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Wednesday, July 02, 2014

Difficulties with PFRDA's Draft Aggregator Regulations, 2014

by Arjun Rajagopal and Renuka Sane.

Recent mis-selling scandals in retail finance in India have brought into focus the dangers of unregulated, or lightly regulated financial intermediation. Financial intermediaries include banking correspondence agents, micro-finance institutions, insurance agents and other such players. They extend the reach of formal finance to a vast under-served population that is dispersed and not yet electronically enabled. Under-served populations with low access to finance are likely to be economically vulnerable, and may also have low levels of financial literacy. This makes them more dependent on the financial intermediaries they interact with, and more vulnerable to mis-selling and outright fraud. Such populations are also likely to have poor access to grievance redress mechanisms, courts and social safety nets.

The micro-finance crisis in Andhra Pradesh in 2010 shows what happens when regulators get it wrong. Loan collection agents in Andhra Pradesh were accused of engaging in large-scale coercive practices. This resulted in a political backlash, from which the industry is still reeling. It is therefore extremely important that India's financial regulators get it right when it comes to regulation of financial intermediation. This includes placing an appropriate emphasis on consumer protection.

Like loan collection agents in the case of micro-finance, aggregators in the pensions industry are a major interface with low income households in the informal sector. Aggregators are used to implement the NPS-Swavalamban (NPS-S) scheme run by the Pension Fund Regulatory and Development Authority (PFRDA). Under this scheme, if a subscriber in the informal sector contributes a minimum of Rs.1000 into her NPS-S account in a financial year, she will receive a co-contribution of Rs.1000 from the government. Aggregators market the scheme, enroll members and continue to service members post enrollment. They also make the investment choice for their customers. Aggregators thus act as execution agents of the NPS-S and as advisors to consumers. This means that aggregators potentially have considerable influence over financial choices of low-income households. Regulators should be very alert to the risk of fraud or mis-selling by these aggregators for three reasons:

  1. The consequences of fraud or mis-selling in the case of a product such as the NPS-S will probably only be detected far in the future, at the time of receipt of benefits.
  2. Older people are less likely to be able to recover from a sudden loss of income, especially if they have chosen to rely on income from the NPS-S.
  3. Public sector involvement in commercial products often gets construed as an official endorsement of the product. This exacerbates the risk of mis-selling.

Any regulation of aggregators must therefore place great emphasis on the goal of consumer protection.

The Draft Aggregator Regulations, 2014

Consumer protection is one of the pillars of the draft Indian Financial Code (IFC). The PFRDA, along with the rest of India's financial sector regulators, has committed itself to voluntarily implementing the consumer protection dimensions of the IFC, as articulated in the Handbook on adoption of governance enhancing and non-legislative elements of the draft Indian Financial Code . The recently released Draft Aggregators Regulation, 2014 are viewed in this context.

The Draft Regulations do recognise the importance of consumer protection as described in the IFC. They set out registration details of the aggregators, their duties and responsibilities and the inspection and disciplinary procedures that the PFRDA may initiate. Schedule VI of the regulations provides the aggregators with a code of conduct. However, we believe the regulations do not go far enough. Here is where the regulations fall short:

