On August 06, 2024, SEBI released a 'Consultation Paper on Review of Regulatory Framework for Investment Advisers and Research Analysts', setting forth for public comments a set of proposed amendments/clarifications to the Securities and Exchange Board of India (Investment Advisers) Regulations, 2013 (‘IA Regulations’) and the Securities and Exchange Board of India (Research Analysts) Regulations, 2014 (‘RA Regulations’). These are intended to put in place a conducive regulatory framework for Investment Advisers (‘IAs’) and Research Analysts (‘RAs’) by simplifying, easing, and reducing the registration requirements and compliance costs for IAs and RAs. We summarize and analyze the key proposals below.
● Relaxation in qualification, certification, and experience requirements – The extant regulations require inter alia that a person seeking registration as IA or RA possess a post-graduation degree. The same requirement is proposed to be reduced by SEBI to a graduate degree. Further, under the extant regulations, IAs and RAs are required to obtain the prescribed base certifications from NISM at the time of registration, as well as each time before expiry of validity of such certifications. SEBI proposes that IAs and RAs be required to obtain the base certifications only initially at the time of registration, and thereafter only certifications based on the incremental changes or developments in the regulatory and professional space concerning IAs and RAs during the previous three years or specified periods of time. Such certifications would be required to be obtained by IAs and RAs before expiry of previous certifications. SEBI proposes to dispense entirely with experience requirements for IAs and RAs.
● Relaxation in net worth requirements– SEBI proposes to remove the requirement of maintaining minimum net worth at all times by IAs and RAs. In its lieu, IAs/RAs would be required to maintain a deposit for a sum specified by SEBI from time to time. Such deposits would be lien marked to the stock exchange as IAASB/RAASB for utilization towards dues emanating out of arbitration and conciliation proceedings, if any, under the Online Dispute Resolution (ODR) Mechanism or any other mechanism as may be specified, if the IA/RA fails to pay such dues. The deposit requirements would be calculated based on the parameters such as number of clients, revenue etc.
● Registration as both IA and RA – SEBI proposes that individuals or partnership firms may be allowed to seek registration as both IA and RA. Individuals or firms so registered would have to comply with the requirements under each of these regulations separately. Further, they would be required to provide an undertaking stating that they would maintain an arms-length relationship between their activities as IA and RA and that they would ensure that their investment advisory and research services are clearly segregated.
● Registration as part-time investment adviser/research analyst – SEBI proposes that individuals or firms be considered eligible for registration as part-time IA/RAs if they are engaged in employment or other business activities that do not involve handling or managing of money or funds, or are not related to providing advice/recommendation in respect of any products/assets for investment. However, the applicant would be considered eligible to register as a part-time IA/RA, if he is engaged in an activity permitted by any financial sector regulator or an activity under the purview of statutory self-regulatory organizations such as Institute of Chartered Accountants of India. An individual who is employed would be required to provide a no objection certificate (NOC) from his/her employer for such registration. Further, a part-time IA/RA would have to provide an undertaking stating that it would maintain an arms-length relationship between its activity as IA/RA and other activities, and would ensure that its investment advisory services or research services are clearly segregated from all its other activities.
● Relaxations in designation of ‘principal officer’ – Under the extant requirements, non-individual IAs are required to appoint a principal officer who must be the managing director or designated director or managing partner or executive chairman of the board or equivalent management body who is responsible for the overall function of the business and operations of non-individual investment adviser. SEBI proposes to allow a non-individual IA, who is engaged in multiple lines of businesses (other than IA and RA services), to appoint as its Principal Officer the business or unit head of its investment advisory activities, who is responsible for the overall function of the business and operations of the investment advisory services. In case of a partnership firm, one of the partners would be required to be designated as Principal Officer and would be required to comply with the necessary requirements including the qualification and certification requirements. Partnership firms which do not have an eligible partner would be provided a timeline to convert their legal structure to a Limited Liability Partnership (LLP). Further, whereas the RA Regulations do not have a specific provision for non-individual RAs or research entities to have a Principal Officer, SEBI proposes a requirement of designating a Principal Officer for non-individual RAs and research entities in the RA Regulations on similar lines as IAs.
