The Hindu Business Line : Price-based auction likely for floaters

THE Reserve Bank of India is understood to be considering modification in the issuance structure of floating rate bonds (FRBs) to price-based auction from yield-basedauction, say money market participants.

Some sections of the market participants are believed to have requested RBI to consider increasing the outstanding amount by reissuing existing floating rate bonds as well as conducting a price-based auction for these papers.

But, no formal announcement in this respect has been received, said an analyst at a Primary Dealer in Mumbai, which underwrites Government debt sales.

Floating rate bonds, popularly known as floaters, are issued through a yield-based auction. This means, on a floater the underlying is predetermined which is usually a 364-day Treasury bill and the spread over the underlying is fixed on basis of bids made by the auction participants.

According to bond market players, instruments such as floaters must provide a hedge against interest rates in a rising interest rate scenario but these are neither functioning as a hedging tool nor providing adequate liquidity.

Cut-off spread has been rising in the yield-based auctions conducted for issuing floaters. This translates into reduction of market value of the paper issued previously at a lower cut-off spread.

Last two FRBs issued also had a devolvement which shows lack of demand at a particular yield level desired by the central bank, said a trader.

There has been no issue of FRBs by the central bank after the September 9 auction.

Although market participants have been less enthusiastic on FRBs in the recent past they concede that a few modifications in respect of the paper would yield good results.

Firstly, to increase liquidity in these papers, preferably the outstanding amount should be increased. By reissuing the same FRBs again, floating stock can be increased to about Rs 15,000 crore or more in a particular paper. This would increase trading in the paper, resulting in more liquidity.

Next, the papers should be auctioned through a price-based auction, which would mean that the cut-off spread is also fixed in addition to fixing the underlying, while price of the paper is allowed to be determined by auction bids.

This could lead to the paper being subscribed below par, but would not lead to sharp northward movement in the cut-off spread.

"Each one basis point upward spread movement translates into a Rs 6.50 loss on the paper; fixing a market determined price would make trading in FRBs easier," said a trader at a Primary Dealer.

Another issue is with fixation of variable base rate of the paper.

At present, variable base rate is based on the average rate of the last three auctions of Government of India 364-day Treasury Bills.

"In a rising interest rate scenario the market yield on 364 day T-bills rises substantially between the gap in each auction.

"Preferably the base rate should be fixed on the basis of the most recent auction to give a more representative rate," said a Fixed Income Head at a large private sector bank.

It is also desirable that the reset of the FRBs be changed to three months from current six months, said a trader at a Primary Dealer.

"With yields on G-Secs rising frequently in the current scenario, a three month reset will provide a return closer to market rates," he added.

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