Delphique Finance08
- 2. Developing Indian Debt Markets Delphique ‘08
- 3. CMYK Sponsor FINANCE Developing Indian Debt Markets PANEL SPEAKERS Subhomoy å Bhattacharjee, Deputy Executive Editor, The Financial Express Any pic å Jasmit Singh Chandhok, Dy. Executive Director, Learning Arc å Kaul, CGM Treasury, Punjab National Mr. Arun Bank å Bhalla, Treasurer, GE Capital Mr. Manoj å Bhatia, AGM (Finance), NTPC Sangeeta available to non-banks as Credit Information EXPERT OPINION Bureau India Limited (CIBIL) reports the defaults The research on the topic 'Development of Indian only for banks. Second is the absence of any debt markets' was very well appreciated by the stringent laws in India on bankruptcy enforcement panelists who suggested the presentation should and protection. Unlike the US where Chapter 11 be made to the regulators to set the way forward. and other laws ensure high degree of restitution The discussion began with a comparison of loans and that too before diminution of asset value, in against bonds and analyzing whether the present India corporate default does not come in the public system is sustainable. According to Mr. Arun Kaul, domain for up to 10 years. banks would prefer to give loans rather than Transparency in disclosures, diversity for issuers investing in bonds because of the direct contact as well as investors, and liquidity dependent on with the client in case of loans, as compared to market infrastructure and intent of institutions were communication through merchant bankers. Mr. identified as major criteria for development of debt Arun Kaul also threw light on how PNB invests market by the panel. Mr. Jasmit Singh Chandhok money in bonds, highlighting that it does not invest and Mr. Arun Kaul pointed out that retail investors in private sector bonds as there is no proper do not have enough incentive to invest in bond secondary market for trading. Two more problems markets where there is doubt about the pricing of were identified in case of institutional investment in bonds, legal issues are cumbersome, and it is corporate bonds. One, data on defaults is not difficult to withdraw money back from market. If at Knowledge Partner 14 FINANCE Delphique ‘08
- 4. KYMC all an exposure to bonds is required, much better price discovery is not efficient. Moreover, the options are available to them in the form of platform established by NSE is more of a reporting undervalued bank equity who in turn have their platform rather than a trading platform as two way investments in bonds of corporates. Hence, retail live quotes are not available. The restriction on investor would have to enter indirectly into this foreign investment is also a major factor in this non- market, which is in line with the worldwide trend of development if we try to benchmark with the majorly wholesale investors in bond market. markets abroad. A point noted by the panel was However, such an entry would be preferred as it is that there is a large contribution of foreign likely to lower the yields in the market. investment in development of Indian equity markets. 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 Next issue discussed was that whether due to its regulation. high dependence on Government bonds to finance Other major reasons for non-development of debt budgetary deficit, is it the Government that does markets were also discussed by the panel. In India, not want the development of corporate bond size of corporate is relatively smaller and they have market. It was concluded by the panel that the access to project loans and working capital loans attempt by Government is not deliberate, but it is such as cash credit from banks which lower their extra cautious to prevent scams. The demand for costs of borrowing to a large extent. In this regard, Government bonds mainly comes from banks that banks' operations are actually hindering the growth need it for their SLR requirements. of bond market in India. Institutional investors like Some subtle issues concerning the corporate bond EPFO and LIC holding their portfolios to maturity market were also touched upon by the panel. While leaves the market in an illiquid situation and hence the panel agreed when Mr. Manoj Bhalla pointed Knowledge Partner 15 Delphique ‘08 FINANCE
- 5. CMYK Sponsor FINANCE Developing Indian Debt Markets out that the bond, cash, and derivative market are Government securities market and corporate debt needed together for an integrated development, market. The corporate debt market can be further there were apprehensions regarding allowing of classified based on the type of issuer being a Public Credit Default Swaps for this development, Sector Undertaking (PSU) or a private company. especially after the recent financial turmoil. It was The Indian debt market is dominated by G-Sec also concluded that for any scope of a market for bonds with market capitalization of Rs. 13,18,419 municipal bonds, these organizations first need to as compared to corporate bond market put their houses in order. Mr. Arun Kaul pointed out capitalisation of only Rs. 68,074 crore at end the need to allow short selling in corporate bond December 2007. Hence, within the realm of market. development of Indian debt markets, our research The panel was finally able to identify removal of was directed towards the development of regulatory ambiguity, funding of stakeholders, and corporate bond market. 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 Characteristics of developed Indian Debt market: Overview debt market For a market to be developed, presence of three Debt Market is the market where fixed income characteristics is very crucial: securities of various coupons, maturity, options and other features are issued and traded. The Liquidity: å For the market to be liquid; there is a Indian debt market has two segments, viz. need for a secondary market. There has to be enough number and type of instruments and Knowledge Partner 16 FINANCE Delphique ‘08
