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The capital market comprises of equities market and debt market. Debt market is a market for the issuance, trading and settlement in fixed income securities of various types. Fixed income securities can be issued by a wide range of organizations including the Central and State Governments, public bodies, statutory corporations, banks and institutions and corporate bodies INTRODUCTION TO FIXED INCOME INSTRUMENTS Fixed Income securities are one of the most innovative and dynamic instruments evolved in the financial system ever since the inception of money. Based as they are on the concept of interest and time-value of money, Fixed Income securities personify the essence of innovation and transformation, which have fueled the explosive growth of the financial markets over the past few centuries. Fixed Income securities offer one of the most attractive investment opportunities with regard to safety of investments, adequate liquidity, and flexibility in structuring a portfolio, easier monitoring, long term reliability and decent returns. They are an essential component of any portfolio of financial and real assets, whether in the form of pure interest-bearing bonds, varied type of debt instruments or asset-backed mortgages and securitized instruments. FIXED INCOME MARKETS - POWERING THE WORLD The Fixed Income securities market was the earliest of all the securities markets in the world and has been the forerunner in the emergence of the financial markets as the engine of economic growth across the globe. The Fixed Income Securities Market, also known as the debt market or the bond market, is easily the largest of all the financial markets in the world today. The Debt Market has, as such, a very prominent role to play in the efficient functioning of the world financial system and in catalyzing the economic growth of nations across the globe. INDIAN DEBT MARKET - PILLARS OF THE INDIAN ECONOMY The Debt Market plays a very critical role for any growing economy which needs to employ a large amount of capital and resources for achieving the desired industrial and financial growth. The Indian debt market is today one of the largest in Asia and includes securities issued by the Government (Central & State Governments), public sector undertakings, other government bodies, financial institutions, banks and corporate. The Indian debt markets with an outstanding issue size of Government securities (Central and state) close to Rs.13,474 billion (or Rs. 1,34,7435 crore) and a secondary market turnover of around Rs 56,033 billion (in the previous year 2007) is the largest segment of the Indian financial markets.(Source RBI & CCIL).
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The Government Securities (G-Secs) market is the oldest and the largest component of the Indian debt market in terms of market capitalization, outstanding securities and trading volumes. The G-Secs market plays a vital role in the Indian economy as it provides the benchmark for determining the level of interest rates in the country through the yields on the government securities which are referred to as the risk-free rate of return in any economy.
TRANSFORMATIONS IN THE MARKET STRUCTURE The Indian Debt Markets are today poised on the threshold of momentous change and transition to an efficient, transparent and vibrant market with significant retail participation. The first half of the twentieth century had witnessed a significant amount of retail interest and participation in the G-Sec market with more than half the holdings of G-Secs issued being held by retail investors, a trend which continued until the early sixties. The administered interest rate regime and the emergence of other equity and debt instruments led to a gradual diminution in the investor interest and participation in the GSec market The Indian Debt Market structure was hitherto that of a wholesale market with participation largely restricted to the Banks, Institutions and the Primary Dealers. The rapidly expanding volumes in the Wholesale Debt Market over the past few years bear the promise of an immense and attractive financial market with a strong potential for retail participation. The Retail Debt Market in India is being created, thanks to the pioneering efforts of the Exchanges and the market participants and the strong leadership and guidance by SEBI, RBI and the Govt. of India. The Honorable Union Finance Minister, while presenting the Union Budget for 20062007, accepted the recommendations of the High Level Committee on Corporate Bonds and Securitization and made a significant policy announcement about creation of a single, unified exchange-traded market for corporate bonds in India. An internal committee under the chairmanship of SEBI Whole Time Member Dr. T.C. Nair was constituted to chalk out a plan for implementation of a Unified Exchange Traded Corporate Bond Market in India. Pursuant to the recommendations of the Committee, SEBI issued a circular on December 12, 2006, entrusting to Bombay Stock Exchange Ltd. the task of rolling out a Unified Reporting Platform for all corporate bonds traded in India with an aggressive target date of January 1, 2007. SEBI has subsequently taken several steps towards creation of a vibrant Corporate Bond market. On July 2,2007 SEBI permitted BSE to launch a trade matching platform with essential features of an OTC Market. Several other initiatives like simplification of the Debt listing agreement, rationalization of stamp duty and introduction of Repos on Corporate Bonds have been taken by SEBI.
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BSE'S BOND WITH INVESTORS Bombay Stock Exchange Limited (BSE), the premier stock exchange in the country, has heralded the capital market revolution in India and has contributed immensely towards the achievement of global standards of efficiency and safety by the Indian capitals market. BSE, with its rich experience of 133 years in the Indian capital market, offers investors an efficient and transparent nation-wide platform for trading in Equities, Debt and Derivative products. BSE is now in the throes of change, having transformed itself into a corporate entity effective August 19,2005, and several significant initiatives are in the offing. BSE - BONDING WITH THE FUTURE The BSE Debt segment would seek to pave the way for the development of a healthy, efficient and active debt market mechanism and market structure in line with world class standards and greater integration with the global economy. The BSE vision for the Indian Debt Market foresees the markets growing in leaps and bounds in the near future, soon attaining global benchmarks of safety, efficiency and transparency. This will truly help the Indian capital markets to attain a place of pride among the leading capital markets of the world.
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Bombay Stock Exchange is the oldest stock exchange in Asia with a rich heritage, now spanning three centuries in its 134 years of existence. What is now popularly known as BSE was established as "The Native Share & Stock Brokers' Association" in 1875. BSE is the first stock exchange in the country which obtained permanent recognition (in 1956) from the Government of India under the Securities Contracts (Regulation) Act 1956. BSE's pivotal and pre-eminent role in the development of the Indian capital market is widely recognized. It migrated from the open outcry system to an online screen-based order driven trading system in 1995. Earlier an Association Of Persons (AOP), BSE is now a corporatized and demutualised entity incorporated under the provisions of the Companies Act, 1956, pursuant to the BSE (Corporatization and Demutualization) Scheme, 2005 notified by the Securities and Exchange Board of India (SEBI). With demutualization, BSE has two of world's best exchanges, Deutsche Börse and Singapore Exchange, as its strategic partners. Over the past 134 years, BSE has facilitated the growth of the Indian corporate sector by providing it with an efficient access to resources. There is perhaps no major corporate in India which has not sourced BSE's services in raising resources from the capital market. Today, BSE is the world's number 1 exchange in terms of the number of listed companies and the world's 5th in transaction numbers. The market capitalization as on December 31, 2007 stood at USD 1.79 trillion. An investor can choose from more than 4,700 listed companies, which for easy reference, are classified into A, B, S, T and Z groups. The BSE Index, SENSEX, is India's first stock market index that enjoys an iconic stature , and is tracked worldwide. It is an index of 30 stocks representing 12 major sectors. The SENSEX is constructed on a 'free-float' methodology, and is sensitive to market sentiments and market realities. Apart from the SENSEX, BSE offers 21 indices, including 12 sector indices. BSE has entered into an index cooperation agreement with Deutsche Börse. This agreement has made SENSEX and other BSE indices available to investors in Europe and America. Moreover, Barclays Global Investors (BGI), the global leader in ETFs through its iSharesÂ® brand, has created the Page | 4
'iSharesÂ® BSE SENSEX India Tracker' which tracks the SENSEX. The ETF enables investors in Hong Kong to take an exposure to the Indian equity market. The first Exchange Traded Fund (ETF) on SENSEX, called "SPIcE" is listed on BSE. It brings to the investors a trading tool that can be easily used for the purposes of investment, trading, hedging and arbitrage. SPIcE allows small investors to take a longterm view of the market. BSE provides an efficient and transparent market for trading in equity, debt instruments and derivatives. It has a nation-wide reach with a presence in more than 359 cities and towns of India. BSE has always been at par with the international standards. The systems and processes are designed to safeguard market integrity and enhance transparency in operations. BSE is the first exchange in India and the second in the world to obtain an ISO 9001:2000 certifications. It is also the first exchange in the country and second in the world to receive Information Security Management System Standard BS 7799-22002 certification for its BSE On-line Trading System (BOLT). BSE continues to innovate. In recent times, it has become the first national level stock exchange to launch its website in Gujarati and Hindi to reach out to a larger number of investors. It has successfully launched a reporting platform for corporate bonds in India christened the ICDM or Indian Corporate Debt Market and a unique ticker-cum-screen aptly named 'BSE Broadcast' which enables information dissemination to the common man on the street. In 2006, BSE launched the Directors Database and ICERS (Indian Corporate Electronic Reporting System) to facilitate information flow and increase transparency in the Indian capital market. While the Directors Database provides a single-point access to information on the boards of directors of listed companies, the ICERS facilitates the corporates in sharing with BSE their corporate announcements. BSE also has a wide range of services to empower investors and facilitate smooth transactions: Investor Services: The Department of Investor Services redresses grievances of investors. BSE was the first exchange in the country to provide an amount of Rs.1 million towards the investor protection fund; it is an amount higher than that of any exchange in the country. BSE launched a nationwide investor awareness Page | 5
programme- 'Safe Investing in the Stock Market' under which 264 programmes were held in more than 200 cities. The BSE On-line Trading (BOLT): BSE On-line Trading (BOLT) facilitates online screen based trading in securities. BOLT is currently operating in 25,000 Trader Workstations located across over 359 cities in India. BSEWEBX.com: In February 2001, BSE introduced the world's first centralized exchange-based Internet trading system, BSEWEBX.com. This initiative enables investors anywhere in the world to trade on the BSE platform.
Surveillance: BSE's On-Line Surveillance System (BOSS) monitors on a real-time basis the price movements, volume positions and members' positions and real-time measurement of default risk, market reconstruction and generation of cross market alerts. BSE Training Institute: BTI imparts capital market training and certification, in collaboration with reputed management institutes and universities. It offers over 40 courses on various aspects of the capital market and financial sector. More than 20,000 people have attended the BTI programs AWARDS:
The World Council of Corporate Governance has awarded the Golden Peacock Global CSR Award for BSE's initiatives in Corporate Social Responsibility (CSR).
The Annual Reports and Accounts of BSE for the year ended March 31, 2006 and March 31 2007 have been awarded the ICAI awards for excellence in financial reporting.
The Human Resource Management at BSE has won the Asia - Pacific HRM awards for its efforts in employer branding through talent management at work, health management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times, BSE will continue to remain an icon in the Indian capital market.
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OBJECTIVE OF THE STUDY
1. To understand the different types of instruments and structure of the Indian Debt Market. 2. To understand the concept of REPO (Repurchase Agreement) and the legal rules involving REPO trade. 3. To collect and analyze information from the European Bond Market and study the functions of the different types of instruments in the European Bond Market. 4. To gather information about the Indian model of a tri-partite REPO which is Collateralized Borrowing and Lending Obligations (CBLO) 5. To study the present situation of the corporate bond market in India, the complexities in it and try to discover methods by which rectifications can be made that might improve the current condition of corporate bonds in India. 6. To study the need of REPO in corporate bonds 7. To suggest a model based on the opinions of experienced REPO traders as well as a personal interpretation and point of view.
