SEBI Implements Mark-to-Market Valuation for Mutual Fund Repo Transactions

The Securities and Exchange Board of India (SEBI) announced on Tuesday the introduction of new valuation guidelines for repurchase (repo) transactions carried out by mutual funds. Under these changes, securities involved in such transactions will now be valued on a mark-to-market basis.

The updated framework is designed to standardize the valuation methods for all money market and debt instruments, addressing potential regulatory inconsistencies that could arise from differing approaches. Sebi specified that these changes will take effect starting January 1, 2025, according to a circular issued by the regulator.

The circular states that repo transactions, including tri-party repo (TREPS) with a tenor of up to 30 days, will transition to mark-to-market valuation. Currently, these transactions are assessed using the cost-plus-accrual method. Moreover, the valuation for all repo transactions, except overnight repos, along with other money market and debt securities, will be derived from valuation agencies.

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A repo transaction, also known as a sale repurchase agreement, involves the sale of securities with an agreement to repurchase them later at a pre-determined price. These instruments are commonly used for short-term capital requirements. In the context of mutual funds, repo transactions are permitted on corporate debt securities, commercial papers (CPs), and certificates of deposit (CDs). For example, a mutual fund needing ₹1 crore for 10 days can use corporate bonds, CPs, or CDs as collateral in a repo transaction to secure a short-term loan at the prevailing market rate.

SEBI also emphasized that all money market and debt securities, including floating rate instruments, must be valued based on the average security-level prices provided by valuation agencies. If valuation agency data is unavailable for a newly issued security not yet held by any mutual fund, the security should be valued at the purchase yield or price on the date of acquisition.

In June, SEBI had expanded the scope for mutual funds to invest in repo transactions involving securities like Commercial Papers and Certificates of Deposit, aiming to foster growth in the corporate bond market. However, mutual funds can only engage in repo transactions involving corporate debt securities rated "AA" or higher.

These revised guidelines aim to ensure consistency across valuation practices for money market and debt instruments while mitigating potential regulatory arbitrage. All valuations must either be obtained or approved by valuation agencies, and for securities without available data, the purchase yield or price at allotment will serve as the valuation basis.

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