Earlier this week, market regulator SEBI issued a consultation paper on swing pricing. This is a mechanism it wants mutual funds to adopt for their debt funds. The idea is to ensure that the opportunistic actions of a few large and privileged investors don’t impact the remaining unitholders. This move may be seen in the backdrop of last year’s Franklin Templeton India episode. A few senior employees withdrew their own money from the six wound-up debt schemes barely a month or weeks before they were eventually wound-up.
Also read: Explained: The full impact of SEBI’s Franklin Templeton order on investors and the MF industry
What is swing pricing?
Typically, when large opportunistic money flows in or out of a scheme, it does so at the NAV (net asset value). That sounds fair on the face of it. The bad news is that this could adversely impact other existing small investors. To protect their interests, swing pricing is proposed during extreme liquidity crunch periods. It’s like a manual adjustment made to the NAV. The objective here is to pass on any additional transaction costs arising from large inflow or outflow to large opportunistic players. The swing pricing is both a deterrent for such investors and a protection to ensure that existing investors don’t get impacted by such transactions.
How does it work?
Say, a scheme’s NAV is Rs 20. A few large institutional or even individual investors may have access to information that they could act upon and either withdraw in large chunks or invest large amounts. Such large, sudden and untimely inflows or outflows into a mutual fund scheme, triggered by large investors can cause a scheme to sell its most liquid securities. What may remain behind in the portfolio could be irrelevant or illiquid securities that could harm those investors who choose to stay behind. In such a scenario, the mutual fund may decide to impose swing pricing. So, the redeeming investors will not be able to transact at the NAV and will have to withdraw at, say, 2 percent below the current NAV.
How does it benefit investors?
If large transactions still go through, the fund house would be able to pass on costs of the sudden flows to the investor responsible rather than to existing investors.
According to R Sivakumar, Head – Fixed Income, Axis Asset Management Company Limited, “It protects the existing investors in a debt scheme in case there are large flows which can potentially disrupt the portfolio. The idea of swing pricing is to shift the cost of such transactions to the redeeming investors rather than existing investors.”
What are the challenges?
The proposal is well-intentioned, but difficult to implement.
First, who would trigger swing pricing? The proposal defines two situations: a) a market dislocation triggering a mandatory swing pricing across fund houses as directed by SEBI; and b) a situation where individual asset managers could face liquidity constraints in their schemes and will have the discretion to use the provisions of swing pricing.
A senior debt fund manager says, “It’s unclear how a swing pricing trigger will be communicated on a timely basis. This is the key to effective implementation on a day of market stress.”
Imagine the Franklin Templeton episode happening again. If left to the fund house, will it have the incentive to redeem units at a lower NAV, if say its senior employees make a rush for the exit gate?
Also, that triggered a more gradual but certain redemption across the credit funds category. At what point does one recognise this as a market dislocation or a market disruption at all, for swing pricing to be triggered? Who defines market disruption in such a scenario?
Or, imagine a situation like what we witnessed in July 2013, when bond market prices crashed owing to the Reserve Bank of India’s (RBI) sudden tightening. It led to a rush of redemptions. The question is: at what point would the market regulator declare the situation as a market dislocation and how will the swing price get communicated to relevant investors before the redemptions come in?
Second, the range of swing pricing suggested at around 1-2 percent is also debatable. In some cases, when the yields are low (and bond prices are high), this can have a big impact. SEBI’s paper suggests that fund houses may have the discretion to decide the boundaries of swing NAVs. However, this could create inequity across asset managers depending on the size of their debt funds.
Third, SEBI appears to have left it for fund houses to decide the criteria. A variety of conditions across fund houses in such an important matter can create confusion. Perhaps, the Association of Mutual Funds of India (AMFI) may get together at a later stage to formulate a commonly-acceptable policy towards swing pricing.
The good news is, there is a chance that a universally applicable and acceptable clear swing pricing policy spelt out by an asset manager may act as a deterrent for large investors. They would realise that their transaction will impact the daily price and, consequently, act as a disincentive to go ahead with the sale of units.
It’s a move in the right direction, with bumps on the way that need to be flattened out.