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The Securities and Exchange Board of India (Sebi) has put on hold its decision to bring index providers within the regulatory ambit. The new regulations could have required global index providers, such as MSCI and Nasdaq — creators of benchmarks tracked by trillions of dollars — to register with the domestic securities regulator.
A regulatory framework for index providers was cleared by Sebi’s board at its meeting held in March. The regulator, however, is yet to notify changes.
A top regulatory official told Business Standard that Sebi planned to make further changes to the framework and would take up the proposal to its board afresh. The exact nature of the tweaks couldn’t be ascertained.
People in the know said regulating global index providers was the more contentious issue for the regulator. According to Sebi’s discussion paper floated in December last year, it wants to regulate all those index providers, services of which are used by domestic asset managers and investors.
Most domestic exchange-traded fund (ETF) assets are linked to benchmarks created by local index providers, such as NSE Indices, an arm of the National Stock Exchange, and Asia Index, a joint venture between S&P Dow Jones Indices and the BSE. However, benchmarks created by MSCI, Nasdaq, Hang Seng, and S&P, too, are used by some domestic asset managers but their assets under management are relatively minuscule.
“Regulating index providers has become a hot topic globally, given the amount of passive assets that track these indices. The European Union has the EU Benchmark Regulation, while the US SEC is looking at whether index providers should be required to register as investment advisors. It remains to be seen if MSCI or FTSE register to come under India’s regulatory ambit. Given that the assets tracking their indices locally are probably not big enough, these index providers may discontinue offering their indices in India,” said analyst Brian Freitas of Periscope Analytics.
The AUM of passive schemes offered by domestic mutual funds (MFs) have crossed Rs 7 trillion, up from Rs 2 trillion in 2020. The number of passive schemes has increased to more than 400, from 150 four years ago. Given this growth, the ability of indices and index providers to influence capital markets has gone up. Further, these benchmarks have a considerable impact on capital flows into the country.
Against this backdrop, Sebi formulated rules aimed at increasing transparency, accountability, governance, and administration at entities that are engaged in creating these financial benchmarks and indices. The markets regulator proposed that index providers would have to be legal entities incorporated under the Companies Act.
Sebi also proposed a minimum net worth of Rs 25 crore for index providers and the constitution of an oversight committee to review their existing index design. Further, index providers would have to carry out an independent external audit once in two years. At present, most index providers publicly disclose their index construction methodology. However, there is still a certain scale of discretion used by index providers. Typically, an inclusion or exclusion or change in the weighting of a stock has a large bearing on the stock price of index constituents.
“The level of discretion in the hands of index providers has led to an increase in possibilities leading to conflict of interest in administration and governance. There is also a chance of inadequate implementation of policies to ensure the protection of sensitive information. Therefore, it is essential that a regulatory framework is introduced for accountability and governance of index providers that have been outside the purview of Sebi, so far,” said Kanjani Sharma, associate, TAS Law.
Globally, most jurisdictions use the IOSCO (International Organization of Securities Commissions) principles as the guiding framework for regulating financial benchmarks and their providers. “The proposed framework will work at the macro level. But, micro-level scrutiny shall be required to be undertaken by the regulator as it has been doing with respect to companies in the Indian market,” said Ravi Prakash, associate partner, Corporate Professionals Advisors & Advocates.
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