The Hindu Business Line : FIMMDA valuation of illiquid bonds draws flak

EVEN as money market participants fall back on the Fixed Income Money Market and Dealers Association (FIMMDA) for valuations of illiquid securities while drawing up their balance sheets, a section of them have expressed dissatisfaction over the valuations of Government securities by the association. They are of the view that FIMMDA valuations of papers of certain maturities, particularly illiquid securities, have been "off the mark."

As per the Reserve Bank of India norms, valuation of securities can be done at traded prices, price list of RBI or prices fixed by FIMMDA. Although it is not mandatory for market players to use FIMMDA valuations, it has been an accepted norm to use it in the absence of other valuation.

Valuations of illiquid securities pose problems, as they are not widely traded in the market and hence these securities have to be valued at prices determined by FIMMDA committee or price list of RBI. Some of these include 4.83 per cent 2006 paper, 11.83 per cent 2014 paper, 11.43 2015 paper and 6.25 per cent 2018 paper.

"We either use broker's valuations or our own valuations for all practical purposes," said a senior bond trader.

Valuations are done through a polling system through which the illiquidity spread of a security is determined. Active market players are asked to give their opinion as to what should be the spread between yields of the liquid and illiquid paper, which gets to be known as the illiquidity spread.

According to a risk management expert at a primary dealing firm, "The valuations given by FIMMDA are at times lower than fair value and at other times higher than fair value."

In case of 4.83 per cent 2006 paper, which is not widely traded, the value was fixed at Rs 98.00. When trades take place in the paper it is done at Rs 98.50 or Rs 98.75, thus showing a discrepancy between traded price and valuation price, he said.

"The bond market was flourishing for the past two to three years, so a Rs 5 crore difference in a Rs 100 crore profit did not have a large effect on the bottom line. But, as the yields have started hardening a Rs 2 crore loss adding to a Rs 50 crore loss does make a difference. That is the primary reason behind taking up this issue", he added.

"Information dissemination is weaker as far as illiquids are concerned. People are not aware of market movements. In case of illiquids, one-off trades are not taken into account," said a highly placed FIMMDA officer.

If traded volume in a security is Rs 25 crore and above and nearly five to six trades have taken place in it, then the traded price is taken for valuation even if trades take place on the last day, he said.

Apart from the poll method, judgment call is also used to determine price, leading to widening spreads in an illiquid market. This might lead to difference in valuations from time to time, he added.