Introduction to DVP, NDS-OM, CCIL and RTGS – Jan 01, 2013

Structure of Presentation

• Introduction to G-Sec mkt.• Evolution of G-Sec mkt.• Delivery Vs Payment System, RTGS and

Securities Settlement System.• Primary Issuance Framework and Secondary

mkt.• Trading in G-Sec.

Introduction to G-Sec markets

Government SecurityDefinition : Govt. Security is a tradeable

instrument issued by the Central or State Govts. Such Securities are both long term (> 1 yr) & short term (<= 1 yr).a. Treasury bills (<= 1 yr)b. Dated government securities (> 1 yr)

Types of dated securities

• Fixed rate bonds• Floating rate bonds• Zero Coupon bonds• Capital indexed bonds• Bond with call/put Options• Special Securities e.g. Oil bonds, fertilizer

bonds etc.

Importance

• Facilitates public borrowings at reasonable costs by the Government.

• Provides the backbone for most fixed income markets through the creation of benchmarks.

• Facilitates the use of indirect instruments of monetary policy viz., open market operations (OMO) and repo operations.

Advantages of investment in G-Sec

• Real time price information• Risk free investment for portfolio risk

management• Wide range of maturity spectrum (91days – 30

yrs)• Liquidity – easy to encash at competitive

prices• Can be used as collateral to borrow funds• Can be held in de-mat form, obviating the

need for safe keeping.

Regional Rural Banks (RRBs) – Section 24 of BR Act 1949 (AACS)

RRBs are required to maintain Statutory Liquidity Ratio (SLR) at 25 % of its demand and time liabilities in India in the form of cash, gold or unencumbered Government and other approved securities.

Categorization of investments (RRBs)

• Permanent Category

No requirement for marking to market.

Entire SLR securities can be under HTM till 2012-13.

Profit should be taken to Investment Fluctuation

Reserve (IFR) and loss should be taken to profit and

loss account

• Current Category –Securities are held in this category with an

intention to trade. Profit or loss on sale of securities from this category

are taken to profit and loss account.

Evolution of G-sec markets

Reforms in G-sec markets

• First round – as part of overall financial sector reforms in 1992

• Second round- to address the issues arising out of FRBM

Pre reform status• Prior to 1992 – Characterized by

– Huge fiscal deficits– Automatic Monetisation– Directed Investment– Administered Rates – to keep the cost low

• Consequently, – Secondary market remained dormant– High interest rates in the system due to cross

subsidisation by banks

Reforms • Fiscal & Monetary Policy:

– Abolition of Ad-hoc treasury bills( 1994)• Ad-hoc treasury bills were issued for short term funding

of Government

– Institution of Ways and Means advances(1997)• Fiscal discipline

– Reduction in Statutory Liquidity Requirement (38.5% to 25%)

• Even the floor removed by latest legal amendment• SLR brought down to 24% ( recent measures)

Delivery Versus Payment System, RTGS and Securities Settlement System

Delivery Vs Payment (DVP)• Delivery versus Payment (DvP) is the mode of settlement of securities

wherein the transfer of securities and funds happen simultaneously. This ensures that unless the funds are paid, the securities are not delivered and vice versa. There are three types of DVP :

DvP I – The securities and funds legs of the transactions are settled on a gross basis, that is, the settlements occur transaction by transaction without netting the payables and receivables of the participant.

DvP II – In this method, the securities are settled on gross basis whereas the funds are settled on a net basis, that is, the funds payable and receivable of all transactions of a party are netted to arrive at the final payable or receivable position which is settled.

DvP III – In this method, both the securities and the funds legs are settled on a net basis and only the final net position of all transactions undertaken by a participant is settled.

DVP (Contd) …• The settlement of G-sec transactions in secondary market is being done on a Delivery

versus Payment (DvP) mechanism (which helps to eliminate the risk that the seller will

give out securities but not receive corresponding funds from the buyer and vice versa) in

the books of RBI since 1995. In July 1995, when this mechanism was first introduced, the

RBI followed DvP-I system wherein both securities and funds were settled on a gross

basis (that is, each transaction is settled individually). Though this helped to reduce the

risk as stated above, it still did not provide an arrangement whereby settlement failures

did not take place i.e., defaults in settlement of SGL transactions. Since April 2, 2004 the

DvP-III mechanism is being followed whereby both securities (security-wise) and funds

are netted. This helps to reduce liquidity requirements for settlement. The securities

obligations are settled at Mumbai PDO in the Securities Settlement System and the funds

are settled in Mumbai DAD.

