New framework for passive debt funds and its impact on investors

SEBI has developed a new framework for passively managed debt funds. In this article, we would be looking at its impact on investors. So, stay tuned! 

The Securities and Exchange Board of India (SEBI) on May 23, 2022, released a circular on the development of passive funds. In this circular SEBI has come up with a new norm for passively managed debt funds. In this article, we would be understanding these norms and also their effects on investors. The new norm is effective from July 1, 2022. 

According to SEBI, debt ETFs or index funds could be made up of indices comprising corporate debt securities or government securities, treasury bills, State Development Loans (SDL) or a combination of corporate debt securities and government securities, treasury bills and SDL. 

Single Issuer or Group Limit 

I.  For an index with at least 80% weight of corporate debt securities, single issuer limit shall be as under: 

1.In respect of AAA-rated securities, a single issuer shall not have more than 15% weight in the index. 

2. In respect of AA-rated securities, a single issuer shall not have more than 12.5% weight in the index. 

3. In respect of A and below rated securities, a single issuer shall not have more than 10% weight in the index. 

II.  For a hybrid index (comprising both corporate debt securities and government securities/SDL) with up to 80% weight of corporate debt securities, 

1. In respect of AAA-rated securities, a single issuer shall not have more than 10% weight in the index. However, for AAA-rated securities of PSU and AAA-rated securities of PFI issuers the said limit shall be 15%. 

2. In respect of AA-rated securities, a single issuer shall not have more than 8% weight in the index. 

3. In respect of A and below rated securities, a single issuer shall not have more than 6% weight in the index. 

III.     For an index based on government securities and SDL, single issuer limit shall not be applicable.

IV.    The index shall not have more than 25% weight in a particular group (excluding securities issued by Public Sector Units (PSU), Public Financial Institutions (PFI) and Public Sector Banks (PSB)). 

V.       The index shall not have more than 25% weight in a particular sector (excluding government securities, treasury bills, SDL and AAA-rated securities issued by PSU, PFI and PSB). However, this provision shall not be applicable for sectoral or thematic debt indices. 

Market Making 

AMC shall appoint at least two Market Makers, who are members of the Stock Exchanges, for ETFs to provide continuous liquidity on the stock exchange platform. 

Market Makers shall transact with Asset Management Company (AMC) only in multiples of creation unit size. AMCs shall facilitate in-kind creation and redemption of units of ETFs (including Debt ETFs) by Market Makers on a best effort basis. 

Exit Load 

In order to enhance liquidity in units of ETFs on the stock exchange platform, it has been decided that direct transactions with AMCs shall be facilitated for investors only for transactions above a specified threshold. In this regard, to begin with, any order placed for redemption or subscription directly with the AMC must be greater than Rs 25 crore. The aforesaid threshold shall not be applicable for Market Makers and shall be periodically reviewed. 

Impact on investors 

These new norms are quite important from an investor's standpoint as these norms will, first of all, bring some standardisation in debt ETF or index. Moreover, these norms will also ensure enough liquidity and also would help in avoiding the concentration of a single issuer or a group, thereby reducing the risk. Therefore, this is a welcome move from SEBI.