PFRDA Proposes 'Dual Valuation Framework' For NPS, APY Investments In Govt Securities; What It Means

The Pension Fund Regulatory and Development Authority (PFRDA) has proposed to apply ‘dual valuation’ framework for government securities held in NPS (National Pension Scheme)/APY (Atal Pension Yojana) schemes managed by the pension funds. In Simple terms, it means to do fair valuation on both – mark to market and accrual basis for Government securities. 

In a consultation paper “Alignment of Valuation Guidelines with the core objectives of Long-only Funds when investing in government securities and calculation of Net Asset Value (NAV)” released on Wednesday, October 22, the regulatory body has pitched the dual valuation methodology, aimed at minimizing the impact of short-term volatility of interest rate on scheme NAV, depicting to subscribers

a simple and stabilized accumulations of pension wealth during their contribution phase or working years and aligning the role of Pension Funds in converting long term savings into productive long gestation capital formation.

National Pension System (NPS) is a Defined Contribution (DC) pension plan wherein the investment risks are fully borne by subscribers.

Pension Fund are required to invest the contributions made by subscribers in those asset classes (i.e instruments permitted by PFRDA) as chosen by the subscriber. Upon completion of the accumulation phase, the pension wealth or outstanding corpus is utilised by subscriber to receive periodic payouts through a variety of mechanisms permitted by PFRDA.

How Does It Work?

Currently, the investments held under NPS are ‘mark to market’ and the pension funds are mandated to declare scheme NAVs at the close of each working day. In this scenario,

the investment returns to subscribers are thus directly linked to the market conditions of each day. Thus, the performance of pension fund (in managing the scheme portfolios) gets adjudged for each day instead of a holistic evaluation of performance during the entire accumulation phase of the subscriber.

Typically defined contribution pension plans, have a long accumulation phase spanning between 20 to 40 years and the method of valuing the investments plays a crucial role in depicting the pension wealth to a subscriber.

For those who opt for long-term securities, notional gain or loss of accumulated pension wealth due to short-term volatility of interest rates may not be of much relevance.

From a subscriber’s perspective, fair valuation of investments is crucial at the point of exercising withdrawals or subscriber receiving payments from the scheme because at this point the exact quantum of accumulated pension wealth gets determined for being paid to the subscriber.

What Are Proposed Changes?

PFRDA is looking to go away with the all-uniform fair valuation, that’s mark-to-market, for government securities.

It is proposed to shift a part of the Government Securities holding into HTM category viz. the illiquid long-dated debt securities. This model may deliver dual benefit of insulating the scheme NAVs from market price fluctuations of debt securities due to short-term volatility of interest rates and provide greater flexibility to pension funds to actively manage the most liquid debt securities (take benefit of interest rate movements) and maintain overall portfolio liquidity.

The consultation paper also underlines that infrastructure holds a key part in India’s developing story and the sources of long-term funds for financing infrastructure are government borrowings or institutional investors like insurance companies, pension funds or sovereign wealth funds.

In other words, NPS/APY investments in Government Securities indirectly supports economic growth, job creation, improved public services which lays the foundation for transition from a developing to a developed nation.

The features and benefits of both the valuation methodologies are briefly outlined below:

(i) With ‘accrual basis’ of valuation or HTM;

− the coupon or interest income on securities gets recognised or accrued as receivable on a daily basis till its receipt. The discount/premium over face value of securities will get amortised over time.

− the aforesaid accounting approach insulates the daily price fluctuations of the securities due to interest rate movements and facilitates valuation of securities at a stable and consistent rate over time, free from interest rate volatility.

− with elimination of short-term notional gain/loss due to interest rate movements, the depiction of subscriber’s pension wealth during accumulation phase gets smoothened out and easy to comprehend.

− pension fund may scale down active debt portfolio management due to shift in their investment focus (deploying subscriber contributions in higher yielding securities as interest rate movement does not impact the scheme portfolio performances).

(ii) With fair or ‘mark to market’ valuation;

− the coupon or interest income on securities gets recognised or accrued as receivable on a daily basis till its receipt. The securities get valued at the price, as if, it will be liquidated in the market.

− the value of securities reflects current market conditions and ensures transparency.

− it depicts to subscriber the actual value of pension wealth if liquidated under current market conditions even though the subscriber may withdraw the pension wealth at a future date after completion of the accumulation phase.

− with investment risks being fully borne by subscribers, ‘mark to market’ valuations imply pension funds are primarily a pass-through entity and this facilitates easier risk management and liquidity management of the scheme portfolio.