Overcaution could stymie investment advisory's growth

In an old Charlie Chaplin movie I was watching recently, a character strikes a matchstick against the wall and then uses it to light his cigar. I wondered what had happened to these ‘strike anywhere’ matches. 

These matches, which were popular in the 19th century, suffered from a key safety issue. They could self-ignite due to friction between the match sticks while being carried around in the pocket. Technological improvements made them safer, but it was too little, too late. They were soon replaced by safety matches that would light only after being rubbed against a special surface on the matchbox’s side.  

Strike anywhere matches are still available at a prohibitive cost (around Rs 11 per matchstick). 

The safety and logistics costs (they are imported in tin boxes from the US) make them prohibitively expensive, fit only as showpiece items.

There is an apt parallel between the fate of strike anywhere matches and the one that possibly awaits the Investment Advisory (IA) profession.

The IA profession was formalised with the implementation of the Investment Advisor Regulations, 2013. The objective was to create a class of professional IAs who would put clients’ interests above their own (termed as fiduciary responsibility). While all good professionals put clients’ interests above their own, IAs are unique in that regulations require them to do so. They can be penalised and even lose their licence if the investor succeeds in proving that the IA didn’t comply with fiduciary obligations.

IAs are supposed to provide holistic financial planning advice and develop and recommend strategies to help clients realise their financial goals after analysing their current financial position and resources. In view of the crucial role they play, regulations contain many stipulations to ensure only people of a certain quality enter this young profession. Minimum qualifications, specific certification, experience in some cases, net worth, and some other criteria were laid down, not only for IAs but also for their employees.

Unfortunately, stock tip providers (some of whom possessed IA licences) in search of a quick buck provided trading call services to gullible investors. A spate of investor complaints led to significant tightening of the regulations in 2020 to keep undesirable elements out. While these changes have largely succeeded in reducing investor complaints, they have also prevented fresh blood from entering the profession. For example, compulsory relevant experience requirement for new entrants means even seasoned professionals from other sectors, like information technology, can’t enter the IA profession even after passing the tough certification exams. They must first serve as an apprentice under another IA professional.

Some of this profession’s current leading lights, who had switched from other sectors, wouldn’t have been able to do so under the current regulations. This profession, and by extension, the investors they serve, would have been the losers. Post-graduation education norms and relevant experience requirement for all client-facing employees mean it is difficult to get new employees. Many existing ones will have to leave the profession when the grace period ends in September 2023.

Fresh employees are vital to any profession. The requirement to retake the tough certification exams every three years creates an aura of uncertainty around the continuance of the practice should one fail to pass the exam again. This deters many from entering the profession.

These regulatory changes are like the safety features added to the strike anywhere matches that have made them too expensive for daily use. Like the separate surface in safety matches, the safety features should apply only to the IAs who provide the type of services that created the issues in the first place.

IAs play a vital role in capital formation within the country. Currently only 1,349 IAs serve a population of around 1.39 billion. Like the strike anywhere matches, we are in the danger of turning into a showpiece service meant exclusively for the rich. The good news is that the regulator is aware of the situation and is contemplating remedial measures, which will hopefully be announced soon.

Disclosure: I am chairperson of the Association of Registered Investment Advisers formed to promote investor interests by elevating the standards of the investment advisory profession. I run an investment advisory firm and have a natural interest in regulations pertaining to the profession. 

Views are personal.

The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor; Twitter: @harshroongta