SEBI, in its latest circular dated June 08, 2023, has allowed mutual funds to conduct repo transactions in Commercial Papers (CPs) and Certificates of Deposit (CDs). The market regulator has also clarified that mutual funds can participate in repo transactions only on corporate debt securities that are rated AA and above. These provisions will come into force with immediate effect.

A repo transaction is one where mutual funds use corporate debt instruments as collateral for raising short-term capital with a commitment to repurchase it at a later date at the prevailing rate. This helps mutual funds meet liquidity needs and redemption requests. Mutual funds will now be able to participate in repo transactions through CPs and CDs.

Commercial Papers are unsecured, short-term debt instruments issued by corporations to finance short-term obligations, while Certificates of Deposit are fixed-income instruments issued by banks and financial institutions in a dematerialised form for a specific period.

It is expected that SEBI’s move will boost the growth of the corporate bond market by increasing liquidity in the system. Currently, mutual funds are allowed to conduct repo transactions in AA and above rated corporate debt instruments.

According to SEBI, the credit rating of exposure on repo transactions for various purposes, such as the Potential Risk Class (PRC) matrix, Liquidity ratios, Risk-o-meter, etc., will be the same as that of the underlying securities, i.e. on a look-through basis.

The market regulator also stated that for the transactions where settlement is guaranteed by a Clearing Corporation, the exposure would not be considered for the purpose of determination of investment limits for single issuer, group issuer, and sector-level limits.

In the past too, SEBI undertook various measures to improve liquidity in the debt market and debt mutual funds, such as mandating debt mutual funds to investment of 10% in liquid assets such as cash, government securities, treasury bills, and repo on government securities, introduction of trading through RFQ platform of stock exchanges, introduction of future contracts on corporate bond indices rated AA+ and above, and introduction of back-stop facility for debt mutual funds, among other measures.

SEBI has also issued a consultation paper to allow direct participation of mutual funds in the tri-party repo segment for corporate bonds.

These measures are being taken so that the participants in the debt market do not face adversities when the market conditions turn uncertain or highly volatile.

While the move will not directly benefit investors, it can help mutual funds to benefit from better liquidity, especially during phases of high redemption pressure.

This article first appeared on PersonalFN here

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