Primary dealers ramp up corporate bond repo borrowing to diversify liquidity sources

Repo in corporate bond

Primary dealers have ramped up their borrowing through repos in corporate bonds in the AMC repo market to diversify their liquidity needs, fund higher-yielding assets, and participate in a growing and increasingly robust market infrastructure.

According to the AMC Repo Clearing Ltd (ARCL) data, primary dealers borrowed 82.24 percent of total volumes in July, sharply higher than 66.08 percent in June.

The total volume on ARCL Tri-party Repo in July was Rs 52,175.10 crore, compared with Rs 39,725.50 crore in June, registering a growth of 32 percent month-on-month.

Similarly, the number of trades has increased to 463 in July, from 357 in June, as per ARCL data.

“Primary dealers actively participate in the government securities (G-Sec) market and often borrow heavily from the AMC repo market to manage liquidity,” said Kashinath Katakdhond, Managing Director at AMC Repo Clearing.

In the last few years, primary dealers have been increasing their investment in high rated corporate bonds as of part of their portfolio diversification and yield enhancement strategies. Since corporate bonds typically offer higher yields than government securities, they’re attractive for primary dealers seeking better returns on their capital.

Holding more corporate debt means primary dealers need ways to finance these assets, and repos are the most efficient tool.

Further, the Reserve Bank of India and the Securities and Exchange Board of India are promoting repos in corporate bonds and encouraging more participation in this market to make it deeper.

The market edge

Although borrowing rates in this market are around 15–20 basis points higher than in the G-Sec repo market, the ability to roll over positions and access funds at relatively low cost — along with the added benefit of settlement guarantees — makes it an attractive and reliable funding source for corporate bond portfolio (trading book) of primary dealers, Katakdhond added.

Primary dealers, key participants in this market, are leveraging this facility as both borrowers and lenders to support their trading and investment activities. However, the majority of lending in this market is done by mutual funds.

Katakdhond explained that mutual funds use overnight and liquid funds to invest in the corporate bond repo market. This is because investing in these instruments allows them to earn higher returns than lending in the Treps market against the collateral of government securities.

On August 13, the weighted average rate on repo in corporate bonds ended at 5.61 percent, higher than 5.36 percent in the Treps market. This shows that mutual funds, which are major lenders in this market, are earning better returns than the Treps market.

As per ARCL data, mutual funds' share of investment stood at 98.06 percent of the total volumes in repo in corporate bonds.