Stock Exchange Index Management Requires Urgent SEBI Intervention

The market regulator normally doesn't interfere with the working of the stock exchanges, especially index management, as long as a defined framework is followed for reconstitution. But recent flip-flops and midway changes in the case of Jio Financial Services Ltd. raises questions about the functioning of index committees that recommend these changes.

To be sure, for a long time, questions have been raised on the rationale behind inclusion of any stock in the index, how it seems arbitrary at times and why some stocks aren't included despite being eligible. There have also been murmurs of external influence, whether regulatory or non-regulatory. While that may be tough to prove, there is surely lack of data disclosure to justify inclusion and exclusion in an index.

It's not just that the country’s two stock exchanges do not follow the same method for index changes, they also don’t have a reason to justify the framework implemented.

Look at what is happening with Jio Financial Services that listed on Aug. 21. Both the exchanges followed a similar path, maintaining that the stock will stay in the index and will be removed after three days if the shares didn't hit the price band for two successive days. 

Jio Financial Services hit the lower price band for five straight days before it snapped out of the circuit limit.

Midway, the Bombay Stock Exchange changed the rule. JFS will be removed from the index unless it hits the lower price band on the third day after its removal was deferred, BSE said. Upper limit is not a concern.

NSE, however, continues with its initial framework: JFS won't be excluded from indices until it does not hit upper or lower price band for two consecutive days.

This ad hoc manner of index management needs intervention.

In the developed markets, companies prefer to list a stock on one stock exchange and very rarely on multiple bourses unless it is through a depository receipt route. But DRs are not part of any index. So, life is easy for index managers. In India, the same stock is listed on two exchanges and is eligible to be on indices of the respective bourse. 

But there is lack of disclosure on what goes into the inclusion or exclusion of stocks in an index. The exchanges have eligibility criteria, including average volume traded, beta of a stock, impact costs, trading history, and liquidity. What is not disclosed is why stocks are excluded despite being eligible.

Global index compilers, such as MSCI and FTSE Russell, release a detailed document at the time of the review. Such a disclosure is absent from Indian stock exchanges, and calls to seek this information more often than not hit a wall. The call to the regulator doesn’t help either as it relates to internal functioning of a stock exchange, though the index management framework requires SEBI's approval. 

The same applies to which stocks can be included in the derivatives segment. According to market participants, even if stocks meet liquidity and trading guidelines for inclusion and exclusion, the list requires the regulator to come on board. And the regulator does not provide reasons to the exchanges or answers queries raised on the issue. 

Nifty Indices, an NSE arm, recently came out with a discussion paper which, if implemented, will require non-derivatives stocks to be removed from the NSE 500 index. Its implementation was put in abeyance ahead of the NSE index review in September. Why was it put in abeyance? Certain companies that are part of NSE 500 would have been removed as they aren't in the derivatives segment but are part of the index.

A logical question is how can a stock be eligible to be in an index but not in derivatives?

If the regulatory regime is becoming principle- and disclosure-based, then exchanges need to set an example.

Sajeet Manghat is Executive Editor at BQ Prime.