Treasury Management: G-Sec Market

TREASURY MANAGEMENT
G-Sec Market
1
Government Securities Market
Primary and Secondary Market for G-Sec
Nature and Organization of G-Sec Markets
Developments in G-sec market
Initiative of Govt and RBI to improve the
G-sec markets
2
Nature and Organisation
Supply stems from issue of Govt. Marketable
debt
Issued by Central Govt., State Govts., Semi-
Govt. authorities, autonomous institutions like
SEBs, PSCs and other govt. agencies
Central Govt. issues bonds, TBs, and special
rupee securities in payment of India's
subscriptions to IMF, ADB, Intl. Dev. Assn. (IDA)
Special rupee securities are a part of internal
floating debt of the govt.
They are non-negotiable and non-interest
bearing claims
3
G-Sec are unique & vital financial
instrument in the financial markets of any
country
Open market operations and SLR are
closely connected with the dynamics of the
market
Holders can obtain loans against the
collateral of theses securities from RBI
and other institutions
4
As the RBI can issue currency notes against the
backing, apart from gold and foreign exchange, or
central govt bonds, they constitute the ultimate source of
liquidity in the economy
It is a gilt-edged security
Central govt. securities are the safest of all claims
They are free of default risk or credit risk which leads to
reduction in market risk
Govt securities provide certainty of capital value not only
at maturity but also prior to maturity, and as such, they
are an ideal financial instrument for diversification of
investment portfolio
5
Issued in denominations of Rs. 100 or Rs. 1000
Rs. 100 till mid 1980s and later
Rate of interest is relatively lower
Government in order to minimize the cost of
servicing public debt deliberately maintains the
interest at a low level
Market for these securities has expanded
because of the regulations, statutory or
otherwise
At the rates of interest that can be earned on
these securities, any other borrower but for
government would have been unable to raise
funds
6
Interest on g-secs is payable half-yearly
Income in the form of interest or dividends on
other approved securities is exempt from income
tax subject to a certain limit
The value of investments in these securities and
other investments specified in the wealth tax act,
1957 is exempt from wealth tax up to a limit
Individuals do not normally invest in these
securities
Savings in tax liability does not seem to be an
important motivation behind investment in them
In US interest on the securities or local
authorities is exempt from tax unlike in India.
7
Securities of different authorities differ in respect of the
extent to which they possess the attributes of liquidity and
safety
There is no need for underwriting or guaranteeing the sale
of central and state Govt securities
RBI is always ready to buy the unsubscribed part of any
loan issued amounts to underwriting of these issues
In 1950s issues of state Govt securities used to be
underwritten, but thereafter such a need has not arisen
Securities of semi-Govt agencies however, may need to
be underwritten though they are also guaranteed by the
central Govt or State Govt for repayment of principal and
interest
8
Three forms of securities
Inscribed stock or stock certificate
Promissory note
Bearer bond
Stock certificates and bearer bonds are
not familiar in India
PNs of any loan can be converted into
stock certificates of any other loan or vice
versa

9
Steps initiated by government to enhance stock
certificates
They are safer than PNs as the name of the holder is registered
in the books of PDO
The stock certificate relating to the application tendered at any
branch of the SBI or its subsidiary is sent to the applicant directly
by registered post by the PDO
The half-yearly interest is remitted to the holder directly by an
interest warrant drawn at par on any Treasury or SBI as
stipulated by the holder or is remitted by Money Order (MO)
The holder can sell it by signing the transfer form on the reverse
of the certificate
Interest on PN is payable only on presentation
The major reason Y stock certificate is not popular in
spite of these advantages is its of lack of quick
transferability and negotiability
10
G-secs are issued through the PDO of the RBI
The method of selling them differs from that of selling
TBs
The issues are notified a few days before they become
open for subscription and they kept open for subscription
for 2/3 days
They may be closed for subscription earlier if the
subscriptions approximate the amount of issue
They are deemed to be listed on stock exchanges
SEBI normally routinely grants NO OBJECTION of
trenches for an year
There will be a small number of large issues
The govt. tries to avoid flooding of the market with
securities at a given time
11
G-secs are mostly bought by institutional
investors
Govt reserves the right to retain subscriptions up
to a specified percentage, say 10 per cent in
excess of notified amounts
Applications for loans are received at the offices
of RBI and at the branches of SBI
In the case of issues of state govt securities
oversubscription of one govt is transferable to
another state govt at the option of the
subscriber
Due to the seasonal character of the money
market issues are mostly concentrated during
slack seasons

