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Blessings in Disguise

The new commission rules might seem like bad news for distributors, but they might end up making things better

While the investment markets go through their ups and downs, many mutual fund distributors are getting increasingly concerned about the new commission rules that SEBI may be in the process of bringing in. Since I last wrote about this a few weeks ago, I’ve come across a number of distributors who feel that the new rules will completely disrupt this business. I believe that there’s a reasonably widespread feeling among the distributor community that the new rules will be a disaster for them.

Up till now, mutual fund distributors are paid a commission by the fund company. This commission is deducted from the investment that the investor has made. The quantum of the commission is a matter between the distributor and the fund company. The new rules envisage a system under which the distributor and the investor will negotiate and decide upon a commission. The payment will be made either directly by the investor to the distributor or through the fund company. Regardless of the route of the payment, if these proposals are implemented as rules, there will be free pricing which will be negotiated between the two parties. Understandably, going from the current administered pricing regime to free, negotiated pricing is a scary prospect for distributors.

Are these fears justified? I’m not sure, but the situation does remind me of an article I read on cnn.com a couple of days back. In a town in Ohio, USA, a café, of all businesses, has switched to an open pricing policy and is apparently thriving on it. Sam Lippert, the café’s owner, has removed all prices from his menu. Now, when patrons finish their food, they walk up to him at his counter by the door, tell him what they thought the food was worth and pay it. He always accepts whatever they offer without complaint or comment. While total sales are way up because of the novelty factor, Lippert finds that his price realisation is also higher than earlier. Some pay less than what he would have charged while others pay more.

Interestingly, Lippert says in the interview that this free pricing is not unique. He got the idea from his Bulgarian girlfriend, who’d told him that in parts of Europe, it wasn’t uncommon for cafés to allow patrons to decide how much a meal was worth.

Will free pricing work in the distribution of retail financial products? I believe it will. Also, I believe that smaller distributors may be at an advantage to bigger ones if this happens. A couple of days back, a recently-sacked sales guy from a top-flight ‘wealth management’ outfit had a long confessional conversation with me. He said that the big outfits consciously churned investors’ fund holdings because that was the only way they could make any profit at all. If an investment is uselessly churned four times a year, then the company makes eight per cent instead of two. This will be harder to do under the kind of transparency that the new rules will bring in.

A differentiated market where different suppliers offer different pricing according to the depth of services they offer will eventually be better for all concerned. Some distributors will find things harder while others will flourish. Of course, the new rules are still not there yet. And from what I hear, there are plenty of lobbies at work to maintain the status quo.