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The Securities and Exchange Board of India has moved to regulate providers of financial market indices, which are in turn used by the mutual fund industry as benchmarks—usually as part of the management of their passive schemes.
The indices and benchmarks—like the Nifty 50—are tracked by fund managers, are owned and managed by subsidiaries of stock exchanges or joint ventures between an exchange and index provider or a credit rating agency, SEBI said in a notification on its website.
Over the past few years, with the proliferation of the passive investment strategy, an array of indices have been introduced.
On the one hand, there are broad market indices—like the Nifty 50 or the Sensex—and on the other, there are indices that are tailor-made to suit the requirements of a fund manager. For example, an index provider can create a healthcare index based on the parameters set by a fund manager.
According to the market regulator, a conflict of interest could arise in the governance and administration of indices and benchmarks because of the discretion in management of indices. For instance, the rebalancing of the constituents of an index happens on the discretion of the index provider.
“It can be implied that the role of stock selection being performed by the fund managers of index funds appears to have been delegated to the Index Providers to a certain degree. Inclusion or exclusion of a stock in the index may also have an impact on volume, liquidity and price of the stock,” the regulator said.
The regulator suggests there could also be a conflict of interest as the administrators of an index may not fully implement policies to ensure protection of sensitive information.
Index providers are currently outside the purview of SEBI’s regulations.
In a bid to fix what it calls “the regulatory vacuum”, and based on the deliberations of the Secondary Market Advisory Committee, SEBI has proposed a regulatory framework for index providers.
Index providers will have to register with SEBI if the users of the index are based in India. The provider will have to be a legal entity incorporated under the Companies Act in its country of origin and must have a minimum net worth of Rs 25 crore. The regulator has also stipulated that independent professionals are ineligible to function as index providers.
Besides this, a number of safeguards will need to be put in place by index providers, including an oversight committee for reviewing existing index design and policies and procedures, to manage conflict of interest and to protect the integrity and independence of various functions performed in connection with the determination of the indices, the market regulator said.
There will also need to be an assessment of the index provider by independent external auditors to evaluate adherence to the rules, once every two years. The first such assessment will have to be carried out within one year of the grant of registration by SEBI.
The capital markets regulator has said that benchmark administrators that provide significant benchmarks notified by the Reserve Bank of India will be excluded from the proposed regulatory framework.
SEBI seeks responses to its consultation paper by Jan. 27, 2023.
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