Regulating investment advice: Fintech vs Sebi

Media reports suggest the Securities and Exchange Board of India (Sebi) wants to redefine the services of research analysts (RAs) and investment advisors (IAs) by tweaking once more the regulations that govern them. Let me start with a disclosure. I run a firm that is regulated by Sebi and so my views may be coloured. However, I have insights into what investors are looking for, something non-practitioners may not be aware of. Sebi brought IAs within its regulatory ambit in 2013 and RAs in 2014. IAs are supposed to be like family physicians who know the health history of every member of the family. What a doctor knows about health, the IA is supposed to know about wealth. But that is where the analogy ends.

If the regulatory burden on doctors is 10 on a scale of 1-100, it is 100 for IAs. And doctors are dealing with our lives! The Sebi regulations of 2013 and 2016 already covered the mandatory risk profiling of clients, the suitability of products recommended, and recording the rationale and suitability of every piece of advice provided. IAs must have a documented process for selecting investments based on the client’s objectives and financial situation, and also have a reasonable basis for believing that a recommendation or transaction entered into meets the client’s objectives and risk profile, among other things. These regulations are getting tighter and tighter.

In 2019-21, Sebi came up with further extensive changes. In December 2019 there was an ad hoc circular. On September 23, 2020, it issued new additional guidelines —just two months after extensive changes were announced in July 2020. As a result of these changes, IAs cannot accept fees through credit cards, will have to sign a 26-clause investor agreement, and have to maintain physical records written and signed by IAs, telephone recording, emails, SMS messages, and any other legally verifiable record for five years. All this may be well-meaning but is it practical? IAs will need an army of people including administrative and technical staff to be compliant. If a doctor is supposed to sign a 25-page form with each patient and maintain the records of every conversation and the reason behind every prescription for five years, and get all this audited every year, he would barely be able to see a few patients in a whole day. His charges would shoot up and medicare would go out of the reach of most people.

The heart of the issue is Sebi’s idea of a model IA, who has to go into every financial detail about clients, including goals, preferences, borrowings, current investments, savings, expenses, personal taxation and so on, and offer advice on all of them holistically. What Sebi has in mind has been reinforced in the extensive case studies IAs have to read to pass the mandatory test run by the National Institute of Securities Market (NISM) every three years. While Sebi may want advisors to extract extensive data and provide highly customised service, clients themselves are often unwilling to share details. Some want to use the services of multiple advisors while others have justifiable trust issues.

At the other end of the spectrum, financial entrepreneurs running fintech are salivating about transplanting the wild success of consumer technology (like Amazon) on to the financial world. They want to register millions of customers in a matter of months. Such a rapid scale can be achieved through a combination of minimum click-throughs, no physical processes, and closing the entire customer experience within minutes. It is impossible to do this under the current regulations, even though fintech firms and Sebi both have the noble objective of ensuring that rational investment advice reaches millions of people. In the eyes of fintech firms, Sebi’s model of physical IAs offering customised services belongs to the Stone Age. At the moment, fintech firms that offer advice and cookie-cutter risk profiling are flouting Sebi rules without consequences.

What consumers want

The bigger question is what customers want. Does each customer want the Saville Row equivalent of financial advice or some are okay with an off-the-rack T-shirt? Remember, financial planning is sold, not bought. Seeing a doctor is a necessity for one who is ailing; sitting in front of a financial planner is not. Of the thousands of queries we have received from clients, 80 per cent fall into three broad types: One, I have Rs 5 lakh of surplus lying in the bank; where should I invest it?; Two, here is my portfolio. Should I hold these shares or sell/switch?; Three, what is your opinion of the following stocks or funds? Under the current Sebi regulations, IAs cannot answer any of these questions without going through the entire rigmarole of extensive financial planning.

How do fintech firms deal with the physical process that Sebi demands? They can’t. They have made up processes that violate Sebi rules. A decade after robo advisory started in the West, Sebi mentioned it in a discussion paper of 2016, but the regulations do not permit it. But it is being offered with impunity without facing regulatory action. One kind of service that has come up to address customer needs (model portfolios) blurs the distinction between what RAs are supposed to do (issue research reports on single companies) and what IAs are supposed to do. Sadly, a few of Sebi’s rules are vague, but the regulator showed no leniency when IAs violated what Sebi had apparently intended. In effect, the gap between what customers need, what they want, what fintech firms are offering and what Sebi regulations demand of IAs, is far too wide. I am eagerly waiting to see how a new discussion paper bridges these gaps.

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers