Here is the relevant extract from SEBI's press release of today's Board Meeting:
(Click here to access the entire press release)
"III. Consultation Paper for "Amendments/ clarifications to the SEBI (Investment Advisers) Regulations, 2013"
SEBI notified the SEBI (Investment Advisers) Regulations, 2013 ("IA Regulations") on January 21, 2013. Under IA Regulations, exemptions from registration as an investment adviser were granted to certain entities who were providing investment advice as an incidental activity to their primary activity.
In order to specify uniform standards and to address the gaps or overlaps in legal or regulatory standards governing all the intermediaries/persons engaged in providing investment advisory services, SEBI Board has approved bringing out a consultation paper proposing certain changes and clarifications in the IA Regulations inter-alia, on the following points:
i. Re-look on the exemption from registration as an investment adviser provided to Mutual Fund Distributors, SEBI registered intermediaries, etc. for providing investment advice as an incidental activity to their primary activity.
ii. Granting of time period of three years to mutual fund distributors who seeks to migrate as an investment adviser so as to enable them to obtain necessary certification and to comply with other requirements specified in IA Regulations.
iii. Segregation of investment advisory services through a separate subsidiary within a period of three years.
iv. Clarification in respect of investment product and investment advice given in electronic/broadcasting media.
v. Applicability of advertisement code to be followed by any person including the investment advisers while issuing advertisement.
vi. Restriction on providing trading tips via bulk SMS, email, etc. and restriction on soliciting investors by offering schemes/competitions/games/leagues/etc. related to securities market and covering these activities under the advertisement code as well as under SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003.
vii. Clarity between the activities of investment adviser and research analyst.
viii. Clarity on mode of acceptance of fee.
ix. Requirement of providing 'Rights and Obligations' document to the clients.
x. Requirements for providing Online Investment Advisory Services and Use of Automated Tools.
The consultation paper will be placed on SEBI website seeking public comments."
So, what does this mean for us?
While SEBI says it will issue a consultative paper, its intention is crystal clear from the press release, on the direction it seeks to steer the regulation of advisory services. Going by history, a consultative paper will be issued, feedback will be taken, but the final regulation is unlikely to be radically different in principle from what has been announced today. What will perhaps be fleshed out is the finer details, based on feedback received.
So, lets take a working assumption that the broad principles of what SEBI's Board has decided today, will in fact be implemented. What does this mean?
Here's my take:
3 year window: SEBI is clearly now forcing the pace on RIA sign ups. But, in a departure from its past track record, it is willing to consider giving a 3 year time frame to enable distributors to make the transition to RIA successfully. There is a lot that needs to be done in these 3 years for serious distributors to upskill themselves, showcase value to clients, start conversations with them on an eventual migration to a fee based model, spruce up systems and processes to ensure compliance and put themselves in a position to succeed in the challenging new environment, 3 years from now.
Hybrid model survives, but bar set higher: The hybrid model for corporate entities will survive, but with a caveat that advisory services need to be hived off into a subsidiary. This will raise the bar for many distributors who have only recently corporatized their practices to comply with SIDD regulations. A separate subsidiary means more clarity on an arms-length relationship between the two companies - one which will distribute and the other which will advise. Smaller companies may find it a lot more challenging to create and maintain a distinct subsidiary. One will have to scale up business sufficiently over the next 3 years to make this viable.
What will pure distribution now mean: Does this mean no more MF distribution and everybody will have to become an RIA over 3 years? That's not what I can gather from their press release. In the present arrangement, we have three broad models - pure distribution, value added distribution and advice. The second one is where most serious distributors are - they offer goal planning services, fund research and recommendations, portfolio rebalancing etc, which currently fits into the "advice that is incidental to distribution" leeway that SEBI has left open for distributors who don't want to become RIAs. This leeway is now going to be closed. You will now either offer pure distribution or you become an RIA. Pure distribution will look distinctly unattractive to investors, as your wings are likely to be clipped on any form of advice that you want to offer to your clients. Clients want advice and guidance, not just access to mutual fund forms and transaction execution and support services. What will be left for distributors to offer in terms of value add is what will be keenly watched when the consultative paper comes out and its final avatar is enforced. That will in effect decide how viable the business of pure distribution will look like in terms of what you can offer to clients. That will in turn decide whether the regulator has effectively told you that you have no choice but to become an RIA or whether there is a meaningful option left for you to consider in remaining a pure distributor.