  • The regulations do not provide well-defined standards of skill and care that aggregators will be expected to exercise towards a customer. The beauty of simple, well-designed products is that they can be sold by agents with even basic financial literacy. However, it is important to specify what that basic level is for a given activity, or at least the standard that will be used to determine that level.
  • The regulations do not define what constitutes unfair and misleading conduct by aggregators. The Handbook discusses the need for regulations defining unfair and misleading conduct. India's experience with coercive and unfair practices by intermediaries should highlight the need for such definitions to be carefully researched and well-thought through.
  • The regulations do not place obligations on the aggregator regarding protection of consumers' personal information. In the context of digitisation and aggregation of information by private and public entities, it is increasingly important for regulators to specify these obligations.
  • The regulations do not provide adequate guidance for avoiding conflicts of interest. Subscribers of the NPS-S often purchase the pension scheme at the time of taking a micro-finance loan. The aggregator may be the intermediary for both these products. This scenario is entirely plausible, and is a foreseeable circumstance in which there may be a conflict of interest. However, the draft guidelines are silent on providing guidance on how aggregators should think about this issue, or the information that they must provide to clarify such conflicts.
  • The regulations do not provide adequate guidance regarding disclosures. Most NPS-S sales today rest on the co-contribution by the Government. It is not certain that this co-contribution will continue after 2017. This is information known to the aggregators, which is highly relevant to potential purchasers of the pension scheme. However, the regulations do not contain any details about such initial and continuing disclosures.
  • The regulations do not require any suitability or appropriateness checks before selling the NPS-S. The NPS-S is a market-linked, illiquid product. An illiquid product with a minimum contribution may not be appropriate for consumers who require cash in hand in the near future. By extension, investing in the NPS-S and simultaneously taking a micro-finance loan may not be a prudent decision for many consumers. Suitability analysis is an important part of the draft IFC's consumer protection for retail consumers. The regulator may take a view that the NPS-S is not a complex product, and therefore does not require suitability checks. In this case, the regulator needs to articulate the reasons why suitability checks are not mandatory. Absent such a justification, the regulations should feature some guidance on the issue of suitability.

The UK's experience with financial regulation shows that broad principles of consumer protection need to be translated into detailed guidance notes, such that both the regulator and the industry understand what is expected.

PFRDA has not used the appropriate processes for framing regulations.

In addition to the substantive concerns listed above, the regulations fail to abide by the procedural requirements of the Handbook, for framing regulations. The PFRDA should have provided the following:

  1. A clear statement of objectives;
  2. A list of problems the regulation seeks to solve; and
  3. A cost benefit analysis of each of the provisions.

The Handbook places major emphasis on the process of soliciting public comments via a well-designed web interface. Examples of such interfaces include the US Commodities Futures Trading Commission public comments page. There is as yet no information about the public comments received by the PFRDA.

Conclusion: Re-do with better public participation

The role of the aggregators, and the vulnerability of their customers should have led the PFRDA to accord a high importance to consumer protection when framing these regulations. The PFRDA needs to revisit these regulations and revise them in accordance with the substantive and procedural requirements of the Handbook. In particular, it would be advisable for PFRDA to quickly upgrade its ability to receive and display public comments on draft regulations. The PFRDA might consider extending the period for public commentary, and engaging more actively with the public to obtain high-quality feedback on this important subject.


  1. Poorly designed processes for financial intermediation is a common crime committed by those who work in the name of the Government. The Common Services Centers in India, an initiative under DIETY, India mediate a range of public services including those of PFRDA lacking such safeguards. If such services were not offered in the name of the Government, it would have been a scandal a long time ago.

    So why is there no action even today by Governments at state level, where such intermediation efforts faced principal-agent problems? It is because Bureaucrats are required to "own up" such poorly designed intermediation projects and indulge in damage control, when cases of misselling become rampant.

    Technology and the rhetoric of e-governance serves as a convenient shroud to hide the politics of such public service reform even from policy wonks like the author of this blog post. But it plays a hideously political role is evident, when ex-bureaucrats like R. Chandrasekhar called for shifting india's National e-Governance Plan to PMO Office rather than the DARPG, which is its right place.

    It is important to strengthen policy feedback mechanisms, to prevent public from being victimized by such superficial policy prescriptions.

  2. Shouldn't the Handbook get extended to MCA as well ? The last para of points towards a problem which is truly disconcerting.

  3. The NPS-S is a conditional cash transfer scheme working in line with various CSS with targets and milestone. In the current structure it is not capable of providing any meaningful pension wealth for the contributors. There has been no analysis of the profile and demographic mix of the contributors. Like any other financial product it is completely incentive driven . There is a serious need to undertake a social and policy audit of the scheme. The draft regulation needs serious discussion but that can happen only when the Regulator/ DFS allows an independent third party appraisal of the scheme.


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