policy prescription for indian corporate bond market

7/30/2019 Policy Prescription for Indian Corporate Bond Market

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Prepared by :Ashaf Faraz

Khan(11BM60024)

Under Guidance of Prof A.K Misra

Policy Prescription for Enhancing RetailParticipation in Indian Corporate Bond

Markets


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Problem Statement


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Public vs Private Issue of Debt -Scenario India

private placements rather than public issues still dominate the debtmarkets and stands at about 99% of total resources mobilized

We are today ,where Brazil was in 2006-2007

Public Issue Private Issue Public as percentage ofTotal Issue size

Issue size2008-2009 1500 173281.18 0.87%2009-2010 2500 212634.92 1.18%2010-2011 9451 218785.41 4.32%

No of Issues*

2008-2009 1 1041 0.10%2009-2010 3 1278 0.23%2010-2011 10 1404 0.71%

Fig in cr


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Though G-Sec Bond market is inline( in terms of percentage of

GDP) with the rest of the world, Indian Corporate Bond specifically

the pubic issuance is lagging far behind. Presently almost all

corporate Bonds are issued via private placement due to various

reasons like limited disclosure requirement and lower regulatory

hurdles. To increase the size of Public issues in corporate Bond

market it is important to increase retail participation. India would be

needing close to USD 1 trillion for development of infrastructure

sector in the 12th Five Year Plan (2012-17).To meet this requirement

I explore the possibility of Increasing the Retail Participation by

Identifying way which can increase liquidity in India in Corporate

Bond Market


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Literature Review


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. a comm eeRecommendation

Developments for Secondary Markets Developments for Primary MarketsTrade Reporting System Stamp Duty (Differential Stamp Duty Levied by state Govt)Clearing and Settlement System TDS (should be similar to the ones applicable to G-Sec)

Order Matching Trading System

Enhancing Issuer Base (Banks should be allowed to issuebonds of maturities of over 5 years for ALM purpose andnot only for the infrastructure sector )

Phased Implementation ofRecommendations relating to Trade

Reporting, Clearing & Settlement andOrder Matching System Market-Makers

Reduction of Shut Period

Listing of Issues ( For listed entities ,incrementaldisclosures every time they approach the market with afresh issue either to the public or through a privateplacement,For unlisted companies issuing bonds toinstitutional investors/QIBs, rating rationale should form thebasis of listing)

Unified Market Convention

Enhancing Investor Base ( investment byprovident/pension/gratuity funds and insurance companiesin corporate bonds)Retail investors should be encouraged to participate in themarket through stockexchanges

Repos in Corporate Bonds Consolidation of Privately Placed Bonds

Introduction of Interest Rate Derivatives Bonds Primary Issuance DatabaseReduction in Market Lot


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Raghuram Rajan Committee Report Point out many Natural Investors such as banks

and Insurance companies have restriction placedon them forcing them to Invest in large amount inGovt. securities

FIs have limited investment potential to invest inGovt securities

Creation of exchange traded Interest rate andForeign exchange derivatives contract for liquidity

Setting up of professional markets andexchanges with a higher order size, that arerestricted to sophisticated investors (based onnet worth and financial knowledge), where moresophisticated products can be traded.


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New Thinking on Corporate Bond Market(by ila Patnaik and Ajay Shah)

Transform Credit Rating Agencies and Credit rating processtowards greater transparency

Improve reliability of benchmark yield curve, by encouragingtrusted issuers banks to issue bonds across maturities

Encourage SMEs to issue bonds and raise funds from the debtmarket

Offer special Repo window to market maker dealing withSME bonds .Fis focusing on SMEs like SIDBI could offersuch special Repo window.

Broaden Investor Base by encouraging participation of retail ,QII, HNWs investors ,offer additional tax break on interest incomefrom debt market instruments over and above current limit of Rs5000.

Establish stop loss threshold during volatile and illiquid market tomitigate risks of market marker .


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New Thinking on Corporate Bond Market(by ila Patnaik and Ajay Shah)

Encourage public issue of bonds over privateplacement revise private placement norms ( to 30from 50)

Corporates issuing bonds more than Rs 4000 cr in

a financial year shall make public issue of bonds forat least 30% of their fund requirements

To offer Liquidity ,All infra bonds to be exchange witha minimum lot size of Rs 5000 /-

Increase deduction under section 80 CCF from theinfrastructure bonds from 20,000 to 50,000


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Methodology


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Analyzing Current RegulationScenario-India

So Far the Development Include : Regulatory jurisdiction over corporate bond market has

been defined.RBI regulates repos in corporate bonds

Budget 2011-12 ,FII limit for investment in corporate

bonds with Residual maturity over 5 year issued bycompanies in infra sector, has been increased to USD20 billion taking total limit to USD 40 billion

No TDS is deducted when debt security is issued in

demat form and listed on recognized stock exchange inIndia

Introduction of Exchange traded interest rates future onnotional 2-year and 5-year coupon bearing Governmentof India securities

Simplification of disclosure and listing requirement


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Industry wise Capital Raised2011

6.54%

8.20% 0.44%1.43%

1.39%

3.64%

8.25%

1.89%

0.62%6.20%

0.04%

0.32%

0.09%0.36%

8.94%

3.18%

48.48%

Banking/FIs

Cement & Construction

Chemical

Electronics

Engineering

Entertainment

Finance

Food Processing

Healthcare

Information Technology

Paper & Pulp

Plastic

Power

Printing

Telecommunication

Textile

Others

Cement

Finance

Telecommunication

Source : SEBI Hand Book 2012


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Various Fixed Instruments Present inIndia

S.No.

