Excerpts from the Indian Household Finance report submitted to the RBI on what financial advice should be:
The definition of financial advice we propose is as follows:
Financial advice is the action of providing personal recommendations to a customer, which can either be initiated by an act of the firm, or by way of a request from a customer. Any situation that involves any of the following set of actions constitutes advice:
1. A personal recommendation, provided in exchange for a fee, is made to a customer to purchase or sell a particular financial product or a set of financial products.
2. A firm or individual consulted by a customer has deemed a product or a suite of products to be suitable to a customer, in exchange for a fee.
3. A customer initiates an action that is in line with the personal recommendation specifically sought from a firm or individual, in exchange for a fee.
A financial advisor is a firm or individual who performs the actions above.
Alongside defining financial advice, the committee feels that the term “distributor” should also be consistently defined. The definition of a financial distributor we propose is as follows:
A Financial distributor is a firm or individual who engages in a financial transaction with a consumer, which is remunerated or compensated by the producer of the financial product by way of a commission, service fee, or any other form of non-monetary remuneration.
Financial advice: Standardised norms
We believe that the provision of financial advice should be regulated in a unified manner consistent with other established professions, such as medicine, law and accounting. A collaborative effort is required in this regard in which governments set expectations for the practice of financial advisory, market integrity, and consumer protection, and regulators in consultation with professional bodies determine professional norms, conduct monitoring, and impose minimum certification standards. We also note here that financial literacy efforts should supplement responsible financial advisory businesses.
In the current scenario, Indian households are unable to differentiate between the titles of “Investment Advisor”, “Independent Financial Advisor”, or even “Insurance Advisor”. We propose that clear nomenclature with uniform rules should apply to all providers of financial advice regardless of their specialisation. The immediate need is to deal with regulatory arbitrage which is now a possibility given that there are differences between the regulation of financial advice depending on the regulator dealing with the underlying product. That is to say, PFRDA, IRDA, and SEBI all have differing definitions of advice, and regulations for the provision of advice.
• We therefore propose that there should be uniformity in definition, the unification of consumer protection, and the application of equally stringent standards across regulators and underlying financial products.
• We propose the creation of a unique “license number” for financial advisors to replace the diversity of current registrations such as the ARN, RIA, RA, and EUIN number. An SRO-driven regulatory system for financial advisors across all products will use this unified identification number.
• We propose that regulation should be uniform across advisors, rather than based on the specific sectors or products that advisors sell, so as to enable advice to households about their entire balance sheets. We therefore propose common regulation of financial advisors across all products, and support the Swarup Committee suggestion of an SRO-driven regulatory system for financial advisors in the medium term.
• We propose that insurance intermediaries be brought under these uniform advisory regulations, and that advisory and distribution functions should be effectively segregated.
– This is also an issue in the provision of investment advice by distributors of mutual fund products, and we propose that they also be brought under the ambit of uniform advisory regulations.
– In general, we oppose the use of exemptions, and propose a uniform structure under which all investment advice is brought, regardless of the specific product or function to which this advice pertains.
• In order to make financial advisors, investors and other stakeholder understand the rules and regulations governing investment advisory activities and to further ease of doing business by investors, rules and regulations should be simple, self-explanatory and easy.
• Information about financial advisors and their standards of professional competence should be made available online. Forms, compliance reports, and payments should be digital and easily accessible.
• Regulations need to be supplemented with adequate monitoring mechanism, including inspection, reporting and analysis by regulators for taking appropriate and timely enforcement actions. We therefore propose that any investment advisor which is a body corporate or a partnership firm shall appoint a compliance officer who shall be responsible for monitoring compliance by the investment advisor, and that swift action should be taken against unregistered/ non-compliant/ errant advisors. This would add substantially to the credibility of the investment advisory business itself and help its orderly development and market growth.
Separating distribution and advisory businesses
• We propose that advice and sales of financial products be separated, supported by a fiduciary standard.
