Impact of the new norm for passive debt funds on investors

SEBI has created a new structure for debt funds that are passively managed. In this post, we'll look at how it affects investors. So, keep an eye out!

On May 23, 2022, the Securities and Exchange Board of India (SEBI) issued a circular on the creation of passive funds. SEBI has issued a new standard for passively managed Debt Funds in this circular. In this post, we will look at these standards and their implications for investors. The revised standard will go into effect on July 1, 2022.

Debt ETFs or index funds, according to SEBI, might be composed of indices consisting of corporate debt securities or government securities, treasury bills, State Development Loans (SDL), or a mix of corporate debt securities and government securities, treasury bills, and SDL.

Single Issuer or Group Limit

I.          The single issuer limit for an index including at least 80 per cent corporate debt instruments should be as follows:

1. In the case of AAA-rated securities, no one issuer shall have more than 15 per cent weight in the index.

1. For AA-rated securities, no one issuer shall have more than 12.5 per cent weight in the index.

1. A single issuer should not have more than 10 per cent weight in the index for A and lower graded securities.

II.       For a hybrid index (comprising both corporate debt securities and government securities/SDL) with a corporate debt securities weight of up to 80 per cent,

1. In the case of AAA-rated securities, no one issuer shall have more than 10 per cent weight in the index. However, the aforementioned limit must be 15 per cent for AAA-rated securities issued by PSUs and 15 per cent for AAA-rated securities issued by PFIs.

1. For AA-rated securities, no one issuer shall have more than 8 per cent weight in the index.

1. In the case of A and below-rated securities, no one issuer shall have more than a 6 per cent weight in the index.

III.     The single issuer limit must not apply to an index based on government securities and SDL.

IV.    The index may not contain more than 25 per cent of its weight in any one category (excluding securities issued by Public Sector Units (PSU), Public Financial Institutions (PFI), and Public Sector Banks (PSB)).

V.       No sector shall account for more than 25 per cent of the index's weight (excluding government securities, treasury bills, SDL and AAA-rated securities issued by PSU, PFI and PSB). This clause, however, does not apply to sectoral or thematic debt indices.

Market Making

AMC should select at least two Market Makers who are Stock Exchange members for ETFs in order to provide continuous liquidity on the stock exchange platform.

Market Makers must only deal with Asset Management Companies (AMC) in multiples of the amount of the creation unit. On a best-effort basis, AMCs should support Market Makers' in-kind creation and redemption of units of ETFs (including Debt ETFs).

Exit Load

To improve liquidity in ETF units on the stock exchange platform, it has been determined that direct transactions with AMCs would be made available to investors only for transactions above a certain level. To begin, any order placed directly with the AMC for redemption or subscription must be higher than Rs 25 Crore. The aforementioned threshold shall not apply to Market Makers and shall be evaluated on a regular basis.

Impact on investors

These new standards are significant from the standpoint of investors since they will, first and foremost, offer some uniformity to debt ETFs or indices. Furthermore, these standards will provide enough liquidity and will aid in preventing concentration on a single issuer or group, hence lowering risk. As a result, this is a positive step by SEBI.