The National Stock Exchange and the Bombay Stock Exchange have launched electronic platforms for tripartite repurchase agreements (repo) in corporate bonds, which is expected to improve the liquidity of, and investor appetite for, these securities.
The Reserve Bank of India (RBI) had introduced repos in corporate bonds way back in 2010, but response has been lukewarm because of non-availability of guaranteed settlement and an electronic dealing platform.
Typically, repos facilitate swift conversion of bonds into cash, which helps investors manage liquidity without having to sell, and thus improve liquidity.
“Globally, repos play a critical role in imparting liquidity to corporate bonds, which typically suffer from lower trading ratio relative to government securities,” said Somasekhar Vemuri, Senior Director, CRISIL Ratings. “Repos will also play a critical role of lowering the cost of market-making and that, in turn, should enliven market-making in the secondary market.”
In the absence of repos, market makers need to hold a large inventory of bonds to provide liquidity to the secondary market. This raises the cost of market-making and hampers the role of market makers.
Globally, corporate bonds are not traded heavily because investors tend to hold them till maturity. For instance, the trading ratio (daily traded volume divided by outstanding amount of corporate bonds) is just 0.27% in India, 0.12% in China, 0.19% for South Korea, and 1.16% for the US1. Higher liquidity in the US is supported by a strong repo market worth $2.3 trillion2. Of this, ~45% employ non-government securities as collateral.
Based on the H R Khan Committee recommendations, a series of measures were implemented in the past two years to improve the depth of the domestic corporate bond market. An electronic market platform with guaranteed settlement for repos was also one of the suggestions.
Investors such as mutual funds, primary dealers, banks and insurers can use corporate bond repos to manage liquidity and asset-liability mismatches. Mutual funds can manage redemptions and secure short-term cash investments.
Insurers can start investing more in corporate bonds as they will be able to optimise asset-liability management and duration better through repos without having to sell from their bond portfolios.
Repos collateralised by high-quality corporate bonds will be a valuable tool for risk-averse end-investors to park temporary cash balances. They will also be another avenue for banks to deploy surplus liquidity.
The basket repos introduced include only select AAA category bonds, A1+ rated commercial papers and certificates of deposit.
Ramesh Karunakaran, Director, CRISIL Ratings, said, “Over the medium term, the expansion of basket repos to include AA category bonds, in line with the RBI directions, will help deepen the liquidity for AA rated papers as secondary trading in AA rated papers constitutes only one-fifth of the corporate bond trading volumes. Overall, success will be a function of interest shown by banks, primary dealers, NBFCs, financial institutions, mutual funds, insurers, and housing finance companies.”
1 Trading ratios as of June 2017
2 Repo agreements outstanding as of June 2017