- 6. KYMC number of participants to have sufficient variety, roles was brought by making primary and inducing fast trades in the market. secondary trading a responsibility of SEBI while repo and reverse repo of debt being a responsibility åSafety: Other than enough types of instruments of RBI. Also, Corporate Bonds and Securitization with differing characteristics which could be used Advisory Committee (CoBoSAC) was set up under to reduce risk exposure, a key requirement for chairmanship of Dr. R.H. Patil to look into further safety is the minimization of counterparty risk. issues. åPresence of market maker: A market maker is From the issuer's perspective, the requirements required to induce trades in the market by quoting regarding continuous disclosures by the issuers two-way quotes. were rationalized; there was a reduction in Shut Other than these characteristics, other important Period to align corporate bonds with Government features for a developed market are efficiency of securities, a reduction in requirement of only one the market, low transaction costs, and availability credit rating agency instead of multiple ones, and of free public information. the requirement of investment grade rating of debt instrument removed. Moreover, Structural Past initiatives to develop Debt restrictions, such as those on maturity, put / call markets option, conversion etc. were removed, corporate debt instruments issued in de-mat form (and listed The Government in February 2006 accepted on recognised exchanges) were made exempt recommendations of the high level expert from TDS, and moderated SEBI Regulations were committee formed under Dr. R. H. Patil. These issued for Issue and Listing of Debt Securities in recommendations were implemented majorly by 2008. These regulations paved the way for one February 2007. The recommendations were aimed listing agreement for public and private issue at improving the market conditions for all irrespective of listed or unlisted company, and stakeholders- from issuers to investors, changes minimal disclosures for companies with listed were brought so as to improve the market equity. 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 bilaterally. Standardization was brought for the Actual Day Count convention for new issues. From the regulatory viewpoint, a clear understanding of Knowledge Partner 17 Delphique ‘08 FINANCE
- 7. CMYK Sponsor FINANCE Developing Indian Debt Markets 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 After obtaining a basic understanding of the Credit, NEFT, and RTGS were to be used for present condition of the debt market and the interest payments & redemption, and material associated issues, a benchmarking of Indian modification in structure of debentures without corporate bond market with US and European prior approval of stock exchange where it is listed corporate bond markets like Eurex was performed. was restricted. The relative standing of Indian corporate bond market and the characteristics lacking in the Indian RESEARCH APPROACH markets were discovered. The corporate debt market has several Investors in India prefer to invest in other fixed stakeholders and the expectations, needs, roles income securities like government bonds, and opinions of these stakeholders on this market Collateralized borrowing and lending obligation differ vastly. Hence, through the research an effort (CBLO) ,bank deposits, national savings was made to look at the corporate bond market certificates, postal savings etc as compared to from the perspective of all the stakeholders in the bonds. Hence it was imperative to compare these process and understand their concerns for not instruments as against corporate bonds. After participating in the corporate bond market. The first plotting the risk-return tradeoff for these step in the research was the reading of several instruments vis-a-vis corporate bonds, customer reports on development of Indian corporate bond preferences in fixed income securities and their market published by companies like Goldman investment needs were also determined. Sachs etc., other reports by SEBI, RBI etc., in addition to news and magazine articles. Finally, to obtain the ground-level picture, opinion was taken from all the stakeholders in the Indian Knowledge Partner 18 FINANCE Delphique ‘08
