Pension funds will be allowed to invest in covered bonds, asset-backed securities

Pension regulator PFRDA will soon allow pension funds to invest in covered bonds and asset-backed securities (ABS), said Chairman RV Verma. The proposed move comes on the heels of the pension funds being allowed to invest in Basel-III compliant bank bonds.

“The main idea is to widen the investment avenues for the pension funds. Inclusion of covered bonds and ABS as eligible instruments for investment would help deepen the capital markets. It will also help the issuers of these two instruments, as more long-term funding will be available to them for asset creation,” Verma told BusinessLine .

He said the financial stability and development council – an apex level body of financial sector regulators – had backed “covered bonds”.

Pension funds will also soon be allowed to invest in ABS issued in line with guidelines specified by the relevant financial sector regulator. These funds will also be permitted to invest in covered bonds issued in line with RBI specified guidelines,” he added.

Covered bonds Covered bonds are basically a type of collateralised debt. The bond seller, typically a bank or a financial institution, maintains a “cover pool” of high-quality assets on his balance sheet to which the bond buyer has priority claim (ahead of any other creditors) should the seller default.

“The additional comfort for an investor in covered bonds is that the bond buyer will have dual recourse to both the specific pool of assets backing the bond as also other assets in the balance sheet, should the seller become delinquent on its payments,” Verma said.

The Reserve Bank of India has already clarified that a bank as an investor could park its funds in covered bonds, which are seen as a means for banks to raise long-term funding at a lower cost.

“In covered bonds, investors will have less risk of defaults and therefore their return expectation will have to be low. Issuers will be able to raise money at lower cost,” Verma said.

The assets underlying a covered bond simply enhances the issuer’s promise to pay back the loan and are not intended to offer exposure to those pool of assets.

Asset-backed securities On the other side, an investor in ABS has limited recourse in the sense that there will be no access to other balance sheet assets beyond the defined underlying pool in case of any default.

In ABS, assets are packaged together (such as loans) and their payment streams are sold.

A securitisation – process of creating ABS – is advantageous to banks as it reduces the amount of capital that the bank must hold to back its loans. However, covered bonds – where the loans are kept on the banks balance sheet – do not provide this benefit.

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