Etf Sebi New Norms: “Investors looking to invest through ETFs will find the new Sebi Norms make their lives easier”

The Securities and Exchange Board of India has issued new standards for index funds and ETFs in the area of ​​equities and debt. The 16-page circular covers many topics, from FoFs in equities to regulations on passive corporate bond funds. The circular also paves the way for passive ELSS.
Shivani Bazaz
of ETMutualFunds contacted
Niranjan Awasthi,
Head of product, Mutuelle, to decipher the circular. Interview edited.

What are the most important aspects of the Sebi flyer?
The first important point is the increase in liquidity in ETFs and in the stock market as a whole. Firstly, Sebi put a limit of Rs 25 crore on transactions with the AMC. Thus, direct transactions with AMCs will only be facilitated for investors for transactions exceeding a determined threshold. Thus, any redemption or subscription directly from the AMC must be greater than Rs 25 crore. This brings more people to the exchange directly. Now, to meet this huge demand, you need market makers, which is another important standard.

Sebi has made it mandatory for each AMC to appoint two market makers. They have also enabled AMCs as well as exchanges to incentivize market markers. The new standards also reduce price risk for market makers. This allows them to offer better liquidity. All of these things will improve the liquidity and transparency of ETFs. I think a lot of this development is aimed at moving towards a developed market situation. In developed markets, all liquidity is managed by market makers. AMCs rarely deal directly with investors. So this is all an attempt to somehow replicate how a developed market works.

In detail, how do market makers work and what are they used for in a market?
You see, ETFs are traded on an exchange and there should be liquidity on the exchange to trade these ETFs. Like any other stock. The big demand gap is very narrow and the trade can occur much closer to the fair price. In the absence of market makers, this gap widens. Sometimes there could be only one offer on an ETF and no demand. In such cases, market makers step in and create the second leg of the order either on the buy side or the sell side.

The goal of market makers is to narrow the bid-ask spread and keep ETF prices closer to fair value. Thus, the impact cost of buying an ETF for an investor is reduced. In a nutshell, the presence of market makers will reduce the cost of trading ETFs.

Will lower costs and increased liquidity attract more retail investors? These investors generally prefer index funds, but will the new standards bring them into the ETF fold?
Between index funds and ETFs, both have their own pros and cons. The advantage of an ETF is that since it is traded on an exchange, you can follow the real prices, but you would need to know the trading. You would need a demat account. Index funds are easy, you don’t need any expertise for them.

Investors who understand and want to invest through ETFs will find these standards to make their lives easier. Those who opt for index funds have very different needs. They have to set up SIPs, SWPs, they don’t want to go through a brokerage, and they’re okay with the valuation at the end of the day. For retail investors looking to relax, index funds remain a lucrative option. For savvy investors and traders, ETFs have gotten better.

Will the standards really deepen the passive debt space? Category segregation and limits on securities below AA as well as the deviation limit, will these rules make the debt passive space lucrative compared to active funds?
Debt liabilities are inherently very transparent. What this circular does is it brings a lot of regulation and risk mitigation into the passive debt space. Now there are limits on sector allocation at 25%, exposure level at group level at 25%, limit at issuer level like AAA, AA, etc. All of these standards will mitigate risk in passive debt funds. The kind of passive debt funds we now see as Bharat Bond. It is a pure passive AAA corporate bond fund. There nothing changes. However, with the space expanding over time, there was a need for some checks in the wallets. If fund companies want to launch a passive AA fund, there is a lot of clarity and set rules for such schemes now.

There is another regulation regarding the tracking difference which has been set at a tolerance level of 1.25%. So on the one hand there is leeway on how the index fund or ETF wants to track the index, it doesn’t have to go haywire. It should remain in line with the performance of the index. There are other deviation band regulations that also encourage more research by the fund house rather than having an overall band of 1 or 2%. Thus, vis-à-vis active funds, these schemes have an advantage in terms of costs and also a clear visibility on the portfolio.

I think the most exciting decision that came in this circular was the authorization of passive ELSS, but it comes with a caveat. Do you see any fund houses joining the party soon or missing it because almost every fund house already has an active ELSS.

The caveat comes from a government advisory that imposes a limit of one ELSS per AMC. This regulation needs to be changed. Other than that, I think given the choice, AMC will launch another passive ELSS. But that won’t be possible at the moment. However, for new market players, it is possible to choose between a passive or active offer with their ELSS offer. There is definitely a demand for passive ELSS because we are getting feedback from our investors that there should be a passive ELSS as well. This was a long-standing industry request.

Do you think a passive ELSS will be a good product for investors in a market like ours?
Yes definitely. I think it is a very good product. We need to understand that investors’ needs are varied and it doesn’t always come down to cost. Many investors want to invest in ELSS to save taxes but they don’t want to choose between funds. Which to buy? How to follow? Investors who want to keep it simple for the long term can totally opt for a passive ELSS.

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