INTRODUCITON

The capital market comprises of equities market and debt market. Debt market is a
market for the issuance, trading and settlement in fixed income securities of various
types. Fixed income securities can be issued by a wide range of organizations including
the Central and State Governments, public bodies, statutory corporations, banks and
institutions and corporate bodies

INTRODUCTION TO FIXED INCOME INSTRUMENTS

Fixed Income securities are one of the most innovative and dynamic instruments evolved
in the financial system ever since the inception of money. Based as they are on the
concept of interest and time-value of money, Fixed Income securities personify the
essence of innovation and transformation, which have fueled the explosive growth of the
financial markets over the past few centuries.

Fixed Income securities offer one of the most attractive investment opportunities with
regard to safety of investments, adequate liquidity, and flexibility in structuring a
portfolio, easier monitoring, long term reliability and decent returns. They are an
essential component of any portfolio of financial and real assets, whether in the form of
pure interest-bearing bonds, varied type of debt instruments or asset-backed mortgages
and securitized instruments.

FIXED INCOME MARKETS - POWERING THE WORLD

The Fixed Income securities market was the earliest of all the securities markets in the
world and has been the forerunner in the emergence of the financial markets as the
engine of economic growth across the globe. The Fixed Income Securities Market, also
known as the debt market or the bond market, is easily the largest of all the financial
markets in the world today. The Debt Market has, as such, a very prominent role to play
in the efficient functioning of the world financial system and in catalyzing the economic
growth of nations across the globe.

INDIAN DEBT MARKET - PILLARS OF THE INDIAN ECONOMY

The Debt Market plays a very critical role for any growing economy which needs to
employ a large amount of capital and resources for achieving the desired industrial and
financial growth. The Indian debt market is today one of the largest in Asia and includes
securities issued by the Government (Central & State Governments), public sector
undertakings, other government bodies, financial institutions, banks and corporate. The
Indian debt markets with an outstanding issue size of Government securities (Central and
state) close to Rs.13,474 billion (or Rs. 1,34,7435 crore) and a secondary market
turnover of around Rs 56,033 billion (in the previous year 2007) is the largest segment of
the Indian financial markets.(Source RBI & CCIL).

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The Government Securities (G-Secs) market is the oldest and the largest component of
the Indian debt market in terms of market capitalization, outstanding securities and
trading volumes. The G-Secs market plays a vital role in the Indian economy as it
provides the benchmark for determining the level of interest rates in the country through
the yields on the government securities which are referred to as the risk-free rate of
return in any economy.

TRANSFORMATIONS IN THE MARKET STRUCTURE

The Indian Debt Markets are today poised on the threshold of momentous change and
transition to an efficient, transparent and vibrant market with significant retail
participation. The first half of the twentieth century had witnessed a significant amount
of retail interest and participation in the G-Sec market with more than half the holdings
of G-Secs issued being held by retail investors, a trend which continued until the early
sixties. The administered interest rate regime and the emergence of other equity and debt
instruments led to a gradual diminution in the investor interest and participation in the G-
Sec market

The Indian Debt Market structure was hitherto that of a wholesale market with
participation largely restricted to the Banks, Institutions and the Primary Dealers. The
rapidly expanding volumes in the Wholesale Debt Market over the past few years bear
the promise of an immense and attractive financial market with a strong potential for
retail participation. The Retail Debt Market in India is being created, thanks to the
pioneering efforts of the Exchanges and the market participants and the strong leadership
and guidance by SEBI, RBI and the Govt. of India.

The Honorable Union Finance Minister, while presenting the Union Budget for 2006-
2007, accepted the recommendations of the High Level Committee on Corporate Bonds
and Securitization and made a significant policy announcement about creation of a
single, unified exchange-traded market for corporate bonds in India. An internal
committee under the chairmanship of SEBI Whole Time Member Dr. T.C. Nair was
constituted to chalk out a plan for implementation of a Unified Exchange Traded
Corporate Bond Market in India. Pursuant to the recommendations of the Committee,
SEBI issued a circular on December 12, 2006, entrusting to Bombay Stock Exchange
Ltd. the task of rolling out a Unified Reporting Platform for all corporate bonds traded in
India with an aggressive target date of January 1, 2007.

SEBI has subsequently taken several steps towards creation of a vibrant Corporate Bond
market. On July 2,2007 SEBI permitted BSE to launch a trade matching platform with
essential features of an OTC Market. Several other initiatives like simplification of the
Debt listing agreement, rationalization of stamp duty and introduction of Repos on
Corporate Bonds have been taken by SEBI.

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BSE'S BOND WITH INVESTORS

Bombay Stock Exchange Limited (BSE), the premier stock exchange in the country, has
heralded the capital market revolution in India and has contributed immensely towards
the achievement of global standards of efficiency and safety by the Indian capitals
market.

BSE, with its rich experience of 133 years in the Indian capital market, offers investors
an efficient and transparent nation-wide platform for trading in Equities, Debt and
Derivative products. BSE is now in the throes of change, having transformed itself into a
corporate entity effective August 19,2005, and several significant initiatives are in the
offing.

BSE - BONDING WITH THE FUTURE

The BSE Debt segment would seek to pave the way for the development of a healthy,
efficient and active debt market mechanism and market structure in line with world class
standards and greater integration with the global economy. The BSE vision for the Indian
Debt Market foresees the markets growing in leaps and bounds in the near future, soon
attaining global benchmarks of safety, efficiency and transparency. This will truly help
the Indian capital markets to attain a place of pride among the leading capital markets of
the world.

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 COMPANY PROFILE

Bombay Stock Exchange is the oldest stock exchange in Asia with a rich heritage, now
spanning three centuries in its 134 years of existence. What is now popularly known as
BSE was established as "The Native Share & Stock Brokers' Association" in 1875.

BSE is the first stock exchange in the country which obtained permanent recognition (in
1956) from the Government of India under the Securities Contracts (Regulation) Act
1956. BSE's pivotal and pre-eminent role in the development of the Indian capital market
is widely recognized. It migrated from the open outcry system to an online screen-based
order driven trading system in 1995. Earlier an Association Of Persons (AOP), BSE is
now a corporatized and demutualised entity incorporated under the provisions of the
Companies Act, 1956, pursuant to the BSE (Corporatization and Demutualization)
Scheme, 2005 notified by the Securities and Exchange Board of India (SEBI). With
demutualization, BSE has two of world's best exchanges, Deutsche Börse and Singapore
Exchange, as its strategic partners.

Over the past 134 years, BSE has facilitated the growth of the Indian corporate sector by
providing it with an efficient access to resources. There is perhaps no major corporate in
India which has not sourced BSE's services in raising resources from the capital market.

Today, BSE is the world's number 1 exchange in terms of the number of listed
companies and the world's 5th in transaction numbers. The market capitalization as on
December 31, 2007 stood at USD 1.79 trillion. An investor can choose from more than
4,700 listed companies, which for easy reference, are classified into A, B, S, T and Z
groups. The BSE Index, SENSEX, is India's first stock market index that enjoys an
iconic stature , and is tracked worldwide. It is an index of 30 stocks representing 12
major sectors. The SENSEX is constructed on a 'free-float' methodology, and is sensitive
to market sentiments and market realities. Apart from the SENSEX, BSE offers 21
indices, including 12 sector indices. BSE has entered into an index cooperation
agreement with Deutsche Börse. This agreement has made SENSEX and other BSE
indices available to investors in Europe and America. Moreover, Barclays Global
Investors (BGI), the global leader in ETFs through its iShares® brand, has created the

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'iShares® BSE SENSEX India Tracker' which tracks the SENSEX. The ETF enables
investors in Hong Kong to take an exposure to the Indian equity market.
The first Exchange Traded Fund (ETF) on SENSEX, called "SPIcE" is listed on BSE. It
brings to the investors a trading tool that can be easily used for the purposes of
investment, trading, hedging and arbitrage. SPIcE allows small investors to take a long-
term view of the market.

BSE provides an efficient and transparent market for trading in equity, debt instruments
and derivatives. It has a nation-wide reach with a presence in more than 359 cities and
towns of India. BSE has always been at par with the international standards. The systems
and processes are designed to safeguard market integrity and enhance transparency in
operations. BSE is the first exchange in India and the second in the world to obtain an
ISO 9001:2000 certifications. It is also the first exchange in the country and second in
the world to receive Information Security Management System Standard BS 7799-2-
2002 certification for its BSE On-line Trading System (BOLT). BSE continues to
innovate. In recent times, it has become the first national level stock exchange to launch
its website in Gujarati and Hindi to reach out to a larger number of investors. It has
successfully launched a reporting platform for corporate bonds in India christened the
ICDM or Indian Corporate Debt Market and a unique ticker-cum-screen aptly named
'BSE Broadcast' which enables information dissemination to the common man on the
street.

In 2006, BSE launched the Directors Database and ICERS (Indian Corporate Electronic
Reporting System) to facilitate information flow and increase transparency in the Indian
capital market. While the Directors Database provides a single-point access to
information on the boards of directors of listed companies, the ICERS facilitates the
corporates in sharing with BSE their corporate announcements.
BSE also has a wide range of services to empower investors and facilitate smooth
transactions:
Investor Services: The Department of Investor Services redresses grievances of
investors. BSE was the first exchange in the country to provide an amount of Rs.1
million towards the investor protection fund; it is an amount higher than that of any
exchange in the country. BSE launched a nationwide investor awareness

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 programme- 'Safe Investing in the Stock Market' under which 264 programmes were
held in more than 200 cities.

The BSE On-line Trading (BOLT): BSE On-line Trading (BOLT) facilitates on-
line screen based trading in securities. BOLT is currently operating in 25,000 Trader
Workstations located across over 359 cities in India.

BSEWEBX.com: In February 2001, BSE introduced the world's first centralized

exchange-based Internet trading system, BSEWEBX.com. This initiative enables
investors anywhere in the world to trade on the BSE platform.

Surveillance: BSE's On-Line Surveillance System (BOSS) monitors on a real-time

basis the price movements, volume positions and members' positions and real-time
measurement of default risk, market reconstruction and generation of cross market
alerts.

BSE Training Institute: BTI imparts capital market training and certification, in
collaboration with reputed management institutes and universities. It offers over 40
courses on various aspects of the capital market and financial sector. More than
20,000 people have attended the BTI programs
AWARDS:

• The World Council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSE's initiatives in Corporate Social Responsibility
(CSR).
• The Annual Reports and Accounts of BSE for the year ended March 31, 2006 and
March 31 2007 have been awarded the ICAI awards for excellence in financial
reporting.
• The Human Resource Management at BSE has won the Asia - Pacific HRM
awards for its efforts in employer branding through talent management at work,
health management at work and excellence in HR through technology

Drawing from its rich past and its equally robust performance in the recent times, BSE
will continue to remain an icon in the Indian capital market.

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 OBJECTIVE OF THE STUDY

1. To understand the different types of instruments and structure of the Indian Debt

Market.

2. To understand the concept of REPO (Repurchase Agreement) and the legal rules

involving REPO trade.

3. To collect and analyze information from the European Bond Market and study

the functions of the different types of instruments in the European Bond Market.

4. To gather information about the Indian model of a tri-partite REPO which is

Collateralized Borrowing and Lending Obligations (CBLO)

5. To study the present situation of the corporate bond market in India, the

complexities in it and try to discover methods by which rectifications can be

made that might improve the current condition of corporate bonds in India.

6. To study the need of REPO in corporate bonds

7. To suggest a model based on the opinions of experienced REPO traders as well

as a personal interpretation and point of view.

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 RESEARCH METHODOLOGY

RESEARCH:

Research in its most common sense refers to search for knowledge. One can also define
research as a scientific and systematic search for pertinent information on a specific
topic. In fact, research is an art of scientific investigation.

