Do Robo-Advisors need to register with SEBI?

Are you a fintech startup?

Are you too planning to offer algorithm based advisory (robo-advisory) through your platform?

Is your company a “one-stop-solution” for investors looking to investment in stock markets?

If you have answered YES to any one of the questions, then let me break the news to you.

You come under SEBI’s purview. In other words, you need to comply with SEBI Regulations.

As it stands today, Robo Advisors come under the ambit of SEBI (Investment Advisors) Regulations, 2013.

What are Robo Advisors?

Robo Advisors are financial advisors or wealth management companies, which offer automated investment advice based on the pre-set algorithms. The algorithm takes inputs in the form of answers to pre set questions from the investor and offers a recommended portfolio for the user of the service.

There is minimal or no human intervention. Some Robo-Advisors extend the advice piece to offer “one-click” execution of the portfolio.

Although there is no ‘specific’ regulation on the Robo-Advisory business, providing advice on stocks and mutual fund (securities) depending on a particular client’s needs and situation is covered under Investment Adviser’s or IA regulations.

If you have not done so, you need to apply to SEBI for a license.

So, what are the requirements for getting SEBI’s license?

#1 – An entity

SEBI has clearly said that an individual cannot provide, both, advisory and execution services. So you need an entity i.e a company or a Limited Liability Partnership (LLP) to provide Robo Advisory services.

As per SEBI IA regulations if an Investment Adviser is providing advisory as well as execution services then both the services should be offered separately. Separate here means a separately identifiable department or division.

Segregating the activities and having separate departments is possible only in case of a company or an LLP.

#2 – Networth

The networth of the entity should be minimum Rs. 50 lacs. In calculating the networth, the networth of the promoters / partners / directors will not be considered.

While calculating the networth of a company, its paid up capital and free reserves are considered. And in case of an LLP, it is the total contribution of the partners.

The networth should be certified by a Chartered Accountant in practice.

#3 – Infrastructure set-up

The entity needs a proper infrastructure set-up to provide the services to the clients. Infrastructure includes:

• office space,
• office equipment,
• furniture and fixtures,
• communication facilities,
• research capacity,
• research software for undertaking investment advisory services, etc.

#4 – Qualification and certification requirements

The qualification and certification requirements are mentioned in the regulation itself. In case of a company, the directors and the employees who are involved in providing the advisory services need to fulfill the qualification and certification requirements. In case of LLP, the partners or employees involved in such services need to fulfil the requirements.

Read more : Qualification requirements by SEBI

The question that arises here is: since Robo Advisory does not have any human intervention, who needs to fulfil the qualification and certification requirements?

In my view, the persons who are involved in creating the rules for the algorithm need to fulfill the requirements.

#5 – Provision for SEBI fees

SEBI has amended the fee for registration of company and LLP as an IA. Click here to know more. 

In case you are a foreign entity and want to provide advisory services, you need to first set up a subsidiary in India and then apply to SEBI for registration.

As mentioned before, there are no specific regulations or requirements for Robo-Advisors.

However, in the consultation paper issued by SEBI in October 2016, SEBI had suggested the following compliance requirements for Robo-Advisors:

1. Risk profiling of investors is mandatory
2. All investment advice should be appropriate to risk profile of the client
3. The records pertaining to risk profiling and risk assessment of the client and suitability assessment of the advice being provided shall have to be maintained by the investment adviser for a period of five years.
4. It should be ensured that the automated tools used are fit for the purpose;
5. Robust systems and controls should be in place to ensure that any advice made using the tool is in the best interest of the client and suitable for the clients;
6. There should be proper disclosures to the clients in relation to how the tool works and its limitations of the outputs it generates;
7. There should be comprehensive system audit requirements in place;
8. Investment adviser using the tool will be held responsible for the advice;
9. The automated tools used by the advisers shall also be subject to audit and inspection.

This should provide a fair guidance as to what Robo-Advisors need to take care of. Since the suggestions were issued under the IA regulation, it is also clarified again that it is the IA regulations that apply to Robo-Advisors.

What is not clear?

In recent times, a lot has been written about mutual fund distributors, investment advisors, and segregation of their business activities, etc.

However, no clarification has been issued for Robo-Advisory business.

Most of the Robo-Advisory platforms offer advisory and execution at one place. If that proposal becomes a regulation, I am not sure how will Robo-Advisors work? Will they have to also separate their businesses? Unlikely since that works against the Robo-Advisory proposition.

My view is that if an Investment Advisor or a Robo-Advisor is providing execution services, say in mutual funds, it has to be in direct plans. With direct plans, there is no brokerage / commission payouts for providing execution services. Hence, the need for separate company or separate department can be done away with.

For several aspects of IA business, it is a wait and watch. The regulation is evolving and the participants will have to adjust to that.