Why SEBI’s investment adviser regulation is great, but only the first step

While retaining the ownership of the brand in the US, the CFP Board sold the CFP brand to Financial Planning Standards Board (FPSB), whose office is across the road on Broadway Suite, for all countries outside the US to develop the international CFP certification programme. It is through this channel that FPSB has leased out the brand to 20 countries across the world, including India, the 15th country to join up, in 2001. Currently, there are talks of FPSB taking charge of the brand for US planners as well. I met all the explorers of this youngest field in financial services and one which I believe will determine the future of intermediation business worldwide.

What I found most interesting was that their concerns about the profession are more or less the same as India’s — transparency, disclosures, standards, costs and commissions. In the context of Draft SEBI (Investment Advisers) Regulations, 2007, released by the Securities and Exchange Board of India (SEBI) last week, this similarity of issues and concerns shows just how globalalised the regulatory framework around the intermediation industry in India and abroad have become, four in particular.

Certification. Today, any uncleji down the road can print a card in any permutation and combination of two sets of three words — financial, investment, insurance; and planner, consultant, adviser — and go about advising clients on which financial product to buy. To sell, however, he needs certification. Once SEBI’s draft guidelines turn into regulation, this unhealthy practice with acute information asymmetry in favour of advisers, sometimes in tandem with industry, will end. While a certification is no guarantee of efficiency, it does raise the bar through minimum qualifications and tests, and increases competency.

SRO. The certification above will not be given to anyone unless s/he’s a member of an SRO, says the SEBI draft proposal. Any potential adviser and seller of financial products will have to apply to an SRO, which after processing the application will forward it to SEBI with its recommendations. Regulators across the world are grappling with problems of administrative costs, compliance determination and individual level tracking. As a result, globally, the SRO model is gaining strength. The problems in India are no different from those in the US — I found that when I met with FINRA (Financial Industry Regulatory Authority), the world’s youngest SRO (renamed in July 2007 through the consolidation of NASD and member regulation, enforcement and arbitration functions of the New York Stock Exchange) on K Street in Washington DC. The SRO model is a sort of regulatory outsourcing — the SRO keeps members in check; regulators keep the SROs in check; together they deliver.

Fiduciary responsibility. According to SEBI, the adviser will have to act in fiduciary capacity towards his clients. He will have to disclose all existing and potential conflicts of interests. Further, he is not to divulge any confidential information about clients without taking prior permission, unless such disclosures are required by law. A fiduciary duty is a legally binding relationship between two or more parties and requires the highest standard of care by advisers towards clients. Again, in tune with global regulatory practices.

Disclosures. SEBI guidelines state that an adviser will have to disclose all material information, including his business, disciplinary history, terms and conditions on which advice is offered, and affiliations with other intermediaries. Before recommending a security, he will have to disclose all commissions and rewards, if any, that he will receive. This will arm consumers with information, based on which they can ask smarter questions like: do you have any real reason to sell this new fund offer (NFO) and not an existing scheme — is it because you’re getting 6 per cent commission on the NFO and 2.25 per cent on an existing one?

These four issues are major regulatory concerns in the intermediation space across the world today. To that extent, with SEBI’s draft investment advisers regulations, India is joining the globalisation of intermediary regulation, as it is in the US, Australia, New Zealand and UK. But this is only the first step.

The bigger issue when seen from the consumers side is one of regulatory arbitrage. From the household’s perspective, the financial services landscape is one unit that helps it meet financial goals. The household has need for, say, investment advice. It goes to an intermediary. That intermediary has an option to sell either securities and mutual funds (under SEBI’s ambit) or insurance products like ULIPs (under Insurance Regulatory Development Authority). If the intermediary does not have similar guidelines while selling high commission insurance products, the adviser could manoeuvre investor money away from funds into ULIPs — he won’t have any fiduciary responsibility, won’t be answerable to any SRO, won’t need to declare commissions (tell the household that he’s getting a 40 per cent commission unlike 2.25-6 per cent in funds).

This will hurt not only consumers of financial products but unduly influence industry weights, cause a sort of market failure. Here’s hoping finance ministry sees light and nudges other regulators, notably IRDA, to sit up, look beyond the narrow confines of regulatory turf, and join this much needed trans-regulatory, trans-country, trans-product initiative that is in the best interests of consumers, industry and regulators.