The axe has fallen
Commission disclosure with absolute amounts being disclosed per investment - that was what was feared (Take the bull by its horns), and that is what has finally happened. And, to spice up the CAS even more, the regulator has mandated that against each investment, the TER of the regular plan and its
direct plan counterpart be disclosed (http://www.sebi.gov.in/cms/sebi_data/attachdocs/1458300086490.pdf).
Development of the market - or a section of the market?
I can't think of a more determined push from the regulator towards direct plans and the RIA model. On the face of it, the regulator is allowing multiple channels to co-exist and let market forces determine what works best. But what's really happening is that instead of market forces determining what's best, the regulator is forcing the market in one direction, that in its wisdom, is the best for investors.
Commission disclosure, by the way, has been decided by SEBI, according to its circular, to protect the interests of investors and promote the development of the market. Disclosing total expenses is necessary. It is a relevant input into an investor's investment decision. But what portion of those total expenses went to the distributor - I can't see how this enables him to take a better informed investment decision. As regards the goal of promoting the development of the market - it sure promotes development - but of two sections the market at the cost of the third.
Lessons from the Canadian experience
In our 2015 Wealth Forum Platinum Circle Advisors Conference, the President & CEO of Investment Funds Institute of Canada (IFIC), Ms. Joanne de Laurentiis spoke about the Canadian regulator's decision to implement exactly this commission disclosure regulation that SEBI has come up with today. The Canadian industry got two years to adjust to the new environment and I learn now that they have managed to get another 1 year extension - their version of CAS with commission disclosure will commence now from Jan 2017. It is however very instructive for us to know what's happened in the Canadian market these last 2 years, since the market was informed about the impending commission disclosure in account statements. Sales of the zero distribution cost version of funds (roughly equivalent to our direct plans) have gone through the roof, and are now estimated to constitute around 70% of all new sales. These distributors effectively switched from a commission embedded model to a fee based model, under the threat of commission disclosures that they believed clients will find unpalatable. Before clients got their statements and found out the dollar amounts of commissions being made, a huge proportion of distributors decided to bite the bullet and switch to a fee only model, negotiating fees that were lower than the commissions they were making. I guess the Canadian regulator achieved their purpose even before the first account statement with these disclosures has been mailed to investors.
Will we get more time?
We have been given 6 months before our spiced up CAS will go out to investors. The industry may plead for more time to get their systems in place to enable these disclosures to be made accurately. Its not just your commissions against each scheme that will be disclosed. The cost of every junket you were taken on, the cost of any gifts given to you and such other non-cash "payments" will also need to be allocated at a scheme level and a customer level for every distributor, to give a "full" picture of total amount you earned from the fund house - in cash and kind - at a customer/scheme level. That's going to be a tall order to compute. I wonder whether the regulator will hear the pleas and grant more time. More likely is that they may give some time for accounting of these "payments in kind" to get sorted, but may insist on October 2016 for the rest of the disclosures anyway.
Competitor scrutiny before investor scrutiny
What are implications on the distribution business? Whether investors scrutinize the CAS or not, distributors will - especially to understand commission structures of competition. A quick glance at any competitor's client CAS that you lay your hands on will tell you exactly how much upfront and trail they are earning at a scheme level. You can expect a huge round of activity within the industry to understand who is earning how much from which AMC and then rush for renegotiation discussions with fund houses.
Lower margins in HNI business - whether distribution or RIA
HNIs who scrutinize their CAS will likely be unhappy to see large absolute amounts being earned by their distributor, unless the distributor has been candid on commission disclosures over the years, as required by regulations. In any case, there is a big perception difference between being told that you earn 1% trail vs knowing that you earned Rs. 100,000 this year on a 1 crore investment made two years ago. "Why should he earn 1 lakh this year for advice he gave me 2 years ago? What has he done to earn this amount this year?" You can see how a typical investor's mind might work, when this data is presented to him.
HNI oriented distributors who have not yet taken up the RIA license through a hybrid model will either seriously consider doing so in the next 6 months, or will mentally prepare themselves for rebating to close discussions on their commissions, whenever such discussions come up. Either way, the business will gravitate towards a lower margin. I would imagine that if the gap between direct and regular plans is 1%, a fee that you can seek confidently is a half-way house, ie 0.5% on assets, and sell only direct plans. Alternatively, if your trail is 1%, and your clients actively browse through the CAS statements that come home, expect rebating discussions to reduce your income to 0.5%. Either way, the HNI business - whether through the RIA model or distribution model, is likely to settle into a 0.5% margin business on equity and lower on debt. It is possible that awareness among clients will happen gradually - after all, few investors actually go through the CAS minutely. Over time however, you must assume that awareness will grow and that conversations on commissions will happen.
