Harun R Khan: Corporate bond markets in India - a framework for further
action
Remarks by Mr Harun R Khan, Deputy Governor of the Reserve Bank of India, at the FICCI
CAPAM 2015, Mumbai, 27 October 2015.
* * *
Accompanying tables can be found at the end of the speech.
The speaker acknowledges the contributions of Shri Vaibhav Chaturvedi and Shri Vivek Singh of the Reserve
Bank of India.
1. Speaking at this event - in this panel - leaves me with a sense of déjà vu. The fact that I
spoke about the same issue at the same forum three years back in 2012 - and many other
fora earlier - reflects the deep-rooted, inertial nature of underlying factors. At least for more
than 10 years now development of corporate bond markets in India has been the focus of all
stakeholders but the arduous pursuit of the 'holy grail' has not delivered desired results. In
the process this has unfortunately become a convenient stick to flag the policy and regulatory
intent. Every set of stakeholders has its own views on what needs to be done but much of
the prognosis ends up giving a limited perspective.
2. Maybe it is time to dispassionately understand the big picture and acknowledge ten
fundamental facts about the financial ecosystem as it exists today:
i. Bond markets globally are institutional in nature - that too buy and hold kind of
investors;
ii. A sound bankruptcy regime is a pre-requisite for deep bond markets;
iii. Development of bond markets needs sustained participation of long-term
institutional investors across the credit curve;
iv. Tax regime for financial instruments remains one of the key drivers of investor
interest;
v. Development of the market mechanisms and infrastructure can at best be an
enabling factor - not the driving factor;
vi. Fiscal consolidation leading to lower sovereign borrowings can enhance the demand
for corporate bonds;
vii. High indebtedness of major corporates both from domestic and external sources is
not conducive for issuance of corporate bonds;
viii. The centrality of banks in the financial system is a given at our stage of economic
development. The corporate debt market, therefore, cannot play a predominant role
in financing in the near future;
ix. Predominant reliance on the banking system to support development of corporate
bond market, directly or indirectly, militates against the very idea of the bond market
de-risking the banking sector; and
x. The corporate debt market cannot be looked as totally detached from the sovereign
bond market. Corporate bond market may get a fillip as the interest rates come
down and the fiscal deficit targets are achieved. The play on spreads across the
credit curve will become more attractive.
3. Alongwith recognizing the hard facts comes the realization that there are not many low
hanging fruits remaining to be plucked - work forward is contingent on multifarious factors
and some hard policy choices.
4. There have been a number of reports on the corporate bond markets, viz., R. H. Patil
Committee report (December 2005), Report of the High Powered Expert Committee on
Making Mumbai an International Financial Centre in 2007 (Percy Mistry Committee) and A
Hundred Small Steps [Report of the Committee on Financial Sector Reforms (CFSR)] in
2009 (Raghuram Rajan Committee), Reports of the City of London, which have examined in
detail various aspects related to the development of corporate bond market and have made
useful recommendations. It has been recently decided by the Financial Stability and
Development Council (FSDC) and its Sub-Committee that the issue needs to be looked into
its entirety. An inter-regulatory group has already started work in this direction. The focus of
this group will be to distill key actionable recommendations made by all earlier committees
and suggest a time bound plan for implementation of the same.
Measures taken to develop the corporate debt market
5. Taking into account the recommendations made by various expert committees, several
measures have been taken by the Government of India, the Reserve Bank of India (RBI) and
the Securities and Exchange Board of India (SEBI) for the development of corporate debt
market in India. The success of these measures in achieving the intended outcomes has,
however, been varied. Impact of some of the measures taken is captured below:
Intended outcomes mostly achieved
• Setting up of reporting platform for post-trade transparency
• Introduction of DvP in settlement of OTC trades in corporate bonds to eliminate
settlement risk
• Issue of long-term bonds by banks allowed with a minimum maturity of seven years
to raise resources for lending to (a) long term projects in infrastructure sub-sectors,
and (b) affordable housing. These bonds have been exempted from computation of
net demand and time liabilities (NDTL) and are therefore not been subjected to
CRR/SLR requirements
• The investment limit for Foreign Portfolio Investors (FPI) has been increased to USD
51 billion during the last few years. Limit allocation methodology have been
rationalized and withholding tax rate has been reduced from 20% to 5%
• FPIs have been permitted to invest only in corporate debts of at least 3 years of
residual maturity
• International financial institutions like IFC were permitted to float a rupee linked bond
overseas to deepen the off-shore rupee bond market so that IFC and other investors
can raise rupees to invest in India. This has facilitated development of benchmark
yield for long term corporate bonds
• SEBI has allowed setting up of dedicated debt segment on the exchanges
Intended outcomes partially achieved/ too early to say
• Banks and PDs allowed to become members of stock exchanges to trade in
corporate bonds
• Investment norms for banks and PDs relaxed to facilitate investment in corporate
bonds
• Final guidelines issued for partial credit enhancements by banks to corporate bonds
• Measures taken to encourage investor interest/participation in the corporate bond
market in terms of liberalizing the listing requirements; simplification in procedures
and processes, simplified disclosure norms and standardisation of market
conventions
Rationalisation of FPI regulations has been put in place for easier registration
•
process and operating framework for overseas entities seeking to invest in Indian
capital markets
Intended outcomes not achieved
• Introduction of Repo in corporate bonds to meet the funding needs
• Introduction of Credit Default Swaps to facilitate hedging of credit risk by the holders
of corporate bonds Reissuance of bonds permitted by SEBI
6. The measures taken by the Reserve Bank of India, SEBI and the Government have
resulted in considerable increase in issuance as well as secondary market trading of
corporate bonds. Total corporate bond issuance has increased by around 155% from
₹ 2709.46 billion in 2010-11 to ₹ 4,789.62 billion in 2014-15. Similarly, the number of
issuances increased by almost 77% from 4,280 in 2010-11 to 10,941 in 2014-15 (Table 1).
