Corporate Bond Markets in India - Challenges and prospects1
Introduction
1. An active corporate bond market serves multiple functions. Apart from providing
borrowers an alternative to bank finance, corporate bonds can lower the cost of long-
term funding. Banks are typically constrained in lending long-term because their
liabilities are relatively of a shorter tenor. An efficient corporate bond market with
lower costs and quicker issuing time can offer an efficient and cost-effective source
of longer term funds for corporates. At the same time, it can also provide institutional
investors such as insurance companies and provident and pension funds with long-
term financial assets ("preferred habitat"), helping them match the durations of their
assets and liabilities.
2. From a macro-financial or financial stability perspective, a well-developed
corporate bond market serves to spread risks away from the banking system. Banks
are key to financial stability, as they provide liquidity services, credit and payment
systems to the economy, and it is important to regulate their risk-taking activities. A
market-based source of finance, such as corporate bond market, therefore, is more
effective in dissipating risk across a much wider category of investors, thereby
contributing to overall financial stability. A reasonably developed corporate bond
market can play the role of the "spare tyre2", mitigating financial shocks and preserving
financial stability.
3. It is against this background that the Government, SEBI and the Reserve Bank
have been taking concerted efforts to facilitate the development of the corporate bond
market in India. I thought I would use this opportunity to dwell upon the various aspects
related to the development of this market, the journey so far, the challenges which
have been encountered and share some thoughts on the potential way forward.
The Regulatory Effort
4. The efforts taken to develop the corporate bond markets broadly over the last
decade and a half have been wide ranging. The reforms and developments have
ranged from advancements in the corporate bond microstructure to the evolution of a
facilitative regulatory framework, complemented by efforts to develop related risk and
derivative markets and measures to enhance secondary market liquