Demystifying RIA/MFD regulations & way forward


The RIA guidelines issued on 3rd July 2020 have brought an absolute clarity in what can be done by MFD’s and RIA’s respectively. All intermediaries in the Mutual Fund space will therefore have to understand the implications and arrange their affairs to comply with the regulations.

My objective is to help the reader understand the respective regulations, choose the right model depending upon the services offered and point to options for the infrastructure requirements.

An intermediary for mutual fund investments can work as a distributor or an investment adviser. Both professions have their regulatory framework & code of conduct prescribed by SEBI & AMFI.

Guidelines and code of conduct for mutual fund distributors has been in existence since 2002 which kept on evolving (until 27th Aug 2009) the last when SEBI came with the circular on code of conduct to be followed by mutual fund distributors. Every year every MFD self declares that the guidelines and code of conduct has been adhered to.

An MFD was allowed to distribute and advise both under the same license but the introduction of RIA regulations in 2013 created lot of confusion for existing MFD’s in choosing a regulatory model for various services offered to investors.

Since the introduction of RIA regulations there have been multiple consultation papers seeking public comments, feedback and participation from the intermediaries in the form of working group to help clarify various clauses, bring in more transparency and form a practical and fair regulatory framework with no ambiguity. Finally on 3rd July 2020 a gazette notification was issued by SEBI making changes and amendments to the RIA regulations originally launched in 2013. With this there is absolute clarity in what can be done by MFD’s and RIA’s respectively.

Following is my perception of the distinction in regulations between an intermediary operating in RIA or MFD capacity.

Let us look at Investment Adviser Regulations 2013-

SEBI introduced RIA Regulations on 21st Jan 2013 with an objective-

  1. To lay down the framework for intermediaries
    1. who provides advice to clients
    2. who acts in a fiduciary capacity towards their clients
  2. To also address the conflict of interest
    1. Arising due to the dual role played by intermediaries as adviser and distributor of financial products.

Under these regulations, Investment Adviser (IA) is required to comply with various requirements such as qualification, certification, min net worth, disclosures, maintenance of records, segregation of activities, code of conduct etc. Further, the investment advisers are mandated to do appropriate risk profiling and have a process to arrive at suitable investment advice in line with the clients’ requirements.

I am sure all of you would have read all circulars, consultation papers, gazette, regulation etc and would have gone through them many times and hence I will not be doing a copy paste from regulation but I would be writing what I feel is the understanding & intent of various clauses which regulator wants the IA’s to follow both in spirit and in law.

Let us look at some of the important terms and their definitions given in regulations-

  1. What is an Investment Advice: Any advice given to clients relating to investing, purchasing, selling or otherwise dealing in securities or investment products, written, oral or through any means of communication & shall include financial planning:
  2. What is Financial Planning: “Financial Planning” shall include analysis of clients’ current financial situation, identification of their financial goals, developing and recommending financial strategies to realize such goals.
  3. Who is an Investment Adviser: “Investment Adviser” means any person, who for consideration, is engaged in the business of providing investment advice to clients or other persons or group of persons and includes any person who holds out himself as an investment adviser, by whatever name called.
  4. What is Networth: "networth" means the aggregate value of paid up share capital plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses, deferred expenditure not written off, including miscellaneous expenses not written off, and networth requirement for other services offered by the advisers in accordance with the applicable rules and regulations.
  5. What is consideration: “consideration” means any form of economic benefit including non-cash benefit, received or receivable for providing investment advice;

My view: It’s clear that if you are advising the clients or doing their financial planning or goal planning, you are considered as investment adviser and you need to register yourself with SEBI as Investment Adviser.

Now if you register as an IA with SEBI you need to comply on various parameters mentioned in regulation for both Individual or Non Individual type of entity, let us look at all of them.

  1. Eligibility Criteria for IA’s – (Net worth / Qualification / Experience / Certification)
  1. Individual IA’s should have
    1. PG degree/diploma (min 2 years) + 5 year’s experience + NISM or similar + 5,00,000/- Net worth
    2. If IA has PAA then all of them should have PG + 2 years exp + NISM or similar
  • 150+ clients, compulsory register as Non Individual IA within 6 months from the date of trigger
  1. Existing IA with more than 50 years of age to be exempt from qualification (except NISM)
  2. All eligibility conditions to be complied within 3 years from the date of Gazette
  1. Non Individual IA’s
    1. Partnership/LLP/Private are considered as Non Individual
    2. The registering entity should have min 50,00,000/- Net worth
  • Principal Officer - PG degree/diploma (min 2 years) + 5 years exp + NISM or similar
  1. If IA has PAA then all of them should have PG + 2 years exp + NISM
  2. All eligibility conditions to be complied within 3 years from the date of Gazette

*PAA (Person associated with investment advice)

Anybody who faces clients and provides advice under whatever name you call it

My view – Anybody with such qualifications, certifications, experience and net worth will be able to give lot of confidence and comfort to both investors and regulators. An IA with such accolades will be able to demonstrate the expertise & the capabilities to conduct duties in line with what the regulation and expectations of the clients are. We have seen similar requirements for IA’s in other developed countries as well where investment advisers proudly hold themselves and commit to highest standard of fiduciary duty in client dealings.

Now that we have seen various eligibility criteria, let us look at some of the important rules that IA’s have to adhered to

  1. Client level Segregation of advisory and distribution activities –
    1. Individual RIAs
      1. Where ever applicable advice direct version (0 commission) products only
      2. Where ever direct version is not available (Disclose the remuneration)
  • Cannot be a distributor (ARN holder) and hence cannot offer distribution services
  1. Cannot offer advisory services to client who is receiving distribution services from any family member of IA (Family of IA include individual, spouse, children, parents)
  2. Existing clients to be given a choice of choosing the service that he would like
  3. PAN to be the controlling record for identification
  • Maintain on record annual certificate from an auditor confirming compliance with the client level segregation
  1. Non Individual RIAs including Partnerships
    1. Can offer both advisory and distribution services
      1. Meaning they can have both RIA and ARN licenses
    2. But need to have clear segregation between advisory and distribution activities
  • A client can either be an advisory client or distribution services client
  1. “Family of a client” may constitute individual, dependent spouse, dependent children, dependent parents (PAN to be the controlling record for identification)
  2. Existing clients to be given a choice of choosing the service that he would like
  3. Maintain on record annual certificate from statutory auditor confirming compliance with the client level segregation

*Distribution Services – To be read as MFD or Corporate RIA selling regular mutual funds and getting commissions.

My viewEarlier same client was given both advisory and distribution services either by a corporate IA having SIDD or through any other family member of the intermediary which regulator looks at it as conflict of interest and increase in the cost to the client.

Now they have made it very clean & clear that client will have to be given one service at a time i.e. either give advisory service (direct plans + fee) or give distribution service (regular plan + commission). You cannot give both services under any arrangement or any business model to same client. It actually makes logical sense to do this as you can choose at a client level what kind of arrangement you need to do with that client.

**Definition of Conflict of Interest

A conflict of interest in business normally refers to a situation in which an individual's personal interests conflict with the professional interests. All corporate board members havefiduciaryduties and aduty of loyaltyto the corporations they oversee. If one of the directors chooses to take action that benefits them at the detriment of the firm, they are harming the company with a conflict of interest.

Example - Working part-time at a company that sells a competing product or service as your full-time employer or representation by a lawyer with a vested interest in the outcome of the trial would be considered a conflict of interest. Additionally, judges who have a relationship with one of the parties involved in a case or lawsuit would be considered a conflict of interest in the process of giving unbiased judgement in the case.

  1. Implementation Services – To be read as execution of advice
    1. Implementation / execution can be offered by IAs but only in Direct Schemes where ever applicable
    2. No consideration to be received in any form for implementation/execution service
    3. Clients to be given choice to choose their implementation partner

My view – Implementation services is allowed for IA’s so that feeds can be received from RTAs or Exchanges and IA’s can monitor the portfolios on an ongoing basis. Implementation service is executing the advice and distribution service is selling mutual funds. Both the services have to be looked independently as they serve different objectives.

  1. Advisory Fee
    1. There are 2 mechanisms under which advisory fees is allowed & can be charged
      1. Assets under advice (AUA):
        1. Aggregate net asset value of securities and investment products for which the investment adviser has rendered investment advice irrespective of whether implementation service is provided by IA or concluded by the client directly or through any other service provider
        2. Any schemes where commissions are already been paid has to be deducted for the purpose of calculating AUA
        3. The max fees that can be charged under this mechanism is 2.5% per annum per family across all schemes/products/services.
        4. AUA has to be demonstrated via Demat / Unit Statements / Portfolio Statements
      2. Fixed fee
        1. Max fixed fee that can be charged is 1,25,000/- per annum per family across all schemes/products/services
      3. 2 quarters advance fee can be charged but in case if the agreement is terminated within 2 quarters the expired period advance fee to be refunded back to client
      4. Profit sharing cannot be charged by IAs as regulator looks at it like a PMS structure
      5. Collection of advisory fees
        1. Can be done in any mode as long as traceability of funds is seen.
        2. No Cash Payments allowed or Payment gateways to be used for collection of advisory fees
      6. Advisory fee charged should be fair and reasonable

My view: % of AUA is definitely a win-win model, IA make more fees if the portfolio goes up and less fees if the portfolio goes down. So if an IA has to make more money the only thing he has to do is to focus on increasing the portfolio. Globally we have seen this number in the range of 75 BPS to 100 BPS

IA to bill the client directly and as long as the traceability of funds can be proved that the money has been paid by client and it’s not a third party payment (TPP), you should be compliant. Basically the regulator wants client to pay advisory fees from their own funds.

IA’s would like to keep the cost to the client similar or lower to what client otherwise would have paid in regular plans. (See the table below).

I have taken actual schemes and there actual TER for illustration purpose-


Recommended by

Portfolio Mix

Portfolio
Expense
Ratio

Commission
to Intermediary

Fees
by RIA

Cost
to Client

Revenue to
Intermediary

MFD

100% Active Regular Plan

1.75%

1%

0%

1.75%

1%

RIA

100% Active Direct Plan

0.75%

0%

1%

1.75%

1%

RIA

70% Active and 30% Index

0.50%

0%

1%

1.50%

1%

RIA

50% Active and 50% Index

0.40%

0%

1%

1.40%

1%


Observations:

  • IA’s can look at keeping the cost to client and revenue to intermediary similar to what an MFD model is
  • IA’s can reduce the cost to client by introducing passive funds and by still maintaining their revenues
  • New scheme categorization + comparison of scheme with TRI will put pressure on fund manager to show alpha
  • Passive funds and ETF’s will become more popular over time
  1. Risk Profiling, Suitability, Rationale, Disclosure and Maintenance of records
    1. Regulations clearly define and expect IA to do proper risk profiling to understand clients risk appetite, risk tolerance levels, and gather all information so that IA can give advice in line with client’s risk profile and objective of investment. Risk Profile should be shared with client after the assessment is done and should be reviewed yearly to see if clients risk profile has changed so that actions on the portfolios or strategy can be taken accordingly.
    2. Whenever a recommendation is given to a client to purchase of a particular financial product, such recommendation or advice is appropriate, has a documented process and based upon a reasonable assessment that the structure and risk reward profile of financial product is consistent with clients experience, knowledge, investment objectives, risk appetite and capacity for absorbing loss
    3. Every investment advice needs to be implemented along with the rational for the advice which should be in line with risk profile, suitability and meets clients objective of investment.
    4. Disclose – All about itself and its practice including terms of advice, conflict of interest, remunerations, features of the schemes, products, warnings, risks, disclaimers etc.
    5. Maintain – All of above points physically or digitally including meetings logs, discussions, actions, tasks, fees, portfolio reviews etc for a period of 5 years and if dispute is there maintain until dispute is resolved

My view: If we advise client knowing his/her personality & behaviour, like how much risk he can take, what is the objective or goal, how will he react in volatile times, doing proper suitability check, recording all meetings discussions and using a proper process in client acquisition, engagement and management then I am sure that his experience in capital markets is going to be far better. Scheme performance will match client’s performance. My doctor just opens my file in his pad and he knows everything about me – the only question that he asks are: has all of the mentioned medicines, exercises and tests are being diligently followed. The onus is not just on IA for the goal to be achieved; now the client is equally involved and responsible for the success of the investment journey and defined goals.

  1. T&C of IA services, Compliance and Audit Requirements
    1. There are 22 clauses mentioned in consultation 4 which has to become a part of IA minimum terms and conditions as a part of document which needs to be shared with client and get his consent that he has read and understood the same and he accepts the terms of IA. No advice to be given or fees to charged until this is received from client.
    2. Audit of the IA to be completed within 6 months from the end of Financial year
    3. Findings and actions taken to be reported to SEBI within 1 month from the date of completion of audit
  1. Code of Conduct for IA’s
    1. Honesty and fairness
      1. IA shall act honestly, fairly & in the best interests of clients and in the integrity of the market.
    2. Diligence
      1. IA shall act with due skill, care and diligence in the best interests of its clients and shall ensure that its advice is offered after thorough analysis and taking into account available alternatives.
    3. Capabilities
      1. IA shall have and employ effectively appropriate resources and procedures which are needed for the efficient performance of its business activities.
    4. Information about Clients
      1. IA shall seek from its clients, information about their financial situation, investment experience and investment objectives relevant to the services to be provided and maintain confidentiality of such information.
    5. Information to Clients
      1. IA shall make adequate disclosure of relevant material information while dealing with its clients.
    6. Fair and Reasonable Charges
      1. IA advising a client may charge fees, subject to any ceiling as may be specified by the Board, if any. The IA shall ensure that fees charged to the clients are fair and reasonable.
    7. Conflict of Interest
      1. IA shall try to avoid conflicts of interest as far as possible & when they cannot be avoided, it shall ensure that appropriate disclosures are made to the clients & that the clients are fairly treated.
    8. Compliance
      1. IA shall comply with all regulatory requirements applicable to the conduct of its business activities so as to promote the best interests of clients and the integrity of the market.
    9. Responsibility of Senior Management
      1. The senior management of a body corporate adviser shall bear primary responsibility for ensuring the maintenance of appropriate standards of conduct and adherence to proper procedures by the body corporate.

Let us look at the guidelines and code of conduct which all MFDs have to adhere to:


Some of the most important definitions from AMFI/SEBI uniform guidelines for ARMFA (AMFI Registered Mutual Fund Advisor): On a lighter note- for whom the guidelines are cannot use the word advisor but the guidelines itself has the word advisor, may be the regulator has still not changed the term used in guidelines

  1. Intermediary: shall mean all persons or entities involved in selling and distribution of mutual fund products including inter alia brokers, sub-brokers, sole proprietor firms, consultants, channel partners, partnership firms, companies or called by any other name
  2. Registration of Intermediaries with AMFI: The SEBI circular has made registration of Intermediaries with AMFI mandatory. This would mean that no person or any entity would be entitled to sell units of mutual funds unless the person is registered with AMFI. AMFI has made provision for issuing an AMFI Registration Number (ARN) and photo-identity card for Individual Intermediaries and Certification of Registration for Corporate/Non-Individual intermediaries. No mutual funds shall empanel Intermediaries who are not registered with AMFI.
  3. Declaration of Self Certification (DSC): AMCs (or Registrars on behalf of AMCs) would obtain once a year, a Declaration of Self Certificate (DSC) from empanelled mutual fund distributor as to their having complied with this guidelines and the code of conduct.

Let us deep dive in the code of conduct which defines what an MFD should do or what the regulator expects them to do

  1. Consider investor's interest as paramount & take necessary steps to ensure it is protected in all circumstances.
  2. Adhere to guidelines issued from time to time related to selling, distribution, advertising, performance.
  3. Be fully conversant, updated with (SID), (SAI) and (KIM), operational requirements of schemes and mf industry.
  4. Recommend schemes appropriate for investor's risk profile, needs by highlighting risk factors of each scheme,
  5. Desist from misrepresentation, exaggeration, indicating/assuring returns in any type of scheme
  6. Extra commission or incentive should never form the basis for recommending a scheme to the investor.
  7. Disclose to the investors all the commissions (in the form of trail or any other mode) received
  8. Do not undertake commission driven malpractices
  9. Intermediaries shall not rebate commission back to investors
  10. Maintain necessary infrastructure to support the AMCs in maintaining high service standards to investors
  11. Abstain from making negative statements about any AMC or scheme
  12. Ensure that comparisons, if any, are made with similar and comparable products along with complete facts.
  13. Maintain confidentiality of all investor details, deals and transactions.
  14. Investor's address, contact details filled in application form are investor's own details, and not of any third party.
  15. All Intermediaries including all sales personnel engaged in sales/marketing shall EUIN and necessary certification
  16. Intermediaries shall comply with the Know Your Distributor (KYD) norms issued by AMFI.
  17. Co-operate with and provide support to AMCs, AMFI, competent regulatory authorities, in DDD process
  18. Be diligent in attesting / certifying investor documents and performing In Person Verification (IPV) of investor's
  19. Observe high standards of ethics, integrity and fairness in all its dealings with all parties
  20. Do not indulge in fraudulent or unfair trade practices of any kind while selling units of Schemes of any fund.

One important observation:

“A focus on financial planning and advisory services ensures correct selling and also reduces the trend towards investors asking for pass back of commissions” was point no 15 in SEBI code of conduct dated 27th Aug 2009 which also gets mentioned in DSC but the latest and revised code of conduct for MFDs on AMFI website does not have this point.

Making it very clear that MFD’s cannot do financial planning or provide advisory services

Amendment in the RIA regulations has not just affected existing RIA’s but also MFD’s. The most important change that has been done for MFDs in the latest amendment is:

  1. Usage of Nomenclature
    1. No person dealing in distribution of securities (MFDs) applicable for both Individuals and Non Individuals, shall use the nomenclature “Independent Financial Adviser (IFA) or Wealth Adviser or any other similar name”, unless registered with SEBI as Investment Adviser.
  1. Disclosures by MFDs
    1. Mutual Fund Distributors (MFDs), while distributing their mutual fund products can explain the features of products to client, and shall ensure the principle of ‘appropriateness’ of products to the client. As per the extant SEBI circulars, appropriateness is defined as selling only that product categorization that is identified as best suited for the client.

Incidental Activity:

  • Happeningbychance or as a minor accompaniment to core activity
  • Lessimportantthan the thing something or someone isconnectedwith or knows as
  • Happening or likely to happen in an unplanned or subordinate conjunction with something else
  • Incurred casually and in addition to the regular or main activity

My view: All circulars, guidelines and code of conduct define a mutual fund distributor or intermediary as person or agent selling, marketing, advertising mutual fund schemes on behalf of AMC’s. MFDs can only sell and distribute mutual fund schemes and in this process they have to ensure “appropriateness” of sold products is checked while distributing to clients like explaining product specification, disclosing product features and risk associated with those products. MFD has to keep clients interest protected and abstain from any misselling activities for any extra commission or any other reason. All commissions to be disclosed and no pass back to be given as an incentive for buying any schemes.

MFDs cannot do financial or goal planning, cannot provide advice for investment in securities or investment products, cannot call them with nomenclature like advisor or with any other similar name as mentioned in amendment.

Regulator wants to clearly differentiate between both professionals, one will be known as distributor of mutual fund scheme whose core responsibility and duty is to sell the schemes to clients and other would be known as investment advisor whose core responsibility and duty is to provide advice to clients.

Understanding the clarity that is now provided by this new circular and the direction that the regulator wants the future of intermediation to be in, I have come to a conclusion that we as intermediaries have to choose a business model after doing some self introspection. These are:

  • What is the vision of the practice that I run?
  • Where do I see my practice in the next 5, 10, 15, 20 years’ time horizon?
  • What are my strengths? And weaknesses?
  • How should I engage my customers?
  • What is going to be my value proposition with clients both existing and potential?
  • What is my growth strategy?

And you may have more questions. When you answer these, I’m sure you will have the clarity in the direction that you or your firm or your practice should take. There are finite possibilities that you would conclude with-

  • Continue as MFD: change in nomenclature, stop providing advice, financial/goal planning, continue with regular plans, depend on commissions as revenue model, and position oneself as a mutual fund distributor.
  • Transition into RIA: Is the difficult choice and comes with challenges of embracing the change. However, there are a lot of considerations that have to be overcome. I will post on this topic separately.
  • Continue as RIA: Prepare your business for adherence to proposed additional requirements to continue as an RIA, review your business processes and adopt technology to help scale and focus on client management.

In my view, there are solutions available today which will help power all the three possibilities mentioned above. These solutions are in the form of Technology platforms for MFD, Specialised Technology platform for RIA and IFA Infrastructure Company. These options allow the intermediary to retain their identity and clients while availing of the infrastructure to meet the requirements imposed by the regulations and pay an affordable subscription for the infrastructure. Please feel free to contact me for further information on the available options.

William Shakespeare once said “No legacy is so rich as Honesty” as “Honest has nothing to Hide”

Build your practice which will last for decades not just for years

I wish all of you are safe and healthy in these unprecedented times, this too shall pass

Best Wishes for a bright future

Aakash Bansal

Founder and CEO

aakash.bansal@mercuryfinancial.co.in

Mercury Platform Services Private Limited

All reference links are mentioned as part of Annexure on last page, to help all readers get access to and download all important guidelines, circulars, code of conduct, reference materials for both RIA’s and MFD’s in a single table.

Disclaimer:

The information contained in this article is intended solely to provide personal views and guidance on matters of interests for the personal use of readers, who accepts full responsibility of its use. Given the changing nature of laws, rules and regulations there may be omissions or inaccuracies in information contained on this article. As such, it should not be used as a substitute for consultation. Before making any decision or taking any action, the reader should always consult a professional adviser relating to the relevant article posting. While every attempt has been made to ensure that the information contained on this article has been obtained from reliable sources, the Author or Mercury Financial is not responsible for any errors or omissions, or for the results obtained from the use of this information. Nothing herein shall to any extent substitute for the independent investigations and the sound technical and business judgment of the reader. In no event will Author or Mercury Financial, or its partners, employees, be liable to the reader or anyone else for any decision made or action taken in reliance on the information on this article. Third parties may submit comments for publication on this article. Any such comments are submitted on the basis that the Author or Mercury Financial will review and may edit such comments, and that not all submissions will be published. Any third party comments published on this article (whether edited or not) are third party information for which the Author or Mercury Financial takes no responsibility and disclaims all liability, and the above disclaimer applies to any such third party comments. All rights are reserved. If you wish to use or copy any of the text or other materials on this article (or any extracts from the same), you must first contact the Author or Mercury Financial for copyright permission in relation to the proposed use. In addition, any use of text or other materials on this article (or any extracts from the same) in published materials must identify the Author or Mercury Financial materials involved and reference the Author's name and Mercury Financial and if so request the email and contact details of the Author and Mercury Financial.

Annexure and links to various circular, guidelines, code of conduct for both RIA and MFD

All important circulars, regulation and consultation paper related to RIAs

21-Jan-13

Introduction of RIA Regulations

Click Here

25-Feb-15

FAQ's on RIA Regulations

Click Here

07-Oct-16

Consultation Paper 1

Click Here

22-Jun-17

Consultation Paper 2

Click Here

02-Jan-18

Consultation Paper 3

Click Here

29-Nov-18

DO and DONT while dealing with IA's

Click Here

27-Dec-19

Circular on strengthen the conduct of IAs

Click Here

15-Jan-20

Consultation Paper 4

Click Here

03-Jul-20

Gazette & Amendment to Regulations

Click Here


All important guidelines, code of conduct and circulars for MFDs

26-Jun-02

SEBI Code of Conduct for MFDs

Click Here

28-Nov-02

SEBI Code of Conduct for MFDs

Click Here

15-Jan-03

AMFI Guidelines for MFDs

Click Here

31-Mar-03

AMFI Guidelines for MFDs

Click Here

18-Jul-08

AMFI Guidelines for MFDs

Click Here

27-Aug-09

SEBI Code of Conduct for MFDs

Click Here

30-Jun-09

SEBI circular on Loads on Mutual Funds

Click Here

22-Aug-11

SEBI circular on Distributor Due Diligence

Click Here

10-Jul-18

SEBI master circular for Mutual Funds

Click Here

22-Oct-18

SEBI circular on TER and Performance Disclosures

Click Here

Not applicable

Latest AMFI guidelines for MFDs

Click Here

My Best Wishes for a yet another Great Financial Year! Happy Investing!

Aakash Bansal

CEO & Founder, Mercury Financial

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