Valuation of Repurchase (Repo) Transactions by Mutual Funds

Monisha Chaudhary

29 Mar, 2025

Recently, on June 27th, 2024, the Securities and Exchange Board of India (SEBI) published a circular regarding the Valuation of Repurchase (Repo) Transactions by Mutual Funds, constituting a significant regulatory change towards increasing transparency, standardization and protection of investors within the Indian mutual fund industry.

Repo transactions are very much a part of money market operations and require accurate pricing methodologies to ensure fair pricing, reduce risk, and comply with regulatory standards. This article will highlight the major constructs of the circular issued by SEBI, its impact on the mutual fund industry, and the details of the alteration of valuation practices concerning repurchase transactions including the rationale behind these changes. Registration of mutual fund with SEBI is crucial in current scenario.

What is Repo Transaction?

A repossession agreement, also known as a repo, is defined as a temporary mode of borrowing that is used mostly by financial institutions such as mutual funds for purposes of keeping liquidity as well as optimizing cash position.

In a repo transaction, one party sells securities to another party with some agreement to repurchase the same securities at a later date, often overnight or for a short duration. The repo rate, or the interest paid for this borrowing, reflects the cost of borrowing liquidity in the short-term money market.

SEBI’s Circular on Repo Valuation

Current Rules for Valuing Investments: As per Chapter 9 of the SEBI Master Circular dated June 27th,2024, if mutual funds have more than 30 days left for maturity, they are required to value their investments in the money market and debt securities (like bonds) using prices from specific, authorized valuation agencies. The valuation agencies specialize in determining the market value of such securities.

Valuation of Short-Term Investments: The short-term deposits with banks as well as repo transactions (including tri-party repos or TREPS) with a maturity of up to 30 days, are currently being valued using the “cost plus accrual” method. Clause 9.6.2 of the Circular number invites stipulation for this. Thus, the value of investments such as these would be calculated by cumulating any interest that had been earned (accrued) with the amount of the original purchase price. 

New Changes to Repo Valuation (Uniformity): To make the valuation process uniform, SEBI has decided that repos, including TREPS, which will now mature for 30 days, are to be valued on a ‘mark-to-market’ basis. Thus, instead of the cost-plus accrual method, the value of these repos would be ascertained based on current market prices, just as with other money market-to-debt securities. This circular has been proposed as a solution to guarantee a uniform and correct appraisal of all assets that mutual funds have under control.

Impact on Repo Transactions (Including TREPS): Repo transactions other than overnight repos would now require a market valuation in addition to money market and debt securities valuations. Repo transactions such as TREPS, a kind of tri-party repo arrangement with clearing corporations as facilitators, will now also be subject to Mark-To-Market (MTM)valuation methodology. This would result in regulatorily inconsistent opportunities for profit across transaction types since the methodology differs for different types.

Agencies Valuation: The circular states that except for overnight repos, all repurchase transactions must be valued by recognized valuation agencies. This is similar to what is being done for valuing money market and debt securities.

Valuation of money market and debt securities: Money markets and strong-debt securities, including floating-rate securities, will be valued based on the average price quoted by the valuation agencies. If any security is newly issued and not yet valued by the agencies as it is not held in any mutual fund, it can be valued by the price or yield at which it is acquired.

Effective Date: The new rules will come into effect starting from January 1, 2025.

Legal Basis: (As written in the circular) This circular is issued in exercise of the powers conferred under Section 11 (1) of the Securities and Exchange Board of India Act, 1992, read with the provision of Regulations 25(19), 47 and 77 of SEBI (Mutual Funds) Regulations, 1996 to protect the interests of investors in securities and to promote the development of, and to regulate the securities market.

Valuation of repo transactions having a maturity period of up to 30 days shall be valued at market prices as opposed to the cost-plus-accrual method. This will enhance uniformity and consistency in the process of valuation.

Key Benefits of the New Valuation Approach

• Increased Transparency: Adopting mark-to-market valuation methodology will increase transparency in the valuation of repo transactions. It provides clarity to the investors on how their investments are priced, and NAVs will reflect real-time market conditions.
• Elimination of Regulatory Arbitrage: The standardization of the valuation of instruments will ensure fairness and also save mutual funds from gaining an undue advantage by taking advantage of differences in valuation methods. The investor is, therefore protected, and such a level playing field is created.
• Investor Protection: Accurate pricing in repo transactions through mark-to-market valuation can especially protect investors, as the NAVs of mutual funds will be based on current market-reflective prices, thus minimizing overvaluation or undervaluation chances regarding fund assets. This will mislead investors about the actual worth of their holdings.
• Improved Risk Management: A new methodology encourages better risk management by ensuring that transactions in repo have their actual market valuation done on them. With the above, the mutual funds also will be able to ascertain more accurate reflections on their exposure towards interest rate and credit risks and thus lead them towards better investment decisions.

Challenges and Considerations for Mutual Funds

Despite the many benefits that the recently issued circular has brought, there are also some challenges and other considerations for mutual funds:

• Implementation Costs: The shift from a cost-plus-accrual to a mark-to-market valuation methodology will require mutual funds to update their internal systems, adopt new valuation practices, and possibly incur additional costs related to the procurement of market prices from approved valuation agencies.
• Market Volatility: Mutual funds may experience more volatility in their NAVs due to fluctuations in the value of repo transactions, especially if market conditions are unstable.
• Availability of Accurate Market Prices: There may be challenges in obtaining reliable market prices when repo transactions are not actively traded, which might lead to valuation uncertainties.
• Impact on Smaller Funds: The newly introduced valuation procedures can make it difficult for smaller mutual funds, which do not have the same resources as larger funds, to implement or absorb associated costs.

Conclusion

With the SEBI circular of June 2024, India’s mutual fund industry has taken a crucial leap in the evolution of regulations that are directly related to repo transactions. This declaration changes the older procedure that valued repos of up to 30 days in a mark-to-market valuation methodology and will be considered a significant regulation on the transparency of the market, the removal of inconsistencies, and the overall protection of the investors.

Following this, SEBI intends to equate repos with the valuation principles applicable to other money market and debt instruments and standardize the approach to mutual fund asset management into an ever-improving trend toward better NAVs and risk management systems.

To get expert assistance in comprehending SEBI regulations pertaining to mutual funds, visit https://enterslice.com/.

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