Re: CFA Institute and IAIP comments on Draft Guidelines on Wealth Management/Marketing/ Distribution Services offered by Banks

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1 31 July 2013 Prakash Chandra Sahoo Chief General Manager, Department of Banking Operations & Development, RBI, 13th floor, Shahid Bhagat Singh Marg, Fort, Mumbai Dear Mr. Sahoo, Re: CFA Institute and IAIP comments on Draft Guidelines on Wealth Management/Marketing/ Distribution Services offered by Banks CFA Institute 1 and IAIP 2 appreciate the opportunity to comment on the Draft Guidelines on Wealth Management/Marketing/ Distribution Services offered by Banks Executive Summary: At the outset, we, at the Indian Association of Investment Professional (IAIP), a member society of CFA Institute appreciates the opportunity to comment on the consultation paper Guidelines on wealth management/marketing/distribution services offered by banks. Before we provide our comments on the guidelines, we think it s useful to state our assumptions about the wealth management industry. 1 CFA Institute, the global association of investment professionals that sets the standard for professional excellence and credentials, is a champion for ethical behaviour in investment markets and a respected source of knowledge in the global financial community. CFA Institute has more than 115,000 members in 138 countries, with membership in India growing at a particularly strong pace. CFA Institute maintains relationships with a number of regulators in major financial markets. 2 The Indian Association of Investment Professionals is an association of over 1000 local investment professionals. The Association consists of portfolio managers, security analysts, investment advisors, and other financial professionals, that; promote ethical and professional standards within the investment industry, facilitate the exchange of information and opinions among people within the local investment community and beyond, and work to further the public's understanding of the CFA designation and investment industry. Page 1 of 7

2 General observations on wealth management industry Wealth management service providers are essentially financial intermediaries between investors and investment opportunities. Investment opportunities could be Capital market securities like equities and bonds Direct real assets like real estate, commodities, collectibles Managed pooled vehicles mutual funds, ETFs, alternative investment funds etc in which lots of small investors pool their investments and hire investment professionals such that they not only get access to the market return from capital markets or real assets (called beta) but also additional returns (or lower risk) through skill (called alpha) Managed accounts portfolio management services, in which larger investors hire investment professionals to manage their portfolio without pooling their investments. The management could be non-discretionary (where investor has final call, so advisory in nature) or discretionary (where portfolio manager is accountable). This is done primarily to access the portfolio manager s skills. Investors are savers who wish to put their savings into more productive investments rather than just in the bank. Investors are usually classified by their net worth into retail or mass (with net worth of less than US$200,000 or INR 1 crore), affluent (US$ 200k to 1m or INR 1-5 crores) and high net worth (above US$1m). They vary in financial sophistication, irrespective of their net worth retail investors could be financial experts while some of the ultra high net worth investors may not be very savvy in investing. They also vary in their willingness and ability to take risk. In some markets, regulations make a distinction between retail and high net worth investors by setting some hurdles for the later to be classified as sophisticated or professional investors. Wealth management services essentially would match investors to investment opportunities. However, the extent of the matching service varies and therefore the price charged for the matching service varies from mere referral to short-listing to investment advice to holistic wealth advice including financial planning (looking at both assets and liabilities/goals) and wealth planning (looking at tax and legal aspects to ensure minimum leakage). The range of services can be ranked by the level of involvement Referral simply referring the investor to a third party product or service provider Distribution providing a researched short-list of products or services to investors, which they can pick from; bank earns commissions from product providers Page 2 of 7

3 Advisory providing advice or recommendations to investors on single or portfolio of investments; bank would charge fee for service to clients under new Investment Advisory Regulations Management - called a portfolio management service, providing advice or recommendations on portfolio of investments and executing under power of attorney; if client approval may be needed (non-discretionary PMS) or may not be needed (discretional PMS). Note the PMS service can be provided by the bank or third party asset management firms, therefore can be seen as a bank service or a third party product. Investors need to protect their wealth (physical assets and portfolios) and wealth-earning ability (their own life and health) from risks, hence they buy other financial products such as life and general insurance products, though they are not strictly investment products. However, insurance companies do bundle the insurance and investment aspects in some products, making them investment products. Providers also choose which side of the matching transaction they wish to sit on they can be the investors agents or that of the investment opportunity providers. Accordingly, some markets distinguish between distributors who get paid by the product provider and advisers who get paid by the investor. Even if they are agents of the product providers i.e. distributors, they need to collect some basic due diligence on the investors and products (suitability analysis) so they can match them appropriately. To understand the investors better, they would need to do needs analysis and/or risk profiling. To understand products better, they need to do or source research on the asset class and provider. Different types of market participants have chosen to provide wealth management services Banks have access to most savers through their branch network, hence are in best position to convert savings into investments Non-bank institutions have brands and balance sheet strength so can match banks services except for core banking services like deposit taking and lending. Independent financial advisers (IFA) individuals or small firms who can build longer term one-on-one relationships with investors; they may form groups to negotiate better rates from service providers. Investors do not hand any money (cash or cheque) to them. Page 3 of 7