● Allowing appointment of independent professionals as Compliance Officer – Under the extant requirements, non-individual IA/RAs must appoint a compliance officer and cannot outsource the compliance function. SEBI proposes that IAs and RAs may appoint an independent professional who is a CA or CS or CMA or any other professional/person as may be specified by SEBI. In such cases, the principal officer would be required to submit an undertaking to SEBI/IAASB/RAASB to the effect that he would be responsible for monitoring the compliance by the IA/RA. Further, independent professionals appointed as compliance officers would have to obtain the relevant certifications from NISM, as may be specified by SEBI.
● Clarification of scope of ‘investment advice’ – Under the extant IA Regulations, “investment advice” includes advice relating to securities or investment products and includes financial planning. However, the exact scope of the advice that IAs may permissibly render has remained unclear. SEBI proposes to clarify the scope of ‘investment advice’. It categorizes asset classes into those regulated by SEBI, those regulated by other financial sector regulators, and other legally permitted asset classes. Under the proposal put forth by SEBI, ‘financial planning’ that IAs may advise on would be confined to broad allocation of different asset classes, across all of these classes. However, IAs would be permitted to render investment advice only in respect of specific instruments/products if they are under the purview of SEBI or other financial sector regulators. Such advice would be regulated by, and the grievances in respect of such advice would be within the jurisdiction of, SEBI or the respective financial sector regulator. A non-individual IA would only be able to advise on products within, or provide services in respect of, other legally permitted asset classes through a legal entity having a different legal and different brand name, and separated at arms’ length from the activities under the IA Regulations. Meanwhile, individual IAs would be barred from advising in respect of products within, or provide services in respect of, asset classes not regulated by SEBI or other financial sector regulators. Further, advice in respect of such other asset classes would be excluded from the purview of the IA Regulations.
● Use of Artificial Intelligence(‘AI’) tools in IA and RA services – SEBI proposes that an IA/RA using AI tools for servicing clients must provide a complete disclosure of the extent of use of such tools to its prospective clients, to enable them to take an informed decision as to continuance or otherwise with the IA/RA. Further, the Consultation Paper emphasizes that the responsibility of data security and regulatory compliance lies solely with the IA/RA, irrespective of the scale and scenario of AI usage.
● Flexibility to IAs to change the modes of charging fee to clients – Under the extant framework, IAs may charge fees either under (i) the Assets under Advice (‘AUA’) mode, subject to a limit of 2.5 percent of AUA per annum per family of client across all services offered by IA, or (ii) the fixed fee mode, subject to a limit of ₹1,25,000 per annum per family of client across all services offered by IA. SEBI proposes to clarify that the limits on fee chargeable to clients by IAs would be applicable only in respect of investment advice related to securities under purview of SEBI. Further, at present, the IA is only allowed to change its mode of charging fees after twelve months of on-boarding or last change of mode. SEBI proposes to allow IAs to change the fee mode for a client at any time, without restriction on the minimum period between two fee mode changes.
● Relaxation in requirement for corporatisation by individual IAs – Under the extant IA Regulations, an individual IA must apply for registration as non-individual IA on or before reaching 150 clients. SEBI proposes that individual IAs be required to apply for registration as non-individual IAs on having 300 clients or fee collection of INR 3 crore during the financial year, whichever is earlier. An individual IA would initially be required to apply for grant of in-principle registration as a non-individual IA. A period of up to three months would be available to the IA to complete the transition process.
● Definitions of ‘research analyst’ and ‘research services’ – Unlike the IA Regulations, the extant RA Regulations do not require payment of consideration for the services provided by an RA as an element of defining a ‘research analyst’. Therefore, SEBI proposes to modify the definition of an RA to provide that persons providing research services ‘for consideration’ would only fall within the definition of an RA. For this purpose, it is specified that ‘consideration’ would mean any form of economic benefit including non-cash benefit, received or receivable, directly or indirectly, in any form, whether from client or otherwise, for providing any research services. Further, it would be clarified that ‘research services’ would include ‘recommendation of model portfolio by RAs’, ‘stop loss target’ and ‘any other service of similar nature or character’. Further, SEBI proposes to clarify that any research service by an RA must be corroborated by research reports containing the relevant data and analysis forming the basis for such research service, and an RA would maintain records of such research reports.
