In the recent past, the corporate bond market has had a dream run due to the quinella of the government and the Reserve Bank of India (RBI) promoting borrowing by Indian companies through the corporate bond market together with the banks’ current fugue state rendering them wary of lending. While borrowing through the bond markets in India was a relatively niche practice for Indian borrowers until a few years ago, this practice has now come into the mainstream. The RBI’s recent issuance of directions on tri-party repos continues the trend of regulatory moves to deepen corporate bond markets.
Following the issuance of draft directions in April, and based on the public feedback received, the RBI issued the Tri-Party Repo (Reserve Bank) Directions, 2017, on 10 August. While other measures have been taken to encourage Indian borrowers to tap the corporate bond market, the issuance of the 2017 directions is important as it has the effect of creating a framework for a tertiary market for corporate bonds, thus enhancing liquidity.
Briefly, a repo is an instrument for borrowing funds by selling securities with an agreement to resell such securities on a specified date and at an agreed price; a reverse repo is an instrument for lending funds by purchasing securities with an agreement to repurchase such securities on a specified date and at an agreed price; and a tri-party repo is a repo contract where a third party (the tri-party agent) acts as an intermediary to facilitate matters such as collateral selection, payment and settlement, custody and management for the repo transaction.
From a bond market perspective, eligible collateral for a repo transaction has been specified in the RBI’s Repo in Corporate Debt Securities (Reserve Bank) Directions, 2015, to include listed non-convertible debt securities with a maturity of greater than one year, commercial papers, and bonds rated as “AA” and above which are issued by multilateral financial institutions such as the Asian Development Bank, entities in the World Bank Group, or the African Development Bank. The 2015 directions also prescribe that eligible participants for repo transactions in corporate debt securities include scheduled commercial banks, non-banking financial companies, mutual funds registered with the Securities and Exchange Board of India, housing finance companies, and insurance companies.
A repo transaction can be for a minimum period of a day and for a maximum period of one year. A tri-party repo can be traded using any trading process authorized by the RBI including bilateral, multilateral, quote-driven or order-driven processes, and can be traded over the counter on any electronic platform or on any stock exchange. Parties to a repo transaction can enter into bilateral master repo agreements, along with a separate agreement between each participant and the tri-party agent in the form prescribed by the tri-party agent.
The 2017 directions also prescribe that scheduled commercial banks, recognized stock exchanges, clearing corporations of stock exchanges, and clearing corporations under the Payment and Settlement Systems Act, 2007, are eligible to be tri-party agents. All tri-party agents require prior authorization from the RBI. A tri-party agent must have a minimum net worth of ₹250 million (US$3.9 million) and at least five years’ experience in the financial sector, preferably in custody, clearing or settlement services.
The roles and responsibilities of a tri-party agent include: (a) reporting of all repos within 15 minutes to the Clearing Corporation of India (CCIL) or any other platform specified by the RBI; (b) prescribing transparent and reliable collateral valuation standards; (c) revaluation of collateral, margin, income payments on the collateral, as well as substitution of any collateral; (d) maintaining records of repo trades for a period of at least eight years; and (e) ensuring that the transaction is in accordance with the RBI’s directions on repos in corporate debt securities.
While the 2015 directions provided a framework for repo trades in the corporate bond market, it is understood from a 2016 report that there was a lack of interest in such transactions due to various factors including lack of guaranteed settlement. In this vein, the report also noted that repos in government securities are more commonplace due to guaranteed settlement by the CCIL. Therefore, the issuance of the 2017 directions creating a framework for repos with settlement and collateral managed by a third party is a crucial step in deepening the corporate bond market.
By providing a mechanism enabling trading of bonds through a third party, the 2017 framework is expected to generate in various financial sector entities greater interest to invest as well as to trade in corporate bonds.
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