7. In comparison to other economies, the size of the bond market in India, however, remains
moderate as a percentage of GDP (Table 2).
8. It, however, needs to be noted that the development of a corporate bond market in India
has lagged behind in comparison with other financial market segments due to certain
structural issues. Some of these issues include:
• The corporate bond issuance is dominated by private placements as these account
for more than 95% of the total issuance of corporate debt (2014-15);
Issuances are concentrated in the AA or above rating, largely by public sector
•
entities and financial institutions
A majority of the issuances are concentrated in the 2-5 year tenor;
•
• Limited/narrow investor base. Investment mandates of institutional investors such as
insurance companies, pension funds and provident funds do not permit large
investment in corporate bonds;
• Reissuance of bonds has not picked up;
• Lack of functional trading platform with CCP facility like NDS-OM (as available in
Government securities market) impedes the growth of secondary market;
• Market for credit risk protection instruments like CDS has not yet developed;
• Non-standardized stamp duties on corporate bonds across various states affects
issuances.
Way forward
9. Activating the corporate bond market will require a number of regulatory measures to
address both the macro issues as well as the market micro-structure issues. While creating
an efficient market infrastructure will create conditions for issuers and investors, the
structural issues can be addressed over the longer term as the market evolves and the
financial system gets more integrated with international markets. It would be convenient to
look at the set of issues in a comprehensive manner. I would like to classify some of the
possible measures in the "7I" framework which I had talked about in one of my earlier
speeches.
Issuer
Reissuance of bonds
10. Corporates may be encouraged to re-issue existing bonds under the same ISIN code.
This will augment market liquidity and potentially reduce the cost of borrowings. Though
SEBI has recently allowed reissuances by the corporates, there has not been any reissue of
bonds by any corporate. In order to encourage reissuances, there may be a need for some
incentives in the form reduced documentation formalities, less issuance fees, etc.
Issuance of municipal bonds
11. An active corporate bond market would enable market for municipal bonds issued by the
Urban Local Bodies (ULBs). The potential for issuing municipal bonds assumes importance
in the context of the proposal to set up 100 smart cities. However, the size of the municipal
bond market in India is rather limited and is distributed over a few strong municipalities of
Ahmadabad, Nasik, Nagpur, etc. The possible reasons could be overlapping jurisdiction on
municipal bodies leading to plethora of rules; perceived lack of specialized project
management support in ULBs; non-transparent budgeting and accounting systems in many
of the ULBs and limited exit route for investors due to lack of secondary market trading.
12. To address these issues some of the measures which could be considered, are
strengthening the governance structure of the municipal issuers by ring fencing the municipal
bond funds; providing partial or full guarantee by the Central/ State government; mandating
Escrow account for debt servicing of bond proceeds, etc. SEBI has since issued the
Regulations for Issue and Listing of Securities by Municipalities.
Investor
Liberalising the investment guidelines for long term players
13. In order to encourage demand, investment norms for regulated entities may be reviewed
to facilitate their active participation in corporate debt market. The current investment
guidelines for pension and other retirement benefit funds may be reviewed from ownership
criteria (public sector / private sector) to ratings based criteria. They may also be permitted to
use interest rate swaps, repos and credit default swaps.