The Advanced Learner’s Dictionary of Current English lays down the meaning of
research as ‘a careful investigation or inquiry especially through search for new facts in
any branch of knowledge.’

Research is, thus, an original contribution to the existing stock of knowledge making for
its advancement. It is the pursuit of truth with the help of study, observation, comparison
and experiment.

RESEARCH DESIGN:

A research design is the arrangement of conditions for collections and analysis of data in
a manner that aims to combine relevance to the research purpose with economy in
procedure. In fact, the research design is the conceptual structure within which research
is conducted; it constitutes the blueprint for the collection, measurement and analysis of
data.

For the purpose of this project, the following is the research design:

a. What is the study for? The study is for getting more knowledge on Repurchase
Agreement (REPO).
b. Why is the study being made? The study is being made to find out possibility of
REPO in corporate bonds.
c. Where will the study be carried out? The study will be carried in Bombay Stock
Exchange.
d. What period of time will the study include? The study includes a period of 60
days.

DATA COLLECTION

While deciding about the methods of data collection to be used as the study, the
researcher should keep in mind two types of data which are:

a) Primary Data

b) Secondary Data

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Primary Data:

Primary Data is that data which is collected fresh and is used for the first time and thus
happen to be original in character. There are several methods of collecting primary data,
particularly in surveys and descriptive researches. Important ones are
I. Observation method.
II. Interview method etc.

Secondary Data:

Secondary Data is that data that has already been collected by someone else and has
already passes through the statistical process. When the researcher utilizes secondary
data, then he has to look into various sources from which he has to obtain them.
Secondary data can be either published or unpublished data. Usually published data is
available in
I. Publications of central or state governments
II. Publications of foreign governments or of international bodes
III. Technical and trade journals
IV. Books, magazines and newspapers, etc.

The data used by me for the purpose of this project was Primary Data as well as
Secondary data. I had more of interactions with people,
I was fortunate to collect some primary data with help of the Interactive sessions with
some of the end user of the concerned financial instrument i.e. REPO.

Names of the people whom I interviewed are given below:

Mr. Benny Antony (Vice President, Treasury of Kotak Mahindra Bank, Mumbai)
Mr. Nilesh Patil (Dealer in Treasury, SBI DFHI, Mumbai)
Mr. Kapil Agarwal ( Back office Treasury, ICICI Bank, Mumbai)

Secondary data which was used by me comprises of Publications of Clearing

Corporation of India Ltd (CCIL) and the facts from the R.H. Patil Report on Corporate
bonds. I also referred some of the financial website with official website of BSE, RBI,
Eurex Repo etc. for collecting data for my project.

LIMITATIONS
a) The time period of 60 days seemed to be a little less for the entire project.
b) At times I found that there was a bit of hesitancy and reluctance on the part of
people to answer questions.
c) Since I was not a full time employee of the BSE, It was difficult to get
appointments of the concerned people
d) Since the Treasury department of any bank contains highly confidential
information, I did not get a chance to access the actual trading in REPO market.

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 INTRODUCTION TO THE PROJECT

1. Indian Debt Market

a) Types of Instruments
b) Structure of Indian Debt Market
c) Participants in Indian Debt market

2. Repurchase Agreement (REPO)

a) Types of REPO
b) Legal Rules

3. European Bond Market

a) Euro REPO Trade
b) GC Pooling
c) CHF Market

4. Collateralized Borrowing and Lending Obligation (CBLO)

a) Introduction
b) Clearing and Settlement procedure
c) Risk Management and Default Handling
d) Fees and Charges
e) RBI’s Regulatory Provisions
f) Corporate Actions and Benefits

5. Corporate Bonds in India

a) Advantages & Disadvantages
b) The Complexities
c) What needs to be done

6. REPO in Corporate Bonds

a) Need
b) Existence of an Arbitrage Opportunity
c) Entry of a Retail Investor

7. Proposed Model
a) Participants
b) Collaterals
c) Introduction of Standard Tenor
d) Risk Management

8. Conclusion

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 INDIAN DEBT MARKET

The capital market comprises of equities market and debt market. For a developing
economy like India, debt markets are a crucial source of funds. The debt market is much
more popular than the equity markets in most parts of the world. In India the reverse has
been true. This has been due to the dominance of the government security in the debt
market and that too, a market where government was borrowing at pre-announced coupon
rates from basically a captive group of investors, such as banks. Thus there existed a
passive internal debt management policy. This, coupled with automatic monetisation of
fiscal deficit prevented a deep and vibrant government securities market. It includes
government securities – the largest component - and bonds issued by public sector
undertakings, other government bodies, financial institutions, banks and companies. Debt
markets are now considered an alternative route to banking channels for finance.

The debt market in India comprises broadly two segments

• Government Securities Market and
• Corporate Debt Market.

The Corporate Debt Market is further classified as Market for

• PSU Bonds
• Private Sector Bonds.

Debt Instruments are obligations of issuer of such instruments as regards certain future
cash flows representing Interest & Principal, which the issuer would pay to the legal
owner of the Instruments. Generally debt instruments represent agreements to receive
certain cash flows as per the terms contained within the agreement. They can also be said
to be tradable form of loans.

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TYPES OF INSTRUMENTS

Debt Instruments are of various types like Bonds, Debentures, Commercial Papers,
Certificates of Deposit, Government Securities (G secs) etc. A brief detail about some of
these investment options are given below.

GOVERNMENT SECURITIES-
Government Securities are securities issued by the Government for raising a public loan
or as notified in the official Gazette. They consist of Government Promissory Notes,
Bearer Bonds, Stocks or Bonds held in Bond Ledger Account. They may be in the form
of Treasury Bills or Dated Government Securities.

Mostly Government Securities are interest bearing dated securities issued by RBI on
behalf of the Government of India. GOI uses these funds to meet its expenditure
commitments. These securities are generally fixed maturity and fixed coupon securities
carrying semi-annual coupon. Since the date of maturity is specified in the securities,
these are known as dated Government securities, e.g. 8.24% GOI 2018 is a Central
Government security maturing in 2018, which carries a coupon of 8.24% payable half
yearly.

Features of Government Securities

1) Issued at face value
2) No default risk as the securities carry sovereign guarantee.
3) Ample liquidity as the investor can sell the security in the secondary market
4) Interest payment on a half yearly basis on face value
5) No tax deducted at source
6) Can be held in D-mat form.
7) Rate of interest and tenor of the security is fixed at the time of issuance and is not
subject to change (unless intrinsic to the security like FRBs).
8) Redeemed at face value on maturity
9) Maturity ranges from of 2-30 years.
10) Securities qualify as SLR investments (unless otherwise stated).

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The dated Government securities market in India has two segments:

1) Primary Market:
The Primary Market consists of the issuers of the securities, viz., Central and Sate
Government and buyers include Commercial Banks, Primary Dealers, Financial
Institutions, Insurance Companies & Co-operative Banks. RBI also has a scheme of non-
competitive bidding for small investors (see SBI DFHI Invest on our website for further
details).

2) Secondary Market:
The Secondary Market includes Commercial banks, Financial Institutions, Insurance
Companies, Provident Funds, Trusts, Mutual Funds, Primary Dealers and Reserve Bank
of India. Even Corporates and Individuals can invest in Government Securities. The
eligibility criterion is specified in the relative Government notification.

Auctions: Auctions for government securities are normally multiple- price auctions either
yield based or price based.

Yield Based: In this type of auction, RBI announces the issue size or notified amount and
the tenor of the paper to be auctioned. The bidders submit bids in term of the yield at
which they are ready to buy the security. If the Bid is more than the cut-off yield then its
rejected otherwise it is accepted

Price Based: In this type of auction, RBI announces the issue size or notified amount and
the tenor of the paper to be auctioned, as well as the coupon rate. The bidders submit bids
in terms of the price. This method of auction is normally used in case of reissue of
existing government securities. Bids at price lower then the cut off price are rejected and
bids higher then the cut off price are accepted. Price Based auction leads to a better price
discovery then the Yield based auction. Occasionally RBI holds uniform-price auctions
also.

Underwriting in Auction:
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One day prior to the auction, bids are received from the Primary Dealers (PD) indicating
the amount they are willing to underwrite and the fee expected. The auction committee of
RBI then examines the bid on the basis of the market condition and takes a decision on
the amount to be underwritten and the fee to be paid. In case of devolvement, the bids put
in by the PD’s are set off against the amount underwritten while deciding the amount of
devolvement and in case the auction is fully subscribed, the PD need not subscribe to the
issue unless they have bid for it.

G-Secs, State Development Loans & T-Bills are regularly sold by RBI through periodic
public auctions. SBI DFHI Ltd. is a leading Primary Dealer in Government Securities.
SBI DFHI Ltd gives investors an opportunity to buy G-Sec / SDLs / T-Bills at primary
market auctions of RBI through its SBI DFHI Invest scheme (details available on website
itself). Investors may also invest in high yielding Government Securities through “SBI
DFHI Trade” where “buy and sell price” and a buy and sell facility for select liquid scrips
in the secondary markets is offered.
.
CORPORATE BONDS-
Corporate Bonds are issued by public sector undertakings and private corporations for a
wide range of tenors normally upto 15 years although some corporates have also issued
perpetual bonds. Compared to government bonds, corporate bonds generally have a
higher risk of default. This risk depends, of course, upon the particular corporation
issuing the bond, the current market conditions, the industry in which it is operating and
the rating of the company. Corporate bondholders are compensated for this risk by
receiving a higher yield than government bonds.

CERTIFICATE OF DEPOSIT
CDs are negotiable money market instrument issued in demat form or as a Usance
Promissory Notes. CDs issued by banks should not have the maturity less than seven days
and not more than one year. Financial Institutions are allowed to issue CDs for a period
between 1 year and up to 3 years.
CDs are like bank term deposits but unlike traditional time deposits these are freely
negotiable and are often referred to as Negotiable Certificates of Deposit. CDs normally
give a higher return than Bank term deposit. CDs are rated by approved rating agencies
(e.g. CARE, ICRA, CRISIL, and FITCH) which considerably enhance their tradability in
the secondary market, depending upon demand. SBI DFHI is an active player in
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secondary market of CDs.

Features of CD
• All scheduled banks (except RRBs and Co-operative banks) are eligible to issue CDs.
• They can be issued to individuals, corporations, trusts, funds and associations.
• NRIs can also subscribe to CDs, but on non-repatriable basis only. In secondary market
such CDs cannot be endorsed to another NRI.
• They are issued at a discount rate freely determined by the issuer and the
market/investors.
• CDs issued in physical form are freely transferable by endorsement and delivery.
Procedure of transfer of dematted CDs is similar to that of any other demat securities.
• For CDs there is no lock-in period.
CDs are issued in denominations of Rs.1 Lac and in the multiples of Rs. 1 Lac thereafter.
Discount/Coupon rate of CD is determined by the issuing bank/FI.Loans cannot be
granted against CDs and Banks/FIs cannot buy back their own CDs before maturity.

COMMERCIAL PAPERS-

A CP is a short term security (7 days to 365 days) issued by a corporate entity (other than
a bank), at a discount to the face value. One can invest in CPs starting from a minimum
of 5 lacs (face value) and multiples thereof. CPs are rated by approved rating agencies
(e.g. CARE, ICRA, CRISIL, FITCH). CPs normally gives a higher return than fixed
deposits & CDs. We deal in investment grade CPs only. CPs can be traded in the
secondary market, depending upon demand. An element of credit risk is attached to CPs.

TYPES OF BONDS

Classification on the basis of Variability of Coupon

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Zero Coupon Bonds
Zero Coupon Bonds are issued at a discount to their face value and at the time of
maturity, the principal/face value is repaid to the holders. No interest (coupon) is paid to
the holders and hence, there are no cash inflows in zero coupon bonds. The difference
between issue price (discounted price) and redeemable price (face value) itself acts as
interest to holders. The issue price of Zero Coupon Bonds is inversely related to their
maturity period, i.e. longer the maturity period lesser would be the issue price and vice-
versa. These types of bonds are also known as Deep Discount Bonds.

