The third googly
Even as distributor attention is riveted on service tax and commission caps - both of which make a material impact on revenue models, there's another angle that potentially makes an even more significant impact on distribution business models : I am referring to the FAQs that SEBI put up a few weeks ago as clarifications on its Investment Advisor regulations. FAQs normally clarify - this one confuses more than it clarifies. Or perhaps it clarifies regulatory intent, but we just don't want to see it that way, so we are confused.
The Registered Investment Advisor (RIA) regulations are not exactly new - they are now 2 years old and distributors had found their equilibrium after an initial round of excited discussions. Some advisors opted to register as RIAs, while many preferred to remain distributors, under the exemption given to MF distributors who only offer advice that is incidental to their core distribution proposition.
Are distributors really exempt from becoming RIAs?
The recently published FAQs now put a spanner in the works of the equilibrium that existed, and have triggered a fresh round of debates. A plain reading of the FAQs would suggest that if you are a multi-product distributor (ie you also distribute insurance, bonds, IPOs etc), you now need to register as an RIA. That means that you stop earning commissions from all products you distribute and commence charging fees from your clients as an RIA.
There are 2 FAQs that are relevant in this context - these are reproduced below:
14. What does 'incidental activity' mean with respect of distributor of mutual fund?
Mutual Fund Distributors registered with Association of Mutual Funds in India (AMFI) can only provide basic advice to its mutual funds clients incidental to its distribution activity. Incidental activities with respect to distribution of mutual funds means providing basic advice pertaining to investment in mutual fund schemes limited to such schemes / products being distributed by him to his clients/ investors or any other MF product. However, if a distributor of mutual fund is engaged in providing investment advice to general investors other than or in addition to mutual fund clients, and in securities (such as shares, debentures, bonds, derivatives, securitised instruments, structured products, units of AIF, REIT, InvIT, etc.) other than or in addition to Mutual Fund Schemes distributed by him, then such distributor is required to get registration as an investment adviser. An investment adviser has fiduciary obligations.
15. Whether a person acting in multiple capacities such as insurance agent, pension advisor, mutual fund distributor, etc. is exempted from obtaining registration under IA Regulations?
A person acting in multiple capacities such as insurance agent, pension advisor, mutual fund distributor, etc. and expand his scope of activities to include investment advice on other financial products or engaged in the financial planning of the clients, then he may be registered and regulated under IA Regulations for advising on such other financial products or financial planning of the clients.
The wording of FAQ no 14 is very clear and unambiguous, perhaps because it talks about all products that fall within SEBI's jurisdiction. If you distribute AIFs, tax free or taxable bonds, IPOs - basically any capital market product that comes under SEBI's jurisdiction, in addition to your core business of distributing mutual funds, you are required to get registration as an RIA. The text does not really leave too much scope for interpretation.
FAQ 15 is less directive in its wording - it uses the phrase "may be registered" rather than "required to be registered", perhaps because it discusses products that are beyond SEBI's immediate jurisdiction. The drafting is poor, which creates some confusion. The message however is pretty much the same, and importantly, the intent seems clear. If you are distributing multiple products, you can't really call yourself a product distributor - you need to become an investment advisor.
What if you don't charge a fee?
There is a view that despite both these FAQs, distributors who do not charge clients a fee, continue to be exempt from RIA regulations. This view comes from the definition of an investment advisor, which has been reiterated in these FAQs - reproduced below.
4. Who is required to make an application to get registration under IA Regulations?
Any person, who for consideration, is engaged or willing to engage in the business of providing investment advice to clients or other persons or group of persons is required to make an application to get registration under IA Regulations unless specifically exempted under IA Regulations. A sole proprietor can also make an application for registration as an Investment Adviser, which will be processed as in the case of individual applicant.
The regulations provide exemptions to certain persons such as insurance agents, pension advisers, mutual fund distributors, stock broker or sub-broker , portfolio managers, fund manager, advocate, solicitor or law firm, etc., from obtaining registration under regulation 4 of IA Regulations subject to the fulfillment of the conditions stipulated. [Ref. Regulation 2(1)(m) and Regulation 4]
The key phrase here is "for consideration". There is an argument that if you are not seeking any consideration from your client for offering advice, then you are out of the ambit of the RIA regulations. While this argument appears persuasive, it may not be water-tight. After all, a distributor is receiving consideration. A multi-product distributor receives consideration from multiple sources. Now, the regulation doesn't specify consideration from an investor, does it?
This is where the specific exemptions provided in the same section offered relief to mutual fund distributors for the last 2 years - until these FAQs have now come in, which effectively limit the exemption to distributors who only distribute mutual funds and nothing else. Even if you distribute tax free bonds now, you could well come into the ambit of RIA regulations. Or, if you sell a PMS offering from the same AMC whose mutual funds you distribute, you could now be asked to register as an RIA.