● Clarity in identification of ‘persons associated with research services’ – In contrast to the IA Regulations, the extant RA Regulations do not separately identify ‘persons associated with research services’ and any associated person who reports directly or indirectly to an RA in connection with research activities is identified as an RA. SEBI proposes to define the term ‘persons associated with research services’ in the RA Regulations to mean any member, partner, officer, director or employee, staff or any person occupying a similar status or performing a similar function irrespective of the nature of association with the RA or research entity, who is engaged in providing research services to the clients or other persons or group of persons or general public. All client and public facing persons would be deemed to be ‘persons associated with research services’. However, the term would not include persons who discharge clerical or office administrative functions without connection with research services or client contact.
● Exemption to Proxy Advisers from RAASB framework – The SEBI CP proposes that proxy advisers may be exempted from the RAASB framework and their administration and supervision would lie entirely with SEBI.
● Registration of a partnership firm as RA – The extant RA Regulations do not contemplate the registration of partnership firms as RAs for grant of registration. SEBI proposes to explicitly provide for consideration of partnership firms for registration as RA. Further, SEBI proposes to clarify that partners of an RA are required to have NISM certifications only if they are engaged in providing research services.
● Fees chargeable to clients by RAs – Similar to IAs, SEBI proposes that RAs be subject to a fee ceiling specified by SEBI and be required to ensure that fee charged to clients is fair and reasonable. In particular, RAs would be required to charge a maximum of ₹1,25,000 per annum per family in case of individual clients. However, such fee limit would not be applicable in case of non-individual clients including QIBs, accredited investors, and institutional investors seeking recommendation of proxy adviser. The RA would be allowed to charge advance fees of up to one month if agreed to by the client. If agreed by the client, RA may charge fees in advance. An RA would be required to refund proportionate fees for the unexpired period in the event of premature termination of the agreement, and would not be allowed to charge any breakage/separation/alienation fee.
● Client-level segregation of research and distribution services by RAs – SEBI proposes a clear segregation at client level of research services and distribution services of a RA or research entity, similar to the extant framework for IAs. Therefore, an individual RA or his family would not provide distribution services to a client of an RA, and an individual RA would not provide research services to a client receiving distribution services from other family members. A non-individual RA or research entity would be required to have client-level segregation at group level for research services and distribution services. The same client would not be offered both research services and distribution services within the group of the non-individual RA, such that a client could be either a research services client where no distributor consideration is received at the group level, or a distribution services client where no fee for research services is collected from the client at group level. A non-individual RA or research entity would be required to maintain an arm’s length relationship between its activities as RA and distributor by providing research services through a separately identifiable department or division. For the purpose of maintaining client-level segregation, the family of a client would be reckoned as a single client. However, IAs/RAs providing investment advisory or research services exclusively to institutional clients and accredited investors would not be subject to compliance with the aforesaid segregation requirements if the investor signs a standard waiver stating the same.
● Disclosure of terms and conditions of services to clients – SEBI proposes that RAs disclose to the client the terms and conditions of the research services offered such as consideration, conflict of interest, risk factors, mechanism for grievance redressal and dispute resolution, and rights and obligations. Neither any research service would be rendered nor any fee charged until consent is received from the client on the terms and conditions. A set of minimum mandatory terms and conditions is provided as an annexure to the Consultation Paper to be included in the aforesaid disclosure. These include a consent by the client to the understanding that any reliance placed on the research report would be per the client’s own judgement and assessment, that any investments based thereon would be subject to market risk, that recommendations in the research report do not provide any assurance of returns, and that there would be no recourse for losses incurred on investments based on the report. Further, the Most Important Terms and Conditions (MITC) to be disclosed by IAs and RAs would be standardized by industry associations/experts in consultation with IAASB/RAASB and SEBI. In particular, SEBI proposes that IAs include a term specifying inter alia that the client not permit the IA to execute any trade on the IA’s behalf without his explicit consent. IAs/RAs would also provide guidance to their clients in the agreement or disclosure of terms and conditions on the centralised fee collection mechanism for IAs and RAs. The consents obtained by IAs/RAs would be signed by the client in person or through Digilocker enabled Aadhaar based e-signature.
