Call off the wild

The need for these 2 million intermediaries — 41,000 mutual fund distributors, 500,000 small savings agents, 1.9 million insurance agents and the expected 50,000 certified financial planners over the next five years —to be selling advice and financial products is unquestioned. Household prosperity is on the rise. The state’s receding hairline through lower returns on government-guaranteed products is telling households that they have to take their own risk; if they want higher returns it won’t be from government-backed schemes but from market-sensitive instruments.

The responsibility of financial planners is far greater than other intermediaries. They are expected to take a holistic view of consumers’ financial goals (house, education, retirement, inter-generational transfer) through insurance, credit, investments, tax-efficiency and estate planning rather than the other way round. Today’s offerings are segmented, unrelated product sales. Tomorrow’s need is integrated, cross-product, goal-actualising advice.

But the landscape is wild and the animals are three. One, wrong advice like selling equity to a low-risk consumer. Two, privacy violation like sharing information garnered through an account-opening form with the bank’s related entities. And three, outright fraud; one mutual fund CEO told this writer last Friday how an intermediary changed the applicant’s name using a genuine applicant’s cheque. Luckily, these are few.

Why does this happen? Morality aside, the first problem is low entry barriers. The question banks of Amfi or IRDA examinations are freely available with mutual funds and insurance companies, so it’s not much of an exam. Besides, as many would know through personal experience, cheating is rampant and often encouraged. The second problem comes from the regulatory arbitrage derived through tax advantages (which, with the abolition of long-term capital gains has made insurance and mutual funds tax-neutral) and commission structures — as low as 2.25 per cent for mutual funds and 40 per cent for insurance companies (going as high as 60 per cent, unofficially). But I won’t blame the agent here. Who in his right mind will sell a low-commission product, even if it’s more efficient, when he can get a higher return on a similar product?

What’s needed to be done are four things. First, ‘advice’ needs to be defined. According to Financial Planning Standards Board (FPSB), advice is “any recommendation, guidance or proposal of a financial nature furnished, by any means or medium, to any client or group of clients”. So an advisor is one who delivers this advice and needs to be regulated at the top end of a three-step pyramid. Next follow advice executors, intermediaries who sell the products recommended by the advisor — the two could be different in case of a fee-only planner. At the bottom of the regulatory pyramid stands the information supplier who delivers information about various products — without passing any judgement on who should buy.

Second, advice should be recorded. The terms of reference and extent of advice should be written down, on paper. Third, disclosures on every product and of every type have to be listed, upfront. And fourth, penalties for violation. This is not a prescription for precise actions but for contextual ones. That is, the attempt is to create a paradigm under which regulation of intermediaries in general and financial planners in particular needs to be seen. Practically speaking, what’s needed are standards and licenses on the one hand and their ruthless enforcement on the other. And most importantly, resting on disclosures.

Disclosures are of two types. The first formalises the client-planner relationship, on paper, through disclosure of qualifications, licenses, work experience, regulatory strictures or membership expulsions, if any, and the nature and extent of advice offered. The next part talks about fees and commissions: nature of fees (fee only, commissions, or both — we may need to re-examine rebating for that), fixed and variable components of the fee (upfront and/or trail commissions), ties with companies (in case of insurance agents), difference between gross and net returns (net of costs, that is), alternative options and conflicts of interest.

None of this is rocket science or the discovery of America. This writer studied best practices in 19 countries and found that financial ‘planning’ is regulated in four countries (Australia, Malaysia, South Africa, UK), financial ‘planners’ are regulated in three (Brazil, Malaysia, South Africa), ‘quality of advice’ is regulated in five (Australia, Austria, France, Germany, South Africa), and disclosures are ‘written’ in nine (Austria, France, Germany, Hong Kong, New Zealand, Singapore, South Africa, UK and US).

But to regulate intermediaries and planners, legitimacy is needed. To the best of my knowledge, there has been just one instance of a mutual fund agent’s license being revoked by Amfi, an association whose mandate is to promote the interests of AMCs. That legitimacy can come only through a regulator. That’s tough because a planner sells products across the financial spectrum, involving RBI, Sebi, IRDA and tomorrow PFRDA. As a first step, therefore, this quad will need to work together, share information. As a second step, a new regulator for intermediaries could be considered, which of course involves legislation and needs time.

It is here that the role of the FPSB becomes important. With a strong intellectual infrastructure in place, through its code of ethics and professional responsibility, its disciplinary rules, its procedures and best practices, and global experience in enforcing them in 19 countries, the FPSB has a two-forked enabling mechanism. It can either become an SRO or an advisor to the regulator(s). And help call off the wild.

(Edited version of a lecture given at the Financial Planning Congress 2006, organised by FPSB, India on May 29, 2006)

gautam.c@expressindia.com