Treasury Strips
Treasury strips are more popular in the United States and not yet available in India. Also
known as Separate Trading of Registered Interest and Principal Securities, government
dealer firms in the United States buy coupon paying treasury bonds and use these cash
flows to further create zero coupon bonds. Dealer firms then sell these zero coupon
bonds, each one having a different maturity period, in the secondary market.

Floating Rate Bonds

In some bonds, fixed coupon rate to be provided to the holders is not specified. Instead,
the coupon rate keeps fluctuating from time to time, with reference to a benchmark rate.
Such types of bonds are referred to as Floating Rate Bonds.
For better understanding let us consider an example of one such bond from IDBI in
1997. The maturity period of this floating rate bond from IDBI was 5 years. The coupon
for this bond used to be reset half-yearly on a 50 basis point mark-up, with reference to
the 10-year yield on Central Government securities (as the benchmark). More frequently
used in the housing loan markets where coupon rates are reset at longer time intervals
(after one year or more), these are well known as Variable Rate Bonds and Adjustable
Rate Bonds. Coupon rates of some bonds may even move in an opposite direction to
benchmark rates. These bonds are known as Inverse Floaters and are common in
developed markets
CLASSIFICATION ON THE BASIS OF VARIABILITY OF MATURITY

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Callable Bonds
The issuer of a callable bond has the right (but not the obligation) to change the tenor of
a bond (call option). The issuer may redeem a bond fully or partly before the
actual maturity date. These options are present in the bond from the time of
original bond issue and are known as embedded options. A call option is
either a European option or an American option. Under an European option,
the issuer can exercise the call option on a bond only on the specified date,
whereas under an American option, option can be exercised anytime before
the specified date. This embedded option helps issuer to reduce the costs
when interest rates are falling, and when the interest rates are rising it is
helpful for the holders.

• Puttable Bonds
The holder of a puttable bond has the right (but not an obligation) to seek redemption
(sell) from the issuer at any time before the maturity date. The holder may exercise put
option in part or in full. In riding interest rate scenario, the bondholder may sell a bond
with low coupon rate and switch over to a bond that offers higher coupon rate.
Consequently, the issuer will have to resell these bonds at lower prices to investors.
Therefore, an increase in the interest rates poses additional risk to the issuer of bonds
with put option (which are redeemed at par) as he will have to lower the re-issue price of
the bond to attract investors.

Convertible Bonds
The holder of a convertible bond has the option to convert the bond into equity (in the
same value as of the bond) of the issuing firm (borrowing firm) on pre-specified terms.
This results in an automatic redemption of the bond before the maturity date. The
conversion ratio (number of equity of shares in lieu of a convertible bond) and the
conversion price (determined at the time of conversion) are pre-specified at the time of
bonds issue. Convertible bonds may be fully or partly convertible. For the part of the
convertible bond, which is redeemed, the investor receives equity shares and the non-
converted part remains as a bond.

CLASSIFICATION ON THE BASIS OF PRINCIPAL REPAYMENT

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 • Amortising Bonds:
Amortising Bonds are those types of bonds in which the borrower (issuer) repays the
principal along with the coupon over the life of the bond. The amortising schedule
(repayment of principal) is prepared in such a manner that whole of the principle is
repaid by the maturity date of the bond and the last payment is done on the maturity date.
For example - auto loans, home loans, consumer loans, etc.

• Bonds with Sinking Fund Provisions

Bonds with Sinking Fund Provisions have a provision as per which the issuer is required
to retire some amount of outstanding bonds every year. The issuer has following options
for doing so:
1. By buying from the market
2. By creating a separate fund which calls the bonds on behalf of the issuer
Since the outstanding bonds in the market are continuously retired by the issuer every
year by creating a separate fund (more commonly used option), these types of bonds are
named as bonds with sinking fund provisions. These bonds also allow the borrowers to
repay the principal over the bond’s life.

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 Structure of the Indian Debt Market

Regulators

SEBI, RBI

MARKET ISSUERS SECURITIES INVESTORS

PARTICIPANTS
CENTRAL
GOI dated RBI
GOVT securities, Treasury
/SEGMENT Bills, State govt.
GOVERNMENT securities, index
STATE bonds, zero coupon DFIs
bonds
GOVT

GOVT BANKS
AGENCIES & Govt. Guaranteed
STATUTORY Bonds/ Debentures
BODIES
PENSION
PSU Bonds, FUNDS
PUBLIC SECTOR
PUBLIC SECTOR Debentures, Comm.
UNDERTAKINGS Papers
FIIs
CORPORATE

COMMERCIAL
BANKS/DFIs
CD, Debentures,
Bonds
S
INDIVIDUALS

CORPORATES
Bonds, debentures,
THE PRIVATE Comm. Paper (CP)
SECTOR Secured Promissory PROVIDENT
Notes, FCDs, PCDs, FUNDS
ZCBs

INSURANCE Cos,
PRIVATE SECTOR Bonds, Debentures, TRUSTS,
BANKS CPs and CDs MUTUAL FUNDS

Page | 19
From the above diagram we can observe that there are three main segments of the debt
market in India: government securities, public sector unit (PSU) bonds and private
corporate securities. The market for government securities comprises the central
government securities such as T-bills and state government securities. The PSU bonds
are generally treated as surrogates for sovereign paper, sometimes due to explicit
guarantees and often due to the comfort of public ownership. Some of the PSU bonds are
tax-free, unlike most other bonds, including government securities. Private corporate
securities include corporate bonds and debentures, which are mostly medium-term
papers with maturities up to seven years, and commercial paper, which is a short-term
corporate debt instrument with maturities from 15 days to one year. The money market
overlaps with the debt market inasmuch as T-bills and other short-term debt papers with
maturities up to one year form an integral part of the money market

Market structure consists of issuers, instruments, processes, investors, rating agencies

and regulatory environment.

i) Issuers
Indian Debt Market has almost all-possible variety of issuers, as is the case in many
developed markets. It has large private sector corporate, public sector undertakings
(union as well as state), financial institutions, banks and medium and small companies:
Thus the spectrum appears to be complete. Figure 1, delineates details on various classes
of issuers. Two main classes include private sector corporate and banks.

ii) Instruments
The above chart provides names of some of the more popular instruments that have been
issued. Till recently Indian debt market was predominantly dominated by plain vanilla
bonds. Over a period of time, many other instruments have been issued. They include
partly convertible debentures (PCDs), fully convertible debentures (FCDs), deep
discount bonds (DDBs), zero coupon bonds (ZCBs), bonds with warrants, floating rate
notes (FRNs) / bonds and secured premium notes (SPNs). The coupon rates mostly
depend on tenure and credit rating. However, these may not be strictly correlated in all
cases. The maturities of bonds generally vary between one year to ten years. However,
the median could be around four to five years. The maturity period by and large depends
on outlook on interest rates. In expectation of falling interest rates environment,
Page | 20
corporate, it is observed, mostly go to shorter-term instruments while the opposite is true
in case of possible hike in interest rates. For the past few years interest rates have been
falling and short end issues are on the rise. This is one of the reasons that many corporate
are reluctant to go for public issue route and listing of their securities.

iii) Processes
There are several processes that are in vogue in India as well as in other markets. The
more popular ones are public issue and private placement routes. Both these have their
own pros and cons. In a mature and developed market where large number of
institutional investor /sophisticated investors are available and a highly developed mutual
fund industry is in operation, the private placement route may be acceptable to issuers,
investors and regulators. In a less developed market / small market it is a catch 22
position. Private placement is not suitable because this market do not have adequate
number of informed investors and the public issue route may create regulatory arbitrage,
higher compliance costs resulting sometimes in migration of markets. In India private
placement route is highly popular owing to various reasons

iv) Intermediaries
Two classes of intermediaries required for the proper development of debt market are
broker and investment banker/ merchant banker. Most of the brokers as well as merchant
bankers in India are inadequately capitalized and their professional knowledge also needs
further improvement. In some markets, it is observed that there are dedicated “Debt
Managers” who facilitate subscription or sometimes subscribe to the issue and later on
even facilitate trading in bonds. India needs a dedicated “Bond Manager” concept.

v) Investors
For the development of Corporate Debt Market / Fixed Income Securities Market, it is
necessary and sufficient to have a large as well as diverse number of sophisticated /
institutional investors. The above figure lists some of the classes of investors that have
been investing in the debt market. Institutional Investors in India are few in number and
the variety also is limited. Banks and financial institutions, by and large, do not take
active interest in Corporate Debt Market. Investors with diverse expectations are a
precondition for the development of corporate debt market. Diversity could be in terms
of maturity needs as well as expectations on interest rates. The most important structural
Page | 21
weakness in India is lack of large and diverse institutional investors. India has large
number of retail investors; however, their expectations are quite contrary to market
principles - risk and return. Most investors think and perceive that investments in bonds
should provide them guarantee, repayment of principal and regular payment of coupons.
Any delay/default causes worries in their minds. And sometimes these investors
complain to regulators or to the government for non-receipt of coupons or non-
repayment of principal. This type of behavior implies lack of understanding of the
principles of the capital market on the part of the investors
.
vi) Rating agencies
India has a well developed Credit Rating Agency system and rating agencies are well
experienced and regarded. By and large, their ratings do carry confidence in the market.

Page | 22
 PARTICIPANTS IN INDIAN DEBT MARKETS

Primary Debt Market

• Govt. of India
• State Government
• Govt. / Local Bodies
• Public Sector Corporate
• Private Sector Corporate

2. Secondary Debt Market

• Banks
• Financial Institution
• Primary dealers
• Insurance Companies
• Pension Funds, PFs, Trusts, Mutual Funds.
• Individuals

3. Traditional Investors
• Public Sector Banks
• Private Sector & Foreign Banks
• Primary Dealers
• Financial Institutions Companies
• LIC, GIC

4. New Class of Investors

• FIIs & Mutual Funds
• Co-operative Banks
• Private Insurance Companies
• NBFCs & Housing Finance
• Corporate & Retail Investors

Page | 23
 REPURCHASE AGREEMENT (REPO)

A Repurchase agreement (also known as a repo or Sale and Repurchase Agreement)

allows a borrower to use a financial security as collateral for a cash loan at a fixed rate of
interest. In a repo, the borrower agrees to sell immediately a security to a lender and also
agrees to buy the same security from the lender at a fixed price at some later date. A repo
is equivalent to a cash transaction combined with a forward contract. The cash
transaction results in transfer of money to the borrower in exchange for legal transfer of
the security to the lender, while the forward contract ensures repayment of the loan to the
lender and return of the collateral of the borrower. The difference between the forward
price and the spot price is the interest on the loan while the settlement date of the forward
contract is the maturity date of the loan.

Structure and terminology

A repo is economically similar to a secured loan, with the buyer receiving securities as
collateral to protect against default. There is little that prevents any security from being
employed in a repo; so, Treasury or Government bills, corporate and
Treasury/Government bonds, and stocks/shares (it is not secured loans and have to be
removed from repo securities list), may all be used as securities involved in a repo.
However, the legal title to the securities clearly passes from the seller to the buyer, or
"investor". Coupons (installment payments that are payable to the owner of the
securities) which are paid while the repo buyer owns the securities are, in fact, usually
passed directly onto the repo seller. This might seem counterintuitive, as the ownership
of the collateral technically rests with the buyer during the repo agreement. It is possible
to instead pass on the coupon by altering the cash paid at the end of the agreement,
though this is more typical of Sell/Buy Backs.
Although the underlying nature of the transaction is that of a loan, the terminology
differs from that used when talking of loans because the seller does actually repurchase
the legal ownership of the securities from the buyer at the end of the agreement. So,
although the actual effect of the whole transaction is identical to a cash loan, in using the
"repurchase" terminology, the emphasis is placed upon the current legal ownership of the
collateral securities by the respective parties.

