Sebi in talks with other regulators to streamline pricing of corporate bonds

Sebi in talks with other regulators to streamline pricing of corporate bonds

The Securities and Exchange Board of India (Sebi) is in discussion with other financial regulators to arrive at a uniform methodology for valuing corporate bonds in a bid to deepen the bond market, according to three people aware of the matter.

Sebi is of the opinion that the uniform methodology may be reviewed by Association of Mutual Funds in India (Amfi), Fixed Income Money Market and Derivatives Association (FIMMDA) of India periodically, said one of the people cited earlier. The regulator has held two meetings since May, a second person said.

Emails and calls to Sebi, RBI and FIMMDA were not answered till the time of going to press.

Currently, banks and mutual funds, two leading participants in the bond market, follow different methods for valuing their bond portfolio, which impedes price discovery and deters transactions.

Banks use the so-called credit matrix spread that is published by FIMMDA on a fortnightly basis. Some insurance companies also follow this spread. Here, since corporate bonds are priced at a premium over risk-free government securities, FIMMDA provides a spread that is used by banks to value their corporate bond portfolio. This is useful because most of the securities, apart from the top-rated, do not frequently trade in the secondary market.

The spread, which is derived from polling in case a particular bond is not traded, is available based on the rating of the bond, its tenor and the type of issuer class, whether financial or non-financial, private or government-owned etc. For instance, there will be credit spread for AAA-rated five-year paper of say, a NBFC. This spread will be added to the annualized yield on five-year government bond for arriving at its valuation.

On the other hand, fund houses use scrip-level valuation to compute the net asset value of schemes where corporate bonds are the underlying exposures. Here, fund houses get the valuation done by the credit rating agencies.

“The difference is at times as high as 100 basis points, especially in below AA+ bonds, which are not frequently traded and hence there can be pricing issue in executing secondary market trades,” said a senior treasury official with a private sector bank.

An August 2016 report on developing the bond market by a committee led by former Reserve Bank of India deputy governor H.R. Khan had also recommended the need for a uniform approach for valuation.

To be sure, valuation is more of an accounting practice and market participants uses other risk-metrics while buying or selling corporate debt in the secondary market. However, a uniform methodology will ensure that valuation are not distorted and eventually benefit in better pricing of corporate bonds, especially when there is regulatory push for companies to meet their fund requirement through the bond route rather than solely depending on bank loans.

According to Lakshmi Iyer, chief investment officer (debt) at Kotak Mutual Fund, a uniform process for debt will ensure that underlying value of the bond is the same just like stock prices.

“This will help evolve the debt market because there will be no guess work on what is the right valuation of bonds and deal execution will be easier,” she said.