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There are two significant regulations that will potentially change Indian financial markets for the better as well as give significant benefits to investors in fixed income assets.

One is from the Securities and Exchange Board of India (Sebi) and the other from Reserve Bank of India (RBI).

They are interlinked in an indirect way but the end-beneficiary is the fixed-income market.

The regulation by Sebi pertains to the change in valuation norms of fixed-income securities, while that by RBI is the change in base lending rates of banks.

The rules take effect from July 1, 2010.

The Sebi one is for mutual funds. The watchdog has directed that all debt securities with residual maturity of 91 days or more are to be marked to market.

Earlier, debt securities (debentures, not money market instruments) with a residual maturity of over 182 days were to be valued thusly.

This is significant for mutual funds as a large part of their fixed-income assets are in the 91 to 250 days maturity bucket, and a significant portion of these assets are not valued at market due to the previous regulation.

The benefits to investors are many.

The first is that the investor putting money into or redeeming a short maturity fund comes in and exits at prevailing market levels, which is not the case now.

The investor now comes in and goes out at historical market levels, which used to literally subsidise one investor at the cost of another.

No more.

The second benefit is that an investor will have options to grade his risk profile and time horizon.

An investor with low risk profile and short time horizon will be in a fund that caters to his investment preference whereas an investor with higher risk profile and longer time horizon will be in a different fund.

Similar classes of investors clubbed together will reduce volatility in terms of inflows and outflows, thereby reducing volatility in fund returns.

The other benefits to investors will be prudent risk management practices followed by fund managers as losses cannot be hid through valuations.

The papers will also get traded at realistic levels in the market as papers will have to be marked to market.

The Sebi regulation will also reduce systemic risk to the market as market risk is passed on to investors and not borne by thinly capitalised asset management companies.

On the other hand, from July 1, banks cannot lend below the base lending rate as is the practice right now. This rule will shift activity from the loan market to the corporate bond market. Banks were happy to lend below base rates as they didn’t need to mark loans to market. The loan bazaar cannibalised the bond market due to this single factor.

The fact that banks cannot lend at below base rates will force companies to come to the corporate bond market to borrow. The rates will be realistic as set by markets and corporates will have to pay for the market perception of their creditworthiness. Banks will be forced to actively participate in the corporate bond market for deploying cash.

In the short term. corporate bond yields will go up as banks will stop lending at below base rates and markets will demand yields close to base rates. However. in the long term the market will settle down and trade on the basis of demand and supply and other macro factors rather than on technical factors.

The two regulations, while directed at different participants, will on the whole bring about vibrancy to the fixed income market thereby benefit investors.

Disclaimer:The writer is head, fixed income, IDFC Mutual Fund. Views are personal.