Page | 24
The following table summarizes the terminology:

Repo Reverse repo

Participant Borrower Lender

Seller Buyer
Near leg Sells securities Buys securities

Far leg Buys securities Sells securities

TYPES OF REPO AND RELATED PRODUCTS

There are three types of repo maturities: overnight, term, and open repo. Overnight refers
to a one-day maturity transaction. Term refers to a repo with a specified end date. Open
simply has no end date. Although repos are typically short-term, it is not unusual to see
repos with a maturity as long as two years.
Repo transactions occur in three forms: specified delivery, tri-party, and held in custody.
The third form is quite rare in developing markets primarily due to risks. The first form
requires the delivery of a prespecified bond at the onset, and at maturity of the
contractual period. Tri-party essentially is a basket form of transaction, and allows for a
wider range of instruments in the basket or pool. Tri-party utilizes a tri-party clearing
agent or bank and is a more efficient form of repo transaction.

DUE BILL/HOLD IN-CUSTODY REPO

In a due bill repo, the collateral pledged by the (cash) borrower is not actually delivered
to the cash lender. Rather, it is placed in an internal account ("held in custody") by the
borrower, for the lender, throughout the duration of the trade. This has become less
common as the repo market has grown, particularly owing to the creation of centralized
counterparties. Due to the high risk to the cash lender, these are generally only transacted
with large, financially stable institutions.

Page | 25
TRI-PARTY REPO

The distinguishing feature of a tri-party repo is that a custodian bank or international

clearing organization acts as an intermediary between the two parties to the repo. The tri-
party agent is responsible for the administration of the transaction including collateral
allocation, marking to market, and substitution of collateral. Both the lender and
borrower of cash enter into these transactions to avoid the administrative burden of bi-
lateral repos. In addition, because the collateral is being held by an agent, counterparty
risk is reduced. A tri-party repo may be seen as the outgrowth of the due bill repo, in
which the collateral is held by a neutral third party.

WHOLE LOAN REPO

A whole loan repo is a form of repo where the transaction is collateralized by a loan or
other form of obligation (e.g. mortgage receivables) rather than a security.

EQUITY REPO

The underlying security for most repo transactions is in the form of government or
corporate bonds. Equity repos are simply repos on equity securities such as common (or
ordinary) shares. Some complications can arise because of greater complexity in the tax
rules for dividends as opposed to coupons.

SELL/BUY BACKS AND BUY/SELL BACKS

A sell/buy back is the spot sale and a forward repurchase of a security. It is two distinct
outright cash market trades, one for forward settlement. The forward price is set relative
to the spot price to yield a market rate of return. The basic motivation of sell/buy backs is
generally the same as for a classic repo, i.e. attempting to benefit from the lower
financing rates generally available for collateralized as opposed to non-secured
borrowing. The economics of the transaction are also similar with the interest on the cash

Page | 26
borrowed through the sell/buy back being implicit in the difference between the sale
price and the purchase price.
There are a number of differences between the two structures. A repo is technically a
single transaction while a sell/buy back is a pair of transactions (a sell and a buy). A
sell/buy back does not require any special legal documentation while a repo generally
requires a master agreement to be in place between the buyer and seller (typically the
SIFMA/ICMA commissioned Global Master Repo Agreement (GMRA)). Typically,
sell/buy-backs do not allow for marking to market and margin call, which can result in
larger counterparty risks than those of securities lending or repo agreements. Any coupon
payment on the underlying security during the life of the sell/buy back will generally be
passed back to the seller of the security by adjusting the cash paid at the termination of
the sell/buy back. In a repo, the coupon will be passed on immediately to the seller of the
security.
A buy/sell back is the equivalent of a "reverse repo".

SECURITIES LENDING

The general motivation for repos is the borrowing or lending of cash. In securities
lending, the purpose is to temporarily obtain the security for other purposes, such as
covering short positions or for use in complex financial structures. Securities are
generally lent out for a fee. Securities lending trades are governed by different types of
legal agreements than repos.

REVERSE REPO

A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not
the seller's. Hence, the seller executing the transaction would describe it as a "repo",
while the buyer in the same transaction would describe it a "reverse repo". So "repo" and
"reverse repo" are exactly the same kind of transaction, just described from opposite
viewpoints.

Page | 27
USES

For the buyer, a repo is an opportunity to invest cash for a customized period of time
(other investments typically limit tenures). It is short-term and safer as a secured
investment since the investor receives collateral. Market liquidity for repos is good, and
rates are competitive for investors. Money Funds are large buyers of Repurchase
Agreements.

For traders in trading firms, repos are used to finance long positions, obtain access to
cheaper funding costs of other speculative investments, and cover short positions in
securities.

In addition to using repo as a funding vehicle, repo traders "make markets". These
traders have been traditionally known as "matched-book repo traders". The concept of a
matched-book trade follows closely to that of a broker who takes both sides of an active
trade, essentially having no market risk, only credit risk. Elementary matched-book
traders engage in both the repo and a reverse repo within a short period of time,
capturing the profits from the bid/ask spread between the reverse repo and repo rates.
Presently, matched-book repo traders employ other profit strategies, such as non-
matched maturities, collateral swaps, and liquidity management.

LEGAL RULES

1. The objective of this Code is to set out standards of best practices or the repurchase
agreements (repos) market. A high standard of conduct and professionalism is vital to the
development of any market and it would be hoped that the code of conduct laid down
will be followed in letter and spirit by not only principals and intermediaries in the
market but all those who deal in the repo market. Also, all individuals must comply with

Page | 28
the rules and regulations governing the market and keep up-to-date with changes that
may happen from time to time.

2. A Repo transaction is defined as a transaction wherein the securities are sold at a

particular price by one party (Seller) to the other (Buyer) with commitments on the
Seller’s part to repurchase the equivalent securities from the buyer (and a corresponding
commitment on the part of the Buyer to sell the equivalent securities back to seller) on a
certain date and at a certain price, both such date and price being fixed as a part of the
same transaction. Securities are equivalent to other securities for the purpose of this
framework, if they are (i) of the same issuer; (ii) part of the same issue; and (iii) are of
identical type, nominal value, and description as those other securities.
3. Reverse Repo Transaction is defined as a transaction wherein the securities are bought
at a particular price by one party (Buyer) from the one (seller) with a commitment on the
Buyer’s part to sell the Equivalent Securities back to the Seller (and to corresponding
commitment on the part of the Seller to repurchase the Equivalent Securities from the
Buyer) on a certain date and at a certain price both such date and price being fixed as a
part of the same transaction. Securities are equivalent to other securities for the purpose
of this accounting framework, if they are
(i) Part of the same issue; and
(ii) They are of identical type, nominal value, description and amount as those
other securities.

4. Repos will fall within the definition of 'investments' as far as the purchaser of
securities is concerned since the title of the securities bought is transferred to the buyer.

5. Participants in the repo market should at all times treat the names of parties to
transactions as confidential.

6. Participants should know their counterparties and will maintain records of their
conversion – both internal or with the investor – material to their relationship. Where
these are in written form, records must be kept in line with statutory requirements.

Page | 29
7. Participants must accept responsibility for the actions of their staff and all participants
must ensure that any individual of one institution who commits to any other institution
does so within authority.

8. Personnel in back office functions should be functionally separate from those in the
front office. Persons who conclude trades shall not be involved in the confirmation or
settlement of deals.

9. Deals recorded by the trader should be confirmed independently by the back office in
all details recorded by the trader.

10. Experience has shown that recourse to tapes proves invaluable to the speedy
resolution of differences and disputes. Tapes relating to disputed transactions should be
retained until the problem is resolved.

11. All firms, whether acting as principals, agent or broker, have a duty to make
absolutely clear whether the prices they are quoting are firm or corresponding trade.
Also, there is need to define the time by which confirmation should be returned.
Exceptions should be brought to the attention of management by back office and the
management should satisfy themselves of the genuineness of the trade. Prices quoted by
brokers should be taken as indicative unless otherwise qualified.

12. The principals should regard themselves as bound to deal once the price, name
acceptability, credit approved and any other key commercial terms have been agreed.
Original agreements are considered binding.

13. The written confirmation provides a necessary final safeguard against dealing errors.
Conformations should be dispatched and checked promptly, even when oral deal checks
have been undertaken. The issue of checking of confirmation should be a back office
responsibility that should be carried out independently from those who initiate deals.

14. Participants should act with due skill, care and diligence and to facilitate the same
staff should be properly training in the practices of the repo market. Also, they should be
familiar with this code.
Page | 30
15. The market participants should pay particular attention to ensuring fair treatment for
their clients especially where conflicts of interest cannot be avoided.

16. Participants should ensure that they are eligible, legally to undertake repo
transactions and have obtained all the required permissions from their regulatory
authorities, wherever required for the purpose.

17. Where a custodian undertakes a repo transaction on a client, if and when explicitly
permitted by the regulatory authority, the provisions given in the operational guidelines
for Constituents’ SGL Account by RBI will be kept in view as far as transactions in
Government securities are concerned. This is apart from obtaining the necessary
authority for this activity from the client in a clear legal agreement stating therein the
terms and conditions for undertaking the transaction.

18. Participants should ensure that they have adequate systems and control with a view to
satisfying that any repo transactions have been properly authorized before cash or stock
is released, adequate documentation to over the types of transactions are undertaken and
appropriate accounting systems in general and taxation treatment in particular are
followed.

19. Repo transactions should be subject to a legal agreement between the two
participants concerned. A Master Repurchase Agreement should be used for this
purpose. The agreement should provide for the absolute transfer of title to securities,
daily marking to market of transactions, appropriate initial margin and for the
maintenance of margins whenever the mark to market reveals a material change of value,
the events of default and consequential rights and obligations of the counterparties,
clarification on rights of the parties regarding substitution of collateral and the treatment
of coupon and interest payments in respect of securities subject to it etc.

20. Suitable initial margins as per norms laid down by the regulatory authority should be
reflected in the transaction apart from daily margins as required for essential protection
for participants in repo transactions. Collateral including where relevant margins should
be delivered to the account of the counterparty or his agent or a designated third party.
Page | 31
21. The dealing hours will have to be uniform and as stipulated by the regulatory
authority. In cases where deals are undertaken outside of these hours the management
should satisfy themselves that there were good reasons for concluding deals after
prescribed dealing hours.

EUREOPEAN BOND MARKET

Euro REPO Trade Market Concept

PROCESS FLOW OF A EURO REPO TRADE

1) Bank A quotes.
2) Bank B accepts.
3) A trade is generated. Eurex Clearing is now the legal counterparty.
4) Eurex Repo transmits the trading data to Eurex Clearing.

Page | 32
5) Eurex Clearing sends a confirmation to Eurex Repo.
6) Eurex Repo sends a confirmation to the participants.
7) Eurex Clearing transmits settlement information either to Clearstream Banking or to
Euroclear.
8) Margin deposit with Clearstream Banking Frankfurt or at SIS, SegaInterSettle.

A REPO EXAMPLE

A brief description of Repo

The repo (sale and repurchase agreements) business is not well known to the public.
Repo involves the sale of securities (as collateral) and the simultaneous undertaking to
repurchase those securities at a later date. The maturity date is either fixed at the outset
of the agreement, or extended on a day-to-day basis (open repo). Essentially, a repo
simply represents a loan that is backed by investment securities.
Upon expiry of the repo contract, the seller is obliged to repurchase the collateral at the
original selling price. In addition, he pays the buyer interest based on the duration of the
loan and the principal amount involved.
If the seller were to default on his obligation to repay the money, the purchaser is entitled
to sell the pledged securities. Conversely, the seller can use the loaned amount to replace
his securities if the buyer fails to return the original collateral.
Both the risk and reward associated with the pledged securities accrue to the seller. He
remains the beneficial owner, even though the buyer owns the collateral during the term
of the agreement. Should the value of the securities fall during the contract period, the
seller incurs the loss. He also bears the risk of default by the company, which issued the
securities. The buyer's risk is thus negligible, as the seller and the issuer are most
unlikely to default simultaneously.

