Clearing corporations to reform bond market

Trading will continue to happen on a bilateral basis, but after a deal is struck, the buyer and seller will transfer funds and securities, respectively, to the clearing corporation

1 December is likely to be remembered as the day the revival of the corporate bonds market in India was set in motion. All entities regulated by the Reserve Bank of India (RBI) and the Securities Exchange Board of India (Sebi) will compulsorily start settling their trades in corporate bond from Tuesday through clearing corporations of stock exchanges. This includes a large number of active participants such as banks, primary dealers and mutual funds.
Currently, corporate bonds are traded and settled bilaterally. Once a deal is struck, the buyer transfers the funds to the seller, who then hands over the bonds to the buyer. Since the bonds have to be handed over only after the funds have been received, it creates huge settlement risk from a buyer’s perspective.

Settlement through a clearing corporation will be vastly different. Trading will continue to happen on a bilateral basis, but after a deal is struck, the buyer and seller will transfer funds and securities, respectively, to the clearing corporation. It’s only after both parties have honoured their obligations that the clearing corporation will release funds to the seller and securities to the buyer. Counterparty risk will reduce considerably, leading to lower transaction costs, increased liquidity and better price discovery.
Of course, there’s still the chance that one of the parties would default, in which case the clearing corporation would return the funds or securities.
This is unlike the equities market, where the clearing corporation guarantees all trades. If, say, the seller defaults, the clearing corporation procures the securities from the market and transfers them to the buyer. Whatever loss the clearing house would have incurred in procuring the securities from the market at prevailing prices (vis-à-vis the traded price) is recovered from the margins collected from the seller. This process is difficult in the corporate bond market because they are far less liquid compared with equities, and hence isn’t being attempted.
But defaults are normally few and far between, and would hardly take away from the larger good a central clearing system will bring. Thanks to the reduction in settlement risk, players will be more comfortable trading.
According to a fund manager at an insurance company, foreign institutional investors haven’t been active in the corporate debt market primarily because of the counterparty risk involved in the settlement process.
What’s more, details of most trades will be captured by clearing corporations because of the compulsory settlement diktat, resulting in a higher degree of post-trade transparency. The transparent dissemination of corporate bond prices and quantities traded will also facilitate better participation by market participants. Once the settlement system is in place, it’ll pave the way for a corporate bond repo market. Ultimately, all this will help in reviving the primary market for corporate bonds.
There are likely to be some teething problems, however, with the new settlement system. The circulars by RBI and Sebi apply only to entities regulated by them. Pension funds, for instance, which are relatively large players in the corporate bond market, haven’t been issued any circular by India’s Pension Fund Regulatory and Development Authority (PFRDA).
Some market participants say that pension funds are likely to be slow adopters of the new system, and one large section of the market may be relatively inactive in the near term. It’s not that pension funds can’t register with clearing houses of stock exchanges, but regulated entities in India generally act cautiously and are unlikely to be proactive in registering unless a circular is issued.
Of course, this could be detrimental for them since a large section of the market, namely banks and mutual funds, will have to compulsorily settle through a clearing corporation. Unless they, too, register, they would have to trade with each other or with brokers, which will entail bigger spreads, and hence higher transaction costs. While this learning happens in the first few months of the new settlement system, trading with at least some of the small pension funds spread across the country could be affected.
This is a classic example of inefficiencies in some sections of the Indian markets because of multiple regulators. The corporate bond market will be governed be Sebi, but participants are regulated by multiple regulators such as RBI, Sebi, PFRDA and the Insurance Regulatory and Development Authority. One may argue that all new ventures have teething problems and that they would eventually get sorted out. But as one market intermediary points out, regulators should be involved in ironing out operational difficulties rather than making things more difficult.
Another example of the confusion caused by having multiple regulators is RBI’s decision to continue with the diktat that all its regulated entities have to necessarily use the reporting platform of the Fixed Income Money Market and Derivatives Association of India (Fimmda) to report their corporate bond transactions. Now that all RBI-regulated entities will be compulsorily settling their trades through clearing corporations, all their trades will be captured, and there’s no need for an additional level of reporting. Quite evidently, this makes the circular on reporting trades redundant.
Perhaps there is need for better coordination among regulators to see the obvious.

Source: http://www.livemint.com/2009/11/30222605/Clearing-corporations-to-refor.html?h=B

'Beyond a point, wealth creation is more important than protection'

Birla Sun Life Mutual Fund, India’s fifth largest, is looking to increase the proportion of its equity assets to total assets from 16 per cent to 25 per cent in the next few years. CEO A BALASUBRAMANIAN, speaks to Neha Pandey and Joydeep Ghosh on wealth creation and impact of regulator arbitrage. Excerpts:

Are you happy with the industry’s debt-equity mix?

The equity portion could be much higher than the current exposure, somewhere around 25 per cent, for the industry as a whole. However, fixed income assets cannot be ignored, too, as they cater to the regular income needs of the conservative investor class. We believe this pie will continue to grow.

What is Birla Sun Life’s mix?

Our equity portion is roughly 16 per cent. Some of the bigger players have around 25 per cent. With our recent drive in creating awareness for our schemes, we would expect our equity assets to come closer to the top five industry average sooner than later.

