SEBI proposes framework to regulate Index providers

SEBI now wants to create a proper regulation framework for the index service providers. A lot of passive money running into billions of dollars ride on the indices provided by such index providers. However, SEBI feels that for the influence they wield, the regulation is not adequate. To address this shortfall, SEBI has proposed a comprehensive framework for index providers like MSCI, FT, Bloomberg etc. The entire gamut of regulations would be aimed at improving transparency and accountability in governance and administration of the financial benchmarks. As stated earlier, the passive investors rely on such indices for allocating billions of dollars through index funds and index ETFs. For that kind of influence, the view is that the overall regulation and accountability is just too low.

So what exactly is an index? Typically, in the stock markets, an index is a method of measuring a change in value of a group of securities forming part of the index. Most indices have a base year or base date to which it is compared. For instance, the base value of the Nifty is 1,000 in year 1994 and the current value of the Nifty 50 on a daily basis is benchmarked to this rate only. Index helps the investors in understanding the health of the market and also enabling them to study the market sentiment as well as the extent of wealth creation done by the set of stocks in the market. This enables performance measurement and benchmarking, by check for outperformance of fund managers.

As per the statement made by SEBI, the proposed regulation will be made applicable to the domestic and the international index providers as long as the users of these index products based on such indices are located in India. That would cover all such indices which are benchmarked to the Indian markets, either directly or indirectly. Under the proposed framework, all such eligible index providers offering indices for use in India would be mandatorily required to register with SEBI prior to offering such services and introducing indices in India. In addition, it is stipulated that the index provider should be a legal entity incorporated under the Indian Companies Act.

The minimum net worth requirement in this case is Rs25 core, but should not be much of an issue. In addition, it is also mandated that the index provider will have to constitute an oversight committee for reviewing existing index design and also monitor on a continuous basis. Such a committee shall review proposed changes to benchmark methodology and approve the same. The index provider must also set out clear cut policies and procedures to manage conflicts of interest. It must ensure skin in the game without leading to the buyer seller conflict that is so common in such business lines. The idea here is to protect the integrity and independence of the entire index process from end to end.

One of the key announcements is the ringfencing of related activities. For instance, if the index provider is engaged in any other activity, then such activity of being an index provider must be completely ringfenced to prevent sharing or leakage of sensitive information. Big index providers like MSCI already follow stringent global standards, but they now have to submit themselves to India specific scrutiny also. Also, the index provider must publicly document the methodology for index calculation and make it available on the website. In addition, index providers would be regularly assessed by independent external auditors to evaluate adherence to IOSCO principle, once in a period of 2 years.

It is a step in the right direction. In the last few years we have seen a massive shift to passive investing and it remains to be seen how the new regulations will avoid some of the problems that we are already getting to see.