Page | 33
Phase 1
A bond trader (the seller) wishes to borrow € 25 million to finance the purchase of € 24
million of 6.5% Bund 2003 securities for one week.

Phase 2
A repo dealer (the purchaser) offers the bond trader a repo rate of 5.25%.

Phase 3
The bond trader accepts the offer. On the value date, he delivers the € 24 million
principal amount of 6.5% Bunds of 2003 against € 25 million in cash.

Phase 4
On the value date, the repo dealer pays € 25 million in return for the € 24 million
nominal amount of 6.5% Bunds of 2003.

Phase 5
At the end of the one-week term of the contract, the purchaser returns the € 24 million of
Bunds to the seller. The latter repays the loan of € 25 million, plus interest of:

Page | 34
 STATISTICS

Established in July 2001, the Eurex Repo Euro Market has become one of the largest
markets for collateralized funding and Special trading in European securities. The
evolution of this successful market model has been achieved by constant functional
development with strong focus on market needs. To date, the Euro Repo Market has
more than 50 participants, mainly banks from Austria, Germany, United Kingdom,
France, Belgium and Switzerland.
Since its inception in 2001 the Euro Market has grown continuously. The annual average
growth rate until 2008 is 67%.
Euro Market - Development of Outstanding Volume from August 2001 to May 2009
in million EUR

Page | 35
GC POOLING (GENERAL COLLATERAL)

Principles

GC Pooling® is a cash-driven general collateral market of Eurex Repo® and offers an

unique combination of collateralized money market trading with the efficiency and
security of Eurex Clearing AG's central counterparty. It is easy to trade extremely large
tickets and deals can be seamlessly completed and then processed automatically without
any issues over credit or security allocation.
The compelling advantage of GC Pooling® is the re-use possibility of received collateral
for further money market transactions and refinancing within the framework of ECB
open market operations. The OneWeek Tender term with flexible value dates for term
legs enables participants to utilize surplus liquidity resulting from the European Central
Bank tender in an efficient manner.
GC Pooling® was developed jointly by Eurex Repo, Eurex Clearing and Clearstream
Banking and launched in March 2005 with the expressed purpose of delivering all the
recognizable advantages of electronic trading, through a well-regarded Clearing House in
combination with a centralized collateral management system.

Major Advantages at a Glance

Trading

• Secured Euro cash funding collateralized by unique, harmonized baskets

• Cash-driven General Collateral (GC) trading on an open order book basis
• Two available baskets comprises approximately 8,000 or more than 23.000
ECB/Bundesbank-eligible securities
• Multiple terms: OverNight, TomNext, SpotNext, OneWeek Tender, SpotTerm
and FlexTerm.*
• Anonymous trading via Eurex Clearing stepping in as central counterparty

Clearing as Central Counterparty

• Minimize risk through the use of Eurex Clearing as central counterparty

• Netting at clearing level with Eurex Clearing delivery management
• Balance sheet netting due to central counterparty

• Re-use of collateral and pledge to ECB/Bundesbank (Euro GC Pooling® Basket

only)
• Linking of Clearstream Banking, Frankfurt and Clearstream Banking,
Luxembourg assets to one virtual collateral pool
• Automated processing in Clearstream Banking, Luxembourg and Clearstream
Banking, Frankfurt security accounts
• Automated allocation of securities
• Real-time substitution of securities
• The collateral management services are provided by the Clearstream Systems
Xemac® and CmaX.

Page | 36
*Specifications

Terms Trade day Settlement front leg Settlement term leg

Euro GC Pooling OverNight (ON) T T via RTS T+1 in SDS1
Euro GC Pooling Tomorrow Next T T+1 in SDS1 T+2 in SDS1
(TN)
Euro GC Pooling OneWeek Tender T T+1 in SDS1 T+X in SDS1
Euro GC Pooling SpotNext (SN) T T+2 in SDS1 T+3 in SDS1
Euro GC Pooling Spot Term (S T T+2 in SDS1 T+X in SDS1
FORWARD)
Euro GC Pooling Flex Term T T+X in SDS1 T+X in SDS1

RTS = Real Time Settlement; SDS1 = Same Day Setttlement

Market Concept

Page | 37
 STATISTICS

GC Pooling® - Development of Outstanding Volume from March 2005 to May 2009

in million EUR

CHF MARKET

Page | 38
Principles
The Repo market in Swiss francs got off to a successful start in June 1999.
Swiss and foreign participants can carry out their funding and collateral management
operations directly on the interbank market as well as at the almost daily auctions of the
Swiss National Bank (SNB), thereby also facilitating their intraday liquidity management
in Swiss francs.
The SNB now relies almost exclusively on repo auctions via this electronic platform to
conduct its open market operations, and in principle accepts government bonds from
Switzerland, Germany and other European countries as well as German Jumbo
"Pfandbriefe".

A type of bond issued by German mortgage banks that is collateralized by long-term

assets used. These types of bonds represent the largest segment of the German private
debt market and are considered to be the safest debt instruments in the private market.
The term Jumbo Pfandbriefe is used to refer to the larger, more liquid segment of the
Pfandbriefe market and with face values of around 500 million euros (about $6 million).

Advantages for the participant

 Screen based trading increases trading volume, price transparency and rapidity of
trading. Ultimately, this results in narrower spreads.
 The term and collateral overview fulfils the dealing requirements of both General
Collateral and Special repo traders.
 Integrated clearing/settlement is the basis for secure, fast and cost-effective
execution.
 Eurex Repo makes it possible to take part in central bank auctions, which means
that participants can manage their intraday liquidity efficiently in Swiss francs.
 Internet technology permits simple installation and use, and low-cost system
operation (plug & play).
 Multi-currency and multi-market capability enables repo trading on one platform.

INTRADAY REPO
Page | 39
Unique in the electronic Repo environment, intraday contracts enables both national and
international participants to organize their intraday liquidity management in Swiss francs
in accordance with their particular needs.

Multi Currency Repo Trading

The Multi Currency service is based on the already existing CHF repo trading system
and uses the same principles as the Swiss Triparty Repo market. Liquidity in EUR, USD
and GBP can be managed from intraday up to 12 months with General Collateral
baskets.
Multi Currency repo trading is based on the well established cooperation between Eurex
Zürich AG and SIX SIS (SegaInterSettle). The already existing multi-lateral contract
applicable for CHF repo trading also applies for Multi Currency trading.

Electronic CHF Repo Market with a fully integrated value chain

Fully integrated trading, clearing and settlement

Over 100 participants are using the CHF Repo Market platform since the
successful start in June 1999

A market for all

The electronic CHF Repo Market is open for all interested participants who fulfill the
Trading and Clearing Admission.

Contract Size

Minimum CHF 1 Million for GC Repo

Minimum CHF 10,000 for Special Repo

Specifications Fixed Income Baskets:

SNB GC Basket: Defined from the Swiss National Bank, is equivalent to the sum of the
all other baskets.

CHF GC Basket: In Switzerland issued bonds with a minimum rating of A and a

minimum issue size of CHF 100 million.

GOV GC Basket: Government bond issues of the following countries: Austria, Belgium,
Finland, France, Germany, Ireland, Netherlands and Spain.

International GC Basket: Pfandbriefe, Int. Organizations, Agencies and County Issues.

EEA FI GC(European Economic Area Fixed Income)Basket: ECB eligible securities

with a minimum rating of A-/A3 and a minimum issue size of EUR 200 million.

Open Order Book

Page | 40
All quotes are binding. Participants can use the Fill-or-Kill trading restriction. All orders
and quotes will be automatically deleted at market close.

Order Types

Indication of Interest, Quote, Addressed Offer

Trading Fees

The fee models apply to the entire Swiss Franc Repo Market, including foreign
currencies

 No admission fee
 No software license fee

Trading Fees Market Driver I Market Driver II Market Participant

Quoting Non-Agg. Aggressor Non-Agg. Aggressor Non-Agg. Aggressor
IN, TIN, ON, TN, SN 0.006 % 0.006 % 0.006 %
1W bis 1M 0.001% 0.002% 0.0015% 0.003% 0.0025% 0.003%
2M bis 12M 0% 0.001% 0.001% 0.003% 0.002% 0.003%
SPC, NON, IMM 0.003% 0.003% 0.003%
Annual fee (CHF) 150'000/- 50'000/- 5'000/-
Minimum invoice per
25'000/- 10'000/- 800/-
month (CHF)
Minimum fee per
10/- 10/- 10/-
transaction (CHF)

Minimum transaction fee per currency: EUR 6.50; USD 8; GBP 4.50
Non-Aggressor=Participant who has entered into the system the quote or indication of
interest (IOI) that ultimately results in a given transaction.
Aggressor=Participant who has traded on the basis of a quote or indication of interest
(IOI) published in the system.

A SCREEN ON YOUR PC

Page | 41
The "Term Overview" assists dealers in gaining a sense of the term structure, and is
primarily used by GC traders.

The "Collateral Overview" assists dealers in gaining a sense of the collateral structure,
and is primarily used by Special traders.

MARKET CONCEPT

Page | 42
TRADING AND CLEARING ADMISSION

Page | 43
Trading Admission Eurex Repo

 The applicant must be under the regulation of a domestic regulatory authority

 The applicant must have the status of a bank (i.e. allowance to carry out deposit-
taking, lending and financial-commission business activities), the status
equivalent to that of Swiss securities dealer or a special permit from Eurex Zürich
AG for Central Banks, International Organizations as well as for other applicants
without holding banking status or a securities dealer permit
 Branch offices may also be admitted as participants
 The applicant is responsible for the technical connection to the Eurex Repo®
trading system

Settlement and Clearing Admission

The applicant needs the admission to operate via SIX SIS (SegaInterSettle) and SIX
Interbank Clearing for Collateral and Cash operations.

 Cash Clearing: an SNB Giro Account and a Settlement Account at SIX Interbank
Clearing
 Settlement and pledging of Securities:
Security deposit: at SIX SIS (SegaInterSettle)
- Pledged Securities Account: at SIX SIS (SegaInterSettle)

Statistics

Total outstanding volume in the CHF Repo Market

Page | 44
Record volumes in the Eurex Repo CHF Market:
Interbank Outstanding:73.7 bn. on October 16, 2008.

Outstanding Interbank volume as per May 1, 2009: CHF 42.4 bn.

Outstanding SNB volume as per April 1, 2009: CHF 62.4 bn.

AUCTION MARKET

Automated Swiss Primary- and Auction-Market

Page | 45
The introduction of a fully electronic primary and issue market represents a further
milestone in the modernization of the Swiss financial centre. Auctions of new issues,
which have so far been conducted mostly by phone and fax, as well as subsequent
trading in the primary market, can now be executed much more efficiently.

Market Concept

1. Auctioneer starts the auction.

2. Participants reply.
3. Auctioneer defines size and executes trade.
4. Fully automated clearing and settlement through SIX SIS and SIX Interbank
Clearing.

Comprehensive service

The electronic trading system supports bond trading in the primary market (the gray
market) with a direct tie-in to clearing and settlement. In conjunction with SIX SIS (Sega

Page | 46
Inter Settle) and SIX Interbank Clearing is this fully automated execution offered as a
complete value-added chain.
Unique to Switzerland, auctions of new issues and additional issues of existing securities
can be carried out by the issuers themselves. Pricing can be in accordance with the Dutch
allocation (descending) or the American allocation (ascending). The expanded over-the-
counter functionality is aimed primarily at banks, with their large-volume trading. In
order to satisfy the requirements of this market, trading may also be conducted
anonymously.
Banks and other institutions are able to use this platform already today for their own
auctions. The platform can easily be upgraded to handle additional products and markets.