● KYC requirements and maintenance of records – SEBI proposes that RAs be required to follow the KYC procedure for their fee paying clients and maintain KYC records for their clients. Further, IA/RAs would be required to maintain records of clients such as list of clients, their PAN, date of service provided, nature of service, details of the securities or investment products for which the service was provided, and fee/consideration charged for such service. The RA would be required to maintain a record of disclosures of the terms and conditions of services offered to clients, as well as records of communication with clients and prospective clients related to its services. IAs providing implementation/execution services would be required to maintain call recording of every consent for implementation/execution obtained from the client.
● Circumstances under which a person is required to obtain registration as IA/RA – The SEBI CP proposes to specify that persons providing investment advisory services or research services are required to obtain certificate of registration as IA/RA from SEBI if they intend to provide investment advisory services or research services in relation to Indian securities to investors based in India, NRIs, or PIOs. Further, under the extant RA Regulations, a person located outside India is allowed to issue research report or do research analysis in respect of securities listed or proposed to be listed on a stock exchange in India by entering into an agreement with a RA or research entity registered with SEBI, without obtaining a certificate of registration under the RA Regulations. SEBI proposes that, similar to the provisions in IA Regulations, persons located outside India who propose to engage in providing research services to clients located in India with respect to securities listed or to be listed on stock exchanges in India be required to obtain certificate of registration as RA under the RA Regulations through a subsidiary or office set up in India.
● Compliance audit requirements for IAs and RAs– Under the existing regulatory provisions, IA/RAs and research entities are required to conduct annual audit in respect of compliance with the IA/RA Regulations and circulars issued thereunder from a member of the ICAI or ICSI. SEBI proposes to specify that the annual compliance audit report for IA/RAs and research entities would specify each of the provisions in respect of which compliance is reported. Further, an IA/RA or research entity would be required to complete the annual compliance audit within sixty days from the end of each financial year and submit a compliance audit report to SEBI/IAASB/RAASB within the specified time. Further, they must submit adverse findings of audit along with action taken in respect thereof to SEBI/IAASB/RAASB within a period of one month from the date of the audit report. Finally, they are required to maintain on record an annual certificate from a member of ICAI/ICSI/ICMAI confirming compliance with client level segregation requirements, which would form part of the compliance audit. IAs, RAs, and research entities would mandatorily have their own website and publish compliance audit reports on their website.
● Clarity in applicability of IA and RA Regulations to trading calls – SEBI proposes to clarify that trading calls provided after risk profiling of the client and product suitability assessment would come under the purview of IA Regulations, but would be under the purview of RA Regulations otherwise.
● Guidelines on ‘model portfolio’ – The Consultation Paper includes a set of draft guidelines for RAs seeking to issue model portfolios. Key features of the guidelines are as below:
(i) A ‘model portfolio’ would be defined to mean a basket of securities for which a research report is issued by an RA recommending the relevant weightages for one or more securities mentioned therein, and excluding a summary or consolidated presentation of securities recommended without weightages.
(ii) A model portfolio would be issued through a research report with all constituent securities being recommended to be covered in the research report and rebalancing to be done at such intervals as the RA deems appropriate. Further, the opinion of the RA on any constituent securities forming part of the model portfolio could not be contrary to its opinion on each of such securities individually. A model portfolio report would be required to contain disclosures, rationale, methodology, launch date, update date and type of model portfolio contained therein.
(iii) A model portfolio report would be required to specify the investment horizon of the model portfolio so that the investor can match that to their investment period.
