What does Swing Pricing for debt funds really mean?

In the last week of September, SEBI announced that Swing Pricing norms would be applicable to debt funds from March 2022.

Oct 07, 2021 09:10 IST India Infoline News Service

SEBI had first put out the consultative paper on Swing Pricing for debt funds back in July this year. In the last week of September, SEBI announced that Swing Pricing norms would be applicable to debt funds from March 2022. What exactly is swing pricing in the case of debt funds, what role does it play and why it is a move that was long called for.

Here is a quick look at the idea behind swing trading.

What exactly is meant by Swing Pricing?

Let us understand swing pricing with an example. If a debt fund has an AUM of Rs150cr, and if one large institutional investor wants to redeem Rs12cr in a single day, it is significant. If the fund is invested in liquid G-Secs it may not be much of a problem. However, if it is invested in less liquid bonds then there may be a fire-sale at lower prices. The problem is that this cost will be borne by the investors who stay back in the scheme.

To avoid this, the swing pricing mechanism will apply and the redemption NAV will be reduced proportionately. The idea is that the cost of redemption like brokerage, commissions and liquidity costs are borne by the redeemer and not by the investor who stays back in the fund.

Will the swing pricing be applicable to all debt funds?

The swing pricing formula will be applicable to all open-ended debt funds, with the exception of 3 categories of funds which are excluded from swing pricing.
  • Overnight Funds
  • Gilt Funds
  • Gilt (with 10-year maturity) funds
Apart from these 3 categories of debt funds, swing pricing mechanism will be applicable to all other categories of debt funds. This will include conservative hybrid funds, although closed-ended debt funds will be excluded.

Will swing pricing apply to debt funds at all times?

The framework for applicability of swing pricing for debt funds will be worked out by AMFI in consultation with the mutual fund AMCs. Broadly there will be two situations in which the swing pricing will apply.
  • There will be a partial swing applicable during normal times, which funds can define to protect the interests of long term investors. This is at AMC discretion.
  • Mandatory full swing pricing, which would be only applicable in the case of market dislocation or extreme volatility in the markets.
It must be noted that market dislocation can occur due to volatility in bond markets, major defaults by issuers or spike in interest rates. Such swings will impact in various forms. To begin with, the criteria for applicability of extreme swing pricing will be heavy outflows from debt funds.
The definition will be expanded subsequently.

Who will decide if special swing pricing has to be applied or not?

AMFI will create the framework for determining special situations that qualify for full swing pricing. Once the parameters are met, funds can declare swing pricing with SEBI approval. Risk, for the purpose of swing pricing, will be based on Macaulay Duration (MD). Here are 3 situations and the interplay of MD and credit risk.
  • If MD is less than 1 year, swing pricing is mandatory only if the credit risk score is less than 10
  • If MD is less than or equal to 3 years, swing pricing is mandatory only if the credit risk score is less than 12
  • If the MD is more than 3 years, then the swing pricing is applicable irrespective of the credit risk score.
The above conditions will only be applicable in the case of open-ended debt funds.

Once swing pricing is triggered, will it be applicable to all redemptions?

Swing pricing is meant to protect the interests of retail investors. Hence, swing pricing will not be applicable if redemption value is less than Rs200,000. However, if redemption is more than Rs200,000 then redemption NAV will be reduced as per swing pricing formula. This limit of Rs200,000 is based on your individual PAN, so you really cannot split your redemptions beyond a point.

Will the swing pricing be applicable only to redemptions of debt funds or also to purchases?

Both present a risk, so swing pricing will apply to sale and purchases once the dislocation is identified and recognized. When there is dislocation, the large knowledgeable investors tend to trade out of funds before the NAV correction and trade into the funds at low NAVs. Both can cause losses to continuing long-term investors.

In case of redemptions during dislocation, NAV will be reduced proportionately for swing costs. Similarly, for fresh purchases during dislocation, NAV will be adjusted upwards so that the entering investors at low NAVs pay the price of dislocation instead of existing investors.

Will the swing pricing not impact the performance of the debt fund I am holding?

Swing pricing will not impact the performance of the fund if you are a continuing investor. That is because, fund performance will be calculated based on unswung NAV performance.

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