Making Regulations Work Is Serious Business

By Suresh Sadagopan

Regulations are needed in every industry to ensure orderly conduct and protect customers. There is generally an asymmetry between the service provider and customer in terms of the knowledge, understanding, and control they exercise.

It is true for the advisory profession as well. 

Regulations emerge around an industry after it has achieved scale. In the case of Financial Advisors, Investment Advisory (IA) Regulations from the Securities Exchange Board of India (Sebi) came much before the advisory practice matured. There has been a revision recently.

Anyone entering the industry would look for three things: how easy it is to get into the industry (entry barriers), the ease of doing business after that, and the potential for growth. 

The structural factors governing the industry, like the readiness of clients to seek advice and pay fees, are something the regulations cannot do anything about. But even here, regulations can help.

Some relaxations are enablers – The recent regulatory changes in the IA Regulation made compulsory corporatisation easier by raising the client count to 300 or the revenue to Rs 3 crore, whichever is earlier. 

This is a relief, though compulsory corporatisation itself is not a great idea. Even individuals can hire advisors under them and service any number of clients. Many individual RIAs (Registered Investment Advisers) had done this in the past. 

The relaxation in education & experience criteria for employees an advisor recruits is positive and enabling. Before this, finding those with PG qualifications in finance, economics, etc., along with two years of relevant experience was like spotting the Himalayan Yeti!

Also, allowing RIAs to offer their advice and second opinion on existing regular funds, after clearly explaining the charge implications to the clients, is useful, for in practice most clients want advice on all parts of their portfolio, not just the portfolio the advisor manages.  

When entry barriers are half-foot poles – The industry needs a steady influx of good talent. This will ensure a good pool of advisors ensuring industry growth.

However, it is in everyone’s interest that the quality of advisors be maintained so that delivering high-quality fiduciary advice is feasible.

If the barrier is too low, it can directly impact the quality of advisors who troop in. Allowing graduates in any field with NISM XA/ XB to become IAs, without any experience, may be good in the intent to increase the number of advisors but has the potential to dilute advisor quality standards. That could shake customer trust, lower the salience of advisory profession, and become a drag on the profession.

Structural problems remain – Financial Advice is generally offered as incidental, free advice by product providers, which largely tends to be self-serving. 

The culture of accessing advice for a fee is largely absent. What compounds the fee payment is the human behavioural aspect. Paying a fee directly is psychologically far more difficult compared to if the amount was deducted from the scheme expenses.

Also, when a fee is paid, 18% GST is applicable. In many cases, redemption from the portfolio may be necessary to pay the fee, which optically looks like advisor taking their money from the portfolio! Also, capital gains taxes will apply at redemption. Due to this, the costs to the clients go up.

Compliance burden – Proper compliance is needed for customer protection and for orderly growth of the industry. However, compliance intensity is high and has gone up quite a bit since inception. 

RIAs need to maintain records of clients, advice given and the rationale for five years, services offered and the fees charged, client level segregation, comply with periodic filings as required by the regulator, do compliance audits annually, ensure SAAS & Cyber Security related compliance, maintain website and update complaint records monthly, ensure advisors comply with periodic certifications, complaint redressal enablement through SCORES and Smart ODR,  comply with Advertisement code, be ready for inspection from the regulator as called upon, etc.

RIAs also need to ensure client KYC/ CKYC, compliance with PMLA, periodic risk profiling, risk variance documentation, suitability of advice, and ensure and demonstrate adherence to the fiduciary standard.

These are some of the compliance requirements that make it onerous. 

Making it work – Just bringing down the educational/ experience requirements is not going to increase the numbers of RIAs significantly. In fact, it makes sense to keep the entry barriers at a level where advisor quality is very good. 

The regulator needs to make efforts make the advisory profession desirable and viable. Towards that they need to promote it in the interest of financial inclusion, availability and accessibility across the country.  

Today, people do not know about RIAs and that only RIAs are empowered to offer financial advice.  In practice, virtually anyone offers advice and gets away, to the detriment of regulated, registered advisors.  

Tax offsets to customers for fees paid to an advisor is a good incentive that the regulator needs to take up with the Finance Ministry, as this will be a fundamentally new construct. GST waiver like in case of insurance would help too.

Too much compliance adds to the costs significantly and makes the profession unviable. The regulator needs to understand that most advisors will be solo practitioners or will be small entities and tailor compliance with that in mind. For instance, making everyone maintain a website for those with disabilities, while laudable, is impossibly difficult for small firms/ individuals.

Lastly, allowing the profession to settle down and find its feet is important. A constant flurry of changes, new requirements & compliances are costly and unsettling. 

It is difficult to build an industry through regulations, but easy to kill if applied wrongly. 

The advisory profession has tremendous potential and needs all the support from the regulator to ensure that people are able to access advice with ease.

The author is the MD & Principal Officer at Ladder7 Wealth Planners and the author of the book “If God Was Your Financial Planner”

(Disclaimer: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.)