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22Nd Aug 2016
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| RBI (The Total Investment & Insurance Solutions) |
In a bid to deepen the corporate bond market
in India, a report of the Working Group on Development of Corporate Bond Market
in India was released by the Reserve Bank of India (RBI) on 18 August 2016. It
suggested standardisation of corporate bond issuance by allowing investments by
foreign portfolio investors, creation of a bond index, encouraging corporates
to tap the market among other recommendations.
The Working Group has recommended total 29
amendments in order to deepen the regime of corporate bond market in India.
Recommendations include allowing investment by Foreign Portfolio Investors
(FPIs) in certain non-permitted segments; allowing reissuance of bonds through
same International Securities Identification Number (ISIN); extending
electronic book mechanism (EBM) to all issuances; following uniform method of
valuation and creation of centralised database. Let us discuss these
recommendations separately. The Total
Investment & Insurance Solutions
Reissuance and exemption of stamp duty
The primary market has seen a surge in
corporate bonds in India, but trading in secondary market has lacked volume.
One such attributable reason is non-availability of sufficient floating stock
for each ISIN as corporates have preferred for fresh issuances rather than
reissuing of bonds. As new issue comes with new ISIN, older ones become
illiquid.
To augment market liquidity, it is
recommended to encourage corporates to reissuance bonds under the same ISIN by
consolidating various issues into one large issue. Though this may result in
mismatch of assets and liabilities, it can be resolved can by spreading out the
redemption amount across the year through amortising the payments. This could
also help in reducing the cost of borrowing.
SEBI has allowed reissuance of bonds.
It is observed that the issuers of debt securities do not undertake
re-issuances due to stamp duty and the bunching of repayment liabilities. The
group recommended that reissuance not be treated as fresh issuance of bonds for
the purpose of stamp duty.
Allowing FPIs to invest in unlisted and pass
through securities
Currently, in the bond market, FPIs are only allowed to
invest in unlisted non-convertible debentures and bonds issued by
infrastructure companies and in listed or to be listed debt securities. To
attract more foreign funds into markets, the Union Budget envisaged FPIs to
invest in unlisted debt securities as well as in securitised debt instruments
i.e. pass through securities issued by special purpose vehicles (SPVs) or
special purpose distinct entity (SPDEs).
It is therefore, recommended to introduce
necessary amendments, by August 2016, in FEMA Regulations allowing investments
by FPIs in unlisted debt securities and pass through securities issued by SPVs
and SPDEs. The Total Investment
& Insurance Solutions
Another recommendation is to permit FPIs to
transact in corporate bonds both in the over-the-counter (OTC) segment
and in the request for quote platform of a recognized stock exchange, subject
to certain restrictions. This move is sought enable FPIs to trade directly on
electronic trading platforms and thereby help in enhancing liquidity in the
bond market.
Market Making
The liquidity and the frequency of
transactions in India are very low. One method to make the market liquid is by
way of introducing a market making scheme. Market making can help the issuer to
improve the market liquidity and also provide the investors to the option of
entry and exit in the market. SEBI, though had allowed stock exchanges to
introduce the market making scheme, stock exchanges are yet to come up with the
mechanism. The Total Investment
& Insurance Solutions
The Group therefore recommends stock
exchanges to operationalize market making scheme in consultation with SEBI. For
this, banks and primary dealers may be allowed to act as market makers upon
developing an appropriate risk management framework
EBM for all
The debt market in India is dominated by
bringing issue by way of private placements. The percentage is as high as 90%.
Many market participants have indicated that private placements lack
transparency and access is not available to a large pool of investors. The
Union Budget 2016-17 announced that SEBI may operationalise electronic auction
platforms to facilitate transparent private placements.
In this regard, guidelines have been issued
by SEBI on 21 April 2016, which enable introduction of EBM by the stock
exchanges and mandate that all private placements of debt securities in primary
market with an issue size of Rs500 crore and above, inclusive of green shoe
option, if any, should be through such a mechanism. Such EBMs have been operationalized
by the Stock Exchanges. Bonds with issue size of less than Rs500 crore, are
required to disclose the coupon, yield, amount raised, number and category of
investors to the electronic book provider and or to the information repository
for corporate debt market.
