Introduction
The Securities and Exchange Board of India (SEBI) resolved to implement new valuation standards for repurchase or repo transactions conducted by mutual funds. As per the regulation, securities included in mutual fund transactions will be assessed on a mark-to-market (MTM) basis. This significant advancement will boost the transparency and consistency of mutual fund investments by introducing MTM value for repo transactions. This action will start from January 2025 and is expected to improve the dependability of valuations. Repo transactions are crucial for mutual funds since they ease liquidity management and generate short-term rewards
What Are Repo Transactions?
A repurchase agreement (repo) is a short-term borrowing contract. Securities sold in repository transactions—also referred to as a repo or sale repurchase agreement—are sold with the seller committing to buy them back at a later date. This instrument is employed to generate capital in the short term.
The objectives of the new valuation metrics are to guarantee that mutual funds operate on an equal footing in their valuation practices and to resolve concerns regarding regulatory inconsistencies. The revised valuation metrics will establish consistency across money market and debt securities.
SEBI’s Role
To encourage more investment in corporate bonds, SEBI opened up the repo market to mutual funds in June, allowing them to buy Commercial Papers (CP), and Certificates of Deposits (CD). Additionally, corporate debt securities with a rating of "AA" or above allow mutual funds to take part in repo transactions. The change will come into effect starting 1st January 2025, giving mutual fund platforms enough time to adjust to the new framework.
Historically, the amortisation method, which assessed the worth of the security based on its price and a fixed yield, evaluated repo deals in mutual funds. This strategy, although simple, lacked precision, particularly in volatile market situations.
The new valuation criteria seek to standardise the valuation process for all money market and debt instruments while addressing concerns around unintentional arbitrage in regulations resulting from different valuation methodology. It will help investors get a more transparent understanding of their mutual fund assets.
Under its circular, Sebi announced that the "valuation of repurchase (repo) transactions including TREPS with tenor of up to 30 days shall also be valued at mark to market basis". Moreover, the assessment of all repo transactions, excluding overnight repos, along with the evaluation of money market and debt instruments, will be sourced from valuation agencies.
Consequences for Mutual Funds and Investors
The shift to mark-to-market valuation will offer mutual fund managers a more dynamic evaluation of their portfolios. Repo transactions, which are essential for liquidity management, will now display their true market value, allowing fund companies to improve risk management.
Retail and institutional shareholders will have better clarity concerning the outcomes and risk profile of mutual funds. Investors will have a better idea of what their holdings are worth with repo transactions valued at market prices.
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Influence on NAV Variations
Due to the daily revaluation of repo transactions, the net asset value (NAV) of mutual funds is likely to change more often. This may cause temporary volatility, but it guarantees a more accurate representation of a fund's worth.
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Conformity with International Standards
Worldwide, mark-to-market valuation is standard for repo transactions. SEBI's ruling aligns Indian mutual fund procedures with globally recognised norms, building confidence among foreign investors, and bolstering India's credibility in international markets.
Conclusion
SEBI's mark-to-market valuation implementation for repo transactions by mutual funds signifies a substantial advancement in promoting transparency, precision, and confidence within the mutual fund sector. Although it may present temporary difficulties, the long-term advantages for investors and fund management firms significantly surpass these issues.
By conforming to international standards and emphasising fair value, SEBI reinforces its position as an innovative regulator in India's financial sector.
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