Understanding the Importance of Indices

• Due to the vast number of stocks traded on global stock markets and their ever-changing prices, market watchers often gauge a market's overall direction and volatility by referencing broader benchmark indices.
• To illustrate, the Dow Jones Industrial Average is composed of 30 of the largest and most actively traded stocks on the New York Stock Exchange.
• The fluctuations in market indices serve as a barometer for confidence levels in the economy. Investors, whether individual or institutional, use these indices to assess performance, predict future growth, and make investment decisions.
• Mutual funds and portfolio managers employ these indices to frame their proposals to potential investors.
• For retail investors, these indices provide helpful insights for making investment decisions.

Popularity of Index Funds in India

• Although index funds and exchange-traded funds (ETFs) have been available to Indian investors for nearly two decades, they have seen a significant surge in assets since 2015. Hence, these funds have gained immense popularity in India.

Creating Indices and the Role of Providers

• Indices can be created based on various criteria such as industry sectors, company size, and so on.
• They can also incorporate quantitative parameters like liquidity, trading volumes etc. The weightage assigned to each stock in an index may depend on the market capitalization or any other parameter that index providers deem significant.
• For instance, FTSE Russell maintains and manages over 300,000 indices. It includes numerous ETFs listed both in the UK and abroad.
• Each index is based on a specific methodology and is reviewed periodically. It also follows a procedure to add or remove stocks based on periodic trading data and other defined parameters.
• While the indices of MSCI and other global providers are used by international fund managers to allocate assets to stocks in various markets, they are not regulated by the Securities Exchange Board of India (SEBI).

SEBI's Proposal for Index Providers

• Given the increasing influence of index providers and their importance in the stock market and economy, SEBI has proposed to bring them under its regulatory jurisdiction.
• While these providers do adhere to a certain level of transparency in their operations, SEBI argues that it's possible for index makers to exercise discretion through changes in methodology, leading to the exclusion or inclusion of a stock in the index or changes in the weights of the constituent stocks.
• Such decisions can affect the volumes, liquidity, and prices of stocks. It can also impact the returns of index funds to investors.
• This could potentially result in conflicts of interest in the governance and administration of indices. Hence, SEBI has proposed an accountability mechanism.
• SEBI's plan includes mandatory registration for index providers, eligibility criteria, compliance requirements, disclosures, and periodic audits.
• There are also provisions for penal action for non-compliance and incorrect disclosures.