Passive funds set for boost as Sebi eases market making, NFO and ETF rules

Industry players expect assets to double in five years

The passive fund industry has received a major shot in the arm from the Securities and Exchange Board of India (Sebi), which industry players say, could help double assets under management (AUM) in less than five years.

The market regulator has relaxed several rules around market making, launch of new fund offerings (NFOs) and promotion of debt exchange traded funds (ETFs) through a circular titled ‘development of passive funds.’

At present, passive schemes, which include both ETFs and index funds, have an AUM of Rs 5.27 trillion—less than 15 per cent of the total AUM of the mutual fund (MF) industry.

ETFs are funds that track indices such as the Nifty or the Sensex or an underlying asset such as gold. The ETF constituents change whenever the underlying index undergoes rebalancing. They can be bought or sold on a stock exchange platform. The cost of investing in an ETF or an index fund is lower than that of an actively-managed MF scheme. This coupled with underperformance of active schemes have increased the popularity of ETFs in India.

Sebi has now made operational changes to how ETFs formed and managed to provide MF houses more flexibility. For instance, the regulator has allowed net settlement for market makers. Further, Sebi has reduced the minimum subscription amount to just Rs 10 crore for debt ETFs and Rs 5 crore for other ETFs. More importantly, the regulators have introduced an alternative for ETF NFOs, whereby the asset management company can contribute the initial fund for unit creation. The AMC can subsequently transfer the units to market makers or investors.

“Sebi has put in place the right building blocks for the passive fund industry to grow significantly in the coming years. To boost ETF liquidity, Sebi has eased the market making norms by allowing net settlement for market makers which will make the process less capital intensive and will encourage more players to act as market makers. Further, Sebi has made changes which will encourage more trades to take place on the exchange platform thus increasing the overall liquidity. Other measures such as display of live intra-day NAVs on exchange platforms, lower minimum subscription for NFOs and lowering of investor education charges are all welcome steps," said Mukesh Agarwal, CEO - NSE Indices.

Sebi has said any redemption or subscription of over Rs 25 crore can be placed directly with an AMC, while smaller orders will have to be placed on the exchange platform. The regulator has also halved the investor education and awareness charges to just 1 basis points of net asset value of the scheme for ETFs and index funds. For fund of funds this charge has been waived off.

For debt ETFs and index funds, Sebi has said there will three categories comprising of corporate debt securities, government securities (G-Sec) and hybrid securities. Regulator also laid down norms for index constitution, single issuer limit based and group level exposure limit.

Bhushan Kedar, director – fixed income research at Crisil said, “The new guidelines focus more on duration, interest rate and credit risk-based replication.  By easing the norms for partial replication of indices, the guidelines have become more streamlined to global practices.”

If an index has at least 80 per cent weight towards corporate debt securities, a single issuer limit on AAA-rated securities has been set at 15 per cent. In respect of AA-rated securities, a single issuer shall not have more than 12.5 per cent weight and for A and below rated securities, a single issuer shall not have more than 10 per cent weight in the index.

For an index based on G-Sec and state development loans (SDLs), a single issuer limit shall not be applicable.

The new regulatory framework introduced by Sebi is based on recommendations made by a working group which had representation from AMCs, trustees, brokers and stock exchange officials.

“If we look at the global markets, the role of authorised participant (AP) and MMs is very strong. Any activity on exchanges or even outside the exchanges are handled by MM and AP. AMCs have a very limited role in terms of creating and redeeming units. Usually, APs and MM interact directly with the AMCs, investors usually don’t interact with AMCs. But in India it was the other way round, with this they are trying to strengthen the role of MM and incentivise them,” said Niranjan Avasthi, head product, marketing and digital business, Edelweiss MF.