Repo market can deepen corporate bond market: Report

The domestic corporate bonds market is worth USD 287 billon, which is around 14 per cent of GDP only, way lower than the equity markets that is around 80 per cent of GDP.

Recently, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) launched an electronic platform for repos (repurchase agreements) which will provide much-needed liquidity, Crisil said in a report today.

Investors like 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.

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.

Repos facilitate swift conversion of bonds into cash, helping 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.

Repos will also play a critical role of lowering the cost of market-making which in turn enlivens market-making in the secondary market, he added.

In the absence of repos, market makers need to hold a large inventory of bonds to provide liquidity to the secondary market, which again is not developed as there is low depth in the 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 per cent in our country, 0.12 per cent in China, 0.19 per cent in South Korea, and 1.16 per cent in the US, as of June, he noted.

But higher liquidity in the US is supported by a strong repo market, worth USD 2.3 trillion. Of this, around 45 per cent employ non-government securities as collateral, as of June.

Based on the HR Khan panel report, a series of steps were taken over the past two years to improve depth of the corporate bond market. And the NSE and BSE setting up a repo platforms with guaranteed settlement was one of the suggestions of the panel.

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, said, "Over the medium term, the expansion of basket repos to include AA category bonds, in line with the RBI directions, will help deepen liquidity for AA-rated papers as secondary trading in such papers constitutes only one-fifth of the corporate bond trading volume.

"Overall, the success will be a function of interest shown by banks, primary dealers, NBFCs, financial institutions, mutual funds, insurers, and housing finance companies," he added.