Market Concept

PUBLIC SECTOR ISSUES

As first-time users, the Swiss Federal Financial Administration and the Swiss National
Bank (SNB) have decided to use this platform for their auctions.

Page | 47
Advantages for the participants

 Participation in First Public Sector Issues is free of charge.

 Fast and easy software installation on standard Windows NT PC infrastructure.
 Easy and standardized handling. Guaranteed and fair allocation if the offer is
within the set range of prices

CBLO

Page | 48
Introduction:
“Collateralized Borrowing and Lending Obligation (CBLO)", a money market
instrument as approved by RBI, is a product developed by CCIL for the benefit of the
entities who have either been phased out from inter bank call money market or have been
given restricted participation in terms of ceiling on call borrowing and lending
transactions and who do not have access to the call money market. CBLO is a discounted
instrument available in electronic book entry form for the maturity period ranging from
one day to ninety Days (can be made available up to one year as per RBI guidelines). In
order to enable the market participants to borrow and lend funds, CCIL provides the
Dealing System through:
- Indian Financial Network (INFINET), a closed user group to the Members of the
Negotiated Dealing System (NDS) who maintain Current account with RBI.
- Internet gateway for other entities that do not maintain Current account with RBI.

What is CBLO?

CBLO is explained as under:

• An obligation by the borrower to return the money borrowed, at a specified future date;

• An authority to the lender to receive money lent, at a specified future date with an
option/privilege to transfer the authority to another person for value received;
• An underlying charge on securities held in custody (with CCIL) for the amount
borrowed/lent.

Membership:
Membership to CBLO segment is extended to entities that are RBI- NDS members viz.
Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Financial
Institutions, Insurance Companies, Mutual Funds, Primary Dealers etc.
Associate Membership to CBLO segment is extended to entities that are not members of
RBI- NDS viz. Co-operative Banks, Mutual Funds, Insurance companies, NBFC's,
Corporates, Provident/ Pension Funds etc.

Eligible Securities:
Page | 49
Eligible securities are Central Government securities including Treasury Bills, as
specified by CCIL from time to time.

Trading
Borrowing Limit and Initial Margin
Borrowing limit for the members is fixed everyday after marking to market and applying
appropriate hair-cuts on the securities deposited in the CSGL account. The post hair-cut
Mark-to-Market value after adjusting for the amounts already borrowed by the members
is the borrowing limit, which, in effect, denotes the drawing power up to which the
members can borrow funds. Members are required to deposit initial margin generally in
the form of Cash (minimum Rs.1 lac) and Government Securities. Initial margin is
computed at the rate of 0.50% on the total amount borrowed/lent by the members. Intra
day BL/IM enhancements facility is also provided to CBLO members. Members can also
withdraw unencumbered portion of BL intra day. However, intra day cash withdrawal is
not possible.

Auction Market
Auction market is available only to NDS Members for overnight borrowing and
settlement on T+0 basis. Access to auction market is not available to Associate members.
Based on the borrowing limits fixed by CCIL, members submit their borrowing requests
to CCDS through CBLO System indicating clearly the amount, maturity and the cap rate
before commencement of the auction session. i.e. from 10.30 A.M. to 11.00 A.M.
Members are permitted to borrow and lend funds on overnight basis indicating the cap
rate/s which is/are linked to CCBOR (a cap rate is the maximum rate up to which the
borrower is willing to pay). Currently the permissible caps are:
a) CCBOR
b) CCBOR + 10 bps
c) CCBOR – 10 bps
d) No cap specified.
CCDS approves the requests of the members subject to availability of borrowing limit
and places the same on the specified auction windows on behalf of the borrowing
members. The lenders willing to lend place their bids directly on the respective auction
window indicating the amount and the rate during the auction session which is open from
11.15 A.M. to 12.15 P.M. At the end of the Auction market session, CCDS initiates
Page | 50
auction-matching process based on Uniform Yield principle. The successful borrowers
and lenders are notified well before the close of business hours regarding borrowing and
lending of funds by them through the dealing system.

Normal Market
Normal Market is available for all members (including Associate Members) for
settlement on T+0 and T+1 basis. The Normal market can be accessed for borrowing
funds to the extent of their available borrowing limit, besides members can sell CBLOs
held by them to meet their funds requirement instead of holding till maturity. Members
intending to sell CBLOs (borrow funds) place their offers directly through order entry
form on the CBLO System indicating the amount and rate for a specific CBLO. Like-
wise, members willing to buy CBLOs (lend funds) place their bids through order entry
form specifying the amount and rate for a particular CBLO. The matching of bids and
offers takes place on Best Yield – Time Priority basis. Normal market session for NDS
Members is currently open from 9.00 A.M. to 4.00 P.M for T+0 and 9.00 A.M to 5.30
P.M for T+1 Settlement on weekdays and on Saturdays from 9.00 A.M. to 2.00 P.M for
both Settlements. Similarly, for Associate Members, the normal market session is open
from 9.00A.M. To 2.30 P.M. for T+0 and 9.00 A.M. to 5.30 P.M. for T+1 Settlement on
weekdays and from 9.00 A.M. to 10.30 A.M. for T+0 and 9.00A.M. to 2.00 P.M for T+1
settlement on Saturdays

Clearing & Settlement procedure:

The Redemption & T+1 trades are taken up for processing before the start of the trading
session on the settlement date and all T+0 trades of both Auction and Normal markets
are taken up for processing at the end of the respective trading session of NDS and non-
NDS members. CCIL assumes the role of the central counter party through the process of
novation and guarantees settlement of transactions processed as above. CBLO obligation
is generated by netting of trades in the same CBLO for the Normal market whereas the
obligation for CBLOs in the Auction market is worked out on gross basis. Accordingly,
CCIL debits the members' CBLO accounts / borrowing limit to the extent of their final
CBLO Pay-in obligations. In respect of utilization of borrowing limit, securities to the
extent used as collateral are blocked in the CSGL account of the borrowers. There will
be no transfer of securities to the lenders but lenders interest in the underlying securities

Page | 51
is recognized through appropriate documentation. Members can reckon unencumbered
securities for SLR calculations.
Settlement for NDS Members:
The funds obligation for each NDS Member is netted across all the matched trades in the
Auction and Normal market in respect of T+0 trades of the current day, T+1 trades of the
previous day and redemption obligation. The net funds obligation comprising the
member-wise Pay-in and Pay-out position is sent electronically to RBI for effecting
debits and credits in the members’ current accounts through the settlement account of
CCIL. RBI completes the settlement and sends funds settlement confirmation to CCIL.
After receiving settlement confirmation, CCIL posts the CBLOs to the respective buyer
member’s CBLO account.

Settlement for Non-NDS Members:

Similarly, the net fund obligation for such non-NDS members in respect of their trades in
the Normal market is sent electronically to the respective Settlement Banks for effecting
debits and credits in the members’ Current accounts through the settlement account of
CCIL with the Settlement Bank. These entities should ensure that funds to the extent of
their obligations are available in their current account with the concerned Settlement
Bank on the day of settlement. CCIL transfers CBLOs to the respective buyer member’s
CBLO account after receiving the funds settlement confirmation from the Settlement
Banks.

RISK MANAGEMENT:
CCIL addresses risk relating to trading and settlement by adopting stringent membership
norms by restricting its membership only to the entities which meet the minimum
eligibility criteria. Members are allowed to borrow to the extent of the limit fixed after
MTM valuation of securities with appropriate haircut. The securities in the CSGL
account are subjected to daily valuation and any deficit in the value of the securities vis-
à-vis the borrowed amount (face value of CBLO) is collected from the concerned
members. Besides, CCIL stipulates initial margin for the lenders in the Auction market
and for each bid and offer in the Normal market to address the interest rate risk, in case
the lenders do not honor their commitments. In case of members failure to deposit such

Page | 52
deficit on the same day, it is treated as a Margin Default and penalty is charged
accordingly.
DEFAULT HANDLING:

(i) Funds Shortage:

Shortfall in funds can take place when the members (by lenders on the day of lending
and by borrowers on the day of redemption) fail to meet funds obligation on the day of
settlement. In such cases, CCIL meets the shortage by utilizing the lines of credit
extended by the member banks / Settlement Banks and complete the settlement. CCIL
then initiates the default handling process by withholding the CBLOs receivable by the
lenders (defaulting members). In case of failure by the borrower to meet the redemption
proceeds on maturity of CBLOs, the underlying securities of such member stands
encumbered till the funds are replenished alongwith charges. In case of eventual default,
CCIL liquidates the underlying securities/CBLOs and adjust the proceeds towards the
shortfall and other charges.

(ii) CBLO Shortage:

CBLO shortage can take place when the members sell CBLOs without having sufficient
borrowing limit or concerned CBLOs in their account. In case of CBLO shortfall, CCIL
withholds the funds receivable by the defaulting members and creates CBLOs to the
extent of CBLO shortfall quantity by using the withheld funds and credits the same to the
concerned buyers’ CBLO account. Alternatively, CCIL may also opt for Close-out
process by reducing the CBLO shortfall quantity proportionately from the buyers
(lenders) receivable position in the concerned CBLOs.

Schedule of Fees and Charges:

A one time membership fee of Rs. 50, 000/- shall be payable by the NDS and Non-NDS
Members (dealing through internet) of CBLO Segment.
The charges for CBLO trades in the Auction Market and Normal Market are as under:

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A. Transaction Charges: (Effective from 1st October, 2008)

Sr. No. Particulars Charges

1. AUCTION Rs. 5/- per crore of face value per deal per Member subject to
MARKET minimum of Rs.5/- and a maximum of Rs.750/- per deal.
2. NORMAL Rs. 5/- per crore of face value per deal per member subject to
MARKET minimum of Rs. 5/- and a maximum of Rs.750/- per trade.
(to be charged
on the value
date of each
trade)

B. Settlement Charges:

Sr.
Particulars Charges
No.
1. AUCTION Rs. 10/- per crore of face value per deal per member subject to
MARKET minimum of Rs. 10/- and a maximum of Rs. 1750/- per deal for
each member to be charged at the time of initial borrowing and
lending Plus Applicable Service Tax.
2. NORMAL Rs. 10/- per crore of face value per deal per member subject to
MARKET minimum of Rs. 10/- and a maximum of Rs. 1750/- per deal Plus
Applicable Service Tax.

C. Default charges

Sr.
Particulars Charges
No.
Delayed
5 basis points per day on the amount of shortfall till the shortfall
1 deposit of
is met.
Margin
5 basis point per day on the amount of shortage/default till the
shortage/default is fully met; of which, 3 basis point per day will
2 Default
be payable to the non-defaulting Member on the shortfall.
(Minimum charges would be Rs. 100/-)

Page | 54
RBI’s Regulatory Provisions

Reserve Bank of India in its Mid Term Review of Monetary and Credit Policy for the
year 2002 – 2003 has mentioned about the introduction of CBLO as a money market
instrument and of issuance of detailed operating instructions separately in this regard.
RBI vides its letter No. MPD.227/07.01.279/2002-03 dated December 20, 2002 has
decided to permit CBLO developed by CCIL with the following norms:

a) Nature of the Instrument:

CBLO would be treated as a money market instrument. There will be no restrictions on
the minimum denomination as well as lock-in period for its secondary market
transactions. The regulatory provisions for CBLO will be the same as those applicable to
other money market instruments.

b) Term of the Instrument:

CBLO may have original maturity period between one day and upto one year.

c) (i) Issue and Trading Norms:

• CBLO shall be issued in electronic book-entry form only.
• The rate at which CBLO is issued and traded in the secondary market will be decided
by market participants.
• CBLO could be traded in the secondary market without any lock-in period.
• CCIL will provide the trading platform for trading CBLOs to the satisfaction of the
market participants.
• Dissemination of traded prices to all market participants as also to RBI will also have to
be enabled by CCIL.

