Explainer / What is Bharat Bond ETF?

The Union cabinet on December 4 approved the launch of Bharat Bond Exchange Traded Fund (ETF) to create an additional source of funding for Central Public Sector Enterprises (CPSEs) and state-owned financial institutions.

The New Fund Offer (NFO) of this ETF is expected to be launched this month.

Bharat Bond ETF would be the first corporate bond ETF in the country.

“With the creation and launch of umbrella ETF, we hope to diversify the investor base,” Finance Minister Nirmala Sitharaman said after the cabinet headed by Prime Minister Narendra Modi gave in-principle approval to the bond ETF.

It will help deepen the bond market as was announced in the Budget, she said.

What are ETFs?

Exchange Traded Funds (ETFs) are mutual funds listed and traded on stock exchanges just like regular shares. They are a basket of stocks with assigned weights that reflects the composition of an index.

Bond ETF will be a basket of bonds issued by state firms or any government organisation, and will be tradable on exchange, Sitharaman said, adding that the unit size will be of Rs 1,000, allowing small investors to invest.

Each ETF will have a fixed maturity date and will track the underlying index on risk replication basis, she said, adding that for now it will have two maturity series - three and 10 years - with a low cost of 0.0005 per cent.

Bharat Bond ETF structure

* Each ETF will have a fixed maturity date.

* The ETF will track the underlying index on risk replication basis, i.e. matching credit quality and average maturity of the index.

* Will invest in a portfolio of bonds of Central Public Sector Undertakings (CPSUs) Central Public Sector Enterprises (CPSEs), Central Public Financial Institutions (CPFIs) or any other government organisations that matures on or before the maturity date of the ETF.

* As of now, it will have two maturity series - three and 10 years. Each series will have a separate index of the same maturity series.

* The ETF will be launched every six months and the index will be constructed by independent index provider - National Stock Exchange, said Department of Investment and Public Asset Management (DIPAM) secretary Tuhin Kanta Pandey.

Benefits to investors

Bond ETFs will provide safety (underlying bonds are issued by CPSEs and other government-owned entities), liquidity (tradability on exchange) and predictable tax-efficient returns (target maturity structure).

It will also provide access to retail investors to invest in bonds with smaller amount (as low as Rs 1,000) thereby providing easy and low-cost access to bond markets.

This will increase participation of retail investors who are currently not participating in bond markets due to liquidity and accessibility constraints.

Bond ETFs are taxed with the benefit of indexation, which significantly reduces the tax on capital gains for the investor.

Benefits for CPSEs

Bond ETFs would offer CPSEs, CPSUs, CPFIs and other government organisations an additional source of meeting their borrowing requirements apart from bank financing.

It will expand their investor base through retail and high-net worth individual (HNI) participation, which can increase demand for their bonds. With increase in demand for their bonds, these issuers may be able to borrow at reduced cost, thereby reducing their cost of borrowing over a period of time.

Further, bond ETFs trading on the exchange will help in better price discovery of the underlying bonds.

Since a broad debt calendar to assess the borrowing needs of the CPSEs would be prepared and approved each year, it would inculcate borrowing discipline in the CPSEs at least to the extent of this investment.

How will it impact bond markets?

Target Maturity Bond ETF is expected to create a yield curve and a ladder of bond ETFs with different maturities across calendar years.

ETF is expected to create a new ecosystem - market makers, index providers and awareness among investors - for launching new bond ETFs in India.

This is expected to eventually increase the size of bond ETFs in India leading to achieving key objectives at a larger scale - deepening bond markets, enhancing retail participation and reducing borrowing costs.

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