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RESEARCH: Research in its most common sense refers to search for knowledge. One can also define research as a scientific and systematic search for pertinent information on a specific topic. In fact, research is an art of scientific investigation. The Advanced Learner’s Dictionary of Current English lays down the meaning of research as ‘a careful investigation or inquiry especially through search for new facts in any branch of knowledge.’ Research is, thus, an original contribution to the existing stock of knowledge making for its advancement. It is the pursuit of truth with the help of study, observation, comparison and experiment. RESEARCH DESIGN: A research design is the arrangement of conditions for collections and analysis of data in a manner that aims to combine relevance to the research purpose with economy in procedure. In fact, the research design is the conceptual structure within which research is conducted; it constitutes the blueprint for the collection, measurement and analysis of data. For the purpose of this project, the following is the research design: a. What is the study for? The study is for getting more knowledge on Repurchase Agreement (REPO). b. Why is the study being made? The study is being made to find out possibility of REPO in corporate bonds. c. Where will the study be carried out? The study will be carried in Bombay Stock Exchange. d. What period of time will the study include? The study includes a period of 60 days. DATA COLLECTION While deciding about the methods of data collection to be used as the study, the researcher should keep in mind two types of data which are: a) Primary Data b) Secondary Data
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Primary Data: Primary Data is that data which is collected fresh and is used for the first time and thus happen to be original in character. There are several methods of collecting primary data, particularly in surveys and descriptive researches. Important ones are I. Observation method. II. Interview method etc. Secondary Data: Secondary Data is that data that has already been collected by someone else and has already passes through the statistical process. When the researcher utilizes secondary data, then he has to look into various sources from which he has to obtain them. Secondary data can be either published or unpublished data. Usually published data is available in I. Publications of central or state governments II. Publications of foreign governments or of international bodes III. Technical and trade journals IV. Books, magazines and newspapers, etc. The data used by me for the purpose of this project was Primary Data as well as Secondary data. I had more of interactions with people, I was fortunate to collect some primary data with help of the Interactive sessions with some of the end user of the concerned financial instrument i.e. REPO. Names of the people whom I interviewed are given below: Mr. Benny Antony (Vice President, Treasury of Kotak Mahindra Bank, Mumbai) Mr. Nilesh Patil (Dealer in Treasury, SBI DFHI, Mumbai) Mr. Kapil Agarwal ( Back office Treasury, ICICI Bank, Mumbai) Secondary data which was used by me comprises of Publications of Clearing Corporation of India Ltd (CCIL) and the facts from the R.H. Patil Report on Corporate bonds. I also referred some of the financial website with official website of BSE, RBI, Eurex Repo etc. for collecting data for my project. LIMITATIONS a) The time period of 60 days seemed to be a little less for the entire project. b) At times I found that there was a bit of hesitancy and reluctance on the part of people to answer questions. c) Since I was not a full time employee of the BSE, It was difficult to get appointments of the concerned people d) Since the Treasury department of any bank contains highly confidential information, I did not get a chance to access the actual trading in REPO market.
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INTRODUCTION TO THE PROJECT
1. Indian Debt Market a) Types of Instruments b) Structure of Indian Debt Market c) Participants in Indian Debt market 2. Repurchase Agreement (REPO) a) Types of REPO b) Legal Rules 3. European Bond Market a) Euro REPO Trade b) GC Pooling c) CHF Market 4. Collateralized Borrowing and Lending Obligation (CBLO) a) Introduction b) Clearing and Settlement procedure c) Risk Management and Default Handling d) Fees and Charges e) RBI’s Regulatory Provisions f) Corporate Actions and Benefits 5. Corporate Bonds in India a) Advantages & Disadvantages b) The Complexities c) What needs to be done 6. REPO in Corporate Bonds a) Need b) Existence of an Arbitrage Opportunity c) Entry of a Retail Investor 7. Proposed Model a) Participants b) Collaterals c) Introduction of Standard Tenor d) Risk Management 8. Conclusion
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INDIAN DEBT MARKET
The capital market comprises of equities market and debt market. For a developing economy like India, debt markets are a crucial source of funds. The debt market is much more popular than the equity markets in most parts of the world. In India the reverse has been true. This has been due to the dominance of the government security in the debt market and that too, a market where government was borrowing at pre-announced coupon rates from basically a captive group of investors, such as banks. Thus there existed a passive internal debt management policy. This, coupled with automatic monetisation of fiscal deficit prevented a deep and vibrant government securities market. It includes government securities – the largest component - and bonds issued by public sector undertakings, other government bodies, financial institutions, banks and companies. Debt markets are now considered an alternative route to banking channels for finance. The debt market in India comprises broadly two segments • • Government Securities Market and Corporate Debt Market.
The Corporate Debt Market is further classified as Market for • • PSU Bonds Private Sector Bonds.
Debt Instruments are obligations of issuer of such instruments as regards certain future cash flows representing Interest & Principal, which the issuer would pay to the legal owner of the Instruments. Generally debt instruments represent agreements to receive certain cash flows as per the terms contained within the agreement. They can also be said to be tradable form of loans.
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TYPES OF INSTRUMENTS Debt Instruments are of various types like Bonds, Debentures, Commercial Papers, Certificates of Deposit, Government Securities (G secs) etc. A brief detail about some of these investment options are given below. GOVERNMENT SECURITIESGovernment Securities are securities issued by the Government for raising a public loan or as notified in the official Gazette. They consist of Government Promissory Notes, Bearer Bonds, Stocks or Bonds held in Bond Ledger Account. They may be in the form of Treasury Bills or Dated Government Securities. Mostly Government Securities are interest bearing dated securities issued by RBI on behalf of the Government of India. GOI uses these funds to meet its expenditure commitments. These securities are generally fixed maturity and fixed coupon securities carrying semi-annual coupon. Since the date of maturity is specified in the securities, these are known as dated Government securities, e.g. 8.24% GOI 2018 is a Central Government security maturing in 2018, which carries a coupon of 8.24% payable half yearly.
Features of Government Securities 1) Issued at face value 2) No default risk as the securities carry sovereign guarantee. 3) Ample liquidity as the investor can sell the security in the secondary market 4) Interest payment on a half yearly basis on face value 5) No tax deducted at source 6) Can be held in D-mat form. 7) Rate of interest and tenor of the security is fixed at the time of issuance and is not subject to change (unless intrinsic to the security like FRBs). 8) Redeemed at face value on maturity 9) Maturity ranges from of 2-30 years. 10) Securities qualify as SLR investments (unless otherwise stated).
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The dated Government securities market in India has two segments: 1) Primary Market: The Primary Market consists of the issuers of the securities, viz., Central and Sate Government and buyers include Commercial Banks, Primary Dealers, Financial Institutions, Insurance Companies & Co-operative Banks. RBI also has a scheme of noncompetitive bidding for small investors (see SBI DFHI Invest on our website for further details). 2) Secondary Market: The Secondary Market includes Commercial banks, Financial Institutions, Insurance Companies, Provident Funds, Trusts, Mutual Funds, Primary Dealers and Reserve Bank of India. Even Corporates and Individuals can invest in Government Securities. The eligibility criterion is specified in the relative Government notification. Auctions: Auctions for government securities are normally multiple- price auctions either yield based or price based. Yield Based: In this type of auction, RBI announces the issue size or notified amount and the tenor of the paper to be auctioned. The bidders submit bids in term of the yield at which they are ready to buy the security. If the Bid is more than the cut-off yield then its rejected otherwise it is accepted Price Based: In this type of auction, RBI announces the issue size or notified amount and the tenor of the paper to be auctioned, as well as the coupon rate. The bidders submit bids in terms of the price. This method of auction is normally used in case of reissue of existing government securities. Bids at price lower then the cut off price are rejected and bids higher then the cut off price are accepted. Price Based auction leads to a better price discovery then the Yield based auction. Occasionally RBI holds uniform-price auctions also.
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One day prior to the auction, bids are received from the Primary Dealers (PD) indicating the amount they are willing to underwrite and the fee expected. The auction committee of RBI then examines the bid on the basis of the market condition and takes a decision on the amount to be underwritten and the fee to be paid. In case of devolvement, the bids put in by the PD’s are set off against the amount underwritten while deciding the amount of devolvement and in case the auction is fully subscribed, the PD need not subscribe to the issue unless they have bid for it. G-Secs, State Development Loans & T-Bills are regularly sold by RBI through periodic public auctions. SBI DFHI Ltd. is a leading Primary Dealer in Government Securities. SBI DFHI Ltd gives investors an opportunity to buy G-Sec / SDLs / T-Bills at primary market auctions of RBI through its SBI DFHI Invest scheme (details available on website itself). Investors may also invest in high yielding Government Securities through “SBI DFHI Trade” where “buy and sell price” and a buy and sell facility for select liquid scrips in the secondary markets is offered. . CORPORATE BONDSCorporate Bonds are issued by public sector undertakings and private corporations for a wide range of tenors normally upto 15 years although some corporates have also issued perpetual bonds. Compared to government bonds, corporate bonds generally have a higher risk of default. This risk depends, of course, upon the particular corporation issuing the bond, the current market conditions, the industry in which it is operating and the rating of the company. Corporate bondholders are compensated for this risk by receiving a higher yield than government bonds. CERTIFICATE OF DEPOSIT CDs are negotiable money market instrument issued in demat form or as a Usance Promissory Notes. CDs issued by banks should not have the maturity less than seven days and not more than one year. Financial Institutions are allowed to issue CDs for a period between 1 year and up to 3 years. CDs are like bank term deposits but unlike traditional time deposits these are freely negotiable and are often referred to as Negotiable Certificates of Deposit. CDs normally give a higher return than Bank term deposit. CDs are rated by approved rating agencies (e.g. CARE, ICRA, CRISIL, and FITCH) which considerably enhance their tradability in the secondary market, depending upon demand. SBI DFHI is an active player in Page | 14
secondary market of CDs. Features of CD • All scheduled banks (except RRBs and Co-operative banks) are eligible to issue CDs. • They can be issued to individuals, corporations, trusts, funds and associations. • NRIs can also subscribe to CDs, but on non-repatriable basis only. In secondary market such CDs cannot be endorsed to another NRI. • They are issued at a discount rate freely determined by the issuer and the market/investors. • CDs issued in physical form are freely transferable by endorsement and delivery. Procedure of transfer of dematted CDs is similar to that of any other demat securities. • For CDs there is no lock-in period. CDs are issued in denominations of Rs.1 Lac and in the multiples of Rs. 1 Lac thereafter. Discount/Coupon rate of CD is determined by the issuing bank/FI.Loans cannot be granted against CDs and Banks/FIs cannot buy back their own CDs before maturity.
COMMERCIAL PAPERSA CP is a short term security (7 days to 365 days) issued by a corporate entity (other than a bank), at a discount to the face value. One can invest in CPs starting from a minimum of 5 lacs (face value) and multiples thereof. CPs are rated by approved rating agencies (e.g. CARE, ICRA, CRISIL, FITCH). CPs normally gives a higher return than fixed deposits & CDs. We deal in investment grade CPs only. CPs can be traded in the secondary market, depending upon demand. An element of credit risk is attached to CPs.
