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Developing Indian Debt Markets

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Developing Indian Debt Markets

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available to non-banks as Credit Information

Bureau India Limited (CIBIL) reports the defaults

only for banks. Second is the absence of any

stringent laws in India on bankruptcy enforcement

and protection. Unlike the US where Chapter 11

and other laws ensure high degree of restitution

and that too before diminution of asset value, in

India corporate default does not come in the public

domain for up to 10 years.

Transparency in disclosures, diversity for issuers

as well as investors, and liquidity dependent on

market infrastructure and intent of institutions were

identified as major criteria for development of debt

market by the panel. Mr. Jasmit Singh Chandhok

and Mr. Arun Kaul pointed out that retail investors

do not have enough incentive to invest in bond

markets where there is doubt about the pricing of

bonds, legal issues are cumbersome, and it is

difficult to withdraw money back from market. If at

PANEL SPEAKERS

åSubhomoy Bhattacharjee, Deputy Executive

Editor, The Financial Express

åJasmit Singh Chandhok, Dy. Executive Director,

Learning Arc

åMr. Arun Kaul, CGM Treasury, Punjab National

Bank

åMr. Manoj Bhalla, Treasurer, GE Capital

åSangeeta Bhatia, AGM (Finance), NTPC

EXPERT OPINION

The research on the topic 'Development of Indian

debt markets' was very well appreciated by the

panelists who suggested the presentation should

be made to the regulators to set the way forward.

The discussion began with a comparison of loans

against bonds and analyzing whether the present

system is sustainable. According to Mr. Arun Kaul,

banks would prefer to give loans rather than

investing in bonds because of the direct contact

with the client in case of loans, as compared to

communication through merchant bankers. Mr.

Arun Kaul also threw light on how PNB invests

money in bonds, highlighting that it does not invest

in private sector bonds as there is no proper

secondary market for trading. Two more problems

were identified in case of institutional investment in

corporate bonds. One, data on defaults is not

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all an exposure to bonds is required, much better

options are available to them in the form of

undervalued bank equity who in turn have their

investments in bonds of corporates. Hence, retail

investor would have to enter indirectly into this

market, which is in line with the worldwide trend of

majorly wholesale investors in bond market.

However, such an entry would be preferred as it is

likely to lower the yields in the market.

Thereafter the discussion moved on to the role of

credit rating agencies in development of bond

markets. The panel was unanimous on the view

that these agencies had failed to predict a lot of

troublesome situations in the past and hence

excessive reliance on credit rating agencies should

be avoided. In the panel's view these agencies

have good models for current situation but not the

future, and a more sophisticated analysis is

needed from their side. There was also a debate on

the business model of credit rating agencies, but an

important argument was the need to build

accountability for such bodies by bringing in

regulation.

Other major reasons for non-development of debt

markets were also discussed by the panel. In India,

size of corporate is relatively smaller and they have

access to project loans and working capital loans

such as cash credit from banks which lower their

costs of borrowing to a large extent. In this regard,

banks' operations are actually hindering the growth

of bond market in India. Institutional investors like

EPFO and LIC holding their portfolios to maturity

leaves the market in an illiquid situation and hence

price discovery is not efficient. Moreover, the

platform established by NSE is more of a reporting

platform rather than a trading platform as two way

live quotes are not available. The restriction on

foreign investment is also a major factor in this non-

development if we try to benchmark with the

markets abroad. A point noted by the panel was

that there is a large contribution of foreign

investment in development of Indian equity

markets.

Next issue discussed was that whether due to its

high dependence on Government bonds to finance

budgetary deficit, is it the Government that does

not want the development of corporate bond

market. It was concluded by the panel that the

attempt by Government is not deliberate, but it is

extra cautious to prevent scams. The demand for

Government bonds mainly comes from banks that

need it for their SLR requirements.

Some subtle issues concerning the corporate bond

market were also touched upon by the panel. While

the panel agreed when Mr. Manoj Bhalla pointed

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out that the bond, cash, and derivative market are

needed together for an integrated development,

there were apprehensions regarding allowing of

Credit Default Swaps for this development,

especially after the recent financial turmoil. It was

also concluded that for any scope of a market for

municipal bonds, these organizations first need to

put their houses in order. Mr. Arun Kaul pointed out

the need to allow short selling in corporate bond

market.

The panel was finally able to identify removal of

regulatory ambiguity, funding of stakeholders, and

improvement of corporate governance as

immediate measures in the direction of

development of corporate bond market. At the

same time, the establishment of reporting platform

and the application of uniform TDS for Corporate

and Government bonds were stated as positive

steps from the Government's side.