Investment Tenure ExpectedReturn

Tax Applicability Comments

1 BankFixedDeposits

Few daysto severalyears

Usuallyover 8%

Taxable at theinvestors slab

Bank failures are rare in India so bankfixed deposits are a very safe way toinvest your money.The rates is known up front so there isno uncertainty there.Taxes can reduce returns, especially ifyou are in the high tax bracket, but

even then a FD that compoundsquarterly and is done for a longmaturity will yield well.

2 Tax SaverBank FixedDeposits

5 years ormore

Usuallyover8.5%

The amount invested intax saver FD isdeductible from yourtaxable income up to a

limit of Rs. 1 lakh under80C. The interestincome itself is taxable.

Like the bank fixed deposit, this is alsoa very safe and certaininvestment.The drawback is thatmoney is locked in for at least 5 years,

and the positive is that you get sometax benefit to juice up your return.

3 PublicProvidentFund

15 years 8.80%The amount investedis eligible for 80Cdeductions and thereturns are tax free

too.

This is also a very safe investment, and thereturns are spectacular, specially forsomeone in the 30% tax bracket.If you dont

mind the 15 year wait period then no otherfixed income investment can match the PPFreturn for the safety it offers.

4 NSC IX 10 years 8.90%Interest income is This is another safe investment with decent


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Various Fixed Instruments Present inIndia

5 SeniorCitizensSavingsScheme

5 years 9.30% Interest istaxable,investmentamount is eligiblefor 80Cdeduction.

Very useful for elderly people

6 MonthlyIncome

Scheme

5 years 8.50% Interest income istaxable

This is useful if you are looking foran instrument that gives you a

monthly income. Here is link to apost about MIS.

7 Tax FreeBonds

They trade onthe stockexchange soyou can buy orsell any time.

Usuallyupwards of

8%

Income is tax freecategorized as fairly secureinstruments.If you buy these bonds from thestock market right now, they aretrading at higher than their face

value so your effective yield will beless but then there is always achance to make capital gains ifinterest rates come down.

8 FixedMaturityPlans

1 year or more Not fixedbut usuallycomparable

to fixed

deposits

This is taxefficient whencompared withFDs..

Although these are fixed incomeinstruments, there is absolutely noguarantee or indication of what thereturns will be like.

To that extent, they are verydifferent from the other instruments


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Constraints that Limit the demand forthe bonds

On the demand side, pension funds and Provident funds, who couldbe large buyers of corporate debt, are constrained by their prudentialnorms and conservative investment policies.(this is soon going tochange as per new govt policy expected)

Mutual Funds, and to a lesser extent insurance companies, arebuyers of higher yield debt, but do not create enough demand for themarket to grow. India would be needing close to USD 1 trillion fordevelopment of infrastructure sector in the 12th Five Year Plan(2012-17).This requirement alone cannot be met by the bankingsector.

Banks tend to prefer loans to bonds, because loans can be carriedon the books without being marked to market, thus reducing the

possibility of unexpected demands on bank capital. Foreign investors, who do not suffer from the same sources of risk

version as Indian institutions,are allowed only to a very limited extentinto the market (a total of US$ 3 billion).

The absence of a reliable system of resolving financial distress

All these factor give rise to limited liquidity and is not a favorablecondition for Retail participant who would participate only if themarket was vibrant


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Constraints that Limit the issuancefor the bonds

The high interest rates demanded by buyers,because bonds are illiquid and because bondholders are poorly protected in bankruptcy,means that bank debt is available at much more

attractive terms.(syndicated loan) Larger corporate issuers had access to much

cheaper funds in the offshore debt capitalmarkets (Even after hedging their currency risks,

the total cost of borrowing offshore is much lowerthan the cost of borrowing in the domesticmarket, Hence the Strong growth in ECB)

Fear of the Issue not being subscribe(reputational risk)


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Market Participants Opinion(Survey) PSU issues not much credit related issue ,but for Non

PSU much of Due Diligence is required

Volumes are very less

Retail Participant would not come in till Institutions

subscribe large part of the issue Individuals still prefer to go to Banks (9-10% rate)

Most Issues happening by NBFCs (hence appetite isless)

Stamp duty needs to be rationalized ( 0.25% of issue)

Rating cost and Disclosure requirement for everysubsequent issue is stringent

Need for active market making


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Market Participants Opinion Need for Credit enhancement by RBI,to bolster

confidence

Printing cost is high (about 0.25% of the issuesize)

Debt Redemption Reserves is an Issue .(CurrentDRR requires company issuing debentures mustcreate reserves within 12 months ,else a penaltyof 2% is to be paid)


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Negotiable Instrument Act Section 13 (a) of the Act, Negotiable instrument

means a promissory note, bill of exchange orcheque payable either to order or to bearer,whether the word order or bearer appear on

the instrument or not. Section 31 of the Reserve Bank of India Act

provides that no person in India other than theBank or as expressly authorised by this Act, the

Central Government shall draw, accept, make orissue any bill of exchange, hundi, promissorynote or engagement for the payment of moneypayable to bearer on demand.


