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Sebi on Monday proposed introducing swing pricing mechanism for open ended mutual fund debt schemes as part of efforts to ensure fairness in treatment of investors, especially during times of market dislocation.
The regulator has suggested partial swing during normal times and a mandatory full swing during times of market dislocation.
The suggestion is aimed at ensuring fairness in treatment of entering, exiting and existing investors in mutual fund schemes, particularly during market dislocation, Sebi said in a consultation paper.
Generally, swing pricing refers to a process for adjusting a fund’s net asset value to effectively pass on transaction costs stemming from net capital activity to the investors concerned. In a liquidity-challenged environment, quoted bid/ask spreads and overall trading cost can widen and may not be representative of the executed prices that can be achieved in the market.
A proposal is to mandate swing pricing for high risk open ended debt schemes during market dislocation as they carry high risk securities compared to other schemes which possibly have higher costs of liquidation.
“Mandating swing pricing during market dislocation will lead to better predictability, transparency and effectiveness of the said mechanism,” Sebi said.
In subsequent phases, Sebi will examine the applicability of swing pricing mechanism to equity schemes, hybrid schemes, solution oriented schemes and other schemes.
Swing pricing should be made applicable to all unitholders with an exemption for redemptions up to Rs 2 lakh for all unitholders and up to Rs 5 lakh for senior citizens at a mutual fund level. This is in order to keep retail investors and senior citizens insulated from the applicability of swing pricing to a certain extent.
The Securities and Exchange Board of India (Sebi) has sought comments from public on the proposed framework till August 20.
Stressing on the need for swing pricing in India, Sebi said the mechanism is required to address issues related to costs of bid-offer spread and transaction costs, particularly arising during market dislocation in the mutual fund industry or in the underlying bond market.
Further, it said that secondary bond market in India is not as liquid as the equity market and can absorb only a limited amount of paper on any given day.
“Further, liquidity is concentrated in high quality paper and during market dislocation, very high risk aversion is observed and in terms of yield of bonds, spread over benchmark spike, particularly for relatively lower quality paper,” Sebi said.
“Accordingly, swing pricing, an anti-dilution adjustment that seeks to protect investors in a fund from performance dilution as a result of significant outflows from the fund, particularly during market dislocation, is relevant in Indian context,” it added.
During normal times, Sebi suggested that swing pricing will be optional based on pre-determined minimum swing threshold and maximum swing factor. The same should be disclosed in the Scheme Information Document (SID) along with details of swing pricing policies and procedures.
During market dislocation, swing pricing framework will be implemented in a phased manner. In the first phase, it will be mandated only during the times of outflow market dislocation across mutual funds as it is a high risk scenario.
The rationale for mandating swing pricing across mutual funds during market dislocation times is to mitigate risks related to uncertainty of whether swing pricing will apply or not, Sebi said. If it is not mandated uniformly, there will be a race to the bottom among various mutual fund schemes, it added.
During market dislocation, applicability of minimum swing factor will be as stipulated by Sebi, which will be risk-based. Beyond this, the Asset Management Company (AMC) can choose to levy higher swing factor if it considers such a factor to be in the best and equitable interest of its unitholders based on pre-defined parameters — redemption pressure, current portfolio of the scheme as detailed in the scheme information document.
This will be subject to compliance to pre-disclosed cap on swing factor and minimum swing threshold.
The regulator will determine ‘market dislocation’ either based on Association of Mutual Funds in India’s (AMFI) recommendation or based on a combination of various factors like net redemption build up at the industry level, global market indicators, Indian market indicators as well as bond market indicators.
Once market dislocation is declared, it will be broadcast that swing pricing will be applicable for a certain period, which can be extended. During the times of market dislocation, all schemes will give effect to swing pricing and certain minimum uniform swing factor will be made applicable across the industry.
However, when there is a scheme level stress, the fund manager will determine whether to apply swing factor or not.
“When swing pricing mechanism is triggered and swing factor is made applicable (during normal time or market dislocation, as the case may be), both the entering and exiting investors shall get NAV adjusted for swing pricing,” Sebi said.