Encouraging Retail Participation
14. Participation of retail investors in corporate bonds continues to be limited. In order to
increase retail investors' participation in corporate bonds, we need to encourage issuance of
zero coupon bonds, provide clarity on taxation issues, include provision of special quota for
retail investors in debt issues and provide reduced transactions costs for retail investors.
Intermediaries
Introduction of a market making scheme
15. A market making scheme in corporate bond could potentially improve market liquidity.
But market making in an illiquid market is challenging and not many intermediaries will be
ready to take on the risks of making two-way quotes. A viable market making scheme may
have to be formulated with suitable incentives to encourage market participants to provide
two way quotes. Stock exchanges may have to come out with market making scheme in
consultation with the regulators. Perhaps the role of debenture trustees in this regard may
also need to be explored.
Infrastructure
Efficient trading platforms for corporate bonds
16. NSE has developed a dedicated trading platform for privately placed corporate bonds.
There is, however, negligible activity on the trading platform. Although the system provides
for DVP-III guaranteed settlement, it is learnt that the system has some issues, viz. high
margin, high penalty for default, non-availability of all the issued bonds on the platform, etc.
According to some market participants, there is a need for combined settlement for corporate
bond repo and outright market under DVP-III mechanism at par with the G-Sec market in
order to increase the traders' participation.
17. Stock exchanges could discuss with the market participants and make suitable changes
in the existing platform to encourage trading. If required, they may adopt a calibrated
approach in the matter and explore introduction of DVP-II settlement in initial stages and then
move to DVP-III depending on development of the market.
18. An electronic trading platform similar to the CROMS platform for G-sec has been
announced for repo in corporate debt. This needs to be taken forward quickly. Legal
framework for recognizing and regulating such platforms may have to be put in place.
Rating Agencies
19. Rating Agencies play an important role by way of providing credit evaluation of the
instruments like bonds issued by corporates. Their role came into focus internationally after
the Global Financial Crisis and certain principles for reform of the rating agencies had been
agreed internationally. In India also, SEBI had come out with certain transparency and
disclosure norms for the Credit Rating Agencies ("CRAs") in 2010. CRAs. Based on the
experience, the guidelines may need to be reviewed.
Bankruptcy laws
20. A robust and effective bankruptcy regime is essential to development of corporate debt
market from investors' point of view. Steps, such as, reforming bankruptcy law, early
resolution of bankruptcy cases and streamlining the procedures relating to insolvency would
go a long way in achieving the same. The issue of insolvency of financial institutions
established under statutes and bi-lateral netting among them during bankruptcy also need
resolution. One of the most significant steps in this direction was the setting up of the
Bankruptcy Law Reform Committee under Shri T. K. Viswanathan which has just submitted
its report. The Committee has come out with the draft legal framework for resolving matters
of insolvency and bankruptcy which, when fully implemented, will have far reaching impact.
Early enactment of this proposed legislation and the follow-up action will be a game changer
for development of corporate bond markets.
Incentives
Cap on borrowings of corporate from banks for capital purpose
21. Restricting the proportion of borrowings by large corporates from banks and making such
corporates use the market mechanism (such as, corporate bonds, commercial papers and
other instruments) to meet a part of their short term as well as long term financing needs will
help in the development of corporate bonds markets. Reserve Bank has already issued a
Discussion Paper on "Large Exposures Framework and Enhancing Credit Supply through
Market Mechanism" on March 27, 2015.
Resolving distribution tax related issue for securitization
22. Securitization of the corporate debt instruments would provide a big fillip to the market as
it would improve risk transference and diversification and provide liquidity to the issuers.
Subjecting income of SPV to tax hampers the growth of securitized debt. Market participants
have been demanding that the taxation structure in securitized debt needs to be changed
from distribution tax at SPV level to taxation in the hands of investors.
Rationalisation of stamp duty norms
23. In terms of the provisions of entry 91 of Union List, the Central Government has the
power to levy stamp duty on issue of debentures. However, some state stamp laws also
provide for duty on issue/transfer of debentures. Stamp duty laws need to be rationalised to
provide an incentive to issuers and work is already on in this direction.
Use of corporate bonds a collateral
24. Post Global Financial Crisis has seen large scale use of non-sovereign papers as
collateral by the central banks for providing liquidity during periods of stress. Similar enabling
arrangement in India, subject of course to appropriate haircuts and other safeguards, could
be examined. This will enhance the demand for good quality corporate paper.
Instruments
Activating the repo market
25. The reasons cited for lack of interest in corporate bond repo include non-signing of the
Global Master Repo Agreement (GMRA), lack of lenders such as mutual funds and
insurance companies in repo market, etc. Reserve Bank is engaging with other regulators to
address these issues. It is also envisaged to widen the participation base in corporate debt
repo by allowing more investors in repo market.