– We note that this is not the current structure of the finance industry and propose that this transition be phased in. We propose that the first step in this direction is the convergence of advisory activities across products and regulatory jurisdictions. This is to be followed by a rationalisation in fees/commission across financial products such that sellers are indifferent between similarly placed financial products.
• We propose that all transactions be made in electronic form with a pre-determined sunset clause on cash transactions.
• We propose that there be transparency about compensation structures to the households receiving advice. Commissions and incentives paid to distributors (both incremental and cumulative) should be included in every statement sent to investors. RBI’s directive that banks create subsidiaries for investment advisory services and register with SEBI could be used as a yardstick in this context.
• We also propose that in the short-term, every investment should have two tags, namely, a distributor code and an advisor code with uniform nomenclature which is self-explanatory across all financial products. We propose that RBI immediately (rather than after 3 years) requires banks to have a separate entity to sell products.
Fiduciary model for advice
• We propose that an investment advisor shall act in a fiduciary capacity towards its clients and shall disclose all conflicts of interests as and when they arise. The fiduciary duty of the investment advisor towards the client may be defined clearly in the regulations. An investment advisor shall ensure that in case of any conflict of interest of the investment advisory activities with other activities, such conflict of interest shall be disclosed to the client immediately.
Certification and Rating of Advisors
• We propose harmonisation of standards for the provision of advice. We propose the creation of a uniform professional qualification and certification of investment advisors that covers multiple financial products – since we take an integrated view of the household. Any additional specialisation in specific financial products sought by advisors also needs to be standardised with inputs from the respective regulator.
• We also propose that continuous professional education and certification be made mandatory for financial advisors.
• In order to expand the number of advisors and to ensure their professional competence, we propose replacing a minimum experience requirement with a relevant certification requirement for registration as a financial advisor.
• In order to help investors take informed decisions on choosing financial advisors, information about financial advisors, including their expertise, business volume, past credentials, and quality of recommendations should be centralised and made available online. In this regard, the committee notes that FPSB has designed a Rating Model for Advisors, which takes into account parameters to assess the quality of services offered, compliance standards, and professional conduct to arrive at scientific grading. The platform on which this would be made available could help financial consumers to choose the right advisor.7
• We propose that consumers who have received advice from an advisor must be able to provide qualitative feedback for public view on the same platform, which we view as a public platform for open rating of financial advisors. We propose that this public platform be jointly managed by RBI, SEBI, PFRDA and IRDA, as a public good under the FSDC Sub-Committee funded through funds reserved for financial development. Based on publicly available information, an annual report on the quality of financial advice should be produced, and we propose that this be reviewed by the FSDC Sub-Committee.
• The committee believes that technology can play an important role in cost effective expansion of financial advisory services. To quickly scale up the availability of advice across the country, automated advice is a good strategy subject to the right checks and balances, and the committee supports the continuing development of robo-advisory services.
• The committee notes here that different regulatory agencies have not been clear about the legality of providing robo-advice, and so we currently see that the maximum number of such firms are operating in the the context of mutual funds. We therefore propose that all four regulators clarify that robo-advice is permitted, once again subject to the right checks and balances.
• We propose that the legal person behind a robo-advice shall be the firm or individual who own and operate such automated advice. If particular financial advisors are responsible for advice given out in automated advice services, each transaction based on such advice must identify the particular advisor involved in each recommendation as well.
• The committee also notes that the promise of the RBI’s account aggregator rules have only partially been realized. The committee understands that even though a customer may have given an account aggregator access to their own digital information, financial institutions currently have the right to choose whether or not to share the information with the aggregator. This inhibits scalability at present, since it requires a series of bilateral negotiations with individual financial firms. The committee notes that the payment services directive (PSD2) in Europe allows for a solution that better allows households to benefit from account aggregation, and we recommend that this be amended to facilitate customers having better access to their own financial information.
Report of the Household Finance Committee: July 2017