4 Understanding of RBI s concerns We understand RBI s major concerns are a result from the cobrapost.com report, and fall into two broad areas Money laundering banks were found to be flouting KYC and AML guidelines, by using smaller cash amounts or going through financial products that allowed cash investments or had lower KYC requirements. Mis-selling banks were accused of mis-selling, i.e. knowingly or unknowingly mismatching investors and investment opportunities while earning commissions from the product providers. The implication is that wealth management activities lead to reputational and operational risks for banks. This is not good for the banking system. In the context of our understanding of the industry and RBI s concerns, our observations On money laundering RBI s concerns on money laundering are valid. Banks must have better training and processes to manage this risk. We recommend RBI could consider setting explicit training and process requirements for various levels of staff in line with global standards. Apparently some of the banks direct cash investments into insurance products and rely on the KYC processes of the financial product providers. We suggest that the responsibility of doing KYC could be made to fall on the banks, since they are getting paid for the sale. The guidelines propose that transactions above a threshold should only be through customers accounts, and not in cash or cheque of other banks. We believe such a restriction questions the KYC processes of the banking system. We suggest RBI focus on strengthening the KYC processes of the whole system. On wealth management mis-selling Page 4 of 7

5 Amongst the various types of wealth management providers, banks are in a unique position to provide such services, thereby helping the penetration of financial products amongst savers. However, they can only do so if they can leverage their existing banking infrastructure including their frontline bankers. Hence, it would be good to find a solution that allows them to do so. Investors have to make choices amongst various investment opportunities, which range from products including banking products (savings accounts and fixed term deposits), mutual funds, unit-linked insurance products, direct shares and bonds, real estate, alternatives, gold etc. If investors have to make comparisons across the range, it is only fair that they want their advisers (however remunerated) to be able to make comparisons across the range. Hence, we believe that the bank relationship managers should be able to discuss (whether distribute or advise is a business model choice) products across the range, including banking and wealth management services. We believe the mis-selling problem has two main causes incentive structures and lack of training. On the incentive issue, we agree with the sentiments in the RBI guidelines about not allowing relationship managers to be given direct incentives related to transaction volumes. However, banks, like any other wealth management firm, are likely to include such incentives indirectly in the balanced score cards when evaluating performance. RBI could look at setting guidelines on the extent of sales incentives included in the overall performance evaluation. There should be a balanced approach to remunerating policies that include both sales volumes and quality of service, taking into consideration complaints by customers and compliance training. It was noted in the report from the Joint Forum of International Regulators in April 2008 on Customer Suitability in the Retail and Sale of Financial Products and Services that only 60 percent of the firms surveyed took into account compliance issues in remuneration policies. Most markets are moving towards disclosures of all remuneration including any incentives, soft dollar arrangements etc. RBI could work with SEBI on such standards. The guidelines propose the banning of incentives for referrals. We are not sure what this would achieve. If the bank identifies the need for certain financial products and refers the client to appropriate provider, which results in a transaction and therefore referral commission, we do not see harm in such a referral arrangement. However, we Page 5 of 7

6 agree that the bank must obtain the client s consent before sharing their contact details with another party. SEBI has already issued the Investment Adviser Regulations setting higher standards for individuals and institutions, including banks, wanting to offer advice rather than distribution. However, the ground reality is that most banks are choosing to stay as mutual fund distributers and insurance agents, though they may set up a separately identifiable division or department (SIDD) for giving advice to their high net worth clients. This means that banks are choosing not to give impartial advice to retail investors as their business models rely on product commissions. We agree that the relationship managers, when offering wealth management services, should be appropriately trained. Professional designations like CFA which are globally recognized and have high ethical and professional standards should be considered for the same. SEBI, or NISM, can set appropriate training standards for various levels of wealth management services. On regulating wealth management services In today s complex financial services industry investors are offered a vast array of products and service providers to meet their financial needs. As the market evolves, products and providers no longer fit into their neat little boxes. Nonetheless, investors should get the same basic regulatory safeguards and protections whether the product is insurance, securities, banking or investment advisory. The issue, therefore, is the assurance of consistency in the regulation and supervision of products that look and behave in a similar manner, regardless of their origination. Following approaches are followed across different jurisdictions: The integrated approach is a single universal regulator which conducts both safety and soundness oversight and conduct-of-business regulation for all sectors of financial services business. The MAS is an example of the integrated approach. The twin-peaks approach is a separation of regulatory functions between two regulators: one that performs the safety and soundness supervision function and the other that focuses on conduct-of-business regulation. The Australian Prudential Regulation Authority (APRA) and Australian Securities and Investment Commission (ASIC) are examples of the twin-peaks approach. The council-style arrangement aims to promote regular consultations among the various regulatory agencies, identify important issues and trends in the financial system, and enhance the overall quality of supervision by avoiding unnecessary overlaps, inconsistencies and gaps in the regulatory framework. This is quick to set up but would entail cooperation and a commitment to high standards among the agencies. Page 6 of 7

7 Whichever approach is preferred, there has to be consistency in ensuring there are no regulatory gaps between the banking, securities and insurance divisions and entities. We thank you for the opportunity to provide feedback on this important regulatory framework and we shall be delighted to visit your offices to discuss the same in detail. If you or your staff have questions or seek further clarification, please do not hesitate to contact Vidhu Shekhar CFA, at or or Biharilal Deora CFA at at Sincerely yours, Biharilal Deora CFA Secretary Indian Association of Investment Professionals Page 7 of 7