A new consultation paper from India’s Securities and Exchange Board of India (Sebi) on separating investment advisers’ financial advisory functions from product distribution appears to have addressed lingering conflict of interest issues. That is likely to prove more beneficial for investors, according to experts.

The new proposals dictate that market participants can only choose either advisory or distribution. That is seen as a key rule change that should create a more level playing field between larger and smaller entities, and potentially improve the quality of investment advice, as it removes conflicts of interest. 

The consultation paper is an amendment to the Sebi (Investment Advisers) Regulations, 2013, and marks its third effort to eliminate the conflict of interest that arises when an investment adviser both offers advice and sells products. Released on January 2, 2018, it demonstrates an encouraging shift in Sebi’s thinking on investment management, said Manoj Nagpal, chief executive of Outlook Asia Capital, a wealth advisory and investment firm based in Mumbai.

The new paper states that small independent advisers can either be a registered independent adviser (RIA) or a distributor but not both, irrespective of whether the applicant is a small entity or a big bank.

“The new consultative paper brings parity for both larger and smaller entities and tells them to choose one of the two models—and neither one can do both,” Nagpal told AsianInvestor.

As of March 2017, there were 687 mutual fund distributors in the country that fit the criteria defined by Sebi. Assets under management for India's mutual fund industry totalled $332 billion at the end of December 2017, according to the Association of Mutual Funds of India.

According to World Bank data, India's mutual fund AUM to GDP ratio was 7.3% in 2015, the latest available year with data.

The latest consutation paper is also a tacit admission by Sebi that its previous effort to administer investment product advice and distribution, via an earlier consultation paper in June 2017, had been flawed.

That paper suggested that all smaller players such as independent financial advisers (IFAs) move towards becoming registered independent advisors (RIAs) within three years, while larger entities such as banks and national distributors could have a separate entities, one of which could engage in distribution and the other could be advisory.

At the time market participants told AsianInvestor these proposals would hit advisers hard, because India’s pure-advice market is not developed as other markets, and therefore the practice had been to offer advice alongside product recommendations.

“In effect, the earlier consultation paper said smaller entities to move towards an only-advisory services model while larger entities such as banks could do both,” Nagpal said.

“This [new] paper has a more progressive view and there is more clarity of thought than before,” he added, noting that it takes a more considered approach of how the proposals are adding value to investors.

Sebi issued a first consultation paper on October 7, 2016, and then the much-criticised second version on June 22, 2017.

Thumbs-up

Asit Bhansali, a director with the Foundation of Independent Financial Advisers, a non-profit industry body that has around 1,800 members advising on assets totaling $15 billion across India, also gave Sebi's new proposals a cautious thumbs-up.

He said there is relief in the independent adviser community that they have the choice to move to either a distribution or advisory business model, allowing them to pick what best suits their circumstances to service investors.

“Sebi has been very responsive to the needs of the advisers and the latest consultation paper shows they have understood the ground realities,” he told AsianInvestor.

However, he prefers that advisers be able to engage in both distribution and advice, with the option of choosing which activity to engage in with per client.

This will help the industry move towards pure advisory in future, he added.

He had previously told AsianInvestor that Sebi’s second consultation paper would have driven individual advisers—who help channel investor savings from small towns and villages—out of the market, while raising the cost for such retail clients in the long term.

Nagpal added that while Sebi’s goal to separate advice from distribution is commendable, some financial advisers had used the new proposals to charge clients twice over.

“Clients were being charged for advisory and the advisor, working hand-in-glove with some distribution/trade execution outfits, was gaining a share of commission on the distribution side as well,” he said.

In many instances, an adviser’s spouse or a close family member would operate an adviser’s distribution or trade execution division, other experts pointed out.

Conflict prevention

To prevent this conflict of interest, the latest consultation paper proposes that independent advisers only engage in one activity (distribution or advisory) and states that they cannot engage in the other—either directly or through their immediate relatives. This covers spouses, parents, brothers, sisters or children of the applicant.

Nevertheless, Sebi’s paper is unlikely to be the last in its ongoing series of  consultations over investment product advice and distribution.

According to some industry experts, the larger participants such as banks are pushing back on the new proposals, arguing it is unfair for them to choose only one model.

They believe the proposals could see even more fine-tuning and that this paper represents more work-in-progress rather than being the final consultative paper.

“It would be fair to expect one more round of discussions,” Nagpal predicted.