With the margin of private placement being as
high as 90%, the working group is of the recommendation that EBM shall be made
compulsory to all issuances of corporate bonds, but only after reviewing the
success of the EBM for the existing issues and market feedback.
Uniform valuation norms
Currently, RBI and Insurance Regulatory and
Development Authority of India (IRDAI) have advised the entities under their
ambit to follow the valuation norms issued by Fixed Income Money Market and
Derivatives Association of India (FIMMDA), a quasi-self-regulated organisation.
Mutual funds follow valuation norms as advised by credit rating agencies
(CRAs). In addition, mutual funds require daily valuations as they have an
obligation to publish net asset value of their schemes on a daily basis, but
FIMMDA norms for valuation of corporate bonds are calculated on a monthly
basis. Therefore, use of different norms has led to adverse effect on the
market to some extent.
Therefore, it is recommended to follow or
establish a uniform valuation methodology available on a daily basis by the
regulated entities for valuation of their holdings of corporate bonds. The
working group, therefore, advised regulators to explore a mechanism for
valuation including engaging the Financial Benchmarks India Pvt Ltd (FBIL) or
credit rating agencies for the same with necessary safeguards and regulatory
oversight. The Total Investment
& Insurance Solutions
Disclosure norms for CRAs and Banks
At present, CRAs are required to disclose the
movements of credit rating of all outstanding securities on their websites on
half-yearly basis. Market participants have, however, expressed the view that
the level of compliance by the CRAs in adhering to these regulatory
requirements is not high. Currently, banks furnish loan overdue information to
credit information companies (CICs) on monthly basis. Also, CRAs are not
eligible to access the information on bank lending to large borrowers under
stress from CICs for the purpose of determining the ratings for
corporates.
The working group, therefore, recommended
CRAs to publish the credit rating transition matrix more frequently. Also, CRAs
may take up membership of CICs to access relevant credit information. The
working group also opined that RBI may consider whether CRAs may be allowed
access to Central Repository of Information on large credits.
Integrated Trade Repository
A central repository and database enables
investors to get complete information about corporate debt market at one place.
Such database will enhance transparency in the market and enable investors to
take an informed decision. Though, NSDL and CDSL have created a database for
the primary market there is, however, a need to have an integrated trade
repository (TR) and database so that the information of both primary and
secondary markets, such as, issue wise outstanding size, rating, shut period,
price, volume of secondary market trades, rating migration, etc. are available
at one place. Accordingly, an announcement for introduction of an Integrated TR
for primary and secondary market in corporate bond market has been made in the
Union Budget 2016-17. The Total
Investment & Insurance Solutions
Therefore, it is recommended for introducing
a centralized database for corporate bonds covering both primary and secondary
market segments in two phases, for secondary market trades by end August 2016
and for both primary and secondary market by end October 2016.
Index for corporate bond market
There is a strong need of bond market index
in order to cater to the needs of participants who want a platform to act as a
benchmark. In view of the same, the working report recommends Stock Exchanges
to introduce a corporate bond index on the lines of Nifty 50 and BSE
Sensex.
Augmenting partial credit enhancement (PCE)
limit on bonds
RBI Guidelines on PCE of Indian Rupee bonds
issued by infrastructure companies restricts the extent of PCE provided by
banks to 20% of the bond issue size. For investors desiring a minimum of AA
rating on bond, the current PCE seems inadequate to raise ratings for bonds. In
order to encourage corporates to avail of this facility, especially by
infrastructure companies, during the initial phase the upper limit for PCE by
the banking system as a whole may be enhanced to a higher limit with no single
bank having exposure of more than 20 per cent. It is also felt that the capital
required to be maintained by banks because of PCE should be lower if the base
rating of the project improves. This would incentivise banks to provide PCEs on
projects, which are expected to perform better with passage of time.
