Demystifying the Index and Its Need for Regulation

• An index serves as a mirror to the market, providing stakeholders with a comprehensive overview in an instant.
• Prime examples of significant indexes in India are the benchmark indices BSE Sensex and NSE Nifty.
• Regulation becomes indispensable to safeguard investor interests, considering that the scale of market investment via passive mutual fund schemes is governed by these index providers.
• Concerns have been raised about the safety of savings held by passive investors in funds linked to indices that have included or retained numerous high-risk stocks.

Decoding the Role of an Index Provider

• Index providers are entities that formulate and compute indexes.
• They shoulder the responsibility of setting the criteria that dictate which securities are included in each index, how the index is managed, and how securities will be added or removed from the index over time.

The Existing Regulatory Landscape for Index Providers:

• Presently, mutual funds and insurance companies utilize index services provided by exchange platforms and rating agencies to monitor performance and offer ETFs and index funds.
• As it stands, SEBI does not exercise control over index providers. However, in 2017, SEBI introduced a code of conduct for these entities.

Exploring SEBI's Proposed Regulatory Framework for Index Providers

• SEBI, in its draft regulatory framework released in December 2022, expressed concerns regarding possible conflicts of interest in the governance of index providers.
• These entities have the power to modify the methodology, leading to the inclusion or exclusion of a stock from the index or altering the weights assigned to the constituent stocks.
• SEBI posits that their decisions can influence the availability, price, and volume of such stocks, and consequently, the returns that investors derive from index funds.

International Regulations: A Comparative Analysis

• The EU Benchmark Regulation of 2016 stands as one of the pioneering regulations aimed at governing the operations of index providers.
• Countries like the UK, Australia, Singapore, Japan, and Korea have also enacted laws to oversee the benchmark-setting process.

In Conclusion: SEBI has underscored the need for enhanced regulation of presently unregulated index providers. It may initiate dialogues with index providers and motivate them to voluntarily adopt best practices by offering incentives such as a reduction in annual fees or easing procedural requirements.