The choice of rebating vs RIA is a strange one. You either chose to violate a regulation or take on the onus of a much higher level of regulation - and not everybody is equipped to take on those responsibilities. From a longer term point of view, given the regulator's keenness to see the RIA model take root in the country, opting for discounting your way out of any issues that commission disclosure presents you, may not be a very sustainable one.
Threat to annuity model in retail business?
In the retail world, there are two key implications. First, as Ashish Modani rightly points out (Regulator is making one fatal assumption), every retail distributor has a handful of HNI clients, who effectively cross-subsidize scores of smaller investors who will never otherwise be remunerative on a stand-alone basis. With margins on the HNI business set to shrink one way or another, retail business on the whole will suffer.
The second aspect is equally damaging. Distributors sell long term retail SIPs with a view that if the investor actually stays invested for the long haul, the distributor will make sizeable trail commissions in the latter years, to compensate for the efforts he puts into the initial years of education and hand-holding. Imagine a situation where an investor gets his CAS this October, which shows for his 10 year old SIP, the original investment amount, current market value and total trail his distributor earned in the last 6 months from this 10 year old SIP. As these SIPs appreciate (which you will always wish for your clients to happen), your trail as a percentage of original investment will keep increasing. It is quite possible that your earnings over the last 6 months in absolute terms for an old SIP may be actually more than the monthly SIP instalment that the investor invests.
If and when an investor does this math, he may not be very pleased with the remuneration you are earning today on a SIP he started years ago. There can be many difficult conversations that will come up in the months after the new CAS statements reach investors. Margins may come under pressure on long term SIPs and old retail investments that have appreciated substantially.
Should rebating ban continue?
Discounting one way or another can increase. If rebating continues to be treated as a regulatory offense as it now is, the number of defaulters will soar. There really is no sense in continuing with this ban on rebating. The capital market regulator has been a champion of free market pricing on stock broking, does not ban commission passbacks on bond issues that are also regulated by it or on IPO brokerage paid out on IPOs regulated by it, but strangely wants to ban commission passbacks on mutual funds. We are going to create a whole lot of defaulters if we persist with this regulation.
In the retail world, margins may not come under the same level of pressure that we can expect in the HNI segment, but there will be an impact. For retail distributors, the choice between RIA and distribution is a tougher one I suppose. Retail distributors tell us that their clients will not pay. There are exceptions, and the tribe of fee oriented retail advisors is increasing, but its not nearly at a stage where you can call it a trend change. Until that happens, distributors are unlikely to adopt the RIA model - they may prefer to remain distributors with commissions embedded in the products they sell, and look at discounting as a way to retain clients who are uncomfortable with their commissions. Either way, margins will likely come down in the retail space as well, over time.
Remuneration disclosure of fund house senior management
As if this were not enough, SEBI has also decided to ask fund houses to disclose remuneration of their senior management and the ratio of the CEO's salary to median salary of the firm. How will this disclosure help investors make better informed investment decisions? For that matter, how has total earnings of India's leading distributors - which is put up annually on AMFI's website, enabling investors to make better investment decisions? All that this circular does is that it increases the vicarious pleasure that industry participants partake of in knowing who is making how much. In the last couple of years, India's leading IFAs had to face this uncalled for glare on their total earnings. Now, fund house senior management will join the tribe of people whose remuneration details get needlessly published and widely discussed by everybody within the industry, while investors at large remain blissfully unaware and unconcerned about it.
There is clearly a belief within the regulatory body that there is too much fat at the top - the top of the pyramid of distribution as well as fund management. Its ironic that the money management business - which is as capitalistic as it gets - has a regulator with a socialist leaning, and an intense dislike for what they perceive as capitalistic excesses.
To conclude
In the name of investor protection, regulators around the world are seeking more and more disclosures of facts and data points that investors rarely ever consider when making investment decisions. I've said this before and I say it again: ask investors what factors they look at when making investment decisions. Ask independent experts what factors investors ought to look at to make sensible investment decisions. Then go about ensuring disclosure of all these relevant facts in as convenient a way as possible for investors. Anything beyond that begs a question: why exactly do you want this disclosed?
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