The National Stock Exchange (NSE) says, "a stock market index is a measure of the relative value of a group of stocks in numerical terms. As the stocks within an index change value, the index value changes. An index is important to measure the performance of investments against a relevant market index."1
Stock Market Indices are maintained by Index Provider(s) (IP). The most popular Indian stock market indices are Nifty and Sensex. These are provided respectively by NSE Indices Limited and the Asia Index Private Limited, a 50-50 partnership between Bombay Stock Exchange and S&P Dow Jones Indices. A few other global IPs are also active in India.
Nifty 50 and the Sensex, which are the equity market indices serve as benchmarks or market performance indicators and the investors rely on these indices for making their decisions. Unfortunately, there are no extant laws regulating the indice provider and the indice providing business as on date.
Currently IPs are not regulated in India. IP's are neither (a) 'intermediaries' as defined in the SEBI (Intermediaries) Regulations, 2008 nor, (b) 'market participants' as defined in the SEBI (Central Database of Market Participants) Regulations, 2003 nor (c) investment advisors as defined under SEBI (Investment Advisers) Regulations, 2013.
SEBI has been intending to regulate the conduct and functioning of the IPs since some time now. To this effect, a discussion paper on 'code of conduct of IP's' inviting comments from the public and the stakeholders was released on 31 May 2017 (Discussion Paper). Recently on 8 December 2020, SEBI released another paper on 'the compliance standards for IP's' (Consultation Paper) inviting comments from the public and stakeholders.
Both the Discussion Paper and Consultation Paper are pursuant to the International Organization of Securities Commissions (IOSCO) report of July 2013, which has proposed a framework of standards, based on international best practices, for financial benchmarks (or indices) to promote reliability and independence of benchmarks, administration, governance, quality, transparency and accountability.
The Discussion Paper provided for a code of conduct for IP's recommending additional disclosures and substantial transparency while adding or removing a stock from the indices and made following key suggestions:
- an IP is required to have appropriate governance arrangements in place for protecting the integrity of the process pertaining to index administration, resolving conflicts of interest, and differentiate those who are responsible for governance of index from those responsible for commercialising the indices. Such segregation to be done by introducing adequate firewalls and engaging separate reporting lines for each function.
- IP to have an oversight function on all aspects of the administration process relating to index. The said function should be distinct from the usual and direct day-to-day process of calculation of index and its maintenance. The said function should be distinct and separate from the actual index calculation process as well. Additionally, oversight function should check for any need for change in the design of the index or methodology for computation pursuant to changes in market dynamics or any other reason; and overseeing results obtained through audits and implementing the remedial actions recommended by the said audits.
- The methodology documents used in calculation of index should be made publicly available by IP to allow the understanding on how index intends to measure the interest and the process of calculation and maintenance of indices. The IP should also obtain market feedback as may be required for making important changes to the methodology.
- IP should not part away from the audit trails and written records for five years.
- IP should submit a monthly / quarterly report to SEBI providing details on its compliance with the prescribed code of conduct.
- IP upon signing agreements for licensing indices in foreign jurisdiction should inform SEBI immediately. Apart from the above, the IP shall be required to inform SEBI prior to launching any product outside India.
- IP to ensure that the foreign jurisdiction wherein it intends to obtain new license of Indian Indices should be a member of the Financial Action Task Force (FATF).
Apart from the above, the proposed measures intended to address issues like (a) avoiding conflict of interest, (b) introducing a water-tight audit mechanism and (c) implementing a whistle-blower framework to ensure awareness of potential misconduct.
The recent Consultation Paper proposes increased index reliability and efficiency of representation of an index through compliance with the financial benchmark principles of IOSCO. It also sets out the methodologies adopted by different indices across the globe in arriving/calculating the frequency of reviewing stocks. The Consultation Paper proposes to provide for compliance standards for IPs in India.
The Consultation Paper provides for the following key proposals:
- IP should comply with 'Principles for Financial Benchmarks' set out by IOSCO, both on initial and continuous basis.
- IP should immediately intimate the relevant stock exchange or the asset management company if case of any change in the status of it complying with the principles of IOSCO.
- Stock exchange to check and evaluate if any product including derivatives pursuant to such indices, available in a foreign jurisdiction hampers trading of a similar product in the Indian market. Accordingly, if the exchange is of the view that "such product available in a foreign jurisdiction hampers trading of a similar product in India, they shall terminate the existing agreement with such index provider."
- In the event relevant stock exchange intends to continue with their existing data sharing agreement or intends to enters into a fresh agreement, post notification of the said standards, SEBI has proposed that subject to fulfilment of certain conditions, the IP will be allowed to licence the indices. Such conditions include the members governed by the jurisdiction of FATF. Such members to have signed a MoU with the SEBI agreeing to share and exchange information.
- IP should annually confirm to the relevant stock exchange(s) the status of it complying with the above-mentioned conditions. Such information to be published on the relevant stock exchange's website.
- As a relaxation, SEBI has stated that subject to prior written permission of the relevant Indian stock exchange, the said conditions will not be applicable on the issuance of any Exchange Traded Fund (ETF) or similar products on an index by any entity.
An IP, apart from publishing the indices on public domain, also provides index services to various private entities through private arrangements. Further, such private arrangements for providing index related services may attract relevant provisions of the SEBI (Investment Advisers) Regulations, 2013 wherein such IPs may be categorised as an investment adviser (IA). However, it is not clear whether private arrangements for index providing will fall within the ambit of investment advisory services.
SEBI has invited comments on the Consultation Paper till 7 January 2021. This Consultation Paper has come in time when globally questions have been raised on the power and influence exercised by these IP on the investing community. Questions have also been raised on the outsourcing decision in respect of index funds. The paper titled "Steering capital: the growing private authority of IP in the age of passive asset management" published by Johannes Petry, Jan Fichtner and Eelke Heemskerk at the universities of Warwick and Amsterdam2 refers to the growing experiment of self-indexing within investment groups for making their own benchmarks for cost utilisation.
The need of the hour clearly is a robust regulation for index related services.
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