Real Time Gross Settlement (RTGS)• RTGS system is a funds transfer mechanism where transfer of

money takes place from one bank to another on a 'real time' and on 'gross' basis. 'Gross settlement' means the transaction is settled on one to one basis without bunching with any other transaction. Considering that money transfer takes place in the books of the Reserve Bank of India, the payment is taken as final and irrevocable.

• RTGS is a large value (minimum value of transaction should be 2,00,000) funds transfer system whereby financial intermediaries can settle interbank transfers for their own account as well as for their customers.

• Customers can access the RTGS facility between 9 am to 4:30 pm on weekdays and 9 am to 1:30 pm on Saturdays.

• Banks could use balances maintained under the CRR and the intra-day liquidity (IDL) to be supplied by the central bank, for meeting any eventuality arising out of the real time gross settlement (RTGS). The RBI fixed the IDL limit for banks to three times their net owned fund (NOF).

Types of RTGS Members

• Type A - All Scheduled banks allowed to raise both inter bank and customer transactions and are eligible for intra day liquidity facility from the Central Bank.

• Type B – All Primary Dealers allowed to raise only inter bank transactions

• Type C – Avail RTGS facility through a sponsor bank.• Type D – Clearing entities submit multi lateral net

settlement batches.

Types of Transactions

• Institutional transactions.• Customer Transactions.• Delivery Vs Payment transactions.• Multi-lateral Net Settlement transactions.

RTGS-Process Flow • Y-shaped message flow architecture is followed.• The sending bank transmit the full payment message to a

central processor. The central processor then validates the message and sends only the core settlement information to the settlement account with Central Bank (Reserve Bank of India). The original message is kept in the central processor. After settlement the RBI informs the central processor and the central processor rebuilds the entire message and sends to the receiving bank.

• The attraction of Y architecture is that it enables a distinction to be drawn between the Central Bank's core role as settlement agent and the rest of the system processing can be attended to by a third entity

RTGS Vs National Electronic Funds Transfer (NEFT)

• NEFT is an electronic fund transfer system that operates on a Deferred Net

Settlement (DNS) basis which settles transactions in batches. In DNS, the

settlement takes place with all transactions received till the particular cut-off

time. These transactions are netted (payable and receivables) in NEFT whereas

in RTGS the transactions are settled individually. For example, currently, NEFT

operates in hourly batches - there are eleven settlements from 9 am to 7 pm on

week days and five settlements from 9 am to 1 pm on Saturdays. Any

transaction initiated after a designated settlement time would have to wait till the

next designated settlement time Contrary to this, in the RTGS transactions are

processed continuously throughout the RTGS business hours.

Securities Settlement System (SSS) – Introduction

A system which permits the holding and transfer of securities, either free of payment or against payment (delivery versus payment) or against another asset (delivery versus delivery). It comprises all the institutional and technical arrangements required for the settlement of securities trades and the safekeeping of securities. The system can operate on a real-time gross settlement, gross settlement or net settlement basis. A settlement system allows for the calculation (clearing) of the obligations of participants.

Source : OECD

SSS- Centralization of SGL accounts

• One of the objectives of setting up the NDS system was to provide an efficient settlement mechanism for secondary market transactions in G-secs. This was achieved in the form of Securities Settlement System (SSS) a part of the PDO-NDS/SSS application, which holds all balances in all types of SGL Accounts of members.

Benefits - SSS

• Enables STP of securities transactions.• Enables participants to put up collateral to

CCIL in various segments – intra-day liquidity under RTGS etc.

• Overall management of securities balances by members.

Securities Settlement System – Players involved

• IDMD• PDO • DAD • CCIL

Repo trades on CROMS

Trades in CBLO

Trading on NDS-OM

OTC outright trades in G-Sec

OTC Repo trades in G-Sec

CCIL

Reserve Bank of India

Securities settlement in

PDO

Funds settlement in DADDvP

NDS

Owned and managed by

CCIL

Owned and managed by RBI

Auction of securities (incl. T-Bills)

Owned by RBI but

managed by CCIL

SSS - Infrastructure

Government Securities – SGL a/c & CSGL a/c

• SGL a/c : RBI offers SGL facility to select entities who can maintain SGL account with PDO Mumbai.