Overall the discussion was a healthy one which

brought out varied perspectives on what can bring

about a marked change in Indian financial system.

Queries raised by the students were aptly

answered by the panel.

INTRODUCTION

Indian Debt market: Overview

Debt Market is the market where fixed income

securities of various coupons, maturity, options

and other features are issued and traded. The

Indian debt market has two segments, viz.

Government securities market and corporate debt

market. The corporate debt market can be further

classified based on the type of issuer being a Public

Sector Undertaking (PSU) or a private company.

The Indian debt market is dominated by G-Sec

bonds with market capitalization of Rs. 13,18,419

as compared to corporate bond market

capitalisation of only Rs. 68,074 crore at end

December 2007. Hence, within the realm of

development of Indian debt markets, our research

was directed towards the development of

corporate bond market.

Characteristics of developed

debt market

For a market to be developed, presence of three

characteristics is very crucial:

Liquidity: For the market to be liquid; there is a

need for a secondary market. There has to be

enough number and type of instruments and

å

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roles was brought by making primary and

secondary trading a responsibility of SEBI while

repo and reverse repo of debt being a responsibility

of RBI. Also, Corporate Bonds and Securitization

Advisory Committee (CoBoSAC) was set up under

chairmanship of Dr. R.H. Patil to look into further

issues.

From the issuer's perspective, the requirements

regarding continuous disclosures by the issuers

were rationalized; there was a reduction in Shut

Period to align corporate bonds with Government

securities, a reduction in requirement of only one

credit rating agency instead of multiple ones, and

the requirement of investment grade rating of debt

instrument removed. Moreover, Structural

restrictions, such as those on maturity, put / call

option, conversion etc. were removed, corporate

debt instruments issued in de-mat form (and listed

on recognised exchanges) were made exempt

from TDS, and moderated SEBI Regulations were

issued for Issue and Listing of Debt Securities in

2008. These regulations paved the way for one

listing agreement for public and private issue

irrespective of listed or unlisted company, and

minimal disclosures for companies with listed

equity.

number of participants to have sufficient variety,

inducing fast trades in the market.

åSafety: Other than enough types of instruments

with differing characteristics which could be used

to reduce risk exposure, a key requirement for

safety is the minimization of counterparty risk.

åPresence of market maker: A market maker is

required to induce trades in the market by quoting

two-way quotes.

Other than these characteristics, other important

features for a developed market are efficiency of

the market, low transaction costs, and availability

of free public information.

Past initiatives to develop Debt

markets

The Government in February 2006 accepted

recommendations of the high level expert

committee formed under Dr. R. H. Patil. These

recommendations were implemented majorly by

February 2007. The recommendations were aimed

at improving the market conditions for all

stakeholders- from issuers to investors, changes

were brought so as to improve the market

infrastructure and regulatory environment as well.

Reporting platforms were set up by NSE, BSE, and

FIMMDA, and trading platforms from BSE and NSE

became operational. The trade settlement started

happening via exchange or bi lateral ly.

Standardization was brought for the Actual Day

Count convention for new issues. From the

regulatory viewpoint, a clear understanding of

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To make corporate bonds attractive for the

investors, the reporting of OTC and exchange

transactions was made mandatory, the tradeable

lot was reduced to Rs. 1 lakh for all investors, and

market information on secondary market trades

was made available on SEBI website for price

estimation purpose. Also, press release was made

mandatory for issuers in the case of events like

default of payment, failure to create charge on

assets, or a revision of ratings, other than issuance

of compliance reports in public domain by issuers

being made mandatory. The listing agreements of

debentures were also modified, so that ECS, Direct

Credit, NEFT, and RTGS were to be used for

interest payments & redemption, and material

modification in structure of debentures without

prior approval of stock exchange where it is listed

was restricted.

RESEARCH APPROACH

The corporate debt market has several

stakeholders and the expectations, needs, roles

and opinions of these stakeholders on this market

differ vastly. Hence, through the research an effort

was made to look at the corporate bond market

from the perspective of all the stakeholders in the

process and understand their concerns for not

participating in the corporate bond market. The first

step in the research was the reading of several

reports on development of Indian corporate bond

market published by companies like Goldman

Sachs etc., other reports by SEBI, RBI etc., in

addition to news and magazine articles.

After obtaining a basic understanding of the

present condition of the debt market and the

associated issues, a benchmarking of Indian

corporate bond market with US and European

corporate bond markets like Eurex was performed.

The relative standing of Indian corporate bond

market and the characteristics lacking in the Indian

markets were discovered.