12
The method of issue of blocks of securities
and their redemption on single maturity
dates continues in form, but, when the
issue of bonds is announced, a part is
taken over by the RBI which sells the
amount gradually through the sock
exchanges in the ensuing period
13
Continuous tap system Grooming and
Switching
Grooming acquiring securities nearing maturity
to facilitate redemption and making available on
tap a variety of loans to broaden the gilt-edged
market:.
Switches Purchases of one security against
the sale of another security as distinct from
outright purchase of sale of security
This means that securities are available on tap
and the securities thus obtained my be called
tap stocks.
14
Business in the g-sec market is done as a
principal and not as an agent and without
using services of brokers
After the opening of NSE, banks are
permitted to undertake transactions
among themselves and with non-bank
clients through NSE Members
Role of brokers and dealers in the g-sec
market in India is limited unlike in other
countries
15
RBI does have its approved brokers and the major part
of the turnover in the market takes place through these
brokers
With effect from 1978, RBI discontinued the practice of
charging differential interest rates for the purchase and
sale of the central govt securities to enable banks to
approach it directly instead of through brokers
Agency of dealer-banks ahs been more active than that
of individual dealers
There are some active firms of security dealers in
Mumbai elsewhere is limited
Dealers will be in contact with banks, LIC and other
institutional investors
16
G-sec market is an OTC market therefore
each sale and purchase has to be separately
negotiated
Orders received locally by members of the stock
exchange are passed on to the security brokers
and dealers who then try various sources
including the banks
Brokers and dealers explore the possibilities of
business among themselves and with their up-
country correspondents, but such business is
limited and the market is confined mainly to
institutional investors
17
Commercial banks can buy as much as
they want, but they cannot sell securities
beyond a limit due to SLR requirements
Many factors that we have discussed
above restricted the growth of the
secondary market which in turn had
restricted the scope for dealer activity
The RBI acts as the biggest dealer
because of the same also there is a lack of
growth of institution of dealers
18
Further, dealers need funds for their
operations which they need to borrow
from commercial banks the cost is
higher than the return on G-secs by them
this also inhibited their growth in all
Refunding and reissuing is different from
grooming and switches

19
Sometimes, there are triangular switch transactions in
which one investors sale or purchase is matched by the
purchase or sale transactions of another investor, the
RBI being the middle party. RBI fixes an annual quota
based on the size of the bank for switch transactions of
each bank from time to time.
One of the unique feature of trading in this market is
voucher trading or voucher benefit
The banks and financial institutions whose earnings are
taxed, purchase the securities around the interest due
date and unload them in the market after availing
themselves of the voucher for the full year - this feature
has activised trading in these securities around interest
due date
20
This active trading is not genuine trading
Chakravarty committee asked the RBI to
fix quotas for switch transactions, and to
suspend trading in a particular scrip for
one month before interest due date

21
Apart from usual G-sec market there is also
Repos market in G-secs
Such a market became active in the 1980s
In 1987 certain regulatory restrictions were put
on repos transactions
In 1992 the system of repos was extensively
misused banks had raised funds through
repos in securities which they did not possess
As a result repos were banned completely soon
after the scam in 1992 Harshad Mehta
22
Subsequently only some instruments 91
day and 364 day TBs, ZCBs, etc were
allowed to be traded in this market
Wef 15 4 1997 repos and reverse
repos are again back

