Mutual funds: New swing pricing standards for debt funds

In order to discourage large buyouts of open-ended debt mutual funds, the market regulator has now published rules for the swing pricing mechanism. This will prevent large investors from exiting a fund in the event of a market panic and will prevent the collapse of the net asset value (NAV) of the plan. However, overnight funds, gilt funds and gilt funds with a maturity of 10 years are exempt from the swing pricing mechanism.

To begin with, the swing pricing framework will only apply to scenarios related to net exits from the devices and will be a hybrid framework with a partial swing in normal times and a full swing mandatory in times of market dislocation for open debt. at high risk. diets. The swing pricing will be applicable to all unitholders for redemptions above Rs 2 lakh for each mutual fund system and for normal periods and market disruptions. The swing pricing mechanism will come into effect on March 1, 2022.

Swing pricing mechanism
In the event of a market dislocation, swing pricing will be mandatory for high-risk, open-ended debt programs that carry high-risk securities. The swing factor will be between 1 and 2%. Fund houses will have to classify the schemes in the A-III, B-II, B-III, CI, C-II and C-III matrix of the Potential Risk Class (PRC).

All plans belonging to category C – III, which present the maximum credit and duration risks, will have a swing factor of 2%. This means that in times of distress, investors who redeem their units will have to take a lower net asset value of 2%. Likewise, A-IIIs, which present minimum credit and duration risks, will have a swing factor of 1%.

Normally, the Association of Mutual Funds in India will prescribe the general parameters for determining the thresholds for triggering swing pricing. It will also prescribe an indicative oscillation threshold range. In addition, management companies can define their own parameters according to the nature and characteristics of the mutual fund.

Protect investors
The circular from the Securities and Exchange Board of India (Sebi) points out that swing pricing will be applicable to both incoming and outgoing investors and that they will get the net asset value adjusted for the swing factor. All fund houses will need to make clear disclosures as well as illustrations in the system’s disclosure documents, including information on how the swing pricing framework works, under what circumstances it will be triggered and the effect on net asset value. for inbound and outbound investors.

The swing pricing mechanism will reduce the risk of a fund run, because in the event of large debt fund outflows, fund managers have to sell high quality and most liquid paper to pay for the redemption. Existing investors are grappling with shoddy paper and the secondary bond market is not very liquid. Swing pricing is followed in most developed markets such as the United States and the United Kingdom.

Experts say that once the swing pricing mechanism kicks in, it will impose a certain cost on redeeming investors as they contribute to a downward spiral in net asset value. On the other hand, it will encourage those who buy shares as they help stem the downward spiral in net asset value.