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Growth Check Clearing

Source : RBI


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Existing Suggestions from

Literature


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Suggestions Allow Domestic Financial Institutions greater leeway

to invest in corporate Bond

Steadily raise the limit of Foreign Investments

Amend Bankruptcy code so that the right of the

unsecured creditors are protected Reduce the transactions costs in issuing and trading

corporate bonds, including repeated onerousdisclosures (move instead to a shelf-registrationscheme), as well as high stamp duties;

Reduce the artificial preference of banks for loans bysubjecting loans and bonds to similar mark-to-marketrequirements, especially for aspects such as interestrate exposure that are easily measured


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Findings


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Market Design Improvements Presently Govt bonds are traded on NDS (

Negotiated Dealers system).No such similarplatform for Corporate Bond market .

Time to Implements single Trading systems with

multi currency dimension like T2S in europe (i.esingle platform for Trading ,Clearing,SecuritySettlement & Asset Servicing and Cashsettlement),Significantly low settlement fees

for the user (printing cost charges)


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T2S-Eurosystem


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What is Negotiable Negotiation thus requires two conditions (As per

the Act) to be fulfilled, namely:

There must be a transfer of the instrument toanother person; and

The transfer must be made in such a manner as toconstitute the transferee the holder of theinstrument.


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Possibilities of Bond being issued asNegotiable Instrument

Section 13 (a) of the Act, Negotiable instrumentmeans a promissory note, bill of exchange orcheque payable either to order or to bearer,whether the word order or bearer appear on

the instrument or not. Section 31 of the Reserve Bank of India Act

provides that no person in India other than theBank or as expressly authorised by this Act, the

Central Government shall draw, accept, make orissue any bill of exchange, hundi, promissorynote or engagement for the payment of moneypayable to bearer on demand.


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Can be made Negotiable ! Although the Act mentions only these three instruments(such as a promissory note, a bill of exchange and

cheque), it does not exclude the possibility of adding anyother instrument which satisfies the following twoconditions of negotiability: the instrument should be freely transferable (by delivery or by

endorsement. and delivery) by the custom of the trade; and the person who obtains it in good faith and for value should

get it free from all defects, and be entitled to recover themoney of the instrument in his own name.

Hence as such, documents like share warrants payableto bearer, debentures payable to bearer and dividendwarrants are negotiable instruments. But the money ordersand postal orders, deposit receipts, share certificates, billof lading, dock warrant, etc. are not negotiableinstruments.


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Future Objectives Design an elaborate Trading platform similar to

the T2S Trading platform in europe,Keeping inmind the suggested changes

Amend the Negotiable Instrument Act to

Incorporate Bonds

Review Bankruptcy Code for enhancement

Explore ways that can lead to improvements in

financial Literacy while at the same time gaugingthe present level of literacy

Review Bankruptcy Code for enhancement


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References Raghuram Committee report Negotiable Instrument Act 1881

Bankruptcy Code

T2S Trading Platform ,Europe

Budget Speect 2012-2013 Ministry of Finance

R.H Patil Committee (2005)

Working paper : New Thinking on Corporate Bond

Market (by ila Patnaik and Ajay Shah) Speech Y.V reddy (2007) : Developing Debt Market in

India

SEBI HandBook 2012


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THANK YOU


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APPENDIX :Negotiable ActDefinitions Bills-of-Exchange :A non-interest-bearing written order used primarily

in international trade that binds one party to pay a fixed sum of moneyto another party at a predetermined future date.

Promissory Note :A written, dated and signed two-party instrumentcontaining an unconditional promise by the maker to pay a definite sumof money to a payee on demand or at a specified future date.

Bills of exchange are similar to checks and promissory notes. They canbe drawn by individuals or banks and are generally transferable byendorsements. The difference between a promissory note and a bill ofexchange is that this product is transferable and can bind one party to

pay a third party that was not involved in its creation. If these bills areissued by a bank, they can be referred to as bank drafts. If they areissued by individuals, they can be referred to as trade drafts.

A bearer instrument is a document that indicates that the owner of thedocument has title to property, such as shares or bonds. Bearerinstruments differ from normal registered instruments, in that no

records are kept of who owns the underlying property, or of the


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Various Post-Office Scheme Present inIndia


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Emerging Markets Scenario

12.66%

11.27%

10.54%

4.91%

5.81%

2010 2009 2008 2007 2006

BRAZILs Corporate Bonds as a percentage of

Total Bonds issues ( by issues size)

Refer Excel Sheet for detailed comparison

policy prescription for indian corporate bond market

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