Sebi mulls 'formal regulatory framework' for index providers and ETFs

The role of index providers and exchange-traded fund (ETF) providers has come under the spotlight amid a surge in demand for passive investment vehicles and growing clout of large indices such as the Nifty 50 and the S&P BSE Sensex.

As a result, the Securities and Exchange Board of India (Sebi) has started consultations with asset managers and other market players on whether it should come out with a formal regulatory framework for index providers. It is also debating whether certain indices should be designated as ‘significant’ or ‘systematically important’.

The assets under management (AUM) of passive funds offered by domestic mutual funds has grown 50 per cent in the past year to Rs 2.6 trillion and has grown more than 30 fold over the past five years.

At present, some countries like Australia and Singapore have identified certain benchmarks as significant and introduced regulations for them. In the case of Singapore, the benchmarks are on the debt side, but Australia besides its four debt market indices has also earmarked the S&P/ASX 200 Index as ‘significant’.

Given the large sums of money riding on certain indices, Sebi feels the process and criteria for stock selection in certain indices is of “critical importance”. Also, the “quality and integrity” of the indices needs to be administered and maintained.

There currently aren’t any regulatory frameworks specifically aimed at index providers. However, the stock selection criteria for Nifty, Sensex and various other indices are available in the public domain.

“The business of index providing is increasingly becoming complex. Inclusion or removal of a stock from an index has significant bearing on the company and investors. Besides, there are aspects like managing concentration risk, data sharing pacts, ensuring adequate representation of various sectors of the economy and liquidity management, which need to be dealt with impartially. Hence, it is the right time to debate how index providers or indices need to be regulated,” said a senior fund manager, asking not to be named.

There are several global index providers, such as MSCI and FTSE Russell, offering products based on Indian securities. The two most popular indices in the domestic market the Nifty and Sensex are offered by index providing arms of stock exchanges. In the case of Nifty, the index providing firm is NSE Indices and for Sensex it is the Asia Index, a 50-50 partnership between BSE and S&P Dow Jones Indices. Several AMCs use this and many other indices as benchmarks for their funds, there are also derivatives contracts traded with these indices as underlying.

“I am not sure if a formal regulatory provision is the way forward. However, it would be useful to have a discussion on whether there needs to be separation of roles between exchanges or trading service providers and index providers. None of the leading stock exchanges globally are index providers. In India, the exchanges own the indices. This does appear to pose the risk of conflict of interest, which could be mitigated,” said Saurabh Mukherjea, founder and chief investment officer of Marcellus Investment Managers.

Meanwhile, Sebi has proposed that index providers in India should ensure compliance with International Organization of Securities Commissions (IOSCO) standards for financial benchmarking to ensure a certain level of disclosure and transparency.

“As passive industry grows, adherence to IOSCO principles improves investors’ confidence in public markets. In India, there hasn’t been much diversity in terms of number of index providers. If the proposal around IOSCO compliant providers leads to more participation from global players who are already compliant with IOSCO principles, investors will benefit from increased competition and innovation in the marketplace,” said Sivananth Ramachandran, director of capital markets policy (India), CFA Institute.