Union Finance Minister Nirmala Sitharaman recently launched the Corporate Debt Market Development Fund (CDMDF) in Mumbai.
Nirmala Sitharaman in her 2021-22 Union Budget speech had announced the creation of a permanent institutional framework to enhance secondary market liquidity in the Corporate Bond market during stressed and normal times, thereby instilling confidence amongst participants in the corporate bond market.
On 29 March 2023, Securities Exchange Board of India (SEBI) announced the setting up of the Corporate Debt Market Development Fund (CDMDF) with an initial corpus of Rs 3000 crore. It has been set up as an Alternative Investment Fund (AIF).
Corpus of the fund
The initial corpus of the fund will be Rs 3000 crore which will be contributed by specified debt mutual funds and asset management company (AMC).
The time period of the fund will be 15 years .
Function of the Fund
The CDMDF will act as a backstop facility for purchase of investment grade corporate debt securities (Bonds, debentures etc ) during times of stress to help stem panic selling and ease redemption pressures.
The backstop facility will be managed by SBI Mutual Fund.
It will provide support only to those mutual funds which have contributed to the corpus of the CDMDF.
The fund will be guaranteed by the National Credit Guarantee Trust Company (NCGTC) under the Union Ministry of Finance.
The mutual fund during time of distress will be able to withdraw upto 10 times its contribution. It means that if the mutual fund has contributed Rs 10 crore to the CDMDF then it will be able to withdraw a maximum Rs 10 crore x10=Rs 100 crore.
Idea behind CDMDF
Mutual Fund collects funds from the investor and invests in the market. The investor invests in a mutual fund scheme by buying the units of the scheme . Normally one unit is equal to Rs 10 .
Hence if a person invests Rs 1000 in the mutual fund then he will be allotted 100 units of the mutual fund scheme . Suppose the scheme launched by the mutual fund is a debt scheme .It means that the mutual fund will invest the fund collected from the investor in buying the bonds and debentures of companies after deducting its expenses and fees .
The value of the mutual fund investment is reflected in the scheme's Net Asset Value(NAV) . NAV has a direct correlation between the market price of the bonds in which it has invested . Thus ,if the prices of the bonds in which the mutual scheme has invested goes up then the NAV of the unit will go up and if the prices of the bonds go down in the market then the value of the NAV will also go down.
The investor can withdraw his money from the scheme by selling back the units back to the mutual fund at the prevalent NAV. This is called redemption.
Suppose due to various reasons the bond market crashes and the market price of bonds falls . Hence ,if the market price of the bonds falls then the value of the NAV will also go down sharply.
This creates a panic situation for the investor. He thinks that if the price of the bond falls continuously then the value of NAV will also fall sharply, leading to a huge loss for the investor .
The investor panics and starts selling the unit back to the mutual fund to cut his loss. The mutual fund needs funds to buy the unit back from the investor . For this the mutual fund will have to sell the bonds in which it has invested in the market . As the bond market is already in a bad shape the mutual fund will get a very low price for the bonds it is selling .
Thus the mutual fund will face a liquidity crisis. It will not have enough money to meet the redemption request of its unit holder . The mutual fund might collapse as happened to the Templeton mutual fund. If such a thing happens then the people will lose confidence in the mutual funds and stop investing in it.
This will not be good for the economy as the mutual fund mobilises the savings of the public and provides money to the companies by buying its bonds/debentures. The companies use this money to invest and set up factories which creates new jobs.
To prevent such a thing happening and to provide liquidity support to the mutual funds in such a scenario the government has come out with the idea of CDMDF.
Here the CDMDF will step in and provide liquidity support to the mutual fund so that the mutual fund does not collapse and create a crisis of confidence amongst the investor towards the mutual fund sector as a whole.
What is a Backstop facility?
Backstop facility is an arrangement that requires setting up of a secondary source of finance in case the primary source of finance is insufficient to meet the current need.
The facility acts as the last resort of finance for the finance seeker. The risk is taken by the backstop facility provider.
In the CDMDF the risk will be taken by the National Credit Guarantee Trust Company (NCGTC) backed by the government of India. Thus, it is a kind of sovereign guarantee.
What is a Primary and Secondary Market ?
The primary market is the place where the company directly raises funds from the investors. In simple words it is the place where the companies sell their shares or bonds, debentures to the investor for the first time and then the company lists the issued shares or bonds,debentures on a stock exchange.
Secondary market is the market where the listed shares,bonds or debentures of the companies are traded after it has been listed on a stock exchange like BSE, National Stock Exchange of India Ltd. (NSE).
Stock market is a part of the secondary market.