SEBI has proposed new rules for mutual fund distributors that don't seem very practical
26-Jun-2017 •Dhirendra Kumar
Financial regulator SEBI has been on a multi-year quest to separate out those who sell mutual funds to savers from those who give advice. In theory, this sounds like a good thing but in practice, it's not benefitting investors. What's worse, attempts to do so are leading to a regulatory environment which is actually worse for savers.
The genesis of this idea is quite simple. Traditionally, those who sell mutual funds get paid commission by the mutual fund company. This arrangement is identical to what happens in insurance as well as many other financial products. In theory, sellers of these products listen carefully to the needs of the saver, choose the most suitable one, and then sell that product to their client.
In reality, it is an inviolable law of business that he who pays the piper calls the tune. Superficially, it appears that the saver is the agent's customer but that's just an illusion, a polite fiction. The real relationship is that the company is the agent's customer. The saver/investor is actually the product. The agent delivers the saver (you) to the company and gets paid for it. The whole thing is optimised towards maximising the company's sales and the agent's commission while maintaining the facade that it's the saver's future benefit that is being optimised.
To be fair, there are a certain proportion of mutual fund sellers who also pay some genuine attention to the investors' interests. In my experience, this honesty is inversely proportional to the size of the selling organisation. Individuals who operate on a personal basis tend to have at least some focus on the investors' genuine interests. At the other end of the spectrum, 'wealth managers' and such from banks are interested solely in transferring as much of investors' wealth to themselves as possible. This sorry situation is not unique to India--this modus operandi is business as usual for a large chunk of the global finance industry.
Some years ago, SEBI started an earnest attempt to change things in mutual funds. The regulator said that you could either be an advisor or a distributor. Distributors would operate in the original commission-based manner. Advisors, on the other hand, would have to paid by the investor and would not be allowed to receive any commissions from the mutual fund companies. The idea was that since advisors would be paid by investors, they would work in investors' interests. Unfortunately, things didn't quite work out that way. Small distributors knew (correctly) that investors wouldn't pay for advice and remained in the distributor mode.
Big institutional sellers like banks were essentially unaffected because SEBI left a giant loophole for their convenience. The regulations said that as long as such organisations had different departments for advice and distribution, it was fine. It was self-evident to everyone in the financial industry that this made the new arrangement completely ineffective, but the regulator, somehow, didn't discover this. The net effect was that this made the going tougher for the small distributor and thus, on a relative basis, worked out to be an advantage for the big ones.
Unfortunately, it seems that the regulator is now preparing to go further along the same path. Last week it released a "Consultation Paper on Amendments/Clarifications to the SEBI (Investment Advisers) Regulations, 2013". This lists changes to the earlier regulations and invites public comment. In this paper, the proposed regulations take a strange step forward. Earlier, advisors and distributors were segregated on the basis of who got commission, which is an objective fact. Now, one of the proposals is that distributors will be forbidden from offering advice! They can 'describe material facts' about mutual funds, but they cannot give advice.
This can only be implemented by having a list of very well-defined topics about which the distributor and investor cannot have a conversation. How someone can think this to be a practical, implementable law boggles the mind. And again, organisations like banks get an exemption merely by having separate departments that are labelled 'Advice' and 'Distribution'
The proposed rules also say that "MFDs shall refrain from mis-selling of mutual fund schemes. There shall be strict enforcement action on mis-selling of mutual funds..." The amazing thing is that SEBI has never defined mis-selling, nor has it ever tried any qualitative or quantitative analysis of the mis-selling that goes on.
I'm afraid we're getting deeper and deeper into unimplementable micro-regulations which are getting further and further from understanding that people won't act against the financial incentives given to them. If you want to change behavior, change the incentives.