04 February 2010

The missing corporate debt market

While much has been written about the problems of the small and illiquid debt market, nearly all commentators agree that having an active primary and secondary debt market is crucial for development of the infrastructure of the country. Just as we could not have had an Infosys without the deep and liquid equity markets, it is difficult to imagine a robust capital market to fund infrastructure without a solid corporate debt market. Much of the problem has to do with the government debt market crowding out the corporate debt market, but here are some of the key micro issues which need to be looked at to kickstart the market (by the Govt, RBI and SEBI):

Low FII limits

The dissonance between the huge ECB borrowing limits for companies and FII limits on corporate bonds make no sense from a policy perspective. The currency risk is borne by the investor in case of FII investment – by allowing a generous ECB borrowing and limiting the FII exposure to corporate debt we are importing currency risk by regulatory fiat. In any case, they do not substitute completely but complement each other quite strongly

Risk Weightage

The disproportionate risk weighting of corporate bonds per RBI regulations irrespective of issues/ quality/ rating is unfair.

Introduction of Corporate bond derivative products

The optics of CDS securities are not great in this market but drunk driving is not an argument against cars. Well regulated derivative products will help in increasing trading volumes.

Maintain a clear demarcation between retail and wholesale (QIPs – Qualified Institutional Placement) participants in corporate bond markets

Most regulation is driven by the need to protect retail investor but a QIP framework would greatly increase liquidity – a similar success story in private placement (to non-promoters) in the equities’ market in 2006 has ensured that we did not export our equity markets unnecessarily.

Rationalization of stamp duties

Current stamp duties on transfer of debt securities represent overly high transaction costs. As this is a state subject for transfer of debt instruments – getting all the states on board, or at least starting a competitive race to reduce stamp duties would be necessary.

Abolish TDS on coupon payments

This is no longer relevant in an area of dematerialisation and PAN numbers and places an unfair burden on the market. Government securities and certain entities are exempt from TDS, making this an administrative nuisance and back office pain.

Introduction of DVP method of settlement to mitigate principal risk

The bilateral settlement in markets today creates execution, principal and price risk. Isolating the elements in phases and moving to risk free clearing and settlement could greatly increase volume. This could start with guaranteeing exchange (this reduces execution risk) and slowly move to guaranteeing settlement.

Lack of a central database of bonds

Today there is no single and consistent repository of price, yield and trading information. The trade reporting was a great start but things now need to be taken to the next level.

Treat OTC and Exchanges at par but require unified settlement and clearing

All exchange volume in debt today is done offline and reported. Regulators must become agnostic to the market microstructure decision about where a trade is completed (in fact they must ensure a level playing field to create competition) but require that both OTC and exchange trades are reported to a unified clearing and settlement system that should start with guaranteeing exchange and over time move to guaranteeing settlement.

Review investments guidelines for pension funds and Insurance Companies

There is a logical fit between the long tail of liabilities of pension funds and insurance companies and the possibilities of long duration corporate bonds. But today the investment guidelines create artificial allocation and execution issues.

Standardization of coupon frequency; day count conventions would simplification of secondary market trading of bonds would also be very useful – particularly if it were done by regulatory fiat.

Creation of a legitimate yield curve. India still does not have a credible yield curve, making it difficult to value bonds – which are valued in relation to the yield of g-secs.

Bankruptcy laws. While bankruptcy laws need to be updated – the judicial system’s slow delivery of rulings makes bankruptcy rights grossly uncertain. Perhaps creation of a specialized court to dispose of such cases could be mooted – we already have a tribunal for securities cases for instance, and it has a great disposal rate.

An update on reforms by SEBI from 2006 - 09

SEBI (Issue and Listing of Debt Securities) Regulations, 2008

SEBI (Public offer and listing of securitised debt instruments) Regulations, 2008

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