Explained: What is swing pricing and how it can help debt fund investors

The Securities and Exchange Board of India (SEBI) wants to protect small investors who put their money, often significant chunks of their retirement corpus, into debt mutual funds. 

As part of this endeavour, the capital markets regulator has introduced a swing pricing mechanism in open-ended debt mutual funds. SEBI hopes this mechanism will shield small investors in case of redemptions by large institutional investors that lead to a fall in the net asset value (NAV) of debt mutual fund schemes. 

What exactly is swing pricing?

Swing pricing is a mechanism by which redemption costs are apportioned among those unitholders whose trades impacted the NAV. The mechanism is designed in such a way that the remaining unitholders don’t have to bear all the costs of the redemptions made by a select few. 

In a situation where there is a liquidity crunch the swing mechanism effectively ensures that those redeeming their monies are charged for the redemptions, thereby seeking to dissuade them from doing so. 

But why does the NAV fall when there is heavy redemption pressure?

Often times, due to low liquidity, fund houses have to sell their investments to meet redemption demand. This leads to a fall in the NAV of the fund. This also leads to an anomaly in which those—often big institutional investors—who exit first, benefit at the expense of those—often small retail investors—who are left behind to leave later. 

So, what has SEBI done?

A Moneycontrol report says that the Association of Mutual Funds in India (AMFI), the industry lobby group, has been asked to define broad parameters for determination of thresholds for triggering swing pricing and an indicative range of swing threshold for normal times.

The report said that the asset management companies (AMC) are allowed to have additional parameters for swing pricing and that it is up to the discretion of the mutual fund house to opt for swing pricing in normal times.

“If the AMC desires to implement swing pricing in normal times, then the AMC need to make necessary amendments in scheme information document and the same will be treated as a change in fundamental attribute of the scheme,” the report said. 

Moreover, SEBI has asked AMFI to put in place a model to determine the swing. “SEBI will determine ‘market dislocation’ either based on AMFI’s recommendation or suo moto. Once market dislocation is declared, it will be notified by SEBI that swing pricing will be applicable for a specified period,” the market regulator’s circular said.

Have any fund categories been kept exempt from the swing mechanism?

Yes, the new mechanism will not be applicable to overnight funds, gilt funds and gilt funds with 10-year maturity schemes.

When did SEBI begin the process for bringing in the new mechanism?

SEBI had brought a consultation paper on the matter in July this year. After discussions in the Mutual Fund Advisory Committee, it decided to implement the swing mechanism. 

What is the minimum threshold for an investor to be impacted by the new mechanism?

Swing pricing will be applicable only on the redemptions of Rs 2 lakh and more from the scheme at a PAN level.

From when will the new swing pricing be implemented?

Swing pricing—partial for normal times and full swing pricing for times of market dislocations—will be implemented from March 1, 2022.