TYPES OF BONDS Classification on the basis of Variability of Coupon
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Zero Coupon Bonds Zero Coupon Bonds are issued at a discount to their face value and at the time of maturity, the principal/face value is repaid to the holders. No interest (coupon) is paid to the holders and hence, there are no cash inflows in zero coupon bonds. The difference between issue price (discounted price) and redeemable price (face value) itself acts as interest to holders. The issue price of Zero Coupon Bonds is inversely related to their maturity period, i.e. longer the maturity period lesser would be the issue price and viceversa. These types of bonds are also known as Deep Discount Bonds. Treasury Strips Treasury strips are more popular in the United States and not yet available in India. Also known as Separate Trading of Registered Interest and Principal Securities, government dealer firms in the United States buy coupon paying treasury bonds and use these cash flows to further create zero coupon bonds. Dealer firms then sell these zero coupon bonds, each one having a different maturity period, in the secondary market. Floating Rate Bonds In some bonds, fixed coupon rate to be provided to the holders is not specified. Instead, the coupon rate keeps fluctuating from time to time, with reference to a benchmark rate. Such types of bonds are referred to as Floating Rate Bonds. For better understanding let us consider an example of one such bond from IDBI in 1997. The maturity period of this floating rate bond from IDBI was 5 years. The coupon for this bond used to be reset half-yearly on a 50 basis point mark-up, with reference to the 10-year yield on Central Government securities (as the benchmark). More frequently used in the housing loan markets where coupon rates are reset at longer time intervals (after one year or more), these are well known as Variable Rate Bonds and Adjustable Rate Bonds. Coupon rates of some bonds may even move in an opposite direction to benchmark rates. These bonds are known as Inverse Floaters and are common in developed markets CLASSIFICATION ON THE BASIS OF VARIABILITY OF MATURITY
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Callable Bonds The issuer of a callable bond has the right (but not the obligation) to change the tenor of a bond (call option). The issuer may redeem a bond fully or partly before the actual maturity date. These options are present in the bond from the time of original bond issue and are known as embedded options. A call option is either a European option or an American option. Under an European option, the issuer can exercise the call option on a bond only on the specified date, whereas under an American option, option can be exercised anytime before the specified date. This embedded option helps issuer to reduce the costs when interest rates are falling, and when the interest rates are rising it is helpful for the holders. • Puttable Bonds
The holder of a puttable bond has the right (but not an obligation) to seek redemption (sell) from the issuer at any time before the maturity date. The holder may exercise put option in part or in full. In riding interest rate scenario, the bondholder may sell a bond with low coupon rate and switch over to a bond that offers higher coupon rate. Consequently, the issuer will have to resell these bonds at lower prices to investors. Therefore, an increase in the interest rates poses additional risk to the issuer of bonds with put option (which are redeemed at par) as he will have to lower the re-issue price of the bond to attract investors. Convertible Bonds The holder of a convertible bond has the option to convert the bond into equity (in the same value as of the bond) of the issuing firm (borrowing firm) on pre-specified terms. This results in an automatic redemption of the bond before the maturity date. The conversion ratio (number of equity of shares in lieu of a convertible bond) and the conversion price (determined at the time of conversion) are pre-specified at the time of bonds issue. Convertible bonds may be fully or partly convertible. For the part of the convertible bond, which is redeemed, the investor receives equity shares and the nonconverted part remains as a bond. CLASSIFICATION ON THE BASIS OF PRINCIPAL REPAYMENT Page | 17
Amortising Bonds are those types of bonds in which the borrower (issuer) repays the principal along with the coupon over the life of the bond. The amortising schedule (repayment of principal) is prepared in such a manner that whole of the principle is repaid by the maturity date of the bond and the last payment is done on the maturity date. For example - auto loans, home loans, consumer loans, etc. • Bonds with Sinking Fund Provisions
Bonds with Sinking Fund Provisions have a provision as per which the issuer is required to retire some amount of outstanding bonds every year. The issuer has following options for doing so: 1. By buying from the market 2. By creating a separate fund which calls the bonds on behalf of the issuer Since the outstanding bonds in the market are continuously retired by the issuer every year by creating a separate fund (more commonly used option), these types of bonds are named as bonds with sinking fund provisions. These bonds also allow the borrowers to repay the principal over the bond’s life.
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Structure of the Indian Debt Market
GOVERNMENT STATE GOVT GOVT AGENCIES & STATUTORY BODIES
GOI dated securities, Treasury Bills, State govt. securities, index bonds, zero coupon bonds
Govt. Guaranteed Bonds/ Debentures
PUBLIC SECTOR UNDERTAKINGS
PSU Bonds, Debentures, Comm. Papers
PENSION FUNDS FIIs CORPORATE
CD, Debentures, Bonds
CORPORATES THE PRIVATE SECTOR
Bonds, debentures, Comm. Paper (CP) Secured Promissory Notes, FCDs, PCDs, ZCBs
PRIVATE SECTOR BANKS
Bonds, Debentures, CPs and CDs
INSURANCE Cos, TRUSTS, MUTUAL FUNDS
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From the above diagram we can observe that there are three main segments of the debt market in India: government securities, public sector unit (PSU) bonds and private corporate securities. The market for government securities comprises the central government securities such as T-bills and state government securities. The PSU bonds are generally treated as surrogates for sovereign paper, sometimes due to explicit guarantees and often due to the comfort of public ownership. Some of the PSU bonds are tax-free, unlike most other bonds, including government securities. Private corporate securities include corporate bonds and debentures, which are mostly medium-term papers with maturities up to seven years, and commercial paper, which is a short-term corporate debt instrument with maturities from 15 days to one year. The money market overlaps with the debt market inasmuch as T-bills and other short-term debt papers with maturities up to one year form an integral part of the money market Market structure consists of issuers, instruments, processes, investors, rating agencies and regulatory environment. i) Issuers Indian Debt Market has almost all-possible variety of issuers, as is the case in many developed markets. It has large private sector corporate, public sector undertakings (union as well as state), financial institutions, banks and medium and small companies: Thus the spectrum appears to be complete. Figure 1, delineates details on various classes of issuers. Two main classes include private sector corporate and banks. ii) Instruments The above chart provides names of some of the more popular instruments that have been issued. Till recently Indian debt market was predominantly dominated by plain vanilla bonds. Over a period of time, many other instruments have been issued. They include partly convertible debentures (PCDs), fully convertible debentures (FCDs), deep discount bonds (DDBs), zero coupon bonds (ZCBs), bonds with warrants, floating rate notes (FRNs) / bonds and secured premium notes (SPNs). The coupon rates mostly depend on tenure and credit rating. However, these may not be strictly correlated in all cases. The maturities of bonds generally vary between one year to ten years. However, the median could be around four to five years. The maturity period by and large depends on outlook on interest rates. In expectation of falling interest rates environment, Page | 20
corporate, it is observed, mostly go to shorter-term instruments while the opposite is true in case of possible hike in interest rates. For the past few years interest rates have been falling and short end issues are on the rise. This is one of the reasons that many corporate are reluctant to go for public issue route and listing of their securities. iii) Processes There are several processes that are in vogue in India as well as in other markets. The more popular ones are public issue and private placement routes. Both these have their own pros and cons. In a mature and developed market where large number of institutional investor /sophisticated investors are available and a highly developed mutual fund industry is in operation, the private placement route may be acceptable to issuers, investors and regulators. In a less developed market / small market it is a catch 22 position. Private placement is not suitable because this market do not have adequate number of informed investors and the public issue route may create regulatory arbitrage, higher compliance costs resulting sometimes in migration of markets. In India private placement route is highly popular owing to various reasons iv) Intermediaries Two classes of intermediaries required for the proper development of debt market are broker and investment banker/ merchant banker. Most of the brokers as well as merchant bankers in India are inadequately capitalized and their professional knowledge also needs further improvement. In some markets, it is observed that there are dedicated “Debt Managers” who facilitate subscription or sometimes subscribe to the issue and later on even facilitate trading in bonds. India needs a dedicated “Bond Manager” concept. v) Investors For the development of Corporate Debt Market / Fixed Income Securities Market, it is necessary and sufficient to have a large as well as diverse number of sophisticated / institutional investors. The above figure lists some of the classes of investors that have been investing in the debt market. Institutional Investors in India are few in number and the variety also is limited. Banks and financial institutions, by and large, do not take active interest in Corporate Debt Market. Investors with diverse expectations are a precondition for the development of corporate debt market. Diversity could be in terms of maturity needs as well as expectations on interest rates. The most important structural Page | 21
weakness in India is lack of large and diverse institutional investors. India has large number of retail investors; however, their expectations are quite contrary to market principles - risk and return. Most investors think and perceive that investments in bonds should provide them guarantee, repayment of principal and regular payment of coupons. Any delay/default causes worries in their minds. And sometimes these investors complain to regulators or to the government for non-receipt of coupons or nonrepayment of principal. This type of behavior implies lack of understanding of the principles of the capital market on the part of the investors . vi) Rating agencies India has a well developed Credit Rating Agency system and rating agencies are well experienced and regarded. By and large, their ratings do carry confidence in the market.
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PARTICIPANTS IN INDIAN DEBT MARKETS Primary Debt Market • Govt. of India • • • • State Government Govt. / Local Bodies Public Sector Corporate Private Sector Corporate
2. Secondary Debt Market • • • • • • Banks Financial Institution Primary dealers Insurance Companies Pension Funds, PFs, Trusts, Mutual Funds. Individuals
3. Traditional Investors • • • • • Public Sector Banks Private Sector & Foreign Banks Primary Dealers Financial Institutions Companies LIC, GIC
4. New Class of Investors • • • • • FIIs & Mutual Funds Co-operative Banks Private Insurance Companies NBFCs & Housing Finance Corporate & Retail Investors
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REPURCHASE AGREEMENT (REPO)
A Repurchase agreement (also known as a repo or Sale and Repurchase Agreement) allows a borrower to use a financial security as collateral for a cash loan at a fixed rate of interest. In a repo, the borrower agrees to sell immediately a security to a lender and also agrees to buy the same security from the lender at a fixed price at some later date. A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is the interest on the loan while the settlement date of the forward contract is the maturity date of the loan.
Structure and terminology
A repo is economically similar to a secured loan, with the buyer receiving securities as collateral to protect against default. There is little that prevents any security from being employed in a repo; so, Treasury or Government bills, corporate and Treasury/Government bonds, and stocks/shares (it is not secured loans and have to be removed from repo securities list), may all be used as securities involved in a repo. However, the legal title to the securities clearly passes from the seller to the buyer, or "investor". Coupons (installment payments that are payable to the owner of the securities) which are paid while the repo buyer owns the securities are, in fact, usually passed directly onto the repo seller. This might seem counterintuitive, as the ownership of the collateral technically rests with the buyer during the repo agreement. It is possible to instead pass on the coupon by altering the cash paid at the end of the agreement, though this is more typical of Sell/Buy Backs. Although the underlying nature of the transaction is that of a loan, the terminology differs from that used when talking of loans because the seller does actually repurchase the legal ownership of the securities from the buyer at the end of the agreement. So, although the actual effect of the whole transaction is identical to a cash loan, in using the "repurchase" terminology, the emphasis is placed upon the current legal ownership of the collateral securities by the respective parties.
