Why combining investment advisory with distribution of financial products is not always an evil

Posted by: Uma Shashikant on Jan 08, 2018, 06.30 AM IST

The debate around the distributor and investment adviser is back. Sebi has put out another Consultation Paper for amending its Sebi (Investment Adviser) Regulations, 2013. The gist of what is being proposed is: Advisers and distributors, including institutional players such as banks, must make a choice between either one of the two roles by March 2019. Having chosen one role, neither them, nor any related entity, can play the other role. Every entity in this business has to make the choice: Be a distributor who earns commissions from the producer; or an adviser whose fee is paid by the investor.

To ensure that the adviser is the entity an investor would turn to, Sebi has asked these entities to register themselves, complete qualifying examinations (Disclosure: CIEL is a Sebi-approved provider of such certification examinations), subject themselves to due diligence and audit requirements, and such other gatekeeping requirements. An adviser is a more tightly regulated entity, and in order to protect their interests, and encourage streamlining as desired by its regulations, Sebi also bars unregistered entities from offering investment advice.

It is not as if distributors are not subject to regulatory supervision. They also have to clear mandatory exams, obtain, maintain and renew professional membership, follow processes for risk assessment and product suitability before selling, and face penal action if found guilty of mis-selling. However, the regulator sees them as mere facilitators who do not have the capability to give investment advice. It should seem that the transition from distribution to advisory would be aspirational and organic. There are merely 782 Sebi-registered advisers as we speak, and there are real road blocks to the righteous prevalence of advisory over distribution.

The hitch is in the economics of it all. Distributors not only earn an upfront commission, but also a trail commission as long as the investor stays invested. This means, for all the qualitative superiority of becoming an investment adviser, remaining a distributor makes better economic sense. There is more bang for the buck as distribution needs lower quality manpower and pays better.

Every aspiring distributor transitioning to be an adviser has an active book of clients who generate a steady annual income. While they can earn the trail for legacy, they will not earn such income on their future services. Incomes fall and become more risky, costs and compliance increase when one moves up the value chain from being a distributor to becoming an adviser. What needs fixing is this mismatch of incentives.

The two roles have been long entwined. While separating them is desirable, without supporting the transition with adequate incentives and allow it to emerge with time, it is bound to be a rough road.

The regulations kept this developmental orientation and had allowed an adviser to have an independent distribution arm, subject to regulatory requirements for code of conduct, and firewalls as a separately identifiable department or division (SIDD). This enabled banks, NBFCs and broking institutions to offer both advisory and distribution services. Individual advisers paired up with spouses, relatives and such to offer both services. The current consultative paper proposes to ban such joint offers.

Meanwhile, distributors have to continue to ensure that the product they sell is suitable to their client, and are subject to tests of appropriateness in their pitch. While how far the conversations about appropriateness can go remains to be clarified, there is no imminent harm to the steady income a mere distributor will make. These two positions will continue to hurt the development of the advisory profession while making it more economically viable to remain a distributor.

What needs to be done? First, if the idea is to disincentivise so that the desired outcome is achieved, the focus should be on the distributor not the adviser. Making distribution less attractive can be achieved in many ways, including cutting off the trail commissions, capping the upfront commissions and the like. Penalising the advisers will only slow down the process further. Allowing advisers to keep their legacy commissions is a step in the right direction. Enabling them to build their fee-based services, while continuing the distribution arm through SIDD is required, until fee-based advisory is well entrenched. This regulatory crutch is critical to advisers.

Second, large scale investor awareness about investment advisory as a profession is needed. For a profession to gain client confidence, the value it adds needs to be showcased, and supported with facts and substantiated by experiences. There are too few advisers to undertake this activity on a large scale. Given the objectives of the regulation, the regulator should invest in this market development activity.

Third, the thriving distribution business is supported by producers of investment products. They depend on commission-based sellers to expand their assets and investor base. The industry needs a low cost distribution model that is scalable and will remain product centric. Advisory is investor-centric and needs power over the producer. It will be tough to reign in and disincentivise mere distribution without creating a powerful advisory profession. For example, what if a product cannot be distributed unless a fee-based adviser recommends it?

Fourth, modern modes of distribution, including online investing and robo advisory, offer cheap, efficient and scalable distribution choices. They can build volume that supports and executes a valuable advisory service. Instead of seeing all distribution services as evil, regulators should not discount the merits of pairing quality advisory with easy execution, transparency and tracking. The focus should be to make execution and distribution low value, low cost, easy, transparent and fungible.

What the investment industry needs is access to a larger population of investors who also need the benefits of good quality financial advice. These distinct objectives cannot be met by a restrictive approach that modifies who can do what and how often. An investor should be free to directly buy a financial product, or buy it only through the services of an adviser. If advice is made paramount, and distribution made subservient, we may begin to build the beneficial model we have in mind. A DIY investor is of course at liberty to cut free of both advice and distribution.

Investment advice as a profession needs support and incentives. Using distribution services, to initially establish the benefits of holistic wealth management to a large number of investors, is a positive approach. Regulators should work with a realistic time-frame and actively enable such transition.

(The writer is the Chairperson, Centre for Investment Education and Learning)
Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.
This article appeared in Economic Times dated Jan 08, 2018, 06.30 AM IST