(iv) The report must specify whether the model portfolio would be updated and at what intervals. Further, the rebalancing, if any, of the constituent securities must be done within the overall framework of the model portfolio and shall be communicated to the clients along with the underlying rationale.
(v) The report should clearly mention the model portfolio risk.
(vi) Each model portfolio should disclose performance duly validated by Performance Validation Agency (PVA) over different time periods and should be benchmarked with appropriate and relevant index.
● The Consultation Paper is a welcome step that has the potential to substantially reduce the entry barriers and the cost of doing business for IAs and RAs in India, while at the same time maintaining the standards of competence of IA/RAs and high levels of investor protection that are the province of SEBI to preserve. It is particularly worth appreciation that SEBI has proactively sought to lay to rest potentially business-dampening confusions such as about the eligibility of RAs to offer model portfolios and application of IA and RA regulations to non-Indian securities or clients. Such clarifications may go along way in setting to ease the concerns of intermediaries and investors alike, and evidence SEBI’s commitment to the growth of the IA and RA industries.
● At the same time, certain clarifications may be needed in respect of some proposals in the Consultation Paper. In particular, SEBI envisions that individual IAs would be barred from advising in respect of products within asset classes not regulated by SEBI or another financial-sector regulator, but it is left unclear whether they could do so by setting up a corporate entity that provides such advice. Moreover, it is not clear whether the principal officer, the compliance officer, or both would be liable in the manner of a conventional compliance officer in an entity where an independent professional is appointed as Compliance Officer. Therefore, it is important that care be taken in the translation of such proposals to regulatory provisions, in order to avoid creation of new confusions even as previous ones are resolved. Finally, it is worthwhile to question whether some of the proposals have the potential to impose undue burdens or restrictions on regulated persons.
● The proposal to require non-individual IAs to set up a legal entity separated at arms’ length for advising on products within or providing services in respect of asset classes not regulated by SEBI or other financial sector regulators, and to bar individual IAs from doing so altogether, may be unnecessary and counterproductive. Registered IAs undergo a rigorous process of certification to ensure their competence as well as are bound by a framework that ensures high standards of conduct towards clients. Thus, in view of both quality and convenience, investors may often prefer to receive advice or services from the same person or entity in respect of their investments in various assets, whether or not regulated by a financial sector regulator. It is explicit that SEBI’s jurisdiction over advice rendered by IAs is in any event confined to securities within its purview and does not extend to other products whether or not under another regulator’s purview. Therefore, there may be no reason for SEBI to bar the same individuals or entities registered with it to also provide advice or services in respect of all legally permitted asset classes. The same would also serve investor interests in receiving competent financial advice from a single reliable source.
● Further, the proposal to require persons outside India providing research services to clients in India with respect to securities listed in India to register as RAs through an Indian subsidiary or office may have the effect of requiring foreign-based proxy advisory firms to set up Indian offices or subsidiaries. However, under current practice and as permitted by the extant RA regulations, such proxy advisory firms usually enter into partnerships with Indian entities to issue their reports, which are significantly relied upon by global institutional investors. It may place an infeasible burden on such firms to be required to set up and register Indian branches, particularly as they may not always even have personnel solely dedicated to Indian securities. Hence, recognizing the distinct position of proxy advisory firms as already seen from their proposed exemption from the RAASB framework, SEBI may also retain the requirement to enter into an agreement with an RA or research entity registered with SEBI for proxy advisory firms located outside India.
● Further, it may not be in the interests of encouraging growth in the RA market to require PVA-validated disclosures in respect of every model portfolio report given the financial burdens potentially involved in paying the requisite fees to the PVA. Moreover, it is not clear whether a substantial policy goal is served by requiring RAs to follow the KYC procedure for fee paying clients, given that RAs do not handle funds for their clients or indeed render personalized service to clients in any way.
● Nevertheless, despite potential critiques, the regulatory framework and philosophy set out in the Consultation Paper marks an important step in SEBI’s promotion of the evolution of a mature market that affords investors increasingly widespread access to information and analysis relevant to their decision-making.
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