Regulate, before the big swindle

It is in this context that Sebi chief M. Damodaran’s nudge towards setting up a regulatory framework within which the distributor will function needs to be seen. At the Financial Planning Congress, organised by The Indian Express and Financial Planning Standards Board India (FPSBI), Damodaran went on the front foot and, in the context of investors being misled by promises and mis-sold wrong products, wondered aloud that FPSBI could become a self regulatory organisation (SRO), overseeing distributors. FPSBI chairman Shailesh Haribhakti has promised to revert in 45 days with a concrete proposal.

Regulation of distributors is gaining currency not merely among regulators — sources in Insurance Regulatory Development Authority (IRDA) and Pension Funds Regulatory and Development Authority (PFRDA) say that they are equally worried about this last mile but wonder just how to negotiate it on a regulatory plane — but in the ministry of finance as well. K.P. Krishnan, joint secretary (capital markets) announced on the same platform that the ministry is working on an approach paper to regulate distributors.

Just who is this distributor? Answer: anyone — your neighbourhood uncleji, for instance, whose father sold insurance policies to your father as he’s selling mutual funds and ULIPs to you. Why does he have to be regulated? Because, he is today not servicing you, but chasing his commissions. Nothing wrong in that, except what economists call ‘asymmetric information’, which is one party (distributor) to a transaction (selling a financial product) having more or better information than the other party (you). You don’t know, for instance, that when you asked for a mutual fund and were handed an insurance product, it was because the distributor made 40-60 per cent commission rather than a measly 2 per cent. Or that when you wanted to buy a fund, he handed you a closed end new fund offer, where he gets to keep as much as 6 per cent. And so on.

What needs to be done? He has to be brought under a regulatory lens. Systems have to be devised such that when an investor learns that he’s been mis-sold a product, he can get redress. These systems have be in writing, a copy of which should be with the investor. These copies among many other things need to capture data like why a particular product is being recommended, what is the commission the distributor will make, what is the commission in alternative products, how long is the lock in, what is the returns expectation from the product, educational, professional and regulatory track record of the distributor and so on.

Who will regulate him? So far, regulators have been trying to get distributors to take exams before selling a product — IRDA manages it for insurance distributors while AMFI oversees those for mutual funds. But apart from raising the entry barrier and according a number to a person, this has not served much on the best or even acceptable practices front. Clearly, a new regulator is needed. Who will that be — a Sebi-RBI-IRDA-PFRDA combine, an SRO or even a new regulator set up under a new Financial Advisors Act?

Each model is an Achilles — strong and weak. The regulatory combine brings experience but is forced to step on one another’s regulatory toes and create potential turf wars. The SRO model is interesting under the new public private partnership (PPP) focus but there is no experience of private sector in self regulation and we’ll need to tread carefully here, keeping conflicts of interest in mind.

If we’re looking for a fairy tale solution to regulation, it’s better we drop the idea rightaway — such solutions don’t exist. Regulation is equally a process and the evolution of that process to meet changing realities. We need to be nimble footed, constantly moving, changing, reacting fast. While an SRO may be the quickest route to regulating distributors today, it will need to show results to be able to stay the course tomorrow. Distributors must be regulated, but we must not be too stuck up on the ‘who’ question.