Sebi Proposes Mark-To-Market Valuation For Repo Transactions In Mutual Funds

The Securities and Exchange Board of India (SEBI) has proposed a change in the valuation approach for mutual fund investments in repurchase (repo) transactions. The consultation paper said the valuation of repo transactions with a tenure of up to 30 days should be done on a mark-to-market basis.  Currently, these repo transactions,   are valued using a cost-plus accrual method. With the change, Sebi aims to align repo valuations with existing norms for other money market and debt instruments. The public can submit comments until November 14, 2024.

What Are Repo Transactions? Effect of Change in Valuation

In mutual funds, repo transactions are allowed on corporate debt securities, commercial papers (CPs) and certificates of deposits (CDs). Repo transactions, or repurchase agreements is a deal by which MFs sell corporate bonds, CPs, or certificates of deposit, to raise necessary cash quickly. They agree to purchase these assets at a later date. For instance, a fund in need of Rs 1 crore for 10 days can sell these assets and agree to repurchase them later, where the securities act as collateral.

However, under the current system, a disparity exists in valuation. Commercial papers (CPs) are currently valued at market price, while repos for corporate debt securities and CDs are valued based on their cost plus accrued interest.  This means valuing an asset based on its current market price rather than its purchase price or another fixed value can mean the asset can be more valuable or less valuable currently because of market fluctuations.  The cost plus accrual basis currently used values an asset based on its original cost plus any interest that has accrued over time, rather than its current market value.

This inconsistency can create regulatory arbitrage, according to Sebi. For instance, adverse news affecting an issuer may influence the valuation of its CPs more swiftly than those of its bonds used in repo transactions, potentially misleading investors regarding the true value of their investments. In essence, the current cost-plus accrual approach may lag behind real market trends and Sebi proposes to change this valuation mechanism.