Despite hailing SEBI‘s proposal to restructure the equity indices linked to derivatives contracts to prevent market manipulation as a significant move, industry experts on Tuesday said it should have been done long ago.
“While this regulatory response is significant, one may argue that such a framework should have been introduced earlier, as it might have shielded the markets from vulnerabilities that came to light in the Jane Street case,” said Aditya Bhansali, founding partner, Mindspright Legal.
SEBI had accused US-based trader Jane Street of deliberately influencing the bank index, and banned it from trading activities.
Reducing dominance in indices
The phased approach to restructuring, proposed on Monday, aims to strengthen market integrity by making the indices less prone to manipulations.
“It’s a welcome measure from SEBI. Getting the balance right in a index having firms with huge market capitalisation is not an issue just in India, it is a global concern for regulators,” said Pranav Haridasan, MD and CEO, Axis Securities.
SEBI wants to reduce the dominance of a few stocks in an index. When a small number of stocks carry high weightage, it becomes easier for traders to influence the price movement of the entire index by targeting those constituents.
For example, in Bank Nifty, HDFC Bank and ICICI Bank together account for over 55% of the index (29.09% and 26.47%, respectively). Such a level of concentration means movements in these two stocks can swing the whole index, thereby creating opportunities for index-level manipulations.
“This step shall strengthen the structural resilience of the indices against risks. This is a good move by SEBI. The timing of the measure is closely linked to the Jane Street episode, where concerns were raised about possible manipulations,” said Bhansali.
SEBI made the proposal initially to restructure the National Stock Exchange’s Nifty Bank and BSE’s Bankex. The Bank Nifty comprises 12 stocks. SEBI has suggested increasing it to at least 14 to promote diversification and resilience. It has also suggested that weightage of the top constituents can’t be more than 20% each and the total weight of top three constituents cannot be more than 45%.
Practical challenges in implementation
There are practical difficulties in implementing this as two additional constituents will make a miniscule difference in weightages of the index dominated by the top three banks, said brokers. After the May circular on this, the NSE informed SEBI that market participants suggested restructuring existing indices to ensure there is no disruption in linked derivative contracts.
Mutual funds and industry bodies prefer restructuring existing indices to new launches, given the importance of liquidity, brand retention and investor clarity. For indices with major ETF assets under management, SEBI is considering a four-phase implementation over four months. The proposals are open for public responses for now.