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The following table summarizes the terminology:
Repo Participant Near leg Far leg Borrower Seller Sells securities Buys securities
Reverse repo Lender Buyer Buys securities Sells securities
TYPES OF REPO AND RELATED PRODUCTS There are three types of repo maturities: overnight, term, and open repo. Overnight refers to a one-day maturity transaction. Term refers to a repo with a specified end date. Open simply has no end date. Although repos are typically short-term, it is not unusual to see repos with a maturity as long as two years. Repo transactions occur in three forms: specified delivery, tri-party, and held in custody. The third form is quite rare in developing markets primarily due to risks. The first form requires the delivery of a prespecified bond at the onset, and at maturity of the contractual period. Tri-party essentially is a basket form of transaction, and allows for a wider range of instruments in the basket or pool. Tri-party utilizes a tri-party clearing agent or bank and is a more efficient form of repo transaction.
DUE BILL/HOLD IN-CUSTODY REPO In a due bill repo, the collateral pledged by the (cash) borrower is not actually delivered to the cash lender. Rather, it is placed in an internal account ("held in custody") by the borrower, for the lender, throughout the duration of the trade. This has become less common as the repo market has grown, particularly owing to the creation of centralized counterparties. Due to the high risk to the cash lender, these are generally only transacted with large, financially stable institutions.
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TRI-PARTY REPO The distinguishing feature of a tri-party repo is that a custodian bank or international clearing organization acts as an intermediary between the two parties to the repo. The triparty agent is responsible for the administration of the transaction including collateral allocation, marking to market, and substitution of collateral. Both the lender and borrower of cash enter into these transactions to avoid the administrative burden of bilateral repos. In addition, because the collateral is being held by an agent, counterparty risk is reduced. A tri-party repo may be seen as the outgrowth of the due bill repo, in which the collateral is held by a neutral third party.
WHOLE LOAN REPO A whole loan repo is a form of repo where the transaction is collateralized by a loan or other form of obligation (e.g. mortgage receivables) rather than a security.
EQUITY REPO The underlying security for most repo transactions is in the form of government or corporate bonds. Equity repos are simply repos on equity securities such as common (or ordinary) shares. Some complications can arise because of greater complexity in the tax rules for dividends as opposed to coupons.
SELL/BUY BACKS AND BUY/SELL BACKS A sell/buy back is the spot sale and a forward repurchase of a security. It is two distinct outright cash market trades, one for forward settlement. The forward price is set relative to the spot price to yield a market rate of return. The basic motivation of sell/buy backs is generally the same as for a classic repo, i.e. attempting to benefit from the lower financing rates generally available for collateralized as opposed to non-secured borrowing. The economics of the transaction are also similar with the interest on the cash
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borrowed through the sell/buy back being implicit in the difference between the sale price and the purchase price. There are a number of differences between the two structures. A repo is technically a single transaction while a sell/buy back is a pair of transactions (a sell and a buy). A sell/buy back does not require any special legal documentation while a repo generally requires a master agreement to be in place between the buyer and seller (typically the SIFMA/ICMA commissioned Global Master Repo Agreement (GMRA)). Typically, sell/buy-backs do not allow for marking to market and margin call, which can result in larger counterparty risks than those of securities lending or repo agreements. Any coupon payment on the underlying security during the life of the sell/buy back will generally be passed back to the seller of the security by adjusting the cash paid at the termination of the sell/buy back. In a repo, the coupon will be passed on immediately to the seller of the security. A buy/sell back is the equivalent of a "reverse repo".
SECURITIES LENDING The general motivation for repos is the borrowing or lending of cash. In securities lending, the purpose is to temporarily obtain the security for other purposes, such as covering short positions or for use in complex financial structures. Securities are generally lent out for a fee. Securities lending trades are governed by different types of legal agreements than repos.
REVERSE REPO A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not the seller's. Hence, the seller executing the transaction would describe it as a "repo", while the buyer in the same transaction would describe it a "reverse repo". So "repo" and "reverse repo" are exactly the same kind of transaction, just described from opposite viewpoints.
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USES For the buyer, a repo is an opportunity to invest cash for a customized period of time (other investments typically limit tenures). It is short-term and safer as a secured investment since the investor receives collateral. Market liquidity for repos is good, and rates are competitive for investors. Money Funds are large buyers of Repurchase Agreements. For traders in trading firms, repos are used to finance long positions, obtain access to cheaper funding costs of other speculative investments, and cover short positions in securities. In addition to using repo as a funding vehicle, repo traders "make markets". These traders have been traditionally known as "matched-book repo traders". The concept of a matched-book trade follows closely to that of a broker who takes both sides of an active trade, essentially having no market risk, only credit risk. Elementary matched-book traders engage in both the repo and a reverse repo within a short period of time, capturing the profits from the bid/ask spread between the reverse repo and repo rates. Presently, matched-book repo traders employ other profit strategies, such as nonmatched maturities, collateral swaps, and liquidity management.
LEGAL RULES 1. The objective of this Code is to set out standards of best practices or the repurchase agreements (repos) market. A high standard of conduct and professionalism is vital to the development of any market and it would be hoped that the code of conduct laid down will be followed in letter and spirit by not only principals and intermediaries in the market but all those who deal in the repo market. Also, all individuals must comply with
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the rules and regulations governing the market and keep up-to-date with changes that may happen from time to time. 2. A Repo transaction is defined as a transaction wherein the securities are sold at a particular price by one party (Seller) to the other (Buyer) with commitments on the Seller’s part to repurchase the equivalent securities from the buyer (and a corresponding commitment on the part of the Buyer to sell the equivalent securities back to seller) on a certain date and at a certain price, both such date and price being fixed as a part of the same transaction. Securities are equivalent to other securities for the purpose of this framework, if they are (i) of the same issuer; (ii) part of the same issue; and (iii) are of identical type, nominal value, and description as those other securities. 3. Reverse Repo Transaction is defined as a transaction wherein the securities are bought at a particular price by one party (Buyer) from the one (seller) with a commitment on the Buyer’s part to sell the Equivalent Securities back to the Seller (and to corresponding commitment on the part of the Seller to repurchase the Equivalent Securities from the Buyer) on a certain date and at a certain price both such date and price being fixed as a part of the same transaction. Securities are equivalent to other securities for the purpose of this accounting framework, if they are (i) Part of the same issue; and (ii) They are of identical type, nominal value, description and amount as those other securities. 4. Repos will fall within the definition of 'investments' as far as the purchaser of securities is concerned since the title of the securities bought is transferred to the buyer. 5. Participants in the repo market should at all times treat the names of parties to transactions as confidential. 6. Participants should know their counterparties and will maintain records of their conversion – both internal or with the investor – material to their relationship. Where these are in written form, records must be kept in line with statutory requirements.
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7. Participants must accept responsibility for the actions of their staff and all participants must ensure that any individual of one institution who commits to any other institution does so within authority. 8. Personnel in back office functions should be functionally separate from those in the front office. Persons who conclude trades shall not be involved in the confirmation or settlement of deals. 9. Deals recorded by the trader should be confirmed independently by the back office in all details recorded by the trader. 10. Experience has shown that recourse to tapes proves invaluable to the speedy resolution of differences and disputes. Tapes relating to disputed transactions should be retained until the problem is resolved. 11. All firms, whether acting as principals, agent or broker, have a duty to make absolutely clear whether the prices they are quoting are firm or corresponding trade. Also, there is need to define the time by which confirmation should be returned. Exceptions should be brought to the attention of management by back office and the management should satisfy themselves of the genuineness of the trade. Prices quoted by brokers should be taken as indicative unless otherwise qualified. 12. The principals should regard themselves as bound to deal once the price, name acceptability, credit approved and any other key commercial terms have been agreed. Original agreements are considered binding. 13. The written confirmation provides a necessary final safeguard against dealing errors. Conformations should be dispatched and checked promptly, even when oral deal checks have been undertaken. The issue of checking of confirmation should be a back office responsibility that should be carried out independently from those who initiate deals. 14. Participants should act with due skill, care and diligence and to facilitate the same staff should be properly training in the practices of the repo market. Also, they should be familiar with this code. Page | 30
15. The market participants should pay particular attention to ensuring fair treatment for their clients especially where conflicts of interest cannot be avoided. 16. Participants should ensure that they are eligible, legally to undertake repo transactions and have obtained all the required permissions from their regulatory authorities, wherever required for the purpose. 17. Where a custodian undertakes a repo transaction on a client, if and when explicitly permitted by the regulatory authority, the provisions given in the operational guidelines for Constituents’ SGL Account by RBI will be kept in view as far as transactions in Government securities are concerned. This is apart from obtaining the necessary authority for this activity from the client in a clear legal agreement stating therein the terms and conditions for undertaking the transaction. 18. Participants should ensure that they have adequate systems and control with a view to satisfying that any repo transactions have been properly authorized before cash or stock is released, adequate documentation to over the types of transactions are undertaken and appropriate accounting systems in general and taxation treatment in particular are followed. 19. Repo transactions should be subject to a legal agreement between the two participants concerned. A Master Repurchase Agreement should be used for this purpose. The agreement should provide for the absolute transfer of title to securities, daily marking to market of transactions, appropriate initial margin and for the maintenance of margins whenever the mark to market reveals a material change of value, the events of default and consequential rights and obligations of the counterparties, clarification on rights of the parties regarding substitution of collateral and the treatment of coupon and interest payments in respect of securities subject to it etc. 20. Suitable initial margins as per norms laid down by the regulatory authority should be reflected in the transaction apart from daily margins as required for essential protection for participants in repo transactions. Collateral including where relevant margins should be delivered to the account of the counterparty or his agent or a designated third party. Page | 31
21. The dealing hours will have to be uniform and as stipulated by the regulatory authority. In cases where deals are undertaken outside of these hours the management should satisfy themselves that there were good reasons for concluding deals after prescribed dealing hours.
EUREOPEAN BOND MARKET
Euro REPO Trade Market Concept
PROCESS FLOW OF A EURO REPO TRADE 1) Bank A quotes. 2) Bank B accepts. 3) A trade is generated. Eurex Clearing is now the legal counterparty. 4) Eurex Repo transmits the trading data to Eurex Clearing. Page | 32
5) Eurex Clearing sends a confirmation to Eurex Repo. 6) Eurex Repo sends a confirmation to the participants. 7) Eurex Clearing transmits settlement information either to Clearstream Banking or to Euroclear. 8) Margin deposit with Clearstream Banking Frankfurt or at SIS, SegaInterSettle. A REPO EXAMPLE A brief description of Repo The repo (sale and repurchase agreements) business is not well known to the public. Repo involves the sale of securities (as collateral) and the simultaneous undertaking to repurchase those securities at a later date. The maturity date is either fixed at the outset of the agreement, or extended on a day-to-day basis (open repo). Essentially, a repo simply represents a loan that is backed by investment securities. Upon expiry of the repo contract, the seller is obliged to repurchase the collateral at the original selling price. In addition, he pays the buyer interest based on the duration of the loan and the principal amount involved. If the seller were to default on his obligation to repay the money, the purchaser is entitled to sell the pledged securities. Conversely, the seller can use the loaned amount to replace his securities if the buyer fails to return the original collateral. Both the risk and reward associated with the pledged securities accrue to the seller. He remains the beneficial owner, even though the buyer owns the collateral during the term of the agreement. Should the value of the securities fall during the contract period, the seller incurs the loss. He also bears the risk of default by the company, which issued the securities. The buyer's risk is thus negligible, as the seller and the issuer are most unlikely to default simultaneously.
