Aimed at safeguarding the interest of investors during stressful times, this framework is certainly a welcome move
30-Sep-2021 •Sneha Suri
Swing pricing in debt funds is all set to become a reality. In a bid to ensure fair treatment of existing investors and those entering or exiting funds, SEBI has recently introduced a swing-pricing framework for open-end debt funds (except overnight, gilt and gilt with 10-year-maturity funds). Scheduled to be implemented from March 1, 2022, this framework will for now be made applicable in the case of net outflows from funds.
While the concept is new here, swing pricing is a rather common buffer globally. It is a process of adjusting a fund's net asset value (NAV) to pass on the transaction costs of significant inflows or outflows to investors associated with such activities. To gain more insights into this mechanism, read this article that we published when SEBI had floated the related consultation paper.
Oftentimes, during distress in the market, for example in a liquidity-challenged environment, investors rush to exit from funds, thereby forcing managers to liquidate quality bond holdings. This is detrimental to the interest of existing investors, as they are left with lower quality bonds. So, to safeguard remaining investors from any potential loss, swing pricing will come into effect. Here, existing investors will end up redeeming at a value lesser than the prevailing NAV, thereby bearing additional transaction costs.
In a recent circular, SEBI has introduced a hybrid model - partial swing during normal times and a mandatory full swing (in high-risk debt funds) during the time of market dislocation. As per the circular, the minimum swing factor will range from 1-2 per cent during the time of market dislocation, depending on funds' risk profile as determined by the risk-o-meter and potential risk-class matrix. To insulate (to a certain extent) retail investors from the applicability of swing pricing, SEBI has exempted redemptions up to Rs 2 lakh for all unitholders from this mechanism.
For normal times, SEBI has asked the AMFI to describe broad parameters to determine thresholds for triggering swing pricing and an indicative range of swing thresholds. Having said that, AMCs can have other parameters considering the nature of funds. Swing pricing will be optional during the normal market time and if the AMC desires to implement the same, then it will have to disclose it in the Scheme Information Documents (SIDs) and the same will be considered as a fundamental attribute change of the fund. Further, SEBI has asked the AMFI to develop a set of guidelines to determine market dislocation. Once market dislocation is declared, SEBI will notify that swing pricing will be applicable for a specified period.
While more clarity pertaining to important matters like the swing threshold, triggers related to market dislocation, etc., would be announced in the subsequent months, the intent here is to make pooled vehicles like mutual funds a fairer bet for all stakeholders. Thus, it is an investor-friendly move.