23
REPO is a Repurchase Agreement or Ready
Forward Agreement is a transaction in which
one party sells a security to another party
simultaneously agreeing to repurchase it in
future at a specified date and time.
Reverse REPO is essentially a matter of market
jargon it is exactly opposite of REPO in which
a party buys a security from another party with
commitment to sell it back to the latter at
specified time and price
24
Repos are essentially collateralized loans,
they reduce counterparty risk and
therefore interest rate on them is usually
low, say below the call rate
Commitment to buy/sell at a later date
makes the instrument a pledge transaction
It is also a good hedge tool because the
repurchase price is locked in at the time of
sale itself

25
Repo is almost risk free instrument used to
even out liquidity changes in the system
Repos offer safe, short-term outlet for
temporary excess cash at close market
interest rates
Repos are as short-term as call money or
overnight money
Standard maturities range between 1 to 14
days, 1 to 3 weeks, or 1 to 6 months.
26
Multi-day repos are called fixed-term repos
which are renewed each day with the repo rate
adjusted to reflect prevailing market conditions
The repo transactions are arranged OTC by
telephone either by direct contact or through a
group of market specialists
Participants in REPO Market are securities
dealers, commercial banks DFHI, STCI, RBI and
cooperative banks. NBFCs, LIC, GIC, UTI and
the corporates are not allowed to participate in
this market
27
Developments in G-sec Market
Jun
e
199
2
Commenced auction of
Central Govt Securities
at market determined
interest rates for the
first time
To induce
transparency
into the process
Price discovery
has become
very fine over a
period of time
Jan
199
3
91 day TBs offered
through auctions at
market determined
rates
To offer an
instrument for
managing the
liquidity
Emerged as a
very useful
instrument and
now forms a
benchmark at
the short end of
the yield curve
28
Jan 1994 Issued ZCB for the first
time, Securities
Trading Corporation of
India commenced
operations
To add new
instruments and
intermediaries
STCI is now a
Primary Dealer
(PD) & 17 PDs
have become
imp
intermediaries
in G-sec markt
Mar 1995 Guidelines and
procedures for
enlistment of PDs
were issued
To strengthen
the market
intermediation
PD system has
evolved as an
important
segment of G-
sec market
29
July
1995
Delivery-versus
Payment in G-secs was
introduced
To reduce
settlement risk
We are now
graduating to
DVP-III T+1
day settlement
Sep
1995
Floating rate bonds was
introduced
To add more
instruments
Floaters are
now becoming
popular, 15
20% of GoI
borrowing is
now through
FRBs
30
Jan
1997
Technical Advisory
Committee was
constituted
To advise RBI
on developing
G-sec market
Plays a great role
in developing the
G-sec market and
signifies the
consultative and
collaborative
approach of RBI
in implementing
reforms
March
1997
Historical agreement
between Govt and
RBI to inter alia
discontinue adhoc T-
bills
To discontinue
automatic
monetisation
Improved
transparency
and pricing as
also autonomy
in monetary
policy making
31
April
1997
FIMMDA was
established
Repo was permitted in
G-secs to SGL a/c
holders
Self regulation