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Phase 1 A bond trader (the seller) wishes to borrow € 25 million to finance the purchase of € 24 million of 6.5% Bund 2003 securities for one week. Phase 2 A repo dealer (the purchaser) offers the bond trader a repo rate of 5.25%. Phase 3 The bond trader accepts the offer. On the value date, he delivers the € 24 million principal amount of 6.5% Bunds of 2003 against € 25 million in cash. Phase 4 On the value date, the repo dealer pays € 25 million in return for the € 24 million nominal amount of 6.5% Bunds of 2003. Phase 5 At the end of the one-week term of the contract, the purchaser returns the € 24 million of Bunds to the seller. The latter repays the loan of € 25 million, plus interest of:
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STATISTICS Established in July 2001, the Eurex Repo Euro Market has become one of the largest markets for collateralized funding and Special trading in European securities. The evolution of this successful market model has been achieved by constant functional development with strong focus on market needs. To date, the Euro Repo Market has more than 50 participants, mainly banks from Austria, Germany, United Kingdom, France, Belgium and Switzerland. Since its inception in 2001 the Euro Market has grown continuously. The annual average growth rate until 2008 is 67%. Euro Market - Development of Outstanding Volume from August 2001 to May 2009 in million EUR
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GC POOLING (GENERAL COLLATERAL) Principles GC Pooling® is a cash-driven general collateral market of Eurex Repo® and offers an unique combination of collateralized money market trading with the efficiency and security of Eurex Clearing AG's central counterparty. It is easy to trade extremely large tickets and deals can be seamlessly completed and then processed automatically without any issues over credit or security allocation. The compelling advantage of GC Pooling® is the re-use possibility of received collateral for further money market transactions and refinancing within the framework of ECB open market operations. The OneWeek Tender term with flexible value dates for term legs enables participants to utilize surplus liquidity resulting from the European Central Bank tender in an efficient manner. GC Pooling® was developed jointly by Eurex Repo, Eurex Clearing and Clearstream Banking and launched in March 2005 with the expressed purpose of delivering all the recognizable advantages of electronic trading, through a well-regarded Clearing House in combination with a centralized collateral management system. Major Advantages at a Glance Trading
• • • • •
Secured Euro cash funding collateralized by unique, harmonized baskets Cash-driven General Collateral (GC) trading on an open order book basis Two available baskets comprises approximately 8,000 or more than 23.000 ECB/Bundesbank-eligible securities Multiple terms: OverNight, TomNext, SpotNext, OneWeek Tender, SpotTerm and FlexTerm.* Anonymous trading via Eurex Clearing stepping in as central counterparty
Clearing as Central Counterparty
• • • • • • • • •
Minimize risk through the use of Eurex Clearing as central counterparty Netting at clearing level with Eurex Clearing delivery management Balance sheet netting due to central counterparty Re-use of collateral and pledge to ECB/Bundesbank (Euro GC Pooling® Basket only) Linking of Clearstream Banking, Frankfurt and Clearstream Banking, Luxembourg assets to one virtual collateral pool Automated processing in Clearstream Banking, Luxembourg and Clearstream Banking, Frankfurt security accounts Automated allocation of securities Real-time substitution of securities The collateral management services are provided by the Clearstream Systems Xemac® and CmaX. Page | 36
*Specifications Terms Euro GC Pooling OverNight (ON) Euro GC Pooling Tomorrow Next (TN) Euro GC Pooling OneWeek Tender Euro GC Pooling SpotNext (SN) Euro GC Pooling Spot Term (S FORWARD) Euro GC Pooling Flex Term Trade day Settlement front leg Settlement term leg T T via RTS T+1 in SDS1 T T+1 in SDS1 T+2 in SDS1 T T T T T+1 in SDS1 T+2 in SDS1 T+2 in SDS1 T+X in SDS1 T+X in SDS1 T+3 in SDS1 T+X in SDS1 T+X in SDS1
RTS = Real Time Settlement; SDS1 = Same Day Setttlement
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GC Pooling® - Development of Outstanding Volume from March 2005 to May 2009 in million EUR
CHF MARKET Page | 38
Principles The Repo market in Swiss francs got off to a successful start in June 1999. Swiss and foreign participants can carry out their funding and collateral management operations directly on the interbank market as well as at the almost daily auctions of the Swiss National Bank (SNB), thereby also facilitating their intraday liquidity management in Swiss francs. The SNB now relies almost exclusively on repo auctions via this electronic platform to conduct its open market operations, and in principle accepts government bonds from Switzerland, Germany and other European countries as well as German Jumbo "Pfandbriefe". A type of bond issued by German mortgage banks that is collateralized by long-term assets used. These types of bonds represent the largest segment of the German private debt market and are considered to be the safest debt instruments in the private market. The term Jumbo Pfandbriefe is used to refer to the larger, more liquid segment of the Pfandbriefe market and with face values of around 500 million euros (about $6 million). Advantages for the participant
Screen based trading increases trading volume, price transparency and rapidity of trading. Ultimately, this results in narrower spreads. The term and collateral overview fulfils the dealing requirements of both General Collateral and Special repo traders. Integrated clearing/settlement is the basis for secure, fast and cost-effective execution. Eurex Repo makes it possible to take part in central bank auctions, which means that participants can manage their intraday liquidity efficiently in Swiss francs. Internet technology permits simple installation and use, and low-cost system operation (plug & play). Multi-currency and multi-market capability enables repo trading on one platform.
INTRADAY REPO Page | 39
Unique in the electronic Repo environment, intraday contracts enables both national and international participants to organize their intraday liquidity management in Swiss francs in accordance with their particular needs. Multi Currency Repo Trading The Multi Currency service is based on the already existing CHF repo trading system and uses the same principles as the Swiss Triparty Repo market. Liquidity in EUR, USD and GBP can be managed from intraday up to 12 months with General Collateral baskets. Multi Currency repo trading is based on the well established cooperation between Eurex Zürich AG and SIX SIS (SegaInterSettle). The already existing multi-lateral contract applicable for CHF repo trading also applies for Multi Currency trading. Electronic CHF Repo Market with a fully integrated value chain Fully integrated trading, clearing and settlement Over 100 participants are using the CHF Repo Market platform since the successful start in June 1999 A market for all The electronic CHF Repo Market is open for all interested participants who fulfill the Trading and Clearing Admission. Contract Size Minimum CHF 1 Million for GC Repo Minimum CHF 10,000 for Special Repo Specifications Fixed Income Baskets: SNB GC Basket: Defined from the Swiss National Bank, is equivalent to the sum of the all other baskets. CHF GC Basket: In Switzerland issued bonds with a minimum rating of A and a minimum issue size of CHF 100 million. GOV GC Basket: Government bond issues of the following countries: Austria, Belgium, Finland, France, Germany, Ireland, Netherlands and Spain. International GC Basket: Pfandbriefe, Int. Organizations, Agencies and County Issues. EEA FI GC(European Economic Area Fixed Income)Basket: ECB eligible securities with a minimum rating of A-/A3 and a minimum issue size of EUR 200 million. Open Order Book Page | 40
All quotes are binding. Participants can use the Fill-or-Kill trading restriction. All orders and quotes will be automatically deleted at market close. Order Types Indication of Interest, Quote, Addressed Offer Trading Fees The fee models apply to the entire Swiss Franc Repo Market, including foreign currencies
No admission fee No software license fee Market Driver II Non-Agg. Aggressor 0.006 % 0.0015% 0.003% 0.001% 0.003% 0.003% 50'000/10'000/10/Market Participant Non-Agg. Aggressor 0.006 % 0.0025% 0.003% 0.002% 0.003% 0.003% 5'000/800/10/-
Trading Fees Market Driver I Quoting Non-Agg. Aggressor IN, TIN, ON, TN, SN 0.006 % 1W bis 1M 0.001% 0.002% 2M bis 12M 0% 0.001% SPC, NON, IMM 0.003% Annual fee (CHF) 150'000/Minimum invoice per 25'000/month (CHF) Minimum fee per 10/transaction (CHF)
Minimum transaction fee per currency: EUR 6.50; USD 8; GBP 4.50 Non-Aggressor=Participant who has entered into the system the quote or indication of interest (IOI) that ultimately results in a given transaction. Aggressor=Participant who has traded on the basis of a quote or indication of interest (IOI) published in the system.
A SCREEN ON YOUR PC Page | 41
The "Term Overview" assists dealers in gaining a sense of the term structure, and is primarily used by GC traders.
The "Collateral Overview" assists dealers in gaining a sense of the collateral structure, and is primarily used by Special traders.
MARKET CONCEPT Page | 42
TRADING AND CLEARING ADMISSION
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Trading Admission Eurex Repo
The applicant must be under the regulation of a domestic regulatory authority The applicant must have the status of a bank (i.e. allowance to carry out deposittaking, lending and financial-commission business activities), the status equivalent to that of Swiss securities dealer or a special permit from Eurex Zürich AG for Central Banks, International Organizations as well as for other applicants without holding banking status or a securities dealer permit Branch offices may also be admitted as participants The applicant is responsible for the technical connection to the Eurex Repo® trading system
Settlement and Clearing Admission The applicant needs the admission to operate via SIX SIS (SegaInterSettle) and SIX Interbank Clearing for Collateral and Cash operations.
Cash Clearing: an SNB Giro Account and a Settlement Account at SIX Interbank Clearing Settlement and pledging of Securities: Security deposit: at SIX SIS (SegaInterSettle) - Pledged Securities Account: at SIX SIS (SegaInterSettle)
Statistics Total outstanding volume in the CHF Repo Market Page | 44
Record volumes in the Eurex Repo CHF Market: Interbank Outstanding:73.7 bn. on October 16, 2008.
Outstanding Interbank volume as per May 1, 2009: CHF 42.4 bn. Outstanding SNB volume as per April 1, 2009: CHF 62.4 bn.
AUCTION MARKET Automated Swiss Primary- and Auction-Market Page | 45
The introduction of a fully electronic primary and issue market represents a further milestone in the modernization of the Swiss financial centre. Auctions of new issues, which have so far been conducted mostly by phone and fax, as well as subsequent trading in the primary market, can now be executed much more efficiently. Market Concept
1. Auctioneer starts the auction. 2. Participants reply. 3. Auctioneer defines size and executes trade. 4. Fully automated clearing and settlement through SIX SIS and SIX Interbank Clearing.
Comprehensive service The electronic trading system supports bond trading in the primary market (the gray market) with a direct tie-in to clearing and settlement. In conjunction with SIX SIS (Sega Page | 46
Inter Settle) and SIX Interbank Clearing is this fully automated execution offered as a complete value-added chain. Unique to Switzerland, auctions of new issues and additional issues of existing securities can be carried out by the issuers themselves. Pricing can be in accordance with the Dutch allocation (descending) or the American allocation (ascending). The expanded over-thecounter functionality is aimed primarily at banks, with their large-volume trading. In order to satisfy the requirements of this market, trading may also be conducted anonymously. Banks and other institutions are able to use this platform already today for their own auctions. The platform can easily be upgraded to handle additional products and markets. Market Concept
PUBLIC SECTOR ISSUES As first-time users, the Swiss Federal Financial Administration and the Swiss National Bank (SNB) have decided to use this platform for their auctions. Page | 47
Advantages for the participants
Participation in First Public Sector Issues is free of charge. Fast and easy software installation on standard Windows NT PC infrastructure. Easy and standardized handling. Guaranteed and fair allocation if the offer is within the set range of prices
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Introduction: “Collateralized Borrowing and Lending Obligation (CBLO)", a money market instrument as approved by RBI, is a product developed by CCIL for the benefit of the entities who have either been phased out from inter bank call money market or have been given restricted participation in terms of ceiling on call borrowing and lending transactions and who do not have access to the call money market. CBLO is a discounted instrument available in electronic book entry form for the maturity period ranging from one day to ninety Days (can be made available up to one year as per RBI guidelines). In order to enable the market participants to borrow and lend funds, CCIL provides the Dealing System through: - Indian Financial Network (INFINET), a closed user group to the Members of the Negotiated Dealing System (NDS) who maintain Current account with RBI. - Internet gateway for other entities that do not maintain Current account with RBI.
What is CBLO? CBLO is explained as under: • An obligation by the borrower to return the money borrowed, at a specified future date; • An authority to the lender to receive money lent, at a specified future date with an option/privilege to transfer the authority to another person for value received; • An underlying charge on securities held in custody (with CCIL) for the amount borrowed/lent. Membership: Membership to CBLO segment is extended to entities that are RBI- NDS members viz. Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Financial Institutions, Insurance Companies, Mutual Funds, Primary Dealers etc. Associate Membership to CBLO segment is extended to entities that are not members of RBI- NDS viz. Co-operative Banks, Mutual Funds, Insurance companies, NBFC's, Corporates, Provident/ Pension Funds etc. Eligible Securities: Page | 49
Eligible securities are Central Government securities including Treasury Bills, as specified by CCIL from time to time. Trading Borrowing Limit and Initial Margin Borrowing limit for the members is fixed everyday after marking to market and applying appropriate hair-cuts on the securities deposited in the CSGL account. The post hair-cut Mark-to-Market value after adjusting for the amounts already borrowed by the members is the borrowing limit, which, in effect, denotes the drawing power up to which the members can borrow funds. Members are required to deposit initial margin generally in the form of Cash (minimum Rs.1 lac) and Government Securities. Initial margin is computed at the rate of 0.50% on the total amount borrowed/lent by the members. Intra day BL/IM enhancements facility is also provided to CBLO members. Members can also withdraw unencumbered portion of BL intra day. However, intra day cash withdrawal is not possible. Auction Market Auction market is available only to NDS Members for overnight borrowing and settlement on T+0 basis. Access to auction market is not available to Associate members. Based on the borrowing limits fixed by CCIL, members submit their borrowing requests to CCDS through CBLO System indicating clearly the amount, maturity and the cap rate before commencement of the auction session. i.e. from 10.30 A.M. to 11.00 A.M. Members are permitted to borrow and lend funds on overnight basis indicating the cap rate/s which is/are linked to CCBOR (a cap rate is the maximum rate up to which the borrower is willing to pay). Currently the permissible caps are: a) CCBOR b) CCBOR + 10 bps c) CCBOR – 10 bps d) No cap specified. CCDS approves the requests of the members subject to availability of borrowing limit and places the same on the specified auction windows on behalf of the borrowing members. The lenders willing to lend place their bids directly on the respective auction window indicating the amount and the rate during the auction session which is open from 11.15 A.M. to 12.15 P.M. At the end of the Auction market session, CCDS initiates Page | 50
auction-matching process based on Uniform Yield principle. The successful borrowers and lenders are notified well before the close of business hours regarding borrowing and lending of funds by them through the dealing system. Normal Market Normal Market is available for all members (including Associate Members) for settlement on T+0 and T+1 basis. The Normal market can be accessed for borrowing funds to the extent of their available borrowing limit, besides members can sell CBLOs held by them to meet their funds requirement instead of holding till maturity. Members intending to sell CBLOs (borrow funds) place their offers directly through order entry form on the CBLO System indicating the amount and rate for a specific CBLO. Likewise, members willing to buy CBLOs (lend funds) place their bids through order entry form specifying the amount and rate for a particular CBLO. The matching of bids and offers takes place on Best Yield – Time Priority basis. Normal market session for NDS Members is currently open from 9.00 A.M. to 4.00 P.M for T+0 and 9.00 A.M to 5.30 P.M for T+1 Settlement on weekdays and on Saturdays from 9.00 A.M. to 2.00 P.M for both Settlements. Similarly, for Associate Members, the normal market session is open from 9.00A.M. To 2.30 P.M. for T+0 and 9.00 A.M. to 5.30 P.M. for T+1 Settlement on weekdays and from 9.00 A.M. to 10.30 A.M. for T+0 and 9.00A.M. to 2.00 P.M for T+1 settlement on Saturdays Clearing & Settlement procedure: The Redemption & T+1 trades are taken up for processing before the start of the trading session on the settlement date and all T+0 trades of both Auction and Normal markets are taken up for processing at the end of the respective trading session of NDS and nonNDS members. CCIL assumes the role of the central counter party through the process of novation and guarantees settlement of transactions processed as above. CBLO obligation is generated by netting of trades in the same CBLO for the Normal market whereas the obligation for CBLOs in the Auction market is worked out on gross basis. Accordingly, CCIL debits the members' CBLO accounts / borrowing limit to the extent of their final CBLO Pay-in obligations. In respect of utilization of borrowing limit, securities to the extent used as collateral are blocked in the CSGL account of the borrowers. There will be no transfer of securities to the lenders but lenders interest in the underlying securities
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is recognized through appropriate documentation. Members can reckon unencumbered securities for SLR calculations. Settlement for NDS Members: The funds obligation for each NDS Member is netted across all the matched trades in the Auction and Normal market in respect of T+0 trades of the current day, T+1 trades of the previous day and redemption obligation. The net funds obligation comprising the member-wise Pay-in and Pay-out position is sent electronically to RBI for effecting debits and credits in the members’ current accounts through the settlement account of CCIL. RBI completes the settlement and sends funds settlement confirmation to CCIL. After receiving settlement confirmation, CCIL posts the CBLOs to the respective buyer member’s CBLO account.
Settlement for Non-NDS Members: Similarly, the net fund obligation for such non-NDS members in respect of their trades in the Normal market is sent electronically to the respective Settlement Banks for effecting debits and credits in the members’ Current accounts through the settlement account of CCIL with the Settlement Bank. These entities should ensure that funds to the extent of their obligations are available in their current account with the concerned Settlement Bank on the day of settlement. CCIL transfers CBLOs to the respective buyer member’s CBLO account after receiving the funds settlement confirmation from the Settlement Banks. RISK MANAGEMENT: CCIL addresses risk relating to trading and settlement by adopting stringent membership norms by restricting its membership only to the entities which meet the minimum eligibility criteria. Members are allowed to borrow to the extent of the limit fixed after MTM valuation of securities with appropriate haircut. The securities in the CSGL account are subjected to daily valuation and any deficit in the value of the securities visà-vis the borrowed amount (face value of CBLO) is collected from the concerned members. Besides, CCIL stipulates initial margin for the lenders in the Auction market and for each bid and offer in the Normal market to address the interest rate risk, in case the lenders do not honor their commitments. In case of members failure to deposit such
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deficit on the same day, it is treated as a Margin Default and penalty is charged accordingly. DEFAULT HANDLING:
(i) Funds Shortage: Shortfall in funds can take place when the members (by lenders on the day of lending and by borrowers on the day of redemption) fail to meet funds obligation on the day of settlement. In such cases, CCIL meets the shortage by utilizing the lines of credit extended by the member banks / Settlement Banks and complete the settlement. CCIL then initiates the default handling process by withholding the CBLOs receivable by the lenders (defaulting members). In case of failure by the borrower to meet the redemption proceeds on maturity of CBLOs, the underlying securities of such member stands encumbered till the funds are replenished alongwith charges. In case of eventual default, CCIL liquidates the underlying securities/CBLOs and adjust the proceeds towards the shortfall and other charges.
(ii) CBLO Shortage: CBLO shortage can take place when the members sell CBLOs without having sufficient borrowing limit or concerned CBLOs in their account. In case of CBLO shortfall, CCIL withholds the funds receivable by the defaulting members and creates CBLOs to the extent of CBLO shortfall quantity by using the withheld funds and credits the same to the concerned buyers’ CBLO account. Alternatively, CCIL may also opt for Close-out process by reducing the CBLO shortfall quantity proportionately from the buyers (lenders) receivable position in the concerned CBLOs. Schedule of Fees and Charges: A one time membership fee of Rs. 50, 000/- shall be payable by the NDS and Non-NDS Members (dealing through internet) of CBLO Segment. The charges for CBLO trades in the Auction Market and Normal Market are as under:
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A. Transaction Charges: (Effective from 1st October, 2008)
Sr. No. Particulars 1. 2. AUCTION MARKET
Charges Rs. 5/- per crore of face value per deal per Member subject to minimum of Rs.5/- and a maximum of Rs.750/- per deal.
NORMAL Rs. 5/- per crore of face value per deal per member subject to MARKET minimum of Rs. 5/- and a maximum of Rs.750/- per trade. (to be charged on the value date of each trade)
B. Settlement Charges: Sr. No. 1. Particulars Charges AUCTION MARKET Rs. 10/- per crore of face value per deal per member subject to minimum of Rs. 10/- and a maximum of Rs. 1750/- per deal for each member to be charged at the time of initial borrowing and lending Plus Applicable Service Tax. Rs. 10/- per crore of face value per deal per member subject to minimum of Rs. 10/- and a maximum of Rs. 1750/- per deal Plus Applicable Service Tax.
