Sebi issues swing pricing mechanism to protect debt mutual fund investors

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The market watchdog, Sebi, on 19 July 2021, proposed a swing pricing mechanism for the open-ended mutual fund debt schemes. On 29 September, Sebi decided to implement a swing pricing mechanism for open-ended debt mutual fund schemes (excluding overnight and gilt-term funds) to help investors better manage risk.

Further, the only scenarios involving net outflows from the schemes will be covered by the swing pricing mechanism. For high-risk open-ended loan schemes, the structure will be a hybrid one that allows for both 1) a partial swing and 2) a mandated full swing during market dislocation times for high-risk open-ended debt schemes.

Understanding swing price

There are various costs that fund houses incur while buying or selling securities for a mutual fund scheme. This includes brokerage, taxes, additional costs by way of wide spreads in market quotes, etc.

These elements of cost become more prominent during times of market dislocation. There may be significant investments or redemptions from funds in response to several events and developments, which leads to market dislocation.

Big investments and redemptions almost always adversely affect the investors who continue to stay invested. If there is a significant exit from a scheme and the fund manager has to sell off a huge quantum of securities at an adverse price, in the absence of swing pricing, the cost of the redemption is borne by the investors who continue to hold the units in that scheme believes experts.

“The Swing price feature is quite common in the developed markets and has been introduced in the Indian MF space. The swing price feature aims to protect the existing investors from the impact cost incurred by the scheme due to large exits from the fund, at times of market disruptions,” said Sandeep Balga, CEO, TRUST Mutual Fund.

Understanding pricing for a normal swing

-To determine thresholds for triggering swing pricing, AMFI will provide broad parameters that AMCs must follow. AMFI will also give the industry an idea of what a reasonable swing threshold is for normal times.

In addition, AMC may be permitted to include other factors depending on the form and characteristics of the mutual fund scheme.

-AMCs will determine swing pricing and the quantity of the swing factor for normal times depending on scheme-specific issues.

-The AMC will make all of the above information available in its Scheme Information Document (SID).

Understanding swing pricing for market dislocation

-AMFI shall provide a set of guidelines/parameters/model for Sebi to recommend to determine market dislocation. Depending on the suggestion from AMFI, Sebi will evaluate “market dislocation.” The Sebi will notify investors that swing pricing would be in effect for a set period after a market dislocation is declared.

-The swing pricing structure will only be mandated for open-ended debt schemes (excluding overnight funds, Gilt funds, and Gilt with 10-year maturity funds) following the declaration of market dislocation.

How will it benefit investors?

Swing pricing is a tool used to protect the long-term investors in debt schemes and to see that they are not adversely impacted during big-ticket redemptions, typically by large investors.

For instance, when debt funds experience significant outflows, fund managers are pushed to sell the highest quality and most liquid paper to meet redemption pressure.

As a result, existing investors are saddled with substandard paper that is difficult to sell because the country’s secondary bond market is not as liquid as the equity market and can only absorb a limited amount of paper on any one day.

Swing pricing enables the adjustment of a fund’s net asset value (NAV) in order to effectively pass on transaction expenses associated with flows into or out of the fund to the investors associated with that activity.

That said, swing price is not intended to reduce the costs in any way but is singularly targeted at bulk investments and exits which may entail higher costs, and those who are entering or exiting at that time actually pay the costs.

“It is a good measure which protects investors from short term market volatility and encourages long term investments. The swing factor could be applied by individual Fund Houses at their discretion or mandated by SEBI for specific periods of time. Adequate disclosures will be made to investors for effective and proper communication as well,” said Balga. This framework by Sebi will be applicable with effect from March 1, 2022.