(ii) Borrowing Limits:

Borrowing limits for members will be fixed by CCIL at the beginning of the day taking
into account the securities deposited by borrowers in their CSGL account with CCIL.
The securities will be subjected to necessary hair-cut after marking them to market. The
limits so derived in effect will denote the drawing power upto which the members can

Page | 55
borrow funds. Lenders will deposit cash to meet initial margin requirements that are
designed to take care of the settlement risk.

(d) Reserve Requirements:

Cash Reserve Ratio (CRR) / Statutory Liquidity Ratio (SLR): The treatment of CBLO in
regard to CRR and SLR will be as follows.

Cash Reserve Ratio (CRR)

Since CCIL would be the central counter party for both borrowers and lenders, the status
of CCIL would have implications for applicability of CRR. As CCIL is considered as a
non-bank institution, transactions in CBLO will attract CRR even though the actual
borrowers and lenders of the transaction are banks. However, in order to develop CBLO
as a money market instrument, it has been decided to give a special exemption from
CRR for transactions in CBLO subject to the bank maintaining minimum CRR of 3 per
cent.

Statutory Liquidity Ratio (SLR)

Securities lodged in the Gilt Account of the bank maintained with CCIL under CSGL
facility remaining unencumbered at the end of any day will be reckoned for SLR
purposes by the concerned bank. For this purpose, CCIL will provide a daily statement to
banks/RBI listing the securities lodged/utilized/remaining unencumbered.

The statutory pre-emptions relating to CRR and SLR will of course have no applicability
to institutions like PDs, Mutual Funds, Insurance companies, DFIs, etc.

(e) Valuation of Collaterals:

Securities in the Gilts Account of the participant for CBLO can be from any of the three
categories, viz., ‘Held to Maturity’, ‘Available for Sale’, and ‘Held for Trading’. While
CBLO will involve movement of securities from the SGL account of a participant to its
own Gilt Account with CCIL on a value free transfer basis, there is no transfer of
ownership involved. Since the securities will continue to remain in investment portfolio
of the participant even when encumbered, there will be no change in valuation of such
Page | 56
securities. The CBLO arrangement envisages earmarking specified value of securities
(based on the borrowings under CBLO). The intent of earmarking such securities will be
accomplished through a suitable agreement.
(f) Risk Weight:
Market Risk
Since CBLO is fully collateralized by government securities, the risk weight as
applicable to government securities for market risk would be applicable to CBLO.

(g) Accounting Norms:

The accounting treatment of CBLO would be as applicable to any money market
instruments/transactions.

Collateral:
Members of CCIL’s Securities Segment are required to deposit their margin
contributions into CCIL’s Settlement Guarantee Fund (SGF) maintained for this business
segment. Individual member contributions are a function of their outstanding trade
obligations based on the types of trades, securities involved and value dates of
settlement. Members are expected to always maintain adequate balances in their SGF to
cover their unsettled trade exposures. Margins are required to be maintained by every
member for their own trades as well as trades reported by them on behalf of their
constituents.
SGF is received in the form of both cash and securities. SGF cash contributions are
received in CCIL’s Current Account maintained with Reserve Bank of India Mumbai.
SGF security contributions are received and maintained in CCIL’s Constituent SGL
(CSGL) Account maintained with Reserve Bank of India, Mumbai.

Composition:
SGF is received in the form of cash and securities. Members are required to maintain a
minimum of 10% of their total margin requirements in the form of cash contributions to
SGF. Members have the option to maintain their entire SGF contribution in the form of
Cash.
The balance SGF contribution can be held in the form of specified GOI dated securities
and/or Treasury Bills from amongst a list of eligible securities notified by CCIL from
time to time.

Page | 57
Members of CCIL’s Securities Segment are currently required to maintain a ratio of 1:9
in respect of their cash: securities SGF contributions in relation to their margin
requirements.

Work Process:
SGF - Cash
Members desirous of making cash contributions to their SGF are required to intimate
CCIL about the same using a prescribed format. Cash contributions from members are
received by means of their cheques drawn on their Current Account with Reserve Bank
of India, Mumbai. These are expected to be held in multiples of INR 100,000.00.
Relative cheques are deposited at CCIL counters within cut-off timings prescribed for
the purpose. Member SGF balances are updated by CCIL upon receipt of relative funds
into its Current Account with RBI. Transaction Reports and Holding Reports are
electronically delivered to the concerned members along with other daily business
reports.

Members seeking to withdraw from their SGF Cash contributions are required to send a
prior written notice to CCIL about the same using a prescribed format within cut-off
timings prescribed for the purpose. Withdrawal requests are processed and permitted
after taking into account concerned member’s outstanding trade obligation. Withdrawal
payments are made by means of cheques drawn on its Current Account with Reserve
Bank of India, Mumbai. Relative cheques are delivered to concerned members on
relative value date at CCIL counters after their SGF Cash Balances have been suitably
reduced. Transaction Reports and Holding Reports are electronically delivered to the
concerned members along with other daily business reports.
SGF – Securities

All transfers of securities to and/or from CCIL by its members are carried out on a
“Value Free of Payment” basis.

Members desirous of making securities contributions to their SGF are required to notify
CCIL about the same using a prescribed format. Security contributions are received and
maintained in a separate CSGL Account with RBI. SGF security contributions are made

Page | 58
from among the list of specified securities eligible for margin contributions. The list of
Eligible Securities is decided by Risk Management Department.

Deposit of Securities by Members into SGF is carried out electronically using the Value
Free Transfer functionality in RBI’s Negotiated Dealing System (NDS). A securities
transfer request is created and approved by the member. The same is confirmed by CCIL
and forwarded to RBI for authorization and settlement. Members have to ensure
adherence to cut off timings prescribed by RBI for the purpose. Member SGF balances
are updated by CCIL upon receipt of relative securities into its CSGL Account with
Reserve Bank of India. Transaction Reports and Holding Reports are electronically
delivered to the concerned members along with other daily business reports.

Members seeking withdrawal from their SGF contributions are required to send a prior
written notice to CCIL about the same using a prescribed format within cut-off timings
prescribed for the purpose. Withdrawals requests are processed and permitted after
taking into account concerned members’ outstanding trade obligation. Security
withdrawals are effected through Value Free Transfer functionality in NDS. A securities
transfer request is created and approved by CCIL. The same is confirmed by the
concerned member and forwarded to RBI for authorization and settlement. Securities are
transferred to the Proprietary SGL Accounts of members maintained with RBI Mumbai
on relative value date after their SGF security balances have been suitably reduced.
Transaction Reports and Holding Reports are electronically delivered to the concerned
members along with other daily business reports.

Members are entitled to substitute their SGF holdings after giving prior notice as
prescribed by CCIL. Depending on the type of substitution viz., security for cash, cash
for security or security for security, members are required to comply with relative
deposit and withdrawal procedures specified for the same. Transaction Reports and
Holding Reports are electronically delivered to the concerned members along with other
daily business reports upon completion of the process.

Page | 59
Corporate Actions and Benefits:

All corporate actions on member SGF holdings are serviced through the electronic funds
transfer mechanism of Reserve Bank of India. Relative funds are remitted to the Current
Accounts of concerned members with separate individual electronic advices to members
SGF – Cash – Interest Payment

Members are not entitled to any interest on their cash contributions to SGF, which is
expected to be at least 10% of their total margin requirements.

In respect of members holding their entire SGF contribution in the form of cash, CCIL
pays interest to such members at quarterly rests (at the end of every calendar quarter) on
90% of their average cash balances during the relative period @ 100 basis points below
the weighted average 91 Day Treasury Bills’ cut off yields at the last three primary
auctions held before the relevant interest payment date. The benchmark instrument to
which such interest is pegged as well as spread between the yield on the benchmark
instrument and the interest rate paid by CCIL may be changed at the sole discretion of
CCIL from time to time.
SGF – Securities – Interest Payment

Periodic coupon payments received in respect of Members’ SGF security contributions

(held in the form of dated securities) are passed on to concerned Members by CCIL
immediately upon receipt of relative interest from Reserve Bank of India.
SGF – Securities – Redemptions

Redemption proceeds of matured securities are treated as concerned members’ additional

cash contribution to SGF

Page | 60
 CORPORATE BONDS IN INDIA

Corporate Bonds are issued by public sector undertakings and private corporations for a
wide range of tenors but normally upto 15 years. However, some Banks and Companies
like Reliance have also issued Perpetual Bonds.

Compared to government bonds, corporate bonds generally have a higher risk of default.
This risk depends, of course, upon the particular corporation issuing the bond, its rating,
the current market conditions and the sector in which the Company is operating.
Corporate bondholders are compensated for this risk by receiving a higher yield than
government bonds. Some corporate bonds have an embedded call option that allows the
issuer to redeem the debt before its maturity date. Some even carry a put-option for the
benefit of the investors. Other bonds, known as convertible bonds, allow investors to
convert the bond into equity.

Advantages of Corporate Bonds

1. Corporate bonds generally offer higher returns than Government Securities, fixed
deposits, CD’s & CP’s.
2. Corporate bonds are rated by approved rating agencies e.g. CARE, ICRA, CRISIL,
FITCH. (We deal in investment grade scrips only).
3. You can invest in blue-chip corporates with sound credit-quality in a sector of your
choice to meet your investment objectives.
4. Corporate bonds provide you with a steady income stream.
5. You can lock-in high rates for a long period of time.
6. Secondary market trading is possible, depending upon demand.
7. No TDS deduction as per Budget Announcement for 2008-09.

Disadvantages of Corporate Bonds

1.
They are generally unsecured and therefore have an element of credit risk.
2. All Corporate bonds are not actively traded.
3. They form a very small part of the total debt market.
4. While interest rate is generally fixed, all debt securities are subject to market risk, i.e.
the price at which they are traded could vary.
5. Unlike Gilts where RBI sometimes steps in to put trades, there are no market makers
in corporate bonds.
6. The minimum lot is generally bigger for corporate bonds compared to retail G-Secs.
7. ·Stamp Duty is payable on issue and transfer in some states.

However, despite being listed on exchanges, the vast majority of trading volume in
corporate bonds in most developed markets takes place in decentralized, dealer-based,

Page | 61
over-the-counter markets.

The complexities:

The corporate bond market plays second fiddle to the government bond market, since the
Government of India is the largest issuer of debt in the country. Bond market players
tend to shun corporate bonds, terming them illiquid, and preferring to trade in the much
more liquid government bond market.

Typically, corporate bonds factor in two kinds of risks -- credit and liquidity. Credit risk
is usually measured by the ratings assigned to the credit by the rating agencies, while
liquidity risk is measured by the acceptability of a credit in the market.

In India, trading is concentrated in AAA-rated bonds, as they carry the highest safety
and are the most liquid. Among AAA bonds, bonds of public sector units are much more
liquid than private sector bonds. This is because a large part of the market, including
insurance companies, provident funds and banks, has restrictions on private sector paper.
This really means that trading activity in Indian debt market is concentrated in
government debt, directly in government securities and indirectly through bonds of
government-owned entities.

The lack of market for private sector companies has resulted in absolutely no price
discovery for issuers of debt, especially for issuers rated below AAA. This has resulted
in private sector issuers going for bank loans or accessing the foreign currency bond or
loan market. The lack of issuers across the rating scale has led to a non-existent credit
spread curve in the corporate bond market.

Banks in India have a peculiar problem. The Reserve Bank of India has instructed them
to mark corporate bonds taken in their trading books as credit exposures to the
underlying credit.

This has resulted in many of the banks being unable to trade certain credits as they have
hit the exposure limit in their loan books. This has also restricted the freedom of a
corporate bond trader in a bank, as he has to take credit clearance from the credit risk
officer belonging to the corporate bank.

