(Mint)
(Mint)

Opinion | VRR has potential to widen bond markets

New voluntary retention route, or VRR, norms offer more operational freedom to FPIs

During 2011-12, the Reserve Bank of India (RBI) published the first set of guidelines governing investment by foreign portfolio investors (FPIs) in the domestic onshore bond market. Initial investment limits were defined, along with other conditions such as the minimum residual maturity requirement for bond investments.

The last few years have seen multiple modifications to regulations, highlighting the challenge of liberalizing FPI flows while ensuring these do not pose the risk of additional volatility in the domestic market. Going forward, a new structural approach is preferable to letting regulation evolve either piecemeal or reactively to market developments through incremental tweaks to the existing framework. A key takeaway is that frequent regulatory changes are detrimental as investors tend to converge towards a stable and predictable regulatory environment.

The last few years have seen steady growth in the use of the onshore bond market as a financing source, although concentration among ratings, maturity profiles and issuers continue to be areas that can improve. Further, balanced development of bond markets can be best achieved when regulators design and implement a comprehensive and consistent regulatory framework for FPIs. Such an approach promotes both stability and continuity of policy and encourages stable longer-term FPI investment flows over the more speculative kind.

A good example of a new regulatory approach is the new guidelines issued on 1 March by the RBI on the Voluntary Retention Route (VRR) for FPIs. VRR establishes a more liberalized framework for FPIs investing in debt, while mandating a 3-year minimum investment commitment, where 75% of the investment amount committed must remain invested during the required retention period.

RBI has defined investment limits of 40,000 crore for government securities and 35,000 crore for corporate bonds under this framework, to be allocated to individual FPIs either on tap or through auctions. FPIs would bid for the amount they wish to invest, as well as indicate their retention period, which should not be less than the 3-year minimum commitment requirement. Investment limits for the VRR scheme would be incremental to existing general FPI limits. At the end of the retention period, FPIs may either transfer their VRR portfolio to the general FPI category or liquidate and sell holdings.

Alternatively, they may opt to continue the VRR commitment by rolling it over for another round with the same retention period. Participation in the VRR scheme exempts an FPI from other macro prudential restrictions governing FPI investments in debt. VRR also provides additional operational flexibility with regard to hedging of interest rate and currency risk and permits participation in the repo markets for liquidity management.

Additionally, FPIs will be eligible to invest in any government bond or T-Bill, as well as corporate and short term debt instruments including commercial paper, without being subject to minimum residual maturity restrictions or security or portfolio level concentration limits. This route will allow offshore investment managers to introduce India-focused debt fixed maturity plans, as the tenure or diversification restrictions would not apply to investments made vide this route. It would also allow offshore distressed funds to invest in local currency defaulted assets, permitting banks to unlock some of the liquidity that is frozen in non-performing assets.

While introducing this new framework is a step in the right direction, its success will depend on the reception from investors. Typically, there is an inverse relationship between complexity and discretionary elements embedded in any framework and the degree of adoption by the market participants towards whom it is targeted.

VRR offers more operational and regulatory freedom to FPIs and has therefore attracted both investor interest and discussion. However, it is important that the implementation of the VRR guidelines allows for investor flexibility without additional prescriptive requirements for the channel to be successful.

In conclusion, both FPIs and debt issuers would enthusiastically welcome VRR as a structural step towards broadening and deepening the onshore bond markets. How this development plays out will be an interesting space to watch in 2019.

Vaswar Mitra is country treasurer (India) at Barclays.

Close
×
My Reads Logout