To deepen the
repo market
and to shift the
money market
from to call to
collateralized
repo market
Improved
practices
Repo market has
been developing
July
1997
FIIs were permitted to
invest in G-secs
To broaden
market
FII have become
an important
player in the
market today,
particularly in TB
segment
32
Dec
1997
Capital Indexed Bonds
were issued
PDAI was formed
To help
investors
hedge the risk
Efforts being
made to
revitalize this
product
April
2000
Sale of securities
allotted in primary
issues on the same day
To improve
secondary
market
This has also
helped
manage the
overnight risk
June
2000
Introduction of Liquidity
Adjustment Facility
To manage
short term
liquidity mis-
matches
Emerged as
an important
tool
33
Feb
2002
Negotiated Dealing
System (NDS) Phase
I operationalised
For improved
trading and
settlement /
guaranteed
settlement
Contributed to
the
institutional
framework for
the market
reduced
settlement risk
May
2002
Compulsory holding of
G-secs in demat form
by RBI regulated
entities
To reduce the
settlement risk
The progress
of demat is
being
monitored
June
2002
PDs were brought
under the BFS
Jurisdiction
For integrated
supervision of
the market
The position is
being reported
periodically to
BFS
34
July
2002
G-secs with call and put
option was introduced
To offer variety
of instruments
Product may
need
improvement
Oct
2002
Trade data of NDS is
being made available
on RBI website
To improve
transparency
Besides, the
measure is
helping the small
investors as well
Jan
2003
Rading of G-secs on
Stock exchanges
To facilitate
easier access
and wider
participation
This has not
taken off very
well. Efforts are
on to improve
the situation 35
Feb
2003
Eligibility to participate
in the repo market was
extended to non-banks
To widen the
market
Efforts are on to
further widen
and deepen the
repo market.
Extension to
corporates is
being examined
June
2003
Interest Rate
Derivatives have been
introduced
To facilitate
the market
hedge their
market risk
Trading in IRDs
is expected to
get a boost after
SEBIs modified
guidelines
issued in Jan
2003
36
July
2003
Government Debt
Buy-Back scheme
was successfully
implemented
To reduce interest
burden of govt
and to help market
participants
offload their illiquid
securities
Total of Rs. 144
billion securities
were bought back
by the govt and
issued liquid
securities for
equivalent amount
at market yield
Mar
2004
RTGS system
trial run
Real time, online,
large value inter-
bank payment and
settlements
Running
successfully
37
Price Discovery in G-sec Securities
Administered Interest Rates for Banks
Automatic Monetization of fiscal deficit
(March 31 1997)
GoIs willingness to borrow from the
markets at market rates
Introduction of Auction system for sale of
government loans

38
Primary Dealers
March 1995 Guidelines were announced

39
Objective of Government to
introduce Primary Dealers
Strengthen the infrastructure
To make G-sec market vibrant, liquid and broad
based
To ensure development of underwriting &
market making outside RBI for G-sec
To improve secondary market trading system
To discover the price of G-sec
To enhance liquidity and turnover and voluntary
holding
To make PDs an effective conduit for conducting
open market operations
40
Who can be a Primary Dealer
The entity should be a subsidiary of Scheduled
Commercial Bank/FI or a company dedicated
predominantly to the securities business
Minimum Net owned funds Rs. 50 Crore
Should not be a loss making company
Legally they are NBFCs and are also subject to
registration requirements for NBFCs (exemption
Public Deposits are not to be mobilized)
Capital Adequacy standards to be observed by
Primary Dealers
41
Responsibilities of Primary Dealers
Commitment to bid for G-secs and auction TBs
on an annual basis of not less than a specified
amount
PDs have to achieve minimum success ratio of
40 per cent
Maintain risk based capital adequacy as per RBI
instructions
PD has to quote two-way at least in a few
securities
PDs have to underwrite primary auction of G-sec
TBs are not underwritten PDs have to commit
to submit minimum bids at each auction covering
the entire issue amounts
42
Facilities to Primary Dealers
One Current Account and so Subsidiary General Ledger
Accounts for G-Sec at all offices of RBI
Can borrow and lend in the money market including call
money market
Can trade in all money market instruments
Liquidity support through Repos operations or demand
loans with RBI collateralized by dated securities and
Auction Treasury Bills up to the limit fixed by RBI
Favoured access to Open Market Operations
Permission to raise CP as per the provisions contained
in PDs
Facility of transfer of funds from one centre to another
centre under RBIs remittance Facility Scheme
Clearing of cheques arising out of G-sec transactions
43
Obligations of Primary Dealers
Offer a firm two-way quotes for government securities
and take principal positions
Achieving prescribed turn over ratios in government
securities.
Maintenance of physical infrastructure in terms of office,
computing equipment, communication facilities and to
provide advice and education to investors.
Putting in place efficient internal control system.
Obligation to provide to RBI access to all records,
books, information and documents
Adherence to all prudential and regulatory guidelines
prescribed by RBI from time to time.
Formation of self regulatory organisation (SRO).
Maintenance of a separate desk for government
securities business and have audit of accounts
44

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