C. Default charges Sr. No. 1 Particulars Delayed deposit Margin Default of Charges 5 basis points per day on the amount of shortfall till the shortfall is met. 5 basis point per day on the amount of shortage/default till the shortage/default is fully met; of which, 3 basis point per day will be payable to the non-defaulting Member on the shortfall. (Minimum charges would be Rs. 100/-)
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RBI’s Regulatory Provisions Reserve Bank of India in its Mid Term Review of Monetary and Credit Policy for the year 2002 – 2003 has mentioned about the introduction of CBLO as a money market instrument and of issuance of detailed operating instructions separately in this regard. RBI vides its letter No. MPD.227/07.01.279/2002-03 dated December 20, 2002 has decided to permit CBLO developed by CCIL with the following norms: a) Nature of the Instrument: CBLO would be treated as a money market instrument. There will be no restrictions on the minimum denomination as well as lock-in period for its secondary market transactions. The regulatory provisions for CBLO will be the same as those applicable to other money market instruments. b) Term of the Instrument: CBLO may have original maturity period between one day and upto one year. c) (i) Issue and Trading Norms: • CBLO shall be issued in electronic book-entry form only. • The rate at which CBLO is issued and traded in the secondary market will be decided by market participants. • CBLO could be traded in the secondary market without any lock-in period. • CCIL will provide the trading platform for trading CBLOs to the satisfaction of the market participants. • Dissemination of traded prices to all market participants as also to RBI will also have to be enabled by CCIL. (ii) Borrowing Limits: Borrowing limits for members will be fixed by CCIL at the beginning of the day taking into account the securities deposited by borrowers in their CSGL account with CCIL. The securities will be subjected to necessary hair-cut after marking them to market. The limits so derived in effect will denote the drawing power upto which the members can Page | 55
borrow funds. Lenders will deposit cash to meet initial margin requirements that are designed to take care of the settlement risk. (d) Reserve Requirements: Cash Reserve Ratio (CRR) / Statutory Liquidity Ratio (SLR): The treatment of CBLO in regard to CRR and SLR will be as follows. Cash Reserve Ratio (CRR) Since CCIL would be the central counter party for both borrowers and lenders, the status of CCIL would have implications for applicability of CRR. As CCIL is considered as a non-bank institution, transactions in CBLO will attract CRR even though the actual borrowers and lenders of the transaction are banks. However, in order to develop CBLO as a money market instrument, it has been decided to give a special exemption from CRR for transactions in CBLO subject to the bank maintaining minimum CRR of 3 per cent. Statutory Liquidity Ratio (SLR) Securities lodged in the Gilt Account of the bank maintained with CCIL under CSGL facility remaining unencumbered at the end of any day will be reckoned for SLR purposes by the concerned bank. For this purpose, CCIL will provide a daily statement to banks/RBI listing the securities lodged/utilized/remaining unencumbered. The statutory pre-emptions relating to CRR and SLR will of course have no applicability to institutions like PDs, Mutual Funds, Insurance companies, DFIs, etc. (e) Valuation of Collaterals: Securities in the Gilts Account of the participant for CBLO can be from any of the three categories, viz., ‘Held to Maturity’, ‘Available for Sale’, and ‘Held for Trading’. While CBLO will involve movement of securities from the SGL account of a participant to its own Gilt Account with CCIL on a value free transfer basis, there is no transfer of ownership involved. Since the securities will continue to remain in investment portfolio of the participant even when encumbered, there will be no change in valuation of such Page | 56
securities. The CBLO arrangement envisages earmarking specified value of securities (based on the borrowings under CBLO). The intent of earmarking such securities will be accomplished through a suitable agreement. (f) Risk Weight: Market Risk Since CBLO is fully collateralized by government securities, the risk weight as applicable to government securities for market risk would be applicable to CBLO. (g) Accounting Norms: The accounting treatment of CBLO would be as applicable to any money market instruments/transactions. Collateral: Members of CCIL’s Securities Segment are required to deposit their margin contributions into CCIL’s Settlement Guarantee Fund (SGF) maintained for this business segment. Individual member contributions are a function of their outstanding trade obligations based on the types of trades, securities involved and value dates of settlement. Members are expected to always maintain adequate balances in their SGF to cover their unsettled trade exposures. Margins are required to be maintained by every member for their own trades as well as trades reported by them on behalf of their constituents. SGF is received in the form of both cash and securities. SGF cash contributions are received in CCIL’s Current Account maintained with Reserve Bank of India Mumbai. SGF security contributions are received and maintained in CCIL’s Constituent SGL (CSGL) Account maintained with Reserve Bank of India, Mumbai. Composition: SGF is received in the form of cash and securities. Members are required to maintain a minimum of 10% of their total margin requirements in the form of cash contributions to SGF. Members have the option to maintain their entire SGF contribution in the form of Cash. The balance SGF contribution can be held in the form of specified GOI dated securities and/or Treasury Bills from amongst a list of eligible securities notified by CCIL from time to time. Page | 57
Members of CCIL’s Securities Segment are currently required to maintain a ratio of 1:9 in respect of their cash: securities SGF contributions in relation to their margin requirements.
SGF - Cash Members desirous of making cash contributions to their SGF are required to intimate CCIL about the same using a prescribed format. Cash contributions from members are received by means of their cheques drawn on their Current Account with Reserve Bank of India, Mumbai. These are expected to be held in multiples of INR 100,000.00. Relative cheques are deposited at CCIL counters within cut-off timings prescribed for the purpose. Member SGF balances are updated by CCIL upon receipt of relative funds into its Current Account with RBI. Transaction Reports and Holding Reports are electronically delivered to the concerned members along with other daily business reports. Members seeking to withdraw from their SGF Cash contributions are required to send a prior written notice to CCIL about the same using a prescribed format within cut-off timings prescribed for the purpose. Withdrawal requests are processed and permitted after taking into account concerned member’s outstanding trade obligation. Withdrawal payments are made by means of cheques drawn on its Current Account with Reserve Bank of India, Mumbai. Relative cheques are delivered to concerned members on relative value date at CCIL counters after their SGF Cash Balances have been suitably reduced. Transaction Reports and Holding Reports are electronically delivered to the concerned members along with other daily business reports. SGF – Securities All transfers of securities to and/or from CCIL by its members are carried out on a “Value Free of Payment” basis. Members desirous of making securities contributions to their SGF are required to notify CCIL about the same using a prescribed format. Security contributions are received and maintained in a separate CSGL Account with RBI. SGF security contributions are made
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from among the list of specified securities eligible for margin contributions. The list of Eligible Securities is decided by Risk Management Department. Deposit of Securities by Members into SGF is carried out electronically using the Value Free Transfer functionality in RBI’s Negotiated Dealing System (NDS). A securities transfer request is created and approved by the member. The same is confirmed by CCIL and forwarded to RBI for authorization and settlement. Members have to ensure adherence to cut off timings prescribed by RBI for the purpose. Member SGF balances are updated by CCIL upon receipt of relative securities into its CSGL Account with Reserve Bank of India. Transaction Reports and Holding Reports are electronically delivered to the concerned members along with other daily business reports. Members seeking withdrawal from their SGF contributions are required to send a prior written notice to CCIL about the same using a prescribed format within cut-off timings prescribed for the purpose. Withdrawals requests are processed and permitted after taking into account concerned members’ outstanding trade obligation. Security withdrawals are effected through Value Free Transfer functionality in NDS. A securities transfer request is created and approved by CCIL. The same is confirmed by the concerned member and forwarded to RBI for authorization and settlement. Securities are transferred to the Proprietary SGL Accounts of members maintained with RBI Mumbai on relative value date after their SGF security balances have been suitably reduced. Transaction Reports and Holding Reports are electronically delivered to the concerned members along with other daily business reports. Members are entitled to substitute their SGF holdings after giving prior notice as prescribed by CCIL. Depending on the type of substitution viz., security for cash, cash for security or security for security, members are required to comply with relative deposit and withdrawal procedures specified for the same. Transaction Reports and Holding Reports are electronically delivered to the concerned members along with other daily business reports upon completion of the process.
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Corporate Actions and Benefits: All corporate actions on member SGF holdings are serviced through the electronic funds transfer mechanism of Reserve Bank of India. Relative funds are remitted to the Current Accounts of concerned members with separate individual electronic advices to members SGF – Cash – Interest Payment Members are not entitled to any interest on their cash contributions to SGF, which is expected to be at least 10% of their total margin requirements. In respect of members holding their entire SGF contribution in the form of cash, CCIL pays interest to such members at quarterly rests (at the end of every calendar quarter) on 90% of their average cash balances during the relative period @ 100 basis points below the weighted average 91 Day Treasury Bills’ cut off yields at the last three primary auctions held before the relevant interest payment date. The benchmark instrument to which such interest is pegged as well as spread between the yield on the benchmark instrument and the interest rate paid by CCIL may be changed at the sole discretion of CCIL from time to time. SGF – Securities – Interest Payment Periodic coupon payments received in respect of Members’ SGF security contributions (held in the form of dated securities) are passed on to concerned Members by CCIL immediately upon receipt of relative interest from Reserve Bank of India. SGF – Securities – Redemptions Redemption proceeds of matured securities are treated as concerned members’ additional cash contribution to SGF
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CORPORATE BONDS IN INDIA
Corporate Bonds are issued by public sector undertakings and private corporations for a wide range of tenors but normally upto 15 years. However, some Banks and Companies like Reliance have also issued Perpetual Bonds. Compared to government bonds, corporate bonds generally have a higher risk of default. This risk depends, of course, upon the particular corporation issuing the bond, its rating, the current market conditions and the sector in which the Company is operating. Corporate bondholders are compensated for this risk by receiving a higher yield than government bonds. Some corporate bonds have an embedded call option that allows the issuer to redeem the debt before its maturity date. Some even carry a put-option for the benefit of the investors. Other bonds, known as convertible bonds, allow investors to convert the bond into equity. Advantages of Corporate Bonds 1. Corporate bonds generally offer higher returns than Government Securities, fixed deposits, CD’s & CP’s. 2. Corporate bonds are rated by approved rating agencies e.g. CARE, ICRA, CRISIL, FITCH. (We deal in investment grade scrips only). 3. You can invest in blue-chip corporates with sound credit-quality in a sector of your choice to meet your investment objectives. 4. Corporate bonds provide you with a steady income stream. 5. You can lock-in high rates for a long period of time. 6. Secondary market trading is possible, depending upon demand. 7. No TDS deduction as per Budget Announcement for 2008-09. Disadvantages of Corporate Bonds 1. They are generally unsecured and therefore have an element of credit risk. 2. All Corporate bonds are not actively traded. 3. They form a very small part of the total debt market. 4. While interest rate is generally fixed, all debt securities are subject to market risk, i.e. the price at which they are traded could vary. 5. Unlike Gilts where RBI sometimes steps in to put trades, there are no market makers in corporate bonds. 6. The minimum lot is generally bigger for corporate bonds compared to retail G-Secs. 7. ·Stamp Duty is payable on issue and transfer in some states. However, despite being listed on exchanges, the vast majority of trading volume in corporate bonds in most developed markets takes place in decentralized, dealer-based, Page | 61
over-the-counter markets. The complexities: The corporate bond market plays second fiddle to the government bond market, since the Government of India is the largest issuer of debt in the country. Bond market players tend to shun corporate bonds, terming them illiquid, and preferring to trade in the much more liquid government bond market. Typically, corporate bonds factor in two kinds of risks -- credit and liquidity. Credit risk is usually measured by the ratings assigned to the credit by the rating agencies, while liquidity risk is measured by the acceptability of a credit in the market. In India, trading is concentrated in AAA-rated bonds, as they carry the highest safety and are the most liquid. Among AAA bonds, bonds of public sector units are much more liquid than private sector bonds. This is because a large part of the market, including insurance companies, provident funds and banks, has restrictions on private sector paper. This really means that trading activity in Indian debt market is concentrated in government debt, directly in government securities and indirectly through bonds of government-owned entities. The lack of market for private sector companies has resulted in absolutely no price discovery for issuers of debt, especially for issuers rated below AAA. This has resulted in private sector issuers going for bank loans or accessing the foreign currency bond or loan market. The lack of issuers across the rating scale has led to a non-existent credit spread curve in the corporate bond market. Banks in India have a peculiar problem. The Reserve Bank of India has instructed them to mark corporate bonds taken in their trading books as credit exposures to the underlying credit. This has resulted in many of the banks being unable to trade certain credits as they have hit the exposure limit in their loan books. This has also restricted the freedom of a corporate bond trader in a bank, as he has to take credit clearance from the credit risk officer belonging to the corporate bank. Page | 62
A large part of the market does not mark-to-market the corporate bond portfolio. Insurance companies and provident funds, the largest buyers of corporate bonds in India, do not mark-to-market their portfolios. As a result, once any bond goes into their books, it does not come out. This takes away liquidity from the market. The settlement of corporate bonds carries counterparty risk. The settlement takes place between counterparties as there is no centralised clearing system as existing in government securities market. This makes many counterparties not 'dealable' with each other, due to lack of counterparty risk limits.