Page | 62
A large part of the market does not mark-to-market the corporate bond portfolio.
Insurance companies and provident funds, the largest buyers of corporate bonds in India,
do not mark-to-market their portfolios. As a result, once any bond goes into their books,
it does not come out. This takes away liquidity from the market.

The settlement of corporate bonds carries counterparty risk. The settlement takes place
between counterparties as there is no centralised clearing system as existing in
government securities market. This makes many counterparties not 'dealable' with each
other, due to lack of counterparty risk limits.

What needs to be done:

The committee for reviving the corporate bond market in India should focus on the following:

1. Remove limit restrictions on private sector issuers for insurance companies, provident

Page | 63
funds and banks.

2. Separate corporate bond trading and loan books for earmarking credit exposures.

3. Allow corporate bond traders to short interest rates and take on the risk of the underlying credit.

4. Increase depth in the market by allowing FII's to trade in the corporate bond market.

5. Make it compulsory for insurance companies and provident funds mark to market a part of their

corporate bond portfolios.

6. Introduce centralized settlement system for corporate bonds.

7. Allow repos in corporate bonds.

8. Encourage lower rated issuers to access domestic bond markets.

9. Ensure all issuers stick to standard issue norms akin to government securities.

10. A unified exchange trading system and reporting platform is good for the market.

OBSERVATION
In the time period of project I came across few very important observations but the
highlight of the observation would be that, there is requirement of ‘REPO in
corporate bonds, in Indian financial system.
Few observations are explained below:
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REPO IN CORPORATE BONDS

The RBI is the regulatory authority for this part of the market as corporate bond repos
would be regarded as money-market instruments. The RBI has been considering
allowing corporate bond repos for some time—and now may be moving toward
permitting them. CBLOs have been increasingly taking the role of repos but limited to
government bonds. Since late 2007, SEBI has been talking with RBI about corporate
bond repos. Inevitably this is linked to the parallel discussions on settlement with the
exchanges.

Need

 More than 90 percent of bond trading activity place off exchange in the OTC
market.
 In OTC corporate bond deals, prices are quoted over the phone, which often
prevents an efficient price discovery, as the buyer or the seller might be unaware
of the best price available for the debt paper in the market.
 To have more transparency in the market by bringing in a tri-partite Repo in
corporate bonds with Bombay Stock Exchange (BSE) as the Central Counter
Party.
 A central clearing house like the Bombay Stock Exchange will enable a
guarantee in payment and settlements and mitigate counter-party risks. This will
also encourage a larger participation from foreign investors, which in turn may
enhance volumes in the slow-growing corporate bond market.

Existence of an arbitrage opportunity:

 Parking surplus funds with the Reserve Bank of India continues to be an

attractive option for banks despite the cut in the reverse repo rate.

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  Banks, particularly Government owned, are borrowing against their surplus
holding of government securities at a lower rate under Clearing Corporation’s
Collateralized Borrowing and Lending Obligation (CBLO) mechanism and
deploying the funds at a higher rate with RBI.
 By doing so, banks are making a tidy spread of 50-100 basis points a day.
Consider this: If a bank had borrowed on Monday against its surplus government
securities holding at the weighted average interest rate of 2.72 per cent under
CBLO and parked the funds at RBI’s Reverse Repo (R/R) window at 3.25 per
cent, it stands to make a gain of 53 basis points (100 basis points equals 1 per
cent) in just a day.
 Repo in corporate would allow the participants to borrow money at a lower
interest rate and lend it at a higher interest rate in corporate bond market. Thus
giving rise to an arbitrage opportunity.
 For eg: Bank A borrows at a rate of 3%-4% from the CBLO segment or the Call
Money market and lends it at a rate of 10% in the corporate bond market would
make a gain of 6%-7%. Thus makes an arbitrage in the whole transaction.

Entry of a retail investor:

 A retail investor should be given a chance to participate in Repo in corporate

bonds.
 This can be achieved by reducing the size of the Debt paper (in the range of
100,000 to 10,00,000 Rs.)
 The turnover at NSE and FIMMDA is more than that at the BSE but the number
of trades at BSE exceeds far more than the other exchanges, concluding that BSE
has more individual investors.
 BSE has a base of retail investors in the corporate bond market and thus active
participation of retail investors in the proposed model is possible.
 The underlying assumption made above is supported from the statistics shown
below:
Numbers of trades on the three exchanges are given below:

Date BSE* NSE* FIMMDA* Total % of trades

reported on BSE

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Jan-07 to 22999 1846 Nil 24845 92.5
Aug-07
Sep-07 to 8121 1183 1774 11078 73.3
Dec-07
Jan-08 to 279166 3468 9004 291638 95.7
Dec-08
Jan-09 to 259328 5474 5815 270617 95.8
June-09

Source: SEBI

• * Comprises OTC trades and trades done on exchange.

• Trade reporting on FIMMDA started from September 01/2007.

MY SUGGESTIONS ARE IN THE FORM OF A PROPOSED

MODEL

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The given model is based on the opinions of the bankers of the leading Banks like
Kotak Mahindra Bank, ICICI Bank & SBI Bank.

Participants:

 All the active members of CROMS. The current number of active members is 94
(source: CCIL).
 The total no. of participants would include primary dealers, Public sector Banks,
Private sector Banks, Co-op Banks, Foreign Banks, NBFC’s, Mutual funds, FII’s
& Insurance Cos and other corporates.
 A new class of lender should be introduced i.e. Individual investor that would
help in creating larger volumes.

Borrowers:

 Public sector Banks

 Primary dealers
 Private sector Banks
 Co-op Banks
 Other corporates

Lenders:

 All Banks
 Primary dealers
 NBFC’s
 Mutual funds
 FII’s & Insurance Cos
 Individual retailers

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SECURITIES TO BE ACCEPTED AS COLLATERALS

Companies with High Credit Ratings Dominate Corporate Issuance:

The distribution of corporate bonds issued by rating indicates that the number of sub
investment grade issues is minimal and the proportion below AA is small by value. Only
the largest corporations are likely to achieve an AAA rating. Others are thus excluded
from the bond market and obliged to rely on bank finance. Recent figures suggest the
proportion of lower-rated bonds may be increasing in particular the proportion of sub-
investment grade bonds following the SEBI’s relaxing its rules relating to lower-rated
bonds.
 Thus to start with the new product initially only AAA rated corporate bonds
should be accepted as collateral.
 A detail figure of number of bonds listed in the exchange as on August 2005 is
given below:

Corporate Bonds – Outstanding Issues (Aug25, 2005)

Rating No. of Market Issue

class Issues Shares(%) Size(Rs.Cr)
AAA 955 61.61 92609
AA+ 320 20.65 19605
AA 175 11.29 13248
AA- 31 2.00 1272
A+ 16 1.03 1545
A 16 1.03 1512
A- 12 0.77 1063
BBB+ 11 0.71 833
BBB 8 0.52 722
B 6 0.39 257
Grand 1550 100 132666
Rating not
82 9906
available

Source: NSE WDM segment

 At present there are approximately 1800 corporate bonds with AAA rating,
although the exact figure is not known.
 Thus there is a need for setting up a unified exchange traded corporate bond
market under the Bombay Stock Exchange.

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INTRODUCTION OF STANDARD TENOR BY THE EXCHANGE:

 The exchange would like to introduce a standard tenor in the proposed model.

 This would bring more transparency and also reduce the volatility in the market.

 The standard Repo could be overnight repo, 7day repo, 14 day repo and so on till

a year.

RISK MANAGEMENT:

 The Risk Management function would arise as a corollary to BSE’s primary

activity i.e. Settlement of trades.

 By undertaking guaranteed settlement of trades in the corporate bond Repo

segment, BSE would seek to reduce the risk arising out of the settlement failures

due to the default by a counterparty.

 It would achieve this goal mainly by becoming a central counterparty to the trades

done by its members and managing the risks through its risk management

processes in such a manner that the ultimate risk to its member from a settlement

failure should be either eliminated or reduced to the minimum.

 While designing the Risk Management processes, care has to be taken to address

segment specific issues. For instance the nature of the risk associated with the

clearing & settlement process would not only be Market risk but also be Credit

risk.

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HAIRCUT:

 The haircut in the government securities is in the range of 1%-4%.

 But the credit risk in government securities is less as compared to that in corporate

bonds. Thus, there is a need of a different strategy to be adopted while deciding

the haircuts for the corporate bonds.

 The strategy to be adopted by BSE should be a haircut in the range of 10%-15%

depending on the credibility of the underlying security.

 For eg: a bond worth Rs.100,000/-, when pledge will fetch Rs.90,000 or less

irrespective of the tenor.

MARGINING:

The BSE should collect Initial Margin and Mark To Market Margin from the members in
respect of their outstanding trades. In addition to this, BSE may also collect Volatility
Margin in case of an unusual volatility in the market.
Initial Margin:
Initial margin should be collected the likely risk from future adverse movement from the
price of the concerned securities. Members should deposit the initial margin in the form
of cash/securities, in advance, before putting up any bid or accepting any offer.
A proposed initial margin should be 1% for all corporate bonds which would be Repo-
able.

Mark to Market Margin:

Mark to Market Margin is collected to cover the notional loss (i.e. to cover the difference

between the current market price and the contract price of the security covered by the

trade) already incurred by the member.

Mark to Market Margin imposed on a day should be made payable to the BSE on the next

business day.

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 CONCLUSION

The corporate bond market in India has not kept pace with the developments in the equity
market, which has matured and grown to global standards. It has suffered from chronic
neglect, both in terms of policy and infrastructure, and has been almost entirely restricted
to a set of domestic institutional investors. For an active secondary market, there is a need
for a wider range of issuers and of investors, and with different perceptions for investment
and trading in the secondary markets.

Broadening and deepening of the bond market is required to provide long tenor project
finance. India’s financial system is still largely dominated by the banking system with a
deposit base largely of less than 3-year tenors. A borrower who requires long-term funds
(10-15 years) is still dependant on a few providers of such long maturity loans.
Infrastructure projects like power, telecom, ports, airports, urban infrastructure, roads etc
require long-term funds. Consequently, we need a significant growth in the insurance,
pension and provident fund sectors since they are the logical providers of long-term
money. Simultaneously, small investors need to be brought into the long-term debt capital
market. In the absence of such growth, Indian corporates with large expansion plans
would expose themselves to significant refinancing risks.

The recent past has witnessed many Indian corporates effecting overseas acquisitions as
part of their vision of global growth. The overseas subsidiaries of these companies have
accessed foreign currency loan/bond market to fund these acquisitions. Hence there is a
need to develop a more dynamic and transparent corporate bond market.

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Recommendations:

 Corporate bonds should be made repo-able. This has been recommended by the

Expert Panel on Financial Stability Assessment and Stress Testing that has

assisted the Committee on Financial Sector assessment set up by the Finance

Ministry and the RBI to assess India’s financial stability.

 If corporate bonds are made repo-able, they will become more liquid, and the

secondary market will thus become more active.

 “RBI is committed to permitting market repos in corporate bonds,” former RBI

Governor, Dr Y.V. Reddy, had said in a speech in Washington last October.

 If accepted, the measure will add width to the market. The Government has been

laying special emphasis on measures designed to give the moribund corporate debt

market a fillip.

 Reference from the European Bond Market should be taken.

 It will certainly boom the Indian economy.

 The Non-SLR bond market will go up substantially.

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 BIBLIOGRAPHY
A]

ONLINE PUBLISHED MATERIAL ON WORLD WIDE WEB

WWW.GOOGLE.COM

WWW.RBI.CO.IN

WWW.CCIL.COM

Title of search:

REPO

R H PATIL REPORT

EUROX REPO

WWW.WIKIPEDIA.COM

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