Securities and Exchange Board of India, or SEBI, chairman Ajay Tyagi today said that the regulator would soon come out with a circular mandating fund houses to hold a minimum percentage of assets in liquid assets, including government securities and treasury bills for all debt funds.
While addressing at the Association of Mutual Funds in India's 25th annual general meeting, the SEBI chief spoke about the various measures it is taking to improve liquidity in corporate bond markets. Here are a few measures that are in the offing:
Expert committee to frame stress testing
An expert committee is being formed to frame stress testing methodology encompassing liquidity, market and credit risk for all open-end debt schemes. The committee will design a framework to determine the minimum asset allocation required in liquid assets, considering the nature of schemes, assets, type of investors, the outcome of stress testing, minimum redemption requirement during gating, etc.
Treating all unitholders fairly
SEBI chief said that schemes sometimes witness large redemptions. In such cases, schemes may not have very liquid assets to sell off. Thus, there are high chances that more liquid assets get liquidated first and the scheme is then progressively left with a relatively more illiquid portfolio. This benefits the exiting investors at the cost of those who stay, particularly in stressed situations. The proposed expert committee would also examine liquidity risk management tools such as swing pricing or anti-dilution levy for passing on transaction costs to transacting investors. The tools would apply to both incoming and outgoing investors, thereby protecting the interests of existing investors.
Measures to boost corporate bond market liquidity
Tyagi noted that mutual funds are on the largest holders of corporate bonds. They contribute significantly in the secondary market trading for corporate bonds and commercial papers. But under many scenarios, when there are industry-wide trends of subscriptions or redemptions, it becomes difficult for mutual funds to get a sizeable counterparty to cater to their buying and selling needs. Thus, there is a pressing need to increase liquidity in the corporate bond market to ensure smooth functioning of debt funds.
Besides mandating mutual funds to execute a minimum percentage of trades in corporate bonds through Request for Quote, or RFQ, platform of stock exchanges, SEBI is pursuing a host of measures to not only increase liquidity in the secondary market, but also to enable greater issuances of paper rated below AAA. These measures include:
Repo in corporate bonds: A liquid repo market using corporate bond collateral has the potential to greatly enhance demand for corporate bonds as well as secondary market liquidity in corporate bonds. Many investors who do not consider corporate bonds due to their illiquidity would have access to low-cost funds collateralised by their corporate bond holdings. Market makers in corporate bonds needing access to low-cost capital as well as securities to cover their short sales will also be able to carry out their market making operations more cost efficiently in the presence of liquid repo markets. SEBI is deliberating a limited purpose central clearing corporation for guaranteed settlement of tri party repo trades in all investment grade corporate bonds including those below AAA rated paper to boost repo trading in corporate bonds. Mutual funds will be the biggest beneficiaries of this.
Backstop facility: The regulator is mulling setting up a backstop facility entity that can trade in relatively illiquid investment-grade corporate bonds and be readily available in times of stress to buy such bonds from various market participants in the secondary market.
