Index Makers and SEBI [USPC Current Affairs]

 With the recent USA based Hindenburg Research group report on the Adani group, and its volatile effect on the market, the global index providers like MSCI are reviewing some of these stocks’ inclusion in its indices that are replicated by many foreign portfolio managers. This is an important topic for the IAS exam.

Why do indices matter?

• With many stocks traded in stock markets around the world and their prices fluctuating, most observers assess a market’s general trajectory volatility by looking at broader benchmark indices.
• Example: The Sensex is made up of 30 largest and most actively traded stocks on the Bombay Stock Exchange.
• The market indices movements serve as the measure of the confidence levels in the economy. Investors, individual or institutional, use them to evaluate performance, predict future growth, and make investment choices. 
• Mutual funds and portfolio managers use the trajectory to propose their pitch before prospective investors.
• For retail investors, it gives some idea in making investment choices.

How popular are such funds in India?

• While index funds and exchange-traded funds (ETFs) have been an option for Indian investors for about two decades, they have shown very high growth in assets since 2015. So these funds have become very popular in India.

How are indices made and what do providers do?

• Indices could be created on the basis of different categories as industry sectors, size of companies etc. 
• It can also include quantitative parameters such as liquidity, trading volumes etc. the weightage assigned to each stock in an index can depend on the market capitalization or other parameter that index providers want. 
• For example, NSE Indices owns and manages over 350 indices. It includes 117 ETFs listed in India and 12 ETFs listed abroad.
• Each index is based on a methodology and reviewed periodically. It also follows a methodology to add or drop stocks based on periodic trading data and other defined parameters.
• The indices of MSCI and other global providers are used by international fund managers to earmark assets to stocks in various markets. But, they are not regulated by the Securities Exchange Board of India (SEBI).

SEBI proposal:

• With increasing dominance of index providers and their importance in stock market and economy, SEBI has proposed to bring them under its regulatory purview. 
• They do follow “an element of transparency” in their functioning, but  SEBI believes it is possible for index makers “to exercise discretion through changes in methodology resulting in exclusion or inclusion of a stock in the index or change in the weights of the constituent stocks”. 
• With their decision, the volumes, liquidity and prices of stock are impacted. It also impacts index funds’ returns to investors. 
• This could raise possibilities of conflict of interest arising in the governance and administration of indices. So, an accountability mechanism is proposed by SEBI.
• The plan by SEBI includes, mandated registration for index providers, eligibility criterion, compliance, disclosures and periodic audits. 
• There are also provisions of penal action for non-compliance and incorrect disclosures etc.

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