Investors in India prefer to invest in other fixed

income securities like government bonds,

Collateralized borrowing and lending obligation

(CBLO) ,bank deposits, national savings

certificates, postal savings etc as compared to

bonds. Hence it was imperative to compare these

instruments as against corporate bonds. After

plotting the risk-return tradeoff for these

instruments vis-a-vis corporate bonds, customer

preferences in fixed income securities and their

investment needs were also determined.

Finally, to obtain the ground-level picture, opinion

was taken from all the stakeholders in the Indian

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At the same time, developed debt market provides

new fund raising avenues to the borrowers, who

otherwise raise capital through loans from banks or

equities generally. Loans in Indian currency and

equity are expensive sources of capital as

compared to issue of bonds, and hence,

companies can issue bonds to reduce their cost of

capital. Further, interest rate of loans is not

transparent; while bond prices are determined by

market forces introducing transparency in the

borrowing market. Other sources of borrowing like

ECB's are not accessible to all companies

especially SME's making corporate bonds even

more important.

Regulators prefer a sound debt market as it would

reduce the asset liability mismatch of banks. It

would reduce the strain of banking system if

corporates issue bonds instead of bank loans. This

will also infuse liquidity in the market. Development

of credit derivative market is possible only after the

development of the underlying instrument i.e bond

market.

Issues

The main reason hindering the development of

corporate bond market is the lack of liquidity. It is

just like a chicken and egg problem. Issuers do not

want to issue bonds because there are not enough

buyers in the primary and secondary market. As

issuers do not issue bonds, investors do not invest

in the market due to lack of good quality bonds.

Another problem faced by issuers is excessive

disclosures for new and successive issues.

corporate bond debt market such as the issuers,

investors, credit rating agencies, regulators and

exchange. A questionnaire was designed for each

stakeholder, through which the stakeholders were

asked to identify the reasons hindering the

development o f the market and the i r

recommendations for removing these barriers.

They were also requested to do a critique on the

recommendations put forth by the students in the

research. Through this primary research, gaps in

the proposed suggestions by various working

committees and the need of the market participants

were uncovered, which provide the justification for

slow pick-up of bond markets in spite of umpteen

development-focused initiatives and suggest

directions for new policy initiatives. The collective

perspectives of different stakeholders presented

through this research provide a holistic picture and

demarcate the reality from the blame-game being

played for long between the regulators, the issuers

and the investors for failure to develop corporate

bond market.

Payoffs of a developed debt

market

A developed debt market is preferred by the

investors, the issuers/borrowers and the regulators

of an economy alike. For investors, a developed

debt markets provides opportunities to diversify

their portfolio. During times of bearish equity

markets, corporate bonds with assured returns are

a very effective medium to mitigate risk.

At the same time, developed debt market provides

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Retail Investors are not well educated about bond

pricing and on the corporate bond market

structure. The minimum market lot size for

investing in corporate bond market is Rs. 1 lakh.

This is a huge amount in comparison to minimum

amount in equities or bank deposits. Also, the retail

investors believe that since everybody is investing

in equity markets, it must be the best option- a

testimony of a social proof phenomenon. As a

result, they are hesitant to invest in the debt

markets. Information on live trading of corporate

bonds is not freely available on the internet.

Institutional investors have no incentive to trade in

exchanges as their needs for corporate bonds is

met by the Over the counter (OTC) market. Banks

prefer to give loans as they are treated on cost

basis in the balance sheet as compared to bonds

which are valued on mark-to-market basis.

Moreover, the bankruptcy and default laws are not

very stringent in India. The investor is exposed to

credit risk and at the same time the market does not

have sufficient hedging instruments.

For the regulators, the main concern is the lack of

development in the market despite the initiatives

taken recently. Also, the investors are not aware of

the initiatives taken by the regulator or the

exchange.

Recommendations

The corporate bond market cannot develop

without increasing liquidity in the market. In every

market, the market makers are sources of

liquidity. To enable market-making, the exchange

å

or the regulator should provide incentives to

market makers. One of the incentives could be

lower transaction cost.

However, due to high bid-ask spread market

making is very expensive. Hence, repos in

corporate bond market should be introduced to

increase secondary market trading.

The current lot size of Rs. 1 lakh deters retail

investors. To tackle this, the market lot size

should be reduced to as low as Rs. 10000.

It is difficult to get free public information about

bonds. People are not aware about government

initiatives like indiabondwatch.com. it is

imperative to educate the investors especially

the retail investors.

There is no benchmark to measure the

performance of bonds. There should be a

benchmark or a index for corporate bonds similar

to the US and the European market.

The main investors in the bond market are

institutional investors. So, a bond market

managed by consortium of institutions like Eurex

bond market will give the institutions to design a

trading and settlement system as per their needs.

å

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List of companies where executives were contacted for primary research

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