Sebi prompts bourses to consider capping sectoral weightage in indices

The Securities and Exchange Board of India (Sebi) nudged stock exchanges to consider capping sectoral weightage in their benchmark indices, said people with the direct knowledge of the development.

Last week, both the National Stock Exchange (NSE) and the BSE floated consultation papers, seeking feedback from the market on whether to restrict the weightage of the top sector in the benchmark indices to as low as 25 per cent.  

People with knowledge of the matter said the market regulator is concerned over the financial sector’s growing weight in the premier indices, amid turbulence in financial stocks following the default in IL&FS. 

In addition, a sharp swing seen in counters such as YES Bank and Indiabulls Housing Finance have accentuated the issue.

Currently, the financial sector has 37 per cent weightage in the Nifty and over 40 per cent in the Sensex.

“Sebi is uncomfortable with the growing weightage of the financial sector, especially in the wake of the liquidity crisis plaguing NBFCs. As a regulator, it wants to ensure the market doesn’t become too vulnerable to the performance of one particular sector,” said a person privy to the development.

An email sent to Sebi seeking comments on the issue went unanswered. Typically, Sebi itself floats discussion papers on broad policy changes to the market. However, this time around, the regulator has asked the exchanges to study the feasibility of index capping to avoid concentration risks. 

The NSE has invited market comments till May 31, while the BSE has set the deadline for May 17. Both the exchanges will then collate the feedback given by market participants and submit it to the markets regulator, said people in the know.

Index provider Asia Index — a joint venture between the BSE and the S&P Dow Jones — has already written to Sebi on the proposal of index capping.

“Introducing sector caps on broad-based indices will have an impact on investment products linked to those indices… it could alter the liquidity profile of the index…it could also have implications for the wider economy, as constituents no longer qualifying for indices, previously aimed at measuring broader markets or segments, potentially lose access to investor capital,” Asia Index has written to Sebi.

Not an easy decision

While market players have expressed concerns over the growing weightage of the financial sector, they concur that capping a sectoral weight artificially won’t be feasible.

“The weightage is calculated based on the free-float market capitalisation. Capping the top sector weight would mean that you are assigning lower weightage to a stock with higher free float, and in the process allotting a higher weightage to a stock with lower free float. This could lead to imbalances, such as increase in impact costs, higher churn, and tracking error,” said a fund manager, on the condition of anonymity. 

The latest proposal on index capping follows a circular issued by the markets regulator in January, in which it prescribed guidelines aimed at reducing concentration risks in exchange-traded funds (ETFs).

Under the new guidelines, Sebi has said that an index will need to have a minimum of 10 stocks. 

Further, in a sectoral index, the weight of a single stock has been capped at 35 per cent and for a broad-based index, the weight has been capped at 25 per cent. Finally, the weightage of the top three stocks cannot exceed 65 per cent.

Following the January circular, index providers had to tweak the computation methodology. 

However, industry players said that the circular only impacted certain sectoral indices, while broad market indices were already compliant with the new norms.

Will the cap fit?
  • NSE, BSE have started public consultation on index capping
  • Sources say the move was triggered on Sebi’s direction
  • Market players share regulator’s concerns over growing weightage of financial sector
  • Sebi wants to ensure right safeguards amid turbulence in financial stocks
  • Experts say capping weightage artificially not a feasible move

Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel