Managing indices

| Updated on December 14, 2020

Apart from holding index providers to global disclosure standards, SEBI must usher in competition

The Securities Exchange Board of India’s recent consultation paper, which moots new compliance standards for index providers, is welcome because it kicks off debate on regulating this unregulated space. Passive investing is at an inflection point in India with assets managed by index funds vaulting to ₹2.5 lakh crore from ₹70,000 crore in the last three years. The Employees Provident Fund Organisation has taken the exchange-traded fund route to dip its toes into equities and retail investors are increasingly preferring index funds to avoid the high costs of active funds. Hence, it is about time that their construction and maintenance attracted greater scrutiny.

Comparing the Nifty50 and Sensex30 with bellwethers in the Western world, the SEBI paper notes that the construction methodology for Indian indices does not differ very much from developed markets. All of them use market capitalisation and liquidity to select constituents and do not limit weights to individual stocks or sectors, allowing their composition to simply reflect the prevailing mood of the market. In India, of late, there has been debate around whether the Nifty50 and Sensex30 have turned too risky for retail investors with their 40 per cent weight to financials and more than 10 per cent weights to top constituents. SEBI has capped stock weights at 25 per cent, but the paper seems to suggest that further intervention is unnecessary. Since 2013, the European Union, Australia and Japan have ushered in specific regulations for index providers in line with principles provided by the International Organisation for Securities Commissions (IOSCO). SEBI suggests that indices which serve as benchmarks for funds or the underlying for derivatives or ETFs fall in line with the IOSCO principles. To ensure good governance, IOSCO calls for high transparency and public consultations by index providers on their selection methodology. To avoid conflicts of interest, it recommends separation between index administrators and data providers, clear identification of the staff involved in index maintenance and a whistle-blower mechanism to discourage leaks. For accountability, it asks index providers to solicit written complaints and initiate third-party audits. Given that the arms of the two main exchanges in India are also its primary equity index providers, there’s substantial room for a clean-up on all these aspects. Presently, the information put in public domain on methodology and changes even for the bellwethers, is sketchy at best. Basic data such as individual stock weights is paywalled to the public.

While holding Indian index providers to IOSCO standards is important, SEBI needs to stretch its regulatory role further for a better investor experience. Passive investing in India is taking off at a time when the equity cult is still nascent. Therefore, encouraging non-exchange-controlled entities to come up with innovative indices and a strict rule-based regime on their methodology and disclosures may well be critical for orderly development of the passive market.

Published on December 14, 2020

Follow us on Telegram, Facebook, Twitter, Instagram, YouTube and Linkedin. You can also download our Android App or IOS App.

This article is closed for comments.
Please Email the Editor

You May Also Like