Will all commissions stop now for multi-product distributors?
Does this mean that if you register as an RIA, all forms of commissions will stop immediately? Well, for individual multi-product distributors, it seems end of all distribution activities. However there is an FAQ that explicitly states that trail on existing assets (prior to you becoming an RIA) can continue. No commissions can however be earned on any fresh business, after you become an RIA. Here is the actual text:
27. Whether an individual registered as an investment adviser can offer distribution /execution services to his clients?
No. Individuals registered as an investment adviser shall not undertake any distribution/execution services pursuant to grant of registration from SEBI
28. Whether an individual registered as an investment adviser can receive trailing commission for the distribution services provided prior to grant of registration?
Yes. Individuals registered as investment adviser can continue to receive the trailing commission for the distribution services provided by them prior to grant of registration as an Investment Adviser.
It would therefore appear that if you are an individual distributor who wishes to continue advising clients on multiple products, you must become an RIA, your existing trail gets protected and you seek a fee from your clients for any fresh business. And how would you seek a fee? Perhaps by asking them to invest in direct plans, saving some money there and asking clients to pay you a part of that saving as a fee.
There will of course be creative solutions that will be attempted. We are bound to see distributors transferring their insurance agencies and bond agencies to spouses and children, so that they can call themselves pure mutual fund distributors. How long will this last? Perhaps till the next round of FAQs attempts to close this loophole.
Hybrid model for corporate distributors
If however your distribution business sits within a corporate entity, you can perhaps still run a distribution business as well as an advisory business, so long as you create a "Separately Identified Division or Department (SIDD)" and maintain an arms length distance between both divisions. This was specified in the regulations 2 years ago, and the FAQs do nothing to change the interpretation of these regulations.
23. Whether the investment adviser is required to segregate distribution or execution services?
Yes. Investment advisers which are banks, NBFCs and body corporate providing distribution or execution services also to their clients shall keep such activities segregated from investment advisory activities. The investment advisory service has to provided by a separately identifiable department or division (SIDD) or a subsidiary, as the case may be and such SIDD or subsidiary shall include the words 'investment adviser' in its name. Further, such distribution or execution services can only be offered subject to the following conditions: The client shall not be under any obligation to avail the distribution or execution services offered by the investment adviser or its affiliates. The investment adviser shall maintain arms length relationship between its activities as investment adviser and distribution or execution services. All fees and charges paid to distribution or execution service providers by the client shall be paid directly to the service providers and not through the investment adviser. [Ref. Regulation 6(j) and 6(k) read with regulation 13 and regulation 22]
Most banks and large distribution houses have already set up SIDDs and have registered as RIAs. Some of the larger IFAs firms who have teams, have done likewise, and after seeing these FAQs, many more are actively engaged in segregating the two activities as a prelude to applying for an RIA license. We are likely to see a significant jump in RIA registrations in the coming months, as a consequence. SEBI will be very happy with the impact its FAQs are making in terms of driving up RIA registrations.
For all such businesses, although they would have found a way to protect their commission income stream, compliance costs are going to increase substantially. Platforms who seize the moment and offer a comprehensive and compliant solution are likely to see heightened interest from the new breed of "hybrid model" intermediaries - businesses that are both advisors and distributors. Internationally too, platforms really took off only when compliance responsibilities became too onerous for individual advisors and small firms to manage effectively. We are perhaps going to see platforms getting increasingly relevant in the coming years.
What happens to an individual multi-product IFA?
Where does this leave an individual IFA who wishes to serve clients across multiple products? Well, unless SEBI clarifies otherwise, it seems that you have a choice of either giving up all other products and focusing only on one, or register as an RIA, give up commissions on fresh mutual fund business, and start charging fees from your clients.
The compliance responsibilities are pretty much the same for an individual advisor too - which means significantly higher costs for likely lower income. Not an enticing prospect.
SEBI's intent is becoming increasingly clear : if you really want to serve your clients well by offering them multiple products and end-to-end solutions, do it by becoming an RIA and earn your fees from clients for that value added service. Else, remain a mono-line distributor who represents only one set of products to investors - which means your customer proposition will always be weaker than a full service provider. You can't do what an advisor does, but not register as an advisor. The distinction between a distributor and an advisor is now becoming much sharper. Unless, of course you have a large enough entity to offer both solutions under the same roof, through a hybrid model.
Are we likely to see some creative solutions now from individual IFAs? Can we see for example, small groups of likeminded IFAs coming together to form corporate entities, which can then run a hybrid model? Or are we likely to see platforms coming up with creative solutions on the distribution side that make it viable for an individual IFA to register as an RIA and join a platform for transaction execution? We are a nation that prides itself on "jugaad" solutions. What's the jugaad we are going to see in distribution business models now?
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