• Gilt a/c : An investor can open a Gilt Account with a SGL a/c holder, who is eligible to open Constituents’ Subsidiary General Ledger Account (CSGL).

CSGL eligibility The entities mentioned below are eligible to open and maintain a

CSGL account with the Bank on behalf of their constituents, i.e., Gilt Account Holders (GAHs):

• Scheduled commercial banks. • Scheduled urban co-operative banks with net worth of Rs. 200.00 cr

or more and CRAR of 10% & above and belonging to the States which have signed MOU with the Reserve Bank of India.

• Scheduled State co-operative banks with net worth of Rs. 100.00 cr or more.

• Primary Dealers.Provided that the above entities obtain a no-objection certificate from the concerned regulatory department of the Reserve Bank of India to the effect that they meet the above eligibility criteria (as applicable) and that the Bank has no regulatory/supervisory discomfort.

Settlement – Primary & Secondary Mkt

• Once the allotment process in the primary auction is finalized, the successful participants are advised of the consideration amounts that they need to pay to the Government on settlement day. The settlement cycle for dated security auction is T+1, whereas for that of Treasury bill auction is T+2. On the settlement date, the fund accounts of the participants are debited by their respective consideration amounts and their securities accounts (SGL accounts) are credited with the amount of securities that they were allotted.

• The transactions relating to Government securities are settled through the member’s securities / current accounts maintained with the RBI, with delivery of securities and payment of funds being done on a net basis. The Clearing Corporation of India Limited (CCIL) guarantees settlement of trades on the settlement date by becoming a central counter-party to every trade through the process of novation, i.e., it becomes seller to the buyer and buyer to the seller.

• All outright secondary market transactions in Government Securities are settled on T+1 basis. However, in case of repo transactions in Government securities, the market participants will have the choice of settling the first leg on either T+0 basis or T+1 basis as per their requirement.

Primary Issuance Framework & Secondary Market

Primary Issuance Framework– Auctions (1992)

• Price discovery• Auction formats

– Uniform Price– Multiple Price

– Electronic bidding ( 2002)• Wider reach• Operational ease• Shortening of processing time• Results same evening

– Auction Process is STP

Primary Issuance framework

• Non-competitive Bidding– Eliciting retail participation– Earmarking of a portion of notified amount

• Re-issuance of bonds– Consolidation – Of the 127 issuances of securities conducted during

2011-12, 120 were re-issuances

Auction Process cont..

• Yield based auction– For new securities issued– Coupon rate (CUT-OFF) decided in the auction– Applications up to maximum rate of yield are accepted– Applications above the cut-off rate of yield are rejected– Value converted into price

• Price based auction– Where existing securities are reissued/reopened– Cut-off price is decided in the auction– Applications up to minimum price( CUT-Off) are accepted– Applications below the cut-off price are rejected

YIELD BASED AUCTION- Notified Amount Rs. 1,000 cr

No. YieldAmount

(cr)Cumulative

Total Price(8%)

1 6.00% 500 500 113.89

2 7.00% 200 700 110.13

3 7.00% 100 800 110.13

4 8.00% 200 1000 100

5 8.00% 200 1200 100

6 9.00% 150 1350 96.98

PRICE BASED AUCTION-(8% security) Notified Amount Rs.

1,000 cr

No.Price per

Rs. 100Amount

(cr) Cumulative Total

1 120 500 500

2 115 200 700

3 110 100 800

4 105 200 1000

5 105 200 1200

6 102 150 1350

Multiple/Uniform Price auction

No. Yield Amount (cr) Cumulative Total Price(8%)

1 6.00% 500 500 113.89

2 7.00% 200 700 110.13

3 7.00% 100 800 106.56

4 8.00% 200 1000 100

5 8.00% 200 1200 100

6 9.00% 150 1350 96.98

• Bid No. 1 is seeking only 6%. But gets a security with coupon 8% under uniform price, he gets to keep it

• Under multiple price, he pays more ( Rs. 13.89) than Bid No. 4).

