New valuation guidelines of debt securities under NPS with effect from January 1, 2020
PFRDA has made changes in the ‘valuation of debt securities’ as well as ‘valuation policy for securities below investment grade’ in which pension funds NPS can make investments.
Last week, the Pension Fund Regulatory and Development Authority (PFRDA) revised the valuation guidelines for pension schemes. In its circular, PFRDA stated that it has made changes in the ‘valuation of debt securities’ as well as ‘valuation policy for securities below investment grade’ in which pension funds in the National Pension System (NPS) can make investments. The revision in valuation can improve the quality of the debt portion of NPS investments and bring in more transparency as well.
The new rules will be effective from December 1, 2019. However, as per the circular, if necessary software developments at the Pension Fund and Valuation Agency requires some more time, it should be ensured that guidelines are implemented latest by January 1, 2020.
Key changes in valuation policy guidelines 2019
Valuation of debt securities
The debt securities will now be valued at a clean price, i.e., the accrued interest component of the security will be excluded. If corporate bonds and debentures are quoted along with interest on the exchange, the valuation must be done by excluding the accrued interest portion (i.e., from the last due date of interest till date) from the quoted price, since the interest is accrued and accounted separately on a daily basis.
As per the circular, when new security is purchased for which market price is not available on the same day, then such a security will be valued on the basis of scrip level price (for coupon-bearing securities) /scrip level yield (for discounted securities) at which the securities are purchased.
Valuation policy for securities below investment grade
Generally, in the case of securities downgraded to default status, the companies have to provide a haircut (reduction) on the valuation.
As per the PFRDA circular, “Debt securities which were of BBB investment grade at the time of purchase, but which have fallen below this investment grade, except with default rating (other than Government securities) and securities where credit rating agencies have suspended the ratings but are performing assets as per PFRDA guidelines shall be valued at a discount of 25 percent of the face value.”
Also, all non-investment grade debt securities (other than Government securities) not covered above will be valued at the indicative haircut matrix or price provided by the valuation agency. In case the security is traded where the haircut has been applied, lower of the haircut matrix-based price and trade price will be considered.
How these valuation guidelines will help NPS subscribers?
Valuation of securities held under NPS is a necessary activity undertaken by the pension fund at the end of the day to arrive at the scheme-wise net asset value (NAV) at which subscriber transactions such as purchase/ redemption/ switch of units are undertaken.
A PFRDA official said, “The investments under NPS are marked to market on date of valuation (daily basis). The market to market price should reflect the realisable value/fair market value of the security. The matrix-based approach takes into account only the rating, duration and the industry of the security to determine the yield. Hence, the yield to maturity matrix may not be the correct reflection of specific risks affecting the fair value of a security like liquidity risk, issuer risk, promotor background, demand-supply conditions, etc. The Security Level Valuation (SLV) method is more comprehensive and has been designed to address limitations, to some extent, posed by yield to maturity matrix for securities where traded prices are not available. By using a more comprehensive method for valuation, we get more realisable value of the securities.”
Points to note
According to the PFRDA circular, “The main objective of these guidelines is to specify methodology and the manner in which securities/assets should be valued by Pension Funds to ensure consistent valuation and transparency.”
Once these guidelines are implemented, it will then be reviewed annually to ensure the appropriateness and accuracy of the methodologies used and its effective implementation in valuing the securities/assets.