Swing pricing will be applied for both normal times and market dislocation on redemption of over `2 lakh for each mutual fund scheme
In order to discourage large redemptions from open-ended debt mutual funds, the markets regulator has now issued rules for swing pricing mechanism. It will prevent large investors from exiting a fund during market panic and prevent collapse in the scheme’s net asset value (NAV). However, overnight funds, gilt funds and gilt with 10-year maturity funds are exempt from the swing pricing mechanism.
To begin with, the swing pricing framework will be applicable only for scenarios related to net outflows from the schemes and will be a hybrid framework with a partial swing during normal times and a mandatory full swing during market dislocation times for high-risk open ended debt schemes. Swing pricing will be applicable to all unitholders for redemptions over Rs 2 lakh for each mutual fund scheme and for both normal times and market dislocation. The swing pricing mechanism will come into effect from March 1, 2022.
Swing pricing mechanism
In case of market dislocation, the swing pricing will be mandated for high-risk, open-ended debt schemes that carry high risk securities. The swing factor will range between 1 to 2%. The fund houses will have to classify the schemes in A-III, B-II, B-III, C-I, C-II and C-III of Potential Risk Class (PRC) matrix.
All the schemes that fall in C – III category, which have the maximum credit and duration risks, will have a swing factor of 2%. Which means, in times of distress investors redeeming their units will have to take 2% lower net asset value. Similarly, A-III, which have the minimum credit and duration risks will carry a swing factor of 1%.
For normal times, the Association of Mutual Funds in India will prescribe the broad parameters for determining the thresholds for triggering of swing pricing. It will also prescribe an indicative range of swing threshold. Additionally, the asset management companies can set up their own parameters considering the nature and characteristics of the mutual fund scheme.
The Securities and Exchange Board of India’s (Sebi) circular underlines that the swing pricing will be applicable for both the incoming and outgoing investors and they will get the NAV adjusted for swing factor. All the fund houses will have to make clear disclosures along with illustrations in the scheme information documents, including information on how the swing pricing framework will work, under which circumstances it will be triggered and the effect on the NAV for incoming and outgoing investors.
The swing pricing mechanism will reduce risk of run on the fund, as in case of large outflows in debt funds fund managers have to sell high quality and most liquid paper to pay for the redemption. Existing investors are saddled with low quality paper and the secondary bond market is not very liquid. Swing pricing is followed in most developed markets such as the US and the UK.
Experts say once the swing pricing mechanism comes into effect, it will impose a certain cost on investors who are redeeming as they are contributing to a downward spiral in the NAV. On the other hand, it will incentivise those who are buying units as they are helping to stem the downward spiral in the NAV.