For deals worth more than Rs 25 crore, AMCs can now create units directly

13 Jun 2022 , 11:14 AM

An enabling regulatory environment may help an industry expand and survive in the long run by empowering it. The Securities and Exchange Board of India (SEBI) recently issued a host of new laws that have given the passive fund sector a boost and might help it grow even faster. 

The total assets under management (AUM) of passive schemes, which include exchange-traded funds (ETFs) and index funds, is Rs 5.27 trillion at the moment. This equates to around 15% of the mutual fund industry’s total assets under management (AUM), emphasizing the untapped potential.

SEBI is creating a passive fund ecosystem that supports key structural and macroeconomic reforms, with an emphasis on enhancing liquidity and protecting investors, through the circular titled ‘Development of Passive Funds.’ Let’s take a closer look at the many ramifications and effects of the much-needed circular.

Fixed-income passives are on the rise

Investors currently prefer ETFs, and a month-over-month review of index fund data shows that debt accounts for a significant portion of the traffic. As a result, debt is a rapidly developing asset class, with the debt ETF and index fund market now exceeding Rs 80,000 crore in volume. 

SEBI’s circular, which tightens restrictions on asset management firms (AMCs) while also increasing investor demand and overall liquidity, is a crucial and critical enabler for the category as a massive business with immense underlying potential.

The first section of the circular divides debt ETFs into three categories: ETFs that trade only corporate bonds, index funds that trade only government securities, and a hybrid ETF category that trades both corporate debt and G-Secs. The categorization is intended to provide clear boundaries for each of the groups.

Second, the circular explains new debt ETF and index fund rules, stating that SEBI has required graded single-issuer restrictions based on credit rating, such as 15% for AAA-rated papers. This change is likely to require debt index funds to have group-level exposure restrictions, as well as distinct replication criteria for the three categories of debt passive funds.

ETF liquidity is expected to increase

For investors weighing their alternatives, asset class liquidity is an important statistic to consider. High-liquidity assets are easy to sell, making them preferable to assets that may lock up investors’ capital for a longer period of time. The circular ordered procedures to increase ETF liquidity in an attempt to pique investor interest while also enhancing the market’s overall potential. 

As a result, AMCs will be required to select at least two market makers in order to assure ongoing liquidity, as well as create incentive schemes for these organizations. The circular also encourages market maker involvement by introducing a new market-making settling mechanism that balances inflows and so improves liquidity.

Furthermore, AMCs can now create units immediately for transactions worth more than Rs 25 crore. As a result, some transactions will be forced onto exchanges, increasing both demand and supply and providing a powerful structural play for expanded investor engagement and exchange liquidity.