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The Burden Of Commission

SEBI has always represented the interests of the investors but has alienated the distributors with the new proposals

In January 2008, the Securities and Exchange Board of India (SEBI) passed a regulation banning the entry load for investments made in a mutual fund directly by the investor. Investors were a happy lot but the distributors were a bit miffed.

Now a year down the road, the distributors are making no bones about their grouse with the market regulator. This time around, SEBI has proposed some radical changes in the way mutual fund distributors are to be compensated. The motive behind the SEBI move is to enforce complete flexibility and transparency into the commission paid to the distributors. On the one hand, the changes are long-anticipated and many ways logical. But there is no doubting the fact that it will lead to a transformation in the way mutual funds are sold and, in the bargain, many distributors will find it difficult to adjust to the new regime.

Mutual fund distributors (also called Independent Financial Advisors or brokers), are currently paid a commission by the Asset Management Company (AMC) whose funds are being sold. At present AMCs pay a commission of anything between 50 basis points and 3.5 per cent to their distributors. This is over and above the commission of 2 - 2.25 per cent (for equity funds) which is entry load that is paid by the investor. This entry load 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 and is 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 2002, 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. As commissions vary according to different schemes and fund houses, the investor is clueless as to how much the distributor is earning when he recommends or sells a particular scheme. So the question arises as to whether this scheme is genuinely a worthwhile investment or if the distributor is being influenced by the commission. Operationally, SEBI has proposed two methods for implementing flexible commissions.

One, there will be a place in the fund purchase form for mentioning the exact commission percentage that the investor wants the AMC to pay to the distributor. Alternatively, the investor will separately pay the distributor for his services without involving the AMC. In this case, the investor will write two cheques, one for the AMC (for the investment) and one for the distributor (towards his commission). 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 various services and advice of different quality. Some just fill in the form and deposit it, while others actually offer valuable suggestions and guidance. Some give good advice, some bad. Some are self-service online systems while others offer plenty of personalised face-time. The value that the investor gets from each is different and like other goods or services the money he is willing to pay is also different.

Evidently, the pros are all on the investors' side. Unfortunately, the cons are all on the side of the distributor. Many investors will underpay advisors while some may not pay them at all. Smaller distributors are often just individuals who are struggling to run their businesses alone. Now, convincing investors to give them a reasonable commission and chasing them for payments will be a whole new source of business stress.

On another aspect, 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 Unit Linked Insurance Plans (ULIPs). It is ironic that fund distributors are getting squeezed on the 2 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. Ultimately, these changes make the regulatory arbitrage between an investor-friendly SEBI and a historically industry- and agent-friendly Insurance Regulatory and Development Authority even wider.

A Matter Of Opinion (Vikaas M Sachdeva),
Country Head - Business Development
Bharti AXA Investment Managers Pvt. Ltd.)

The proposal on variable load commissions is going to be challenging to implement, both on the conceptual as well as on the implementation front. However, a thorough examination of all issues concerned, and response thereafter should put things in the right perspective.

One aspect of the guidelines is to let the distributor charge for the quality of advice that he renders. However, it has also been found that investors tend to go for the best “deal” possible in all aspects of financial services. It is quite possible that the investor might take advice from one distributor and invest through another, more “cost effective” distributor - or even directly with the AMC.

Hence, it is possible that the role of the intermediary in terms of market development might get marginalized if this proposal is not implemented with utmost care. Distributors are the backbone of the AMC industry. Any positive impact will tend to make the distributor work more intensely in terms of market development. The flip side, however, is equally true.

I think the sentiment is more of “wait and watch”, rather than “worry”. It's quite possible that distributors might sell non-mutual fund products till the time they are unsure of what to expect. However, most distributors today are evolved and would not skew the investor's portfolio dramatically under the overall aegis of a sound asset allocation strategy.