What needs to be done:
The committee for reviving the corporate bond market in India should focus on the following: 1. Remove limit restrictions on private sector issuers for insurance companies, provident
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funds and banks. 2. Separate corporate bond trading and loan books for earmarking credit exposures. 3. Allow corporate bond traders to short interest rates and take on the risk of the underlying 4. Increase depth in the market by allowing FII's to trade in the corporate bond market. 5. Make it compulsory for insurance companies and provident funds mark to market a part of their corporate bond portfolios. 6. Introduce centralized settlement system for corporate bonds. 7. Allow repos in corporate bonds. 8. Encourage lower rated issuers to access domestic bond markets. 9. Ensure all issuers stick to standard issue norms akin to government securities. 10. A unified exchange trading system and reporting platform is good for the market. credit.
In the time period of project I came across few very important observations but the highlight of the observation would be that, there is requirement of ‘REPO in corporate bonds, in Indian financial system. Few observations are explained below: Page | 64
REPO IN CORPORATE BONDS
The RBI is the regulatory authority for this part of the market as corporate bond repos would be regarded as money-market instruments. The RBI has been considering allowing corporate bond repos for some time—and now may be moving toward permitting them. CBLOs have been increasingly taking the role of repos but limited to government bonds. Since late 2007, SEBI has been talking with RBI about corporate bond repos. Inevitably this is linked to the parallel discussions on settlement with the exchanges.
More than 90 percent of bond trading activity place off exchange in the OTC market. In OTC corporate bond deals, prices are quoted over the phone, which often prevents an efficient price discovery, as the buyer or the seller might be unaware of the best price available for the debt paper in the market. To have more transparency in the market by bringing in a tri-partite Repo in corporate bonds with Bombay Stock Exchange (BSE) as the Central Counter Party. A central clearing house like the Bombay Stock Exchange will enable a guarantee in payment and settlements and mitigate counter-party risks. This will also encourage a larger participation from foreign investors, which in turn may enhance volumes in the slow-growing corporate bond market.
Existence of an arbitrage opportunity:
Parking surplus funds with the Reserve Bank of India continues to be an attractive option for banks despite the cut in the reverse repo rate. Page | 65
Banks, particularly Government owned, are borrowing against their surplus holding of government securities at a lower rate under Clearing Corporation’s Collateralized Borrowing and Lending Obligation (CBLO) mechanism and deploying the funds at a higher rate with RBI. By doing so, banks are making a tidy spread of 50-100 basis points a day. Consider this: If a bank had borrowed on Monday against its surplus government securities holding at the weighted average interest rate of 2.72 per cent under CBLO and parked the funds at RBI’s Reverse Repo (R/R) window at 3.25 per cent, it stands to make a gain of 53 basis points (100 basis points equals 1 per cent) in just a day. Repo in corporate would allow the participants to borrow money at a lower interest rate and lend it at a higher interest rate in corporate bond market. Thus giving rise to an arbitrage opportunity. For eg: Bank A borrows at a rate of 3%-4% from the CBLO segment or the Call Money market and lends it at a rate of 10% in the corporate bond market would make a gain of 6%-7%. Thus makes an arbitrage in the whole transaction.
Entry of a retail investor:
A retail investor should be given a chance to participate in Repo in corporate bonds. This can be achieved by reducing the size of the Debt paper (in the range of 100,000 to 10,00,000 Rs.) The turnover at NSE and FIMMDA is more than that at the BSE but the number of trades at BSE exceeds far more than the other exchanges, concluding that BSE has more individual investors. BSE has a base of retail investors in the corporate bond market and thus active participation of retail investors in the proposed model is possible. The underlying assumption made above is supported from the statistics shown below: Numbers of trades on the three exchanges are given below: Date BSE* NSE* FIMMDA* Total % of trades reported on BSE Page | 66
Jan-07 Aug-07 Sep-07 Dec-07 Jan-08 Dec-08 Jan-09 June-09
to 22999 to 8121 to 279166 to 259328
1846 1183 3468 5474
Nil 1774 9004 5815
24845 11078 291638 270617
92.5 73.3 95.7 95.8
Source: SEBI • • * Comprises OTC trades and trades done on exchange. Trade reporting on FIMMDA started from September 01/2007.
MY SUGGESTIONS ARE IN THE FORM OF A PROPOSED MODEL
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The given model is based on the opinions of the bankers of the leading Banks like Kotak Mahindra Bank, ICICI Bank & SBI Bank.
All the active members of CROMS. The current number of active members is 94 (source: CCIL). The total no. of participants would include primary dealers, Public sector Banks, Private sector Banks, Co-op Banks, Foreign Banks, NBFC’s, Mutual funds, FII’s & Insurance Cos and other corporates. A new class of lender should be introduced i.e. Individual investor that would help in creating larger volumes. Borrowers: Public sector Banks Primary dealers Private sector Banks Co-op Banks Other corporates Lenders: All Banks Primary dealers NBFC’s Mutual funds FII’s & Insurance Cos Individual retailers
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SECURITIES TO BE ACCEPTED AS COLLATERALS Companies with High Credit Ratings Dominate Corporate Issuance: The distribution of corporate bonds issued by rating indicates that the number of sub investment grade issues is minimal and the proportion below AA is small by value. Only the largest corporations are likely to achieve an AAA rating. Others are thus excluded from the bond market and obliged to rely on bank finance. Recent figures suggest the proportion of lower-rated bonds may be increasing in particular the proportion of subinvestment grade bonds following the SEBI’s relaxing its rules relating to lower-rated bonds. Thus to start with the new product initially only AAA rated corporate bonds should be accepted as collateral. A detail figure of number of bonds listed in the exchange as on August 2005 is given below: Corporate Bonds – Outstanding Issues (Aug25, 2005) Rating class AAA AA+ AA AAA+ A ABBB+ BBB B Grand Rating not available Source: NSE WDM segment At present there are approximately 1800 corporate bonds with AAA rating, although the exact figure is not known. Thus there is a need for setting up a unified exchange traded corporate bond market under the Bombay Stock Exchange. No. Issues 955 320 175 31 16 16 12 11 8 6 1550 82 of Market Shares(%) 61.61 20.65 11.29 2.00 1.03 1.03 0.77 0.71 0.52 0.39 100 Issue Size(Rs.Cr) 92609 19605 13248 1272 1545 1512 1063 833 722 257 132666 9906
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INTRODUCTION OF STANDARD TENOR BY THE EXCHANGE: The exchange would like to introduce a standard tenor in the proposed model. This would bring more transparency and also reduce the volatility in the market. The standard Repo could be overnight repo, 7day repo, 14 day repo and so on till a year.
RISK MANAGEMENT: The Risk Management function would arise as a corollary to BSE’s primary activity i.e. Settlement of trades. By undertaking guaranteed settlement of trades in the corporate bond Repo segment, BSE would seek to reduce the risk arising out of the settlement failures due to the default by a counterparty. It would achieve this goal mainly by becoming a central counterparty to the trades done by its members and managing the risks through its risk management processes in such a manner that the ultimate risk to its member from a settlement failure should be either eliminated or reduced to the minimum. While designing the Risk Management processes, care has to be taken to address segment specific issues. For instance the nature of the risk associated with the clearing & settlement process would not only be Market risk but also be Credit risk.
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HAIRCUT: The haircut in the government securities is in the range of 1%-4%. But the credit risk in government securities is less as compared to that in corporate bonds. Thus, there is a need of a different strategy to be adopted while deciding the haircuts for the corporate bonds. The strategy to be adopted by BSE should be a haircut in the range of 10%-15% depending on the credibility of the underlying security. For eg: a bond worth Rs.100,000/-, when pledge will fetch Rs.90,000 or less irrespective of the tenor. MARGINING: The BSE should collect Initial Margin and Mark To Market Margin from the members in respect of their outstanding trades. In addition to this, BSE may also collect Volatility Margin in case of an unusual volatility in the market. Initial Margin: Initial margin should be collected the likely risk from future adverse movement from the price of the concerned securities. Members should deposit the initial margin in the form of cash/securities, in advance, before putting up any bid or accepting any offer. A proposed initial margin should be 1% for all corporate bonds which would be Repoable.
Mark to Market Margin: Mark to Market Margin is collected to cover the notional loss (i.e. to cover the difference between the current market price and the contract price of the security covered by the trade) already incurred by the member. Mark to Market Margin imposed on a day should be made payable to the BSE on the next business day.
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The corporate bond market in India has not kept pace with the developments in the equity market, which has matured and grown to global standards. It has suffered from chronic neglect, both in terms of policy and infrastructure, and has been almost entirely restricted to a set of domestic institutional investors. For an active secondary market, there is a need for a wider range of issuers and of investors, and with different perceptions for investment and trading in the secondary markets. Broadening and deepening of the bond market is required to provide long tenor project finance. India’s financial system is still largely dominated by the banking system with a deposit base largely of less than 3-year tenors. A borrower who requires long-term funds (10-15 years) is still dependant on a few providers of such long maturity loans. Infrastructure projects like power, telecom, ports, airports, urban infrastructure, roads etc require long-term funds. Consequently, we need a significant growth in the insurance, pension and provident fund sectors since they are the logical providers of long-term money. Simultaneously, small investors need to be brought into the long-term debt capital market. In the absence of such growth, Indian corporates with large expansion plans would expose themselves to significant refinancing risks. The recent past has witnessed many Indian corporates effecting overseas acquisitions as part of their vision of global growth. The overseas subsidiaries of these companies have accessed foreign currency loan/bond market to fund these acquisitions. Hence there is a need to develop a more dynamic and transparent corporate bond market.
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Recommendations: Corporate bonds should be made repo-able. This has been recommended by the Expert Panel on Financial Stability Assessment and Stress Testing that has assisted the Committee on Financial Sector assessment set up by the Finance Ministry and the RBI to assess India’s financial stability. If corporate bonds are made repo-able, they will become more liquid, and the secondary market will thus become more active. “RBI is committed to permitting market repos in corporate bonds,” former RBI Governor, Dr Y.V. Reddy, had said in a speech in Washington last October. If accepted, the measure will add width to the market. The Government has been laying special emphasis on measures designed to give the moribund corporate debt market a fillip. Reference from the European Bond Market should be taken. It will certainly boom the Indian economy. The Non-SLR bond market will go up substantially.
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A] ONLINE PUBLISHED MATERIAL ON WORLD WIDE WEB WWW.GOOGLE.COM WWW.RBI.CO.IN WWW.CCIL.COM
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REPO R H PATIL REPORT EUROX REPO WWW.WIKIPEDIA.COM
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