The Sumit Bose-led committee, appointed by the Ministry of Finance to study the incentive structures of financial products and hence curb mis-selling, has presented its report. The committee had the following objectives:
- To address the issue of providing a level-playing field in the commission/incentive structure of financial products
- To suggest policy measures such that differential regulatory norms do not favour any particular financial product and to prevent mis-selling
- To address issues with respect to hidden costs and identical financial products under different regulatory jurisdiction
- To rationalise the incentive structure across financial products
The committee focused on 'push' products. Push products, according to the committee, are those which (a) do not offer assured returns and (b) have high and non-transparent cost structures. This classification narrowed down the focus to insurance, mutual funds and pension products. 'Pull' products like bank deposits, the Public Provident Fund (PPF) and post office small savings schemes were excluded from the review as their returns are predictable and they don't have opaque cost structures.
The committee studied the current scenario of the retail financial sector in detail. It consulted the recommendations of the Financial Sector Legislative Reforms Commission (FSLRC) on consumer protection, financial regulation and inclusion, and market development. It also reviewed the approach taken by the Financial Stability and Development Council (FSDC) to implement FSLRC's principles relating to regulatory governance, transparency and improved operational efficiency.
The committee operated between December 2014 and July 2015. It has come up with the following major recommendations:
- Regulation of financial products must be seen in terms of the product function and not form. These functions are insurance, investment and annuity.
- The lead regulator, according to function, should fix the rules of the game. In bundled products, the lead regulator for the function of the sub-part must fix the rules.
- Investment products and investment components of bundled products should have no upfront commissions.
- All investment products, and investment portions of bundled products, should move to an assets-under-management-based trail model.
- Upfront commissions on pure insurance products and pure-risk portions of bundled products should be allowed and should be decided by the lead regulator since pure risk is a difficult product to sell.
- Financial products should have flexible exit options. The cost of exit must be limited. The current rules as decided by Securities and Exchange Board of India (SEBI) for mutual funds and Insurance Regulatory and Development Authority of India (IRDAI) for Unit Linked Insurance Plans (ULIPs) should govern the surrender and lapse costs in traditional plans, and form the basis for future products.
- The costs of surrender for each product should be reasonable. After deduction of costs, the remaining money should belong to the exiting investors.
- Lapsation profits, or profits from exit charges, if any, should not accrue or be booked by product providers.
- At the point of sale, returns should be clearly disclosed and should be a function of the amount invested. Returns in bundled products should be shown on the invested amount.
- At the point of sale a one-page disclosure form that both the customer and the seller sign should be included. The disclosure should be in a manner that an average customer can understand what the product costs and benefits are, and for how long the customer should hold the product.
- The disclosure should show historical returns as an average annual number based on the internal rate of return (IRR) of the product.
- All disclosures should be machine readable. Machine readable does not mean soft copy. Being machine readable means that data can be processed by a computer for further analysis and interpretation. The comma-separated-value format (CSV) is a basic example of the machine-readable format.
- For similar products, there should be a similar structure with regard to service tax, stamp duty, and rural and social sector norms.
- Similar products should have a similar free look-in period.
- Regulators should create a common distributor (including employees of corporate agents) regulation. Each regulator may add rules specific to the products regulated by them.
- Regulators should create a single registry of all distributors. The registry should identify each individual distributor with a unique number. The registry should have the past history of regulator actions and awards for each individual distributor. Strict penalties should be defined for distributors who are not registered.