INTRODUCTION
In early
years of last decade RBI had decided to phase out the non-bank entities from
call money market. RBI had also imposed restrictions on access to call money
market by Banks and Primary Dealers. Entities that were not forming part of the
banking system were not to be allowed to participate in the Liquidity
Adjustment Facility (LAF) auctions conducted by the RBI.
At that time The Clearing Corporation of India (CCIL) had devised a product called as “Collateralized Borrowing and Lending Obligation (CBLO)”. Reserve Bank of India in its Mid Term Review of Monetary and Credit Policy for the year 2002 – 2003 had briefly mentioned about the introduction of CBLO as a Money Market Instrument (MMI) and brief operating instructions were issued in this regard vide its letter No. MPD. 227/07.01.279/2002-03 dated December 20, 2002. CCIL had launched the Collateralized Borrowing and Lending Obligation (CBLO) in January 2003, a money market product which was based on Gilts (G.Secs) as collateral.
In the international market mainly four types of REPOs exit.
1. Buy-sell / Sale-buy back repo
2. Classic repo
3. Bond borrowing and lending repo
4. Tripartite repo
The Tripartite repo operate under a standard global master repurchase agreement, DVP, provision for Substitution of securities, automatic marking to market, reporting and daily administration by single agency which takes care of market risk on itself and automatic roll-overs, while does not disclose identities of counter parties. The process starts with the signing of the agreements with the global master repurchase agreement and tripartite repo service agreement. This minimizes credit risk while dealing with the clients with low credit rating.
The product designed by CCIL is some what comparable to tripartite repo and with the Hold-in-Custody type Repo used exclusively by RBI under Liquidity Adjustment Facility (LAF). However this product was given a color of a transferable / lending / investment product, a Money Market Instrument.
In CBLO the eligible securities are not physically transferred to the third party (CCIL in this case) or to the buyer of CBLO, i.e., Lender of money but are simply kept ‘on hold / Lien’ in the fund’s borrower’s Gilt Account (GA), maintained with CCIL (the third party). The securities continue to be in the name of borrower of funds. Technically Securities of the borrower are held in the Gilt account under GA-Constituent SGL account opened with CCIL and are said to be subjected to a paramount lien.
What is a CBLO?
As CCIL puts it CBLO is:
* An obligation by the borrower to return the money borrowed at a specified future date;
* An authority to the lender to receive money lent at a specified future date with an option/privilege to transfer the authority to another person for value received;
* An underlying charge on securities held in custody (with CCIL) for the amount borrowed / lent.
Thus, under the scheme the borrowing members of CCIL are required to maintain a Gilt Account with CCIL for lodgment of G.Sec which is to be used as collateral for borrowing. The borrowing limits for the members are fixed at the beginning of the day taking into account the securities deposited in the CSGL account. These securities are subjected to necessary haircut, after marking them to market. Then limit is set up for CBLO. The limits in effect denote the drawing power up to which the members can borrow funds. Lenders deposit cash to meet initial margin requirements that are designed to take care of the settlement risks. On date CCIL has 72 members (including associate members). Associate members settle their trades through the members. For simplicity the discussion on and reference to associate members/borrowers is omitted.
Lender of funds in CBLO has an underlying interest in securities that are blocked in the borrowers account (GA) with CCIL. On sale of CBLO by lender of funds, in the secondary market, the underlying interest in the security gets automatically transferred to the new lender of the CBLO. In real terms it is a anonymous borrowing or lending collateralized by G.Sec with CCIL guaranteeing settlement in both issue and repayment leg.
At that time The Clearing Corporation of India (CCIL) had devised a product called as “Collateralized Borrowing and Lending Obligation (CBLO)”. Reserve Bank of India in its Mid Term Review of Monetary and Credit Policy for the year 2002 – 2003 had briefly mentioned about the introduction of CBLO as a Money Market Instrument (MMI) and brief operating instructions were issued in this regard vide its letter No. MPD. 227/07.01.279/2002-03 dated December 20, 2002. CCIL had launched the Collateralized Borrowing and Lending Obligation (CBLO) in January 2003, a money market product which was based on Gilts (G.Secs) as collateral.
In the international market mainly four types of REPOs exit.
1. Buy-sell / Sale-buy back repo
2. Classic repo
3. Bond borrowing and lending repo
4. Tripartite repo
The Tripartite repo operate under a standard global master repurchase agreement, DVP, provision for Substitution of securities, automatic marking to market, reporting and daily administration by single agency which takes care of market risk on itself and automatic roll-overs, while does not disclose identities of counter parties. The process starts with the signing of the agreements with the global master repurchase agreement and tripartite repo service agreement. This minimizes credit risk while dealing with the clients with low credit rating.
