisory.

There is also an implied assumption that there will always be assets under advice, which is not the case in many advisory situations. Also, for one-time engagements the IA would want the fees on completion of the engagement. However, as per the provisions, they will be able to collect only 50 per cent and wait for another six months to collect the rest, which is impractical. In fact, this is one of the most problematic parts of the amendment.

The last word
There are many good points which have been mentioned in the board minutes which will make for a comprehensive agreement that protects the investors’ interests.

It is a relief that the amendment has finally come. IAs have been on tenterhooks all along as they did not know the direction the regulations would take. That uncertainty is now behind us.

SEBI needs to fix the problem areas in the overall best interests of all, including IAs. What needs be fixed are: allow IAs to collect fees, then and there, for discreet advice, allow certifications that are renewed through CPD points as valid for IAs, enhance the criteria for compulsory corporatisation to a turnover of Rs 10 crore or above instead of number of clients and relax the qualification or experience requirements for PAAs.

Advisory is a fledgling profession. It is going to be very useful for the investor community at large. SEBI should support IAs, whom they have birthed and have created a new profession. A bit of accommodation is therefore called for.

(The author is founder, Ladder7 Financial Advisories, a SEBI Registered Investment Advisor.)

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