Winners’ curse

Secondary Market - milestones• G-sec holding in Book entry form

– Mandatory dematerialization– SGL at Public Debt Offices– Gilt account facility for others

• Delivery Vs Payment (1995)– Mitigate the settlement risk– Extended to DvP III (2004)

• Reporting Platform for deals – Negotiated Dealing System (2002)

• Dissemination of traded data

Secondary Market Reforms

• Clearing Corporation– The Clearing Corporation of India Ltd. (2001)– Clearing trades in G-secs ( both outright & repo), in

addition to CBLO and forex– Novation & Central Counterparty– Guaranteed Settlements– Provision for LOC– Provision for SLOC– Daily Margining system

Secondary Market - trading

• Over the Counter- reported on PDO-Negotiated Dealing System (NDS)

• Negotiated Dealing System-Order Matching (NDS-OM)

NDS & NDS-OM

• Negotiated Dealing System (NDS) : Introduced in Feb 2002. Facilitates submission of bids electronically or

applications for Auctions. Membership to NDS restricted to members

holding SGL and Current account with RBI.

• Negotiated Dealing System – Order Matching (NDS-OM)

Introduced in Aug 2005. Anonymous order matching. NDS-OM is operated by CCIL on behalf of RBI. Direct access* is limited to Commercial Banks, PDs,

Insurance Cos & MFs etc. Other participants can access NDS-OM through

their custodians.* The access has been extended to UCBs and NBFCs-ND-SI subject to certain financial criteria and NOC by the regulatory department

• Eligibility criteria for NDS-OM membership : Current account with RBI. SGL account with PDO Mumbai. INFINET membership. NDS membership

Benefits of trading on NDS-OM

• NDS-OM ensures anonymity of participants.• The system provides information – both pre-

trade and post trade – bids and offers.• To facilitate trading in small lot sizes of less

than Rs 5 cr, an odd-lot segment is available.• There is high level of operational ease as the

entire process is automated.• Reporting happens simultaneously with trades

on NDS-OM

Web-based NDS-Auction/OM module

To facilitate direct participation of retail and mid-segment investors in G-Sec auctions, the Reserve Bank has allowed web-based access to negotiated dealing system (NDS)-auction system developed by the CCIL. The system allows gilt account holders to directly place their bids in the auction system through a primary member’s portal, as against the earlier practice wherein the primary member used to combine bids of all constituents and bid in the market on their behalf.

A similar web-based access to NDS-order matching (OM) system for secondary market transaction has been developed and implemented on June 29, 2012.

Data Dissemination – OTC trades (RBI website)

Data Dissemination – Order Matching trades (RBI website)

INDIAN FINANCIAL NETWORK (INFINET)

• INFINET is the communication backbone for the Indian Banking and Financial Sector. All Banks, Public Sector, Private Sector, Cooperative, etc., and the premier Financial Institutions in the country are eligible to become members of the INFINET.

• INFINET is a Closed User Group [CUG] Network for the exclusive use of member banks and financial institutions. The communication backbone is based on IP VPN Layer 3 Network with full mesh VPN network. Presently, the network is spread across 300 cities in our country.

CCIL • Setting up – CCIL was set up in April, 2001 for providing

exclusive clearing and settlement for transactions in Money, G-Secs and Foreign Exchange.

• Objective - The prime objective has been to improve efficiency in the transaction settlement process, insulate the financial system from shocks emanating from operations related issues, and to undertake other related activities that would help to broaden and deepen the money, debt and forex markets in the country.

• Functions - CCIL provides settlement of money, g-sec and forex transactions. It also manages NDS-OM (trading platform on behalf of RBI.

Risk Mitigation mechanism – CCIL

• Settlement Guarantee Fund (SGF): SGF is a fund maintained by market participants

with CCIL in the form of cash or G-Secs. The SGF helps in settlement of secondary market transactions if there is a failure by any of counterparty to complete its part of the transaction (buy or sell g-secs).

Process flow – Secondary market transactions

• Secondary market transactions in NDS & NDS-OM are obtained by CCIL.

• The obligations for both funds & securities are sent to RBI Mumbai for settlement under DVP.

• The securities obligations are settled at PDO Mumbai and funds are settled in Mumbai DAD.

