Sebi clears mark-to-market valuation for repo transactions to remove regulatory arbitrage

The valuation of bank deposits will continue to be on a cost plus accrual basis.

To remove a regulatory arbitrage, the market regulator has said that valuation of all mutual-fund investments in repurchase (repo) transactions shall be done on a mark-to-market basis.

Until now, these investments and bank deposits were valued at cost plus accrual basis, and only money market and debt securities of certain maturity were valued at mark-to-market basis.

This created an unintended regulatory arbitrage because of the different valuation methodologies, according to a circular issued by the Securities and Exchange Board of India (SEBI) on November 26.

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To right this, the circular said that valuation of all repo transactions, except for overnight repos, will be done by agencies empanelled by the Association of Mutual Funds in India (AMFI). These agencies do the valuation for investments in money market and debt securities.

The Master Circular on Mutual Funds stands modified as under:

“Valuation of money market and debt securities:

1. All money market and debt securities including floating rate securities shall be valued at average of security level prices obtained from valuation agencies.

2. In case security level prices given by valuation agencies are not available for a new

security (which is currently not held by any Mutual Fund), then such security may be valued at purchase yield/price on the date of allotment / purchase.

The valuation of bank deposits will continue to be on a cost plus accrual basis.

The Master Circular on this stands modified as given below:

"“Investments in short-term deposits with banks (pending deployment) shall be valued on cost plus accrual basis.”

Mutual funds are allowed to invest in repo transactions with corporate debt securities, commercial papers (CPs) and certificates of deposits (CDs).

A consultation paper released by SEBI on October 24 shared the reasoning behind it.

It said, "Considering the above valuation methodologies, a scenario may arise wherein commercial papers of an issuer (E.g. ‘A’) would be valued at mark-to-market basis whereas borrowing through repos on corporate bond, by the same entity (i.e. ‘A’), would be valued at cost plus accrual basis. Thus, in such cases, impact of any event/adverse news concerning the above issuer may get reflected faster in the valuation of its commercial papers and consequently NAV as compared to the repo transactions, thereby creating an unintended regulatory arbitrage. "