SEBI has floated a consultation paper with new norms seeking to update the Investment Adviser (IA) Regulations 2013.

Smaller investment advisers worried SEBIs new norms will drive them out of business
Money SEBI Wednesday, January 29, 2020 - 16:20

Earlier in January, markets regulator Securities and Exchange Board of India (SEBI) floated a consultation paper proposing new norms for investment advisers to curb false promises of assured returns made by advisers to clients, mis-selling and overcharging.

The proposed norms say that registered investment advisers (IAs) can now offer both advisory and product distribution, but not to the same client. It also asks IAs not to offer investment advice by promising or even suggesting assured returns to clients.

SEBI has also proposed that an IA’s fee be capped at either 2.5% of the assets under advice (AuA) or a flat fee of Rs 75,000 per year.

In its consultation paper, SEBI stated that these proposals were in light of several complaints from customers that IAs were offering assured returns, charging exorbitant fees and mis-selling products.

While the consultation paper attempts to put in place a stronger regulatory framework for the benefit of both IAs and clients, several individual IAs have voiced their concerns over several proposals in the consultation paper, which they fear could wipe out those offering affordable fee-only services and also create barrier for entry of small IAs.

Registered Investment Advisers (referred to as RIAs or IAs) were created by SEBI in 2013 as an intermediary to be able to offer investment advice on all financial products. These are essentially individuals or organisations that advise people on investments, and other financial activities and charge a fee for it. The idea was that clients are given conflict-free advice for their financial goals since these advisers are allowed to advise but cannot sell any product.

As per the new norms, IAs can now offer both advisory and product distribution but not to the same client. This essentially means that IAs can now both advise and sell a financial product, but not to the same client. Under existing regulations, an individual IA cannot distribute. They are only allowed to advice. The paper proposes to include distribution for IAs.

Some of the small IAs are of the opinion that this proposal would dilute the essence of the RIA model, which has been conflict-free advice.

The consultation paper also says that any individual registered as investment advisers whose number of clients exceeds 150 or whose asset under advice exceeds Rs 40 crore should compulsorily re-register themselves as non-individual investment advisers within six months of exceeding either of the given preconditions.

It also states that while investment advisers who are individuals need to have a net worth not less than Rs 10 lakh, non-individual Investment advisers shall have a net worth not less than Rs 50 lakh. “The existing investment advisers shall comply with the aforementioned net worth requirement within three (3) years,” the paper states.

These requirements, small IAs say, are the most damaging points in the paper. According to Brijesh Vappala, a Kerala-based IA, this proposal, if implemented could wipe out smaller IAs that cater to middle-class and upper-middle class clients. Having to re-register in a corporate format will make their business unviable, or force them to increase their fees, he says.

“Take for example an IA whose average fee is Rs 12,000 and whose clients are mostly middle class whose monthly salary itself is in the range of Rs 1-2 lakh. If he has 151 clients, his annual income is Rs 18.12 lakh. After taxes and expenses, his profit will be far lower. How will he maintain Rs 50 lakh as net worth for the business? He will have no option but to wind up this profession and look at other options for livelihood,” Brijesh says.

IAs who are against this proposal believe that they should have the right to choose the organisational format to operate and have the right to service as many clients as they wish as long they comply with the requirements specific to the structure.

Smaller IAs also believe that this helps neither the IA nor the client and could act as a barrier for new IAs and make the profession one which is only for large organisations with deep pockets.

It will also force IAs to charge higher fees, as a result of which, their main client base, who are middle-class and upper middle-class investors, could get wiped out as they wouldn’t be able to afford the high fees.  

The SEBI consultation paper also looks to define the fee chargeable to a client. This is to regulate instances of unfair and unreasonable fees being charged to the client.

SEBI has proposed that fees be charged on the basis of underlying assets under advice (AUA). AUA essentially means securities and investment products that an IA has advised on or sold to a client.

The paper also proposes that the maximum fees that can be charged under this mechanism be 2.5% of AUA per annum per family across all schemes, products and services provided. Under the fixed fee model, it states that the maximum fees that can be charged by any IA shall be Rs 75,000 per annum per family across all services provided.

Some IAs believe that the disparity between AUA based fees and fixed fee does not provide a level playing field. While those who follow the fixed fee model will be stuck with the cap of Rs 75,000, those who follow the model of charging fees based on AUA, using the 2.5% cap, can end up charging a lot more as their AUA increases.

“Most of the fixed fee IAs charge in the range of Rs 12,000-25,000 per annum so that the fee is affordable to the middle class. Hence, a cap of Rs 75,000 is far more than they will ever charge in many years. However, the presence of a cap on fixed fee and the lack of cap on AUA based fee as a matter of principle is unfair. Fee of Rs 75,000 at 2.5% of AUA means AUA is Rs 30 lakh. If the AUA becomes Rs 40 lakh, fixed fee IA’s fees will remain Rs 75,000, while the AUA-based RIA’s fee will become Rs 1 lakh. This does not look like a level playing field by any means,” Brijesh says.

However, the smaller IAs also believe that there are some proposals in the consultation paper which will act as a huge incentive for them.

SEBI has also defined the terms of engagement in the consultation paper. Brijesh says that since the IA model was put in place, there was no clarity on compliance. There was also no check list of resources that defined compliance requirements. That ambiguity will no longer be there.

Public comments have been invited on the consultation paper until January 30.

However, some of them allege that this consultation paper wasn’t circulated to all IAs for comments, because of which they fear their opinions and comments may be drowned amidst those of large organisations registered as IAs.

Brijesh says that he, along with several other individual fixed-fee IAs, have sent in their comments on the proposals in the consultation paper. It’s now wait and watch until further communication from SEBI post the deadline, on what the final regulations for IAs will be.

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