• In case of any shortage, guarantee given by CCIL is invoked.

Market makers – Primary Dealers • PD system made functional in 1996

– strengthen the securities market infrastructure.• Objectives

– Ensure maximum participation in primary auctions– Underwrite the auctions– Enhance the liquidity by quoting two way– Provide inputs to Reserve Bank

55

Primary Dealers

21 PDs in operation, of which 13 are banks.

Absorbed 47.7% in 2011-12of primary issues of dated securities and 71.2 % of T-Bills

Capital adequacy prescribed 15%

Recent developments – PDs PDs to hold Government securities in Held to Maturity category (HTM) to the extent of their audited Net Owned Funds (NOF) as at end March of the preceding financial year.

PDs borrowing limit from call money market in a reporting fortnight, was increased to 225% of their Net-Owned Funds (NOF) from 200% earlier.

The minimum NOF for stand-alone PDs undertaking only G-sec business, was increased from Rs. 50 crore to Rs. 150 crore and for the stand-alone PDs, which intend to undertake other permissible activities, NOF is enhanced to Rs.250 crore from the existing level of Rs. 100 crore.

Existing PDs shall have to submit an annual target along with plan of action for turnover to be achieved on behalf of mid-segment and retail investors at the time of renewal of their PD authorisation. The annual target should not be less than 75% of minimum NOF for standalone PDs/bank PDs.

Development of Market Bodies for co-ordination

• Establishing Fixed Income Money Market and Derivative Association of India (FIMMDA) 1997

• Primary Dealers Association of India (PDAI) 1997

• Technical Advisory Committee (TAC)– For integrated approach to Money, Forex and G-

Sec markets

FIMMDA - functions• FIMMDA – incorporated on June 03, 1998 u/s 25 of Cos

act.• Membership – Nationalized banks, Pvt sector banks,

Foreign banks & PDs.• Acts as an interface between RBI and market participants.• Developmental activities – introduction of benchmark

rates and new derivative instruments.• Releases rates of various G-Secs.• Best market practices.• Website : http://www.fimmda.org/

FIMMDA Code of Conduct• FIMMDA Code of conduct was introduced in Oct

2011.• Code of conduct seeks to lay down directives to the

users of NDS-OM system, so that anonymity, ease of dealing, provided by the system are not misutilized.

• FIMMDA has also prescribed a price band under the code – 20 bps and 25 bps over previous day’s closing prices in case of G-Sec and SDL respectively.

Trading in G-Secs

Trading in G-Secs

• Over the counter (OTC)

• Negotiated Dealing system

• Negotiated Dealing System – Order Matching (NDS-OM)

Dos and don’t s for dealing in G-Secs• Segregate the dealing and back office functions• Monitor all transactions• Keep a record of all SGL forms issued• Seek a SCB, PD or a FI as counterparty• Approved list of brokers (5 % individual limit)• Open and maintain only one gilt account• Open a funds account with SCB or StCB

Risks in G-Sec investment

• Market risk

• Reinvestment risk

• Liquidity risk

Risk mitigation

• Holding securities in HTM category

• Rebalancing portfolio – selling short term & buying long term

• Using derivatives such as interest rate swaps

Factors affecting price of GS

• Changes in interest rates in the economy• Macro economic factors such as inflation• Developments in other markets like money,

foreign exchange, credit and capital markets.• Developments in international bond markets.• Policy actions by RBI such as changes in policy

rates (repo and reverse repo)

Return on a GS

• Return on a GS = Coupon income + Gain/loss on the security

Note : Coupon income remains constant, but due to marking to market there can be gain/losses.

Relationship between Price and Yield• If interest rates or market yields rise, the price of a bond falls. Conversely,

if interest rates or market yields decline, the price of the bond rises. In other words, the yield of a bond is inversely related to its price. The relationship between yield to maturity and coupon rate of bond may be stated as follows:

When the market price of the bond is less than the face value, i.e., the bond sells at a discount.

When the market price of the bond is more than its face value, i.e., the bond sells at a premium.

When the market price of the bond is equal to its face value.

Basic Bond Terminology

• Accrued interest• Coupon • Competitive / Non-Competitive bid• Duration • Odd lot • Yield to Maturity • Weighted Average Price/Yield

Thank Youakashsolanki@rbi.org.in