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New Commission Rules

SEBI's proposed changes in the way commission is paid to fund distributors has as many cons as pros

The securities market regulator, SEBI, has proposed radical changes in the way mutual fund distributors are compensated. SEBI seems set to enforce complete flexibility and transparency into the commission paid to the distributors. The changes are long-anticipated and many ways logical. However, they are likely to lead to a deep transformation in the way mutual funds are sold, and I think many distributors will find it difficult to adjust to the new regime.

Mutual fund distributors (who are now euphemistically called Independent Financial Advisors-IFAs) are currently paid a commission by the Asset Management Company (AMC) whose funds are being sold. This commission is generally around 2-2.25 per cent for equity funds. This is deducted from the invested amount and the investor gets allotted that many fewer units of the fund. The distributor gets the commission from the AMC. Distributors are not permitted to refund any of the commission back to the investors. However, it is an open secret that many knowledgeable investors whose investments are large enough to give them some clout get discounts on the commission in the form of such refunds. Till XXX, such refunds were not a violation of the rules and were routine.

Now, SEBI wants to put an end to the practice of fixed commissions. It wants the actual commission amount to be discussed and settled between the investor and the distributor. Operationally, SEBI has proposed two methods for implementing flexible commissions. One, there will be a place in the fund purchase form for writing in the commission percentage that the investor wants the AMC to pay to the distributor. Or two, the investor will separately pay the distributor for his services without involving the AMC. In the second option, the investor will write two cheques, one for the AMC and one for the distributor.

The pros and cons of these new arrangements are self-evident. On the plus side, it does away with the administered-price regime that we have today. Different distributors provide services and advise of different quality. Some just fill in the form and deposit it, others actually give advice. Some give good advice and some bad. Some come to meet you in kurta and chappals, others come with smart ties and smarter powerpoints. Some are self-service online systems while others offer plenty of personalised face-time. The value that the investor gets from each of these things is different and like other goods or services the money he is willing to pay is also different.

Those are the pros and they are all on the investors' side. Unfortunately, the cons are all on the side of the distributor. Many investors will underpay advisors and some won't pay them at all. Smaller distributors are often just individuals who are struggling to run their businesses alone. Now, chasing investors for payments will be a whole new source of business stress.

There's no easy balance between the two and I guess everyone will find their own price and service point in a freer market. However, the newer rules will worsen one problem-they will further increase the transparency gap between the real mutual funds and the faux-funds being run by insurance companies under the guise of ULIPs. It is ironic that fund distributors are getting squeezed on the two per cent they earn while the insurance industry gets away with their 30 or 40 per cent commissions for hard-selling funds disguised as insurance.

These changes make the regulatory arbitrage between an investor-friendly SEBI and a historically industry- and agent-friendly Insurance Regulatory and Development Authority (IRDA) even wider. And that's not good for the investor.