Why have inflows in equities suffered?

The Indian investor does not realise the importance of wealth creation over the long term. Today, we are still talking about only five per cent penetration. In comparison, insurance penetration is much more, because people are seeking protection for themselves. But beyond a point you don’t need protection, you need wealth.

There is a regulator arbitrage because MF distributors have to negotiate their commission, whereas insurance agents are being paid as per the product specifications. How is this impacting the industry?

Regulator arbitrage is narrowing. While it exists today, it may cease to be there tomorrow. But investment decisions cannot be made on the basis of regulator arbitrage. Both investors and sellers have to decide what is best for them over the long run. Sellers cannot advise on the basis of commissions.

The industry is paying an upfront fee and higher trail commissions. How will it impact balance sheets?

This is a temporary phenomenon. The question is how much the fund house will be able to pay and for how long. It could be one year or more… but these numbers are variable in nature and will get revised.

In the past six months, stock market valuations have shot up significantly. What is your outlook on markets?

In the long term, for a three-five-year period, things look quite positive. For one, the overall economy’s confidence level is on the right track, in terms of the industrial production numbers. Second, interest rates are likely to be supportive. Third, the policy initiative from the government will be more favourable.

Will there be a spike in interest rates in the near future?

Despite inflation concerns, rates will not go up in a hurry unless there is a significant growth in credit off-take. The numbers to be watched are the bank credit numbers, which are quite low now.

What would you advise a new investor?

If you want to invest in equities, have a five to 10-year perspective. If you double the money in three to five years, one should be happy. Today, global investors are looking at India as it offers them growth substantially higher than the global growth. In such a scenario, even Indian investors should hold on to their conviction and stay tuned to the market. Going by the thumb rule, returns should be nominal GDP plus 6 per cent. So, in case of a 7 per cent growth and 4 per cent inflation, the nominal GDP would be 11 per cent. The returns would be around 17 per cent per annum in a normal scenario.

On the debt side, where should one invest?

One can invest in income and gilt funds with a two-three year horizon. Income funds are quite dynamic because the fund manager takes a view on interest rate movements regularly. But FMPs (fixed maturity plans) can be avoided, because rates are quite low.

Source: http://www.business-standard.com/india/news/%5Cbeyondpoint-wealth-creation-is-more-important-than-protection%5C/378155/

NSE's MF platform draws Rs78 lakh assets on Day 1

Though the start of the National Stock Exchange's Mutual Fund Service System on Monday was impressive, marketmen feel there could be hiccups ahead.

Mutual funds (MFs) garnered Rs 77.69 lakh worth of assets from 300 applications on the first day of the system that allows transactions in mutual funds through stock-broker terminals.
To provide a fillip to MF sales through the stock platform -- initially rolled out through 1.5 lakh terminals of National Stock Exchange (NSE) -- goodies are being offered by all entities involved. NSE, National Depository Services (India) (NSDL) and stock brokers have waived charges for the initial period.
Sebi has also clarified that no entry load norm would be applicable on investments made in mutual fund schemes through the online platform launched by the NSE.
UTI Mutual Fund was the first to offer its 30 select schemes on the exchange. It received over 300 applications worth Rs 75 lakh on the first day. "Others such as Tata MF, Birla MF, Reliance MF, ICICI MF and Fidelity MF are expected to come on board soon," said Gagan Rai, MD and chief executive officer, NSDL.
However, while the move (new platform) is beneficial to institutional distributors, independent financial advisors (IFAs) could be hit.
"Post August 2009, when the MF commission regime changed, transactions in MFs through IFAs dropped almost 8-9%, while online MF transactions rose by 6-7%. This indicates that institutional distributors (equipped with adequate trading and online investment platforms) would benefit more," said Vinesh Menon, head - retail distribution at Bajaj Capital.
IFAs are enraged at the decision to permit selling through stock terminals. They say people without advisory skills should not be allowed to sell mutual funds.
Rajendra Dhulla, who runs advisory services via Pratham Services, said, "There are about 2 lakh Amfi-certified agents in the country. How will they sell mutual funds through the Bolt without knowledge about funds?"
Another IFA requesting anonymity said stock brokers would try to sell stocks to people who wish to invest in mutual funds, by promising higher returns.
An industry observer said there is an issue about trusting brokers. "Under the new system, the cheque of the amount to be invested has to be given in favour of the stock broker and not the fund house. People would not be comfortable with writing a cheque in favour of the broker as they are not sure about what would be done with the money."
He added that only individuals already exposed to investing in shares would opt for stock platform. "Only individuals, who account for 8% of the total holdings in BSE-500 stocks, would be interested initially," the observer added.
Though some claim that IFAs can use the platform to transact, it is questionable whether they would be willing to share the income with stock brokers. "There is no clarity on the trail commissions that IFAs and distributors earn," said the industry observer.
The Amfi platform for buying and selling MFs, which is likely to be launched in March as per Amfi chairman A P Kurian and Jaideep Bhattacharya, chief marketing officer of UTI Mutual Fund, would try to iron out the hurdles based on initial response to the stock platform, experts said.

Source: http://www.dnaindia.com/money/report_nse-s-mf-platform-draws-rs78-lakh-assets-on-day-1_1318614