26. Internationally, GMRA is the standard document used by the market participants to
undertake repo transactions. In India also, we have adopted the same document. Market
participants need to highlight the specific issues in GMRA which need to be addressed.
Kickstarting CDS market
27. Unavailability of credit risk transfer mechanism in the corporate bond market works as a
deterrent. Though CDS has been introduced in India, there is no activity in the market. One
of the major constraints is restriction on netting of MTM position against the same
counterparty for capital adequacy and exposure norms. Without netting, the trades in CDS
have become capital intensive as banks and PDs have to provide higher capital charge on
gross basis even if they are acting as market makers and having positive and negative
position against the same counterparty. Netting has not been allowed due to lack of legal
clarity. To provide clarity on the enforceability of netting including close-out netting, suitable
amendments to provisions in the RBI Act are being proposed.
28. Regulators are also examining the possibility of allowing more entities to buy/sell
protection through CDS. Availability of more number of protection sellers will encourage
activity in the CDS market. In this connection, it may be necessary that financially sound
insurance companies and other long term investors may be permitted to sell CDS protection
subject to prudential norms prescribed by the regulators.
Rated Municipal Securities
29. As discussed earlier, a new asset class may be included for rated municipal securities
under the IRDA & PFRDA investment guidelines.
Innovation
Use of banks' PCE facility by corporates
30. Partial credit enhancements (PCE) by banks may give a boost to the corporate bond
market in its evolution phase. Taking into account the feedback received, RBI has now
issued the final guidelines under which the banks may provide PCE to support (senior)
project bonds issued by companies/SPVs, and thereby improve the credit rating of the bond
issue making them more attractive to certain specific set of investors, such as the institutional
and long term investors. It is expected that issuers will take advantage of the scheme to
issue long term bonds.
Bond Index
31. Though indices, such as, Nifty 50 and the BSE Sensex index serve as popular
benchmarks for equities, designing debt indices has posed challenges in India as the market
lacks breadth and depth. Market participants, however, need a debt index to compare the
performance in corporate debt vis-a-vis the performance of different asset classes. More
work needs to be done in this area by benchmark and index companies.
Concluding Thoughts
32. A well-developed corporate bond market can truly address some of the travails of the
existing bank-based financial system. Development of efficient and robust bond markets is a
challenge globally and only a few jurisdictions can claim to have genuine local currency bond
markets. Even in those markets, the concerns relating to market illiquidity are increasingly
being highlighted. The recent IMF Global Financial Stability Report has discussed these
factors at length. While many of the factors may not be of immediate relevance to our
market, the experience may hold important lessons as the regulatory regimes and market
systems across jurisdictions which are increasingly becoming homogenized. While regulatory
changes are likely to have had mixed effects on market liquidity, several structural drivers,
such as, concentrated holdings by institutional investors, growth of electronic platforms and
high frequency trading, reduced market making, etc. have also played a part.
33. We will have to assess the implications of these factors, including the emerging
regulatory regime, on corporate bond market development. While it is recognized that the
regulatory regime may need to respond positively to some of the critical issues unless the
structural factors mentioned earlier are addressed, it would be difficult to have a deep
corporate bond market. Early implementation of the draft bankruptcy code submitted by the
Viswanathan Committee alongwith providing legal certainty to close-out netting for certain
transactions would address the two key issues for enabling a credit market. Work is already
underway in addressing some of the market infrastructure issues, including development of
an electronic platform for repo in corporate bonds. Market making in corporate bonds has
proved to be a challenging issue, particularly the funding of brokers. Banks are explicitly
permitted to fund market making activities but at the end of day, it will be their call based on
commercial judgement. Separate structure for market making with direct/indirect support of
the Government could be a possible way out.
34. It is also important to recognize that the path towards creating an enabling environment
may be fraught with event-specific hurdles which may take the process a few steps back.
The recent case of default on a top rated bond is a case in point. More than the fact of
default, some of the market practices that have come to light through media reports can dent
the confidence of investors in the market. This particular instance reiterates the importance
of strong market practices and institutional frameworks in development of healthy markets.
35. While there is a continuing, concerted effort to identify the constraints and address them
in right earnest, we must, however, be careful that our pursuit of perfect bond markets does
not end up as an endless chimerical chase. Bond markets are part of a broader ecosystem
and it would be best if these markets evolve organically. As a regulator, our endeavor is to
continually facilitate an enabling framework. The group set up under the aegis of the FSDC is
expected to look into the whole gamut of issues, mostly focusing on the recommendations of
all the earlier committees. One can expect more exciting times ahead for the development of
the corporate bond market in India.
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