Sebi proposes swing pricing in open-ended debt schemes to protect investors

Swing pricing refers to the process of adjusting a fund's NAV to effectively pass on transaction costs stemming from either inflows or outflows from the schemes

The Securities and Exchange Board of India (Sebi) on Monday proposed to introduce a swing-pricing mechanism to protect mutual fund investors in an event of market dislocation.

Swing pricing refers to the process of adjusting a fund’s net asset value (NAV) to effectively pass on transaction costs stemming from either inflows or outflows from the schemes.

In a consultation paper, Sebi has said keeping in mind regulatory practices followed by other jurisdictions, a hybrid model is proposed which is partial swing during normal times and a mandatory full swing during times of market dislocation.

Sebi will determine ‘market dislocation’ either based on industry body Association of Mutual Funds in India's (Amfi's) recommendation or based on a combination of various factors like net redemption build up at industry level, global market indicators, Indian market indicators as well as bond market indicators.

The secondary bond market in India is not as liquid as the equity market and can absorb only a limited amount of paper on any given day. Further, liquidity is concentrated in high quality paper and during market dislocation, very high-risk aversion is observed and in terms of yield of bonds, spread over benchmark spikes, particularly for relatively lower quality paper.

“There is a need for a mechanism that imposes certain costs on existing investors (since they are contributing to a downward spiral in NAV) while incentivizing entering investors (since they are helping to stem the downward spiral in NAV). This happens as the NAV is adjusted downwards during times when net outflows are more than the swing threshold and this lower NAV is offered to the entering investors during such times,” said Sebi in the consultation paper.  

If the net inflows are more than the swing threshold NAV will be adjusted upwards and if net outflows are more than swing threshold the NAV will be adjusted downwards. Swing pricing mechanism shall be mandated only for all open-ended debt schemes that have high or very high risk on risk-o-meter.

For example, under Class I, if Macaulay Duration is less than or equal to one year and if credit risk value of the scheme is more than or equal to 12 the swing factor will be optional. While under Class III, a scheme having any Macaulay Duration, but credit risk value of the scheme is less than 10—swing would be 2 per cent.

When swing pricing mechanism is triggered and swing factor is made applicable (during normal time or market dislocation, as the case may be), both the entering and exiting investors shall get NAV adjusted for swing pricing.

Swing pricing framework shall be implemented in a phased manner.  In the first phase, it shall be mandated only during the times of outflow market dislocation across mutual funds as it is a high-risk scenario. Further, it is proposed that in subsequent phases, SEBI will examine the applicability of swing pricing mechanism to equity schemes, hybrid schemes, Solution oriented schemes and other schemes like index funds and exchange traded funds (ETFs).

Swing pricing shall be made applicable to all unitholders with an exemption for redemptions upto Rs 2 lakh for all unitholders and upto Rs 5 lakh for senior citizens at mutual fund level in order to keep retail investor and senior citizen insulated from the applicability of swing pricing to certain extent.

Proposed framework of swing pricing

• It is proposed to implement the framework of swing pricing only for open-ended debt schemes for now.

• Partial swing during normal times, mandatory full swing during times of market dislocation.

• Applicability of swing pricing will be optional based on a predetermined minimum swing threshold and maximum swing factor.

• During market dislocation, all schemes to give effect to swing pricing; certain minimum uniform swing factors to apply across industry.

• Swing pricing to be made applicable to all unitholders with an exemption for redemptions up to Rs 2 lakh for all unitholders and up to Rs 5 lakh for seniors