Alliances and mergers on the cards: There is likely to be a flurry of activity around alliances and mergers like the one we recently profiled (Bold new IFA model from the North East), where like-minded IFAs will get together, pool resources, corporatize, and put themselves in a position to emerge winners in the coming landscape. The 3 year window will be used effectively by far-sighted IFAs. We will see more consolidation - not necessarily in terms of large gobbling up small, but more likely many alliances of small numbers of IFAs - who think they can work together on the basis of shared values and outlook. This will require tremendous maturity to accept a new work culture, as Pallav has so correctly pointed out in his article mentioned above.
What about small IFAs: Alliances and mergers can well be options for the more established IFAs. What about small IFAs who don't think they will be able to succeed in the new world, even if a few of them decide to come together? Perhaps, platforms are the solution for small IFAs. Platforms which enable small IFAs to upskill sufficiently to succeed in the future environment, and which offer holistic practice management support, can become attractive propositions for small IFAs to consider, to make themselves future ready. Platforms that put in place effective fee recovery systems will have a distinct advantage. We've seen this overall trend play out in the stock broking world - where most small brokers ended up becoming sub-brokers to some of the large established players. They leverage the research, technology, compliance and operations support of these large players and focus only on client engagement.
What happens to commissions: At present hybrid model corporates can avail of commissions as well as advisory fees, while this is not possible for individual distributors. Given that the bar for SIDDs is sought to be raised by hiving advice off into subsidiaries, it seems unlikely that individuals will be allowed to offer both services - that will defeat the very purpose of this entire move. So, if 3 years down the road, most of the value added services are offered by advisory subsidiaries of corporate entities who distribute, and by individual RIAs, can one realistically expect distribution commissions to remain at current levels - when most of the value add is no longer offered by distributors? Seems likely to me, one way or another, that distribution commissions will come down to a level that reflect the value of a pure distribution service - of providing access to products and providing transaction execution and reporting services. Commissions will remain, in my view, but at lower levels that what we see now. That will also bring down TERs over a period of time - which is what the regulator wants as a long term objective. We just have to find ways of engaging with investors over the next 3 years to arrive at a position where most of them are willing to pay a reasonable fee for good quality advice. On our part, we need to ensure that we offer good advice and that we are able to clearly demonstrate the value of good advice.
Will we now see a retail advice gap: Countries like UK and Australia that went the whole hog on banning commissions, are now reporting a growing retail advice gap, as fee based advisors typically look for larger clients, and retail commission based distribution ceased to exist. Are we likely to see this happen in India, once these regulations get enforced after 3 years? Looks like SEBI is betting big time on the online channel stepping in to bridge the retail advice gap. We are a young nation, we are hooked onto our smart phones, and broadband access is getting cheaper by the day. SEBI wants to clarify what robo advisors can and cannot do within the purview of a distribution license and an RIA licence. This will clarify the roles of e-commerce players and robo advisors, and give them a road map to penetrate the market with their respective models. What role will this leave for IFAs who aspire to participate in the retail penetration thrust? Seems like as long as the B-15 incentives remain in place, SEBI is perhaps telling us that they want IFAs in smaller towns to do this job, while online propositions can perhaps lead the way in larger cities.
That's quite a lot of crystal ball gazing from one directional statement from the regulator. Some of this may happen, some may not - that's one of the perils of trying to gaze into a crystal ball in an attempt to see the future.
Lets await the consultation paper, lets put our best foot forward in offering constructive inputs and then lets await the final decision by the regulator. But in the interim, it may just be worth your while to consider your own action plan, should the final outcome of this regulatory move turn out exactly the way my crystal ball is telling me.
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