Exchange route mandatory for sub-Rs 25 crore ETF deals from Tuesday

Buying and selling of exchange trade fund (ETF) units worth less than Rs 25 crore will now have to take place compulsorily on the stock exchange platform, according to a new rule which comes into effect on Tuesday.

The fresh norm, which comes into being after two deferments, is aimed at boosting liquidity and reducing tracking error.

At present, investors directly deal with the asset management companies (AMCs) for purchase and redemption of ETFs — passive schemes that track a particular benchmark such as the Nifty50 index.

The Securities and Exchange Board of India (Sebi) had originally announced the move last year as a part of a circular on 'Development of Passive Funds'. While most of the provisions of the circular have already come into effect, the rule around buying and selling of ETFs on a stock exchange platform got extended twice -- once on July 1, 2022 and then on November 1, 2022.

Industry insiders believe that the delay was mostly due to unpreparedness of certain investors -- like provident fund trusts and other institutions -- to start dealing through exchanges. According to AMC officials, many such investors did not have the required mandate to open trading accounts to deal with the exchanges.

To provide better price discovery, AMCs have to appoint market makers for ETF trading. The markets regulator has also eased the market making norms, permitting net settlement which will make the process less capital intensive and will encourage more players to act as market makers.

Other initiatives announced for the development of the passive ecosystem included introduction of three new categories of passive debt funds, creation of a new category in passive for equity equity-linked saving schemes or ELSS.

Further, Sebi has reduced the minimum subscription amount to just Rs 10 crore for debt ETFs and Rs 5 crore for other ETFs. More importantly, the regulator introduced an alternative for ETF new fund offers or NFOs, whereby the AMC can contribute the initial fund for unit creation. The AMC can subsequently transfer the units to market makers or investors.

ETFs have grown significantly in India post Covid-19 with the assets under management (AUM) growing 3x since March 2020 to Rs 4.8 trillion.

However, it still remains an institutional product with the Employees' Provident Fund Organisation (EPFO) alone accounting for almost half of the AUM (at the end of March 2022, EPFO's investments in ETFs stood at Rs 2.3 trillion).

Debt ETFs, popular among corporate investors, account for another 17 per cent of the ETF AUM.