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Financial Regulation Needs Enlightenment

Suresh Sadagopan CFP IndiaBy Suresh Sadogapan, CFP

The financial planning profession in India, is at a nascent stage. It needs careful tending for it to grow and bear fruit. But, are the regulators doing the right thing for the industry? Their intentions seem good but they seem to have missed the realities of what is actually going on.

Since this is a new profession, financial planners are emerging from the Independent Financial Advisor (IFA) community, which is comprised of insurance agents and other financial service intermediaries. IFA’s have all along been product-sellers. Many of them have realized the need to increase their knowledge and skills and have acquired the CFPCM certification.  Slowly, they have started moving towards advisory business; but still, the majority of their revenues come from selling product. It will take time for these people to scale up the advisory business and exit product-selling, as the public at large, are not willing to pay for advice. The advisory business has to be a viable business proposition for them, which it is currently not.

A lot of these IFA’s find it very difficult to charge a fee. Their diffidence stems from the fact that all this time, they have been selling products and have never charged a fee. Some of them have even been passing their commissions back to their clients, even though it is illegal. So, for most IFA’s charging an advising fee to their clients is like leaping over a 6 foot pole. Slowly, they are devising ways and means to start charging a fee and some of the ways are becoming successful.

SEBI Suggests Separation Based on Fees/Commissions

Into this milieu, the regulator (SEBI) brought in a discussion paper which seeks to bring a distinction between:

  1. a class of advisors who will only charge fees (designated as “investment advisors”, in the paper)
  2. and agents, who will be paid by the principal, and would not charge the client.

According to this paper, Investment Advisors encompass financial planners and anyone offering financial advice and actions which would either influence an investment decision or would incidentally cause an investment decision. What financial planners do and what the other agents may be doing is different and it is undesirable to put everyone under an umbrella banner of “investment advisors”.

Financial Planners are NOT Investment Advisors

Financial planners use the appellation “financial planners”, worldwide. Financial planners don’t just offer investment advice. They create a blueprint or a roadmap for their clients to achieve their goals. Offering investment advice is only a small portion of the kind of work they do. It would be perverse to call a financial planner, an investment advisor.

There is a major transition underway in India, as we speak… thousands of IFA’s are slowly transforming themselves from being insurance agents and/or distributors of various financial products, to financial planners. These IFA’s are qualifying themselves and are slowly building the advisory practice. There are challenges galore which these people have to face, along the way.  Since India is in an early stage of development, as far as advisory practice is concerned, these new advisors find it a challenge to charge a fee for services rendered, in many cases.

They are finding that an advisory practice is purely based on fees is not entirely viable and so they are continuing with their distribution activity. Though this kind of regulation is desirable in the long-term, the timing is not right. They would need to offer at least 5 years for the transition.

Various Business Models Require Complete Disclosure

Also, there is nothing wrong with using various models of engagement, and making them all available to the client at the same time. It would actually offer variety and better options. The only issue that needs to be addressed for advisors choosing various models is complete disclosure about the model, engagement, remuneration and the deliverables. Subject to this, it should not matter which model the client chooses. In developed economies like the United States, they have financial planners operating side-by-side who charge:

  • fee only
  • fee offset
  • fee and commission
  • hourly-fee
  • commission only

Even in the US, the number of fee-only financial planners registered with NAPFA is about 2,400, based on their website. Asking all “investment advisors” to be fee-only in India is unnecessary coercion which will put them in a straight jacket and harm all stake holders.

It’s Better to have Tight Regulation than to Ban Everything

Most clients want the advisor to also implement, manage and monitor the investments, as they develop trust in that person.  It is wrong to assume that an advisor will always act selfishly and in their own best interest. It is preferable to have legislation and stringent implementation mechanisms to ensure that clients are not taken for a ride, rather than banning the advisor from implementing a plan. Obviously, it is best to give clients a choice to go to anyone to implement a plan, but if the client ultimately wants to implement through the advisor, he/she should be allowed to.

In this concept paper, it explicitly allows institutions to do just that. It states in the execution services, by  “…making appropriate disclosures, clarify that the client is under no obligation to use their services and maintain an arms-length relationship through creation of Chinese walls”. This means that institutions can continue to virtually operate the way they do and it is only the individuals who have to choose between being an agent or an advisor. This is unfair and creates an uneven playing field, in favor of institutions.

India Will Become a Land of Financial Agents

By creating difficult conditions for IFA’s and making them choose either the agent or advisor role, they are going to remain agents, because compliance is low and their cash flows will not be impacted. This regulation will guarantee that India remains a land of agents. Also, excluding all these agents from the ambit of regulations effectively exposes the investor community at large, to mis-selling and other ill-practices. Effective policing of the agents would be absolutely necessary.

The challenge for the regulator is –

  1. to understand that the existing laws need to be implemented better, through which unscrupulous elements can be punished and weeded out and investor’s interest can be upheld
  2. to appreciate that a transition is underway from agent to advisor and they should act as an enabler
  3. to give a long enough transition time before implementing game changing regulations
  4. to create a level playing field, which gives institutional players and individual advisors the same footing
  5. to understand that financial planners are advisors and not investment advisors in the manner they seek to project

The community is waiting with bated breath to see what the regulator might do on this front.  The contours of the industry can change for better or for worse, based on this. We are hoping that good sense will prevail and they don’t end up driving the proverbial nail in the coffin, in a promising industry.

1 comment to Financial Regulation Needs Enlightenment

  • The best way to deal with a monster is to give him a lot of space. Shift your sight from regulators to investors. Nothing holds you back to develop a successful practice except YOU.

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