The product designed by CCIL is some what comparable to tripartite repo and with the Hold-in-Custody type Repo used exclusively by RBI under Liquidity Adjustment Facility (LAF). However this product was given a color of a transferable / lending / investment product, a Money Market Instrument.
In CBLO the eligible securities are not physically transferred to the third party (CCIL in this case) or to the buyer of CBLO, i.e., Lender of money but are simply kept ‘on hold / Lien’ in the fund’s borrower’s Gilt Account (GA), maintained with CCIL (the third party). The securities continue to be in the name of borrower of funds. Technically Securities of the borrower are held in the Gilt account under GA-Constituent SGL account opened with CCIL and are said to be subjected to a paramount lien.
What is a CBLO?
As CCIL puts it CBLO is:
* An obligation by the borrower to return the money borrowed at a specified future date;
* An authority to the lender to receive money lent at a specified future date with an option/privilege to transfer the authority to another person for value received;
* An underlying charge on securities held in custody (with CCIL) for the amount borrowed / lent.
Thus, under the scheme the borrowing members of CCIL are required to maintain a Gilt Account with CCIL for lodgment of G.Sec which is to be used as collateral for borrowing. The borrowing limits for the members are fixed at the beginning of the day taking into account the securities deposited in the CSGL account. These securities are subjected to necessary haircut, after marking them to market. Then limit is set up for CBLO. The limits in effect denote the drawing power up to which the members can borrow funds. Lenders deposit cash to meet initial margin requirements that are designed to take care of the settlement risks. On date CCIL has 72 members (including associate members). Associate members settle their trades through the members. For simplicity the discussion on and reference to associate members/borrowers is omitted.
Lender of funds in CBLO has an underlying interest in securities that are blocked in the borrowers account (GA) with CCIL. On sale of CBLO by lender of funds, in the secondary market, the underlying interest in the security gets automatically transferred to the new lender of the CBLO. In real terms it is a anonymous borrowing or lending collateralized by G.Sec with CCIL guaranteeing settlement in both issue and repayment leg.
DISCUSSION
CBLO is a Money Market
instrument
RBI has given CBLO a status
of Money Market Instrument. However there is no-gazette notification which
states that CBLO is Money Market Instrument under Sec 45 U (b) of RBI Act. If
we assume it exist it might become security for depository purposes (SEBI
Depository Regulation 28 of 1996) though may not be a security not under SCRA.
It being a transferable product it should be clear whether it is Negotiable
Instrument (NI) or otherwise as the transferability is linked to the nature of
the instrument. As per the current legal frame work, NI is essentially an instrument in writing and
cannot be directly brought in, in an electronic form. In my opinion, no direct creation of NI, in
electronic form, would be possible as in case of equity/bonds. Hence CBLO may
not be NI. Even if such creation could becomes possible as NI or such Money
Market Instrument is treated as bond/debenture it cannot be created without
payment of required stamp duty, unless exemption in stamp duty is granted by
the Central Government. To determine the stamp duty the nature of instrument
needs to be clear. Further is should be noted that CBLO is nothing but
borrowing obligation secured by underlying Govt security held by third party
(CCIL) and lender of funds can sell / transfer the right/s to another person (for a consideration), to receive the underlying amount on maturity
from issuer of CBLO (borrower of funds). The underlying interest in G.Sec is expected
to get automatically transferred along with the transfer of title of CBLO
Asset.
CONCLUSION
CCIL’s
product document states that its risk exposure in the CBLO segment emanates on
two counts:
(a) Risk of default by a borrower in repayment on maturity of a CBLO. As the repayment of borrowing under CBLO is guaranteed by CCIL, it should have enough security to meet any eventuality of a default by the borrower. To take care of this risk, all borrowings are fully collateralized. This process is managed through setting up of a Borrowing Limit from members against their deposit of Government Securities as collateral. These collateral are subjected to hair-cuts and are revalued on a daily basis. Any shortfall in the value of collateral (to meet outstanding borrowing) is collected through end of the day margin calls.
(b) Risk of failure by a lender to meet its obligations to make funds available or by a borrower to accept funds by providing adequate security.
(a) Risk of default by a borrower in repayment on maturity of a CBLO. As the repayment of borrowing under CBLO is guaranteed by CCIL, it should have enough security to meet any eventuality of a default by the borrower. To take care of this risk, all borrowings are fully collateralized. This process is managed through setting up of a Borrowing Limit from members against their deposit of Government Securities as collateral. These collateral are subjected to hair-cuts and are revalued on a daily basis. Any shortfall in the value of collateral (to meet outstanding borrowing) is collected through end of the day margin calls.
(b) Risk of failure by a lender to meet its obligations to make funds available or by a borrower to accept funds by providing adequate security.
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