- 8. KYMC corporate bond debt market such as the issuers, At the same time, developed debt market provides investors, credit rating agencies, regulators and new fund raising avenues to the borrowers, who exchange. A questionnaire was designed for each otherwise raise capital through loans from banks or stakeholder, through which the stakeholders were equities generally. Loans in Indian currency and asked to identify the reasons hindering the equity are expensive sources of capital as development of the market and their compared to issue of bonds, and hence, recommendations for removing these barriers. companies can issue bonds to reduce their cost of They were also requested to do a critique on the capital. Further, interest rate of loans is not recommendations put forth by the students in the transparent; while bond prices are determined by research. Through this primary research, gaps in market forces introducing transparency in the the proposed suggestions by various working borrowing market. Other sources of borrowing like committees and the need of the market participants ECB's are not accessible to all companies were uncovered, which provide the justification for especially SME's making corporate bonds even slow pick-up of bond markets in spite of umpteen more important. development-focused initiatives and suggest Regulators prefer a sound debt market as it would directions for new policy initiatives. The collective reduce the asset liability mismatch of banks. It perspectives of different stakeholders presented would reduce the strain of banking system if through this research provide a holistic picture and corporates issue bonds instead of bank loans. This demarcate the reality from the blame-game being will also infuse liquidity in the market. Development played for long between the regulators, the issuers of credit derivative market is possible only after the and the investors for failure to develop corporate development of the underlying instrument i.e bond bond market. market. Payoffs of a developed debt Issues market The main reason hindering the development of A developed debt market is preferred by the corporate bond market is the lack of liquidity. It is investors, the issuers/borrowers and the regulators just like a chicken and egg problem. Issuers do not of an economy alike. For investors, a developed want to issue bonds because there are not enough debt markets provides opportunities to diversify buyers in the primary and secondary market. As their portfolio. During times of bearish equity issuers do not issue bonds, investors do not invest markets, corporate bonds with assured returns are in the market due to lack of good quality bonds. a very effective medium to mitigate risk. Another problem faced by issuers is excessive disclosures for new and successive issues. At the same time, developed debt market provides Knowledge Partner 19 Delphique ‘08 FINANCE
- 9. CMYK Sponsor FINANCE Developing Indian Debt Markets Retail Investors are not well educated about bond or the regulator should provide incentives to pricing and on the corporate bond market market makers. One of the incentives could be structure. The minimum market lot size for lower transaction cost. investing in corporate bond market is Rs. 1 lakh. However, å due to high bid-ask spread market This is a huge amount in comparison to minimum making is very expensive. Hence, repos in amount in equities or bank deposits. Also, the retail corporate bond market should be introduced to investors believe that since everybody is investing increase secondary market trading. in equity markets, it must be the best option- a testimony of a social proof phenomenon. As a The current å lot size of Rs. 1 lakh deters retail result, they are hesitant to invest in the debt investors. To tackle this, the market lot size markets. Information on live trading of corporate should be reduced to as low as Rs. 10000. bonds is not freely available on the internet. It is difficult å to get free public information about Institutional investors have no incentive to trade in bonds. People are not aware about government exchanges as their needs for corporate bonds is initiatives like indiabondwatch.com. it is met by the Over the counter (OTC) market. Banks imperative to educate the investors especially prefer to give loans as they are treated on cost the retail investors. basis in the balance sheet as compared to bonds There is å no benchmark to measure the which are valued on mark-to-market basis. performance of bonds. There should be a Moreover, the bankruptcy and default laws are not benchmark or a index for corporate bonds similar very stringent in India. The investor is exposed to to the US and the European market. credit risk and at the same time the market does not The main å investors in the bond market are have sufficient hedging instruments. institutional investors. So, a bond market For the regulators, the main concern is the lack of managed by consortium of institutions like Eurex development in the market despite the initiatives bond market will give the institutions to design a taken recently. Also, the investors are not aware of trading and settlement system as per their needs. the initiatives taken by the regulator or the exchange. Recommendations The corporate å 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 Knowledge Partner 20 FINANCE Delphique ‘08
- 10. KYMC List of companies where executives were contacted for primary research Knowledge Partner 21 Delphique ‘08 FINANCE