At a recent summit in Mumbai, SEBI’s whole time director G. Mahalingam said that the regulator is studying global advisory practices on fee versus commission issue to draft adviser regulations for India.
Morningstar has recently released its fifth Global Fund Investor Survey 2017 report which evaluates 25 countries based on four parameters—regulation and taxation, disclosure, fees and expenses, and sales. The full report can be accessed here.
Here are some excerpts from the report on the sales/advisory practices prevalent in four major countries which could offer hints to where Indian advisory regulations could be headed.
Australia
The Australian Securities and Investments Commission (ASIC) is the regulator of corporate markets and financial services. ASIC is the main regulator for retail mutual funds. Starting in July 2013, the Australian Treasury implemented reforms known as Future of Financial Advice (FOFA).
The legislation amends the Corporations Act and introduces:
- A prospective ban on conflicted remuneration structures including commissions- and volume-based payments, in relation to the distribution of and advice about a range of retail investment products. The ban will not apply to some products and advice services, including for example:
- general insurance, where the benefit only relates to a general insurance product;
- basic banking products where advice is only given on a basic banking product;
- financial product advice given to wholesale clients; and
- advice where the client pays the benefit to the provider (e.g. fee for service arrangements).
- A duty for financial advisers to act in the best interests of their clients, subject to a “reasonable steps” qualification, and place the best interests of their clients ahead of their own when providing personal advice to retail clients. There is a safe harbor that advice providers can rely on to show they have met their “best interests” duty. This is intended to be the minimum standard of compliance.
- An opt-in obligation that requires advice providers to renew their clients’ agreement to ongoing fees every two years. ASIC will have the ability to exempt an adviser from the opt-in obligation if it is satisfied that the adviser is signed up to a professional code that makes the need for the opt-in provisions unnecessary.
Sales loads are no longer allowed, and investors have traded traditional commissions in favour of external payments directly for advice. Additionally, there is a mandated annual disclosure statement for advisers itemising the fees paid and services provided to clients.
FOFA requires that advisers act in the best interest of clients, as fiduciaries. This is a stronger investment protection than in most markets. The use of contests to motivate sales of funds and to compensate advisers (either monetarily or through awards) for selling particular funds was outlawed under FOFA in July 2013.
United Kingdom
In force for approximately two years, rules associated with Retail Distribution Review (RDR) are explicitly designed to eliminate any linkage between fund selection by advisers and the payment of commissions by fund houses. As of 1 January, 2013, advisers, unless they elect only to offer "basic advice," are banned from receiving commission payments from fund houses. Independent advisers may not elect this option, which is only available to "restricted" advisers. The main effects are that funds now offer a class free of all commissions (most equity funds, for example, now have an ongoing charge of 1.00%, compared with 1.50%-plus previously) and that most investors are expected to pay advisers directly for their services. In addition to ensuring that investor outcomes are not skewed by incentives provided by funds, the proposals have increased transparency in fees such that investors are more aware of what they pay for investment advice versus fund management.
The RDR has strictly prohibited independent advisers from soliciting or accepting "any commission, remuneration or benefit of any kind" for recommending funds. A subclass of restricted advisers offering "basic advice" can be compensated via commission, fee, or other benefit but must clearly disclose these arrangements to the client prior to providing services. The practice of using sales contests to motivate general sales of funds is prohibited.
United States
Mutual funds, ETFs, and closed-end funds in the U.S. are regulated under the Investment Company Act of 1940 (1940 Act). Federal agency Department of Labor proposed important new rules in 2016 affecting fund sales, a portion of which went into effect in June 2017 while other aspects have been delayed. In addition to these regulators, a self-regulatory body, the Financial Industry Regulatory Authority (FINRA), administrates and interprets the SEC's legal framework for sales literature and fund advertising for securities firms doing business publicly in the U.S.
American investors have all sales channels widely available, including independent advisers, fund supermarkets, traditional brokerages, and banks and insurance companies, and can also buy directly from the fund. No one sales channel dominates fund sales.
Investors can buy funds in a variety of ways in the U.S. If they buy from a commission-based sales agent, stated loads and breakpoints are not negotiable, but the sales loads have breakpoints based on the amount invested and as a result many investors in load funds pay less than the full sales load. More important, in recent years investors have been migrating to fee-based advisors, paying the adviser for advice directly, and thus are able to buy the funds without paying loads. In addition, it is quite common for investors to forgo advisers entirely and invest directly in funds without loads, without receiving any advice. So-called “no-load funds” are widely available and constitute a large part of investor assets. This is one area where the U.S. stands out as unique among countries in the survey.
Traditionally, FINRA has required brokers—and others selling funds who are not registered investment advisers (RIAs)—to make recommendations that are suitable for the investor, but the seller was not required to choose the best option for the investor or even consider comparable products. By contrast, RIAs had to adhere to a higher standard, the “fiduciary standard,” which requires the seller to act in the investor’s best interest—taking into account many factors including cost—rather than choosing an option that might be more beneficial to the adviser.
However, a 2016 Department of Labor proposal, the first part of which went into effect on 9 June, 2017, requires licensed brokers and other advisers to follow the fiduciary standard as well. The proposal specifically applies to tax-sheltered retirement accounts but in effect covers certain other situations as well. Final implementation was due by 1 January, 2018, but in August 2017 that date was pushed to mid-2019. Overall, aspects of the proposal are under debate in both the executive and legislative branches of the federal government, and at this point it is possible that it will be implemented only in part and existing elements altered. That said, in anticipation of the proposal taking effect many firms adopted practices such as eliminating or reducing commission sales, and innovations were introduced such as clean shares as well as T shares, which have identical sales loads and distribution charges across all fund families. Many of these changes are likely to persist even if the Department of Labor requirements are relaxed or rolled back.
China
The China Securities Regulatory Commission (CSRC) is responsible for regulation and supervision of the securities and futures market nationwide, pursuant to applicable laws and regulations including the Securities Law, the Securities Investment Funds Law (Fund Law), and the Ordinance on the Administration of Futures Trading.
The Asset Management Association of China (AMAC) is a self-regulatory organisation that consists of mutual fund companies, banks, other investment companies, and financial-services institutions such as Morningstar.
Sales loads exist in China, and they vary among different distribution channels. For example, investors who purchase funds online often benefit from larger discounts to the sales load listed in the prospectus compared with those who choose to buy from banks.
Purchasing investment advice directly rather than through loads or trails is not a known practice for individual investors in China. Investors can purchase money market funds and sometimes fixed-income funds without loads or retrocessions, but it is rare for equity funds to have these features.
In China, fund choices are widely available through fund supermarkets, traditional brokerages, direct sales, and bank distribution. Fund company direct sales and banks dominate fund distribution, and sales through online platforms are also growing. It is estimated that over 80% of the funds in China are sold through a distributor with an open- or guided-architecture system. Fewer than 50% of locally domiciled products are offered by the 10 firms with the largest lineups.
Advisers are held to a fiduciary standard and are subject to suitability tests that require evidence of why they recommend a particular product. A guideline was issued on 1 July, 2017, that seeks to further enhance the suitability requirements first published on 12 October, 2007, by specifically requiring advisors to know their clients and recommend products that match their clients’ risk profiles. However, advisers are not required to disclose potential conflicts of interest, such as being tied to a specific provider.
Download the full report here.
