SEBI getting set to regulate index providers

The government is going to regulate the practices of market index providers on the Securities Exchange Board of India (SEBI), amid concerns about the safety of passive investors’ savings parked in funds linked to indices that have added or retained several Adani group stocks.

Who are market index providers?

• Index providers are companies that design and calculate indexes.
• They have the responsibility to set the rules that decide what securities to include in each index, how the index will be managed and how securities will be added or removed from that index over time.

How they help investors?

• The process of listing usually determine how stocks can be classified, e.g. are a particular stock a Healthcare or an Oil & Gas stock, or are it a Developed or Emerging market stock.
• An index allows investors and other stakeholders to get a snapshot/idea of the market.

What are index funds?

• An index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index.
• Index funds have lower expenses and fees than actively managed funds.
• Index funds follow a passive investment strategy.
• Index funds seek to match the risk and return of the market based on the theory that in the long term, the market will outperform any single investment.

Need for regulation:

• SEBI had stressed the need for greater oversight on currently unregulated index providers like NSE Indices (a National Stock Exchange subsidiary) and the Asia Index Pvt. Ltd. citing their growing dominance due to the “proliferation” of index funds.
• The firms associated with investors could “exercise discretion through changes in methodology resulting in exclusion or inclusion of a stock in the index or change in the weights of the constituent stocks” and their decisions can impact the volumes, liquidity and price of such stocks, as well as investors’ returns from index funds.

About the development:

• The Securities and Exchange Board of India (Sebi) has proposed a regulatory framework for index providers.
• The proposed framework would mandate index providers to adhere to International Organization of Securities Commissions (IOSCO) principles.
• The proposed regulations would prescribe provisions to ensure eligibility criterion, compliance, disclosures, periodic audits, and penal action in case of non-compliance and incorrect disclosures.

Significance:

• Portfolios of index funds only change substantially when their benchmark indexes change.
• Thus, regulating the market index providers could directly impact the index funds.

Role of Securities Exchange Board of India (SEBI):       

• It is the regulator for the securities market in India. It was established in 1988 and given statutory powers on 30 January 1992 through the SEBI Act, 1992.
• It has empowered to exercise on following areas;
  • To approve by−laws of Securities exchanges.
  • To require the Securities exchange to amend their by−laws.
  • Inspect the books of accounts and call for periodical returns from recognized Securities exchanges.
  • Inspect the books of accounts of financial intermediaries.
  • Compel certain companies to list their shares in one or more Securities exchanges.
  • Registration of Brokers and sub-brokers.