Central bank moots Strips to boost g-sec trading

In order to improve liquidity in trading of government securities, the Reserve Bank of India (RBI) proposes to introduce separate trading of registered interest and principal of securities (Strips) in the current financial year.

Strips is the process of converting periodic coupon payments and the principal of an existing government security into tradable zero-coupon securities.

According to RBI’s annual monetary policy review on Tuesday, the availability of Strips across the term structure will aid the development of a sovereign zero-coupon yield curve.

In short, an investor could get a reference of interest rate as a benchmark for every year even if no government security maturing in that particular year is trading in the market, said a dealer of government securities. At present, an investor has to work out a hypothetical rate for a year in which there are no securities trading in the market.

RBI has already worked out several measures towards this. While a draft guideline has already been prepared in consultation with the market participants and will be placed for public comments by next month, all operational arrangements for the introduction of Strips, including the required software development, have been carried out as part of the public debt office-NDS (PDO-NDS) platform maintained by RBI. The securities have already been identified that will be eligible for stripping/reconstitution by the market participants.

Besides, in order to take advantage of a falling interest rate scenario that may translate into a low-cost government borrowing, trading in floating rate bonds (FRBs) issued by the government till September 2004 has been made easier by changing the pricing structure. The indicative calendar for the issuance of central government securities provides for the issuance of FRBs.

According to the revised structure, the auction of floating rate bonds will be price based and not spread based.

A dealer explained that for bidding in FRBs, a participating bank in the auction will have to quote an absolute price and not just a spread pegged to a benchmark.

This has been done to bring in clarity in pricing.

A spread is sometimes ambiguous and does not fully capture the market while translating the spread to a yield, said a gilt dealer with a PSU bank. Similarly, to attune the pricing of FRBs more towards the market, the base yield for FRBs henceforth will be linked to the primary market cut-off yield of the 182-day treasury bill and not the 364-day t-bill, as is the case now.

The revised issuance structure for FRBs has already been built into the negotiated dealing system (NDS) auction format being developed by Clearing Corporation of India (CCIL).

The floating rate bond is characterised by floating rate of interest, wherein the coupon of the bond is reset every six months. Therefore, the 182-day treasury bill is an appropriate benchmark in line with the reset period rather than a one-year treasury bill, commented a dealer.

RBI has already withdrawn the current account facility for non-banking participants in government security auctions such as mutual funds insurance companies, pension funds and co-operative banks.

However, following the Annual Policy Statement of April 2008, a new settlement mechanism (Multi-modal Settlement) through commercial banks has been put in place to facilitate entities such as mutual funds (MFs), which do not hold a current account with RBI, to directly participate in the government securities market.