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The Securities and Exchange Board of India (Sebi) on Monday proposed a swing pricing mechanism for mutual funds to prevent the collapse in a scheme’s net asset value (NAV) at times of investor exodus.

The mechanism allows fund houses to adjust a scheme’s NAV in response to inflows and outflows, protecting long-term unitholders from value erosion during heavy redemptions.

The move is part of a series of reforms to protect investor interest in the wake of the April 2020 winding up of six debt funds by Franklin Templeton Asset Management (India) Pvt. Ltd.

“Swing pricing is a potential risk-mitigation measure for any product with liquidity risk. This is particularly acute with open-ended debt mutual funds, especially in times of market stress. Even a 10-15% redemption of assets under management in a short span of time can adversely impact the fund," said Kaustubh Belapurkar, director manager - research, Morningstar Advisor India.

While swing pricing will be optional during normal market time, Sebi has proposed to mandate the mechanism for high-risk open-ended debt schemes during market dislocation (panic situations when liquidity in the market dries up and yields spike) as these schemes carry high-risk securities compared to others that possibly have higher costs of liquidation. Swing pricing is already practised in the US, Luxembourg, Hong Kong, France and the UK.

“During market dislocation, applicability of minimum swing factor will be as stipulated by Sebi, which shall be risk-based. Beyond this, the asset management company (AMC) can choose to levy higher swing factor if it considers such a factor to be in the best and equitable interest of its unitholders," Sebi said in the paper, which has been put up on the regulator’s website for comments by stakeholders.

Sebi has proposed a minimum swing factor of 1-2% for open-ended debt schemes based on their risk profile.

Swing factor is a cost that the exiting investor must pay. It is applied as a percentage of the investor’s holding in the fund. It deters large investors from pulling out in a hurry.

When the swing factor is applied, both the entering and exiting investors will ideally get NAV adjusted for swing pricing.

For instance, if the NAV is reduced from 100 to 99 due to swing pricing, the exiting investor will redeem at 99 per unit and the entering investor will get to buy at 99 per unit.

As a relief for small investors, redemptions up to 2 lakh for all unitholders and up to 5 lakh for senior citizens will be exempted from the mechanism of swing pricing.

Sebi will also examine if swing pricing can be applied to equity schemes, hybrid schemes, solution-oriented schemes and other schemes such as index funds or exchange-traded funds.

“There are some drawbacks to this (swing pricing). It can deter corporates from investing in smaller debt funds because the threshold for implementing swing pricing there will be lower. For example, a 5% threshold is 5 crore in a 100 crore fund, while it is 50 crore in a 1,000 crore fund. Corporate treasuries usually have large amounts to invest. Secondly, corporates might try to game the system. If the threshold is announced at 5%, people will try to redeem say 1% per day instead of 5% in a single day," said a debt fund manager on condition of anonymity.

To be sure, internationally, in case of many fund houses, the thresholds are confidential in order to prevent any attempt to avoid a price swing by subscribing or redeeming in an amount just below the threshold.

abhinav.kaul@livemint.com

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