In a move to bring more transparency and structure to the market, SEBI shared a consultation paper on the regulatory framework for index providers. Index providers are those institutions that formulate and manage indices. While S&P Dow Jones, MSCI, and Bloomberg are some of the globally renowned institutions that provide indices, in India that activity is generally carried out by subsidiaries of stock exchanges, a joint venture between an exchange and an index provider entities or working in the area of credit rating.
The most prominent indices in India are the Nifty50 by NSE Indices, and Sensex provided by a venture of S&P Dow Jones Indices and BSE Lied. An index allows investors and other stakeholders to get a snapshot of the market. Since the services of these index providers determine the level of investment in the market through passive mutual fund schemes, it is necessary to regulate these institutions to safeguard investor interests.
The regulations have come after a series of consultations with various stakeholders. SEBI brought out a discussion paper in 2017 and followed it up with a consultation paper on the conduct of index providers in 2020. This framework is in line with the current global trends.
EU Benchmark Regulation was published in 2016 and was one of the first regulations that sought to oversee the functioning of index providers. Along similar lines, the UK, Australia, Singapore, Japan and Korea also brought regulations to govern the benchmark-setting process.
SEBI’s proposed regulations adhere to the principles of the International Organization of Securities Commissions (IOSCO), the global standard setter for the securities sector.
The proposed regulation requires the index providers to be legal entities with a minimum net worth of ₹25 crore. It bars an individual or a group of persons from registering as an index provider. It also requires a minimum vintage of five years in index administration.
The proposed regulations require the index providers to ensure the integrity and independence of the index determination process. The data, processes and interests of the determination of the index need to be kept sacrosanct from any other business interests. Since these indices are to be used by a wide range of users from different classes, it is necessary to keep the index secular from the introduction of any unregulated data that may skew the index in a particular way.
The department responsible for creating the index is expected to be independent of any commercial or personal interests that may influence the objectivity of the index. The accountability part of the regulations require the complaints redress mechanism, appointment of internal/external auditors, maintaining audit trails and assisting the regulatory and supervisory bodies with making available any relevant data, including audit trails.
The proposed regulations require an audit by an external auditor of the benchmarking process every two years, maintaining all audit records and making them available to SEBI when asked for. These two sections ensure a high degree of governance and accountability from the index providers.
SEBI proposes that the index providers need to consider all relevant data for creating an index. It also needs to exercise enough care and caution to ensure that there is no distortion of the data. It needs to exercise due diligence in the on-boarding of data submitters. And, more importantly, the index provider has to ensure that the data submitters source data from only regulated entities and no other sources. It ensures the quality and reliability of the input materials used in constructing the index.
With the exponential increase in the number of passive funds and the asset under management of these funds, the governance of the indices assumes greater significance.
Saravanan is a professor of finance, and Banerjee is a doctoral candidate, at IIM Tiruchirappalli