It was therefore, recommended for RBI, by
August 2016, to enhance the upper limit for PCE to a higher limit with no
single bank having exposure of more than 20 per cent of the bond issue size by
end August 2016. In addition, it was recommended to formulate a separate
regulatory framework for providing credit enhancement of corporate bonds by
NBFCs engaged in such activities to help bolster bond ratings that can attract
investors.
Electronic trading platform
SEBI has prescribed norms for
electronic trading platform (screen based trading) in place for trading of
bonds; but only 15 of such bonds are available for trading. The reason for such
low volume can be attributed to high penalty for short delivery of bonds
(currently, 5% of default amount) given the volatility in bonds. The Total Investment & Insurance
Solutions
To encourage market participants to start
trading on such platforms, the risk management practices of the clearing houses
shall be reviewed and a mechanism similar to equity market where the entity
involved in delivery failure is given a time period to cover from the market
and failing which some penalty is imposed shall be considered. The Total Investment & Insurance
Solutions
Encouraging bond financing rather than bank
financing
In many of the developed countries bonds are
issued without creation of security interest, subject to certain compliances,
to enable easy of raising of funds by the corporates. However, bank borrowing
has been a popular source of funding in India. The reason behind this can be
prevalence of the cash credit system where the burden of the cash management of
the corporations falls on the banks. The objective is to encouraging
alternative sources of funding to bank credit for the corporate sector to
finance growth and to de-risk the balance sheets of banks and spur the bond
market in India. In addition, it was announced in the Union Budget 2016-17 for
RBI to issue guidelines to encourage large borrowers to access a portion of
their financing needs through market mechanism instead of the banks.
The Working Group therefore, recommends large
corporates with borrowings from the banking system above a cut-off level to tap
bond market. The Total Investment &
Insurance Solutions
Acceptance of corporate bonds by RBI
As of now, banks can only pledge government
securities to borrow from the Reserve Bank of India, and allowing them to
pledge corporate bond could spur more buying of the debt by banks.
Internationally, many central banks accept corporate bonds as collateral for
their liquidity operation. It is not uncommon for central banks to take a lead
with a view to developing the financial market.
In order to incentivise banks and PDs to
invest in corporate bonds and thereby create demand for corporate bonds, it is
recommended to RBI to explore the possibility for accepting corporate bonds for
LAF operations with suitable risk management framework including rating
requirements
Investor Protection
A robust, timely and effective bankruptcy
regime is critical to the development of corporate debt market from investors’
point of view. The recently passed Insolvency and Bankruptcy Code, 2016 is
expected to ensure recovery for creditors and address the concerns of investors
in corporate bonds by providing new time bound recovery and resolution
framework and rules under the Code are expected to be issued shortly. In order
to achieve the objective behind the Bankruptcy Code, issues such as early
notification of the rules, development of insolvency professionals, tribunal/court
infrastructure and information utilities and quick redressal of the
transitional problems may be addressed with priority.
Other Recommendations
Credit Default Swaps (CDS)
Pending amendments relating to permitting
netting of OTC derivate contracts may be explored expeditiously within the
purview of existing legal provisions and banking practices.
Repo in corporate bonds
FIMMDA is planning to consult market
participants in order to develop an acceptable market repo agreement for
execution among the market participants by end September 2016. Market makers
may be allowed to participate in the repo market.
Basel III compliant Perpetual Bonds
EPFO and Insurance companies may be allowed
to invest in AT-1 bonds of banks and the maximum investment ceiling of 2% may
be reviewed for relaxation.
Rationalisation of Stamp Duty
The stamp duty on debentures should be made
uniform across states and be linked to the tenor of securities. The Total Investment & Insurance
Solutions
The Indian bond market is in for major revamp
by the regulators. There seems to be a huge drive from the government to
integrate financial market in India further with the rest of the world. If
everything falls in place as expected, the bond market in India expected to
surge and be a much higher part of its GDP. This is expected to bring Indian
bond market in line with that of China, Brazil and other developed countries.The Total Investment & Insurance
Solutions
