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Major amendments to Investment Advisers Regulations

Finsec Law Advisors

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SEBI has issued several consultation papers in past 4 years suggesting changes in the interplay of functions of an investment advisor (“IA”) and distributors of financial products and has also made several recommendations with respect to the eligibility of an IA. However, most of these had faced resistance from market participants. In June 2020, SEBI finally notified certain amendments to the SEBI (Investment Advisers) Regulations, 2013 (“IARegulations”) aiming to reconcile the conflicting opinions. These amendments will come into effect on October 01, 2020, some of which are discussed hereinbelow:

Firstly, SEBI has mandated “client-level” segregation of advisory and distribution activities of an IA. Earlier, an IA could provide distribution services to its clients, however the same had to be done through a separately identifiable department / division / subsidiary (SIDD). Now, an IA which also provides distribution services can receive consideration either for advisory services or distribution from a particular client; the requirement of SIDD and arms’ length transaction continues. Individual IAs cannot provide both services to a common client, at all. However, there is uncertainty among market participants with respect to the use of term distribution by SEBI. It is unclear whether the term distribution activities would include distribution of only mutual fund products or all other financial and investment products.

Secondly, SEBI has introduced Regulation 22A which restricts an IA from taking any kind of implementation fee, including commission or referral fee from their IA clients, neither directly nor through their group / family members. Further, signing a formal IA agreement has been made mandatory now. Practically, since an IA will no longer be able to charge any kind of fee for providing implementation services, most IAs may discontinue providing implementation services as they will not generate any revenue.

Thirdly, the net worth requirement for individual IAs has been increased from INR 1 lakh to INR 5 lakh and for non-individual IAs from INR 25 lakh to INR 50 lakh. Additionally, an individual IA with more than 150 clients will be required to compulsorily register as non-individual IA. It was observed by SEBI that to avoid the high net-worth requirement for non-individual IAs, a number of individuals had obtained registration as individual IAs, however, the actual services were provided by their associated entities. This amendment has been brought to curb this menace. However, at the same time, the increased net worth requirement may dissuade several experienced individuals/teams from registering as IAs.

Finally, the requirement of specific educational qualifications and minimum mandatory years’ experience has been extended to all the persons associated with an IA, including even the sales staff of an IA. Educational qualification in the nature of post-graduation or a professional qualification or a post-graduate diploma (minimum 2 years) is now compulsory for all persons associated with providing IA services. Though the amendment intends to improve the quality of IAs, no carve out has been created for existing IAs who may have completed only their graduation but have several years of practical experience with them.

In view of the above, it is imperative for SEBI to revisit the recent amendments in the IA Regulations before the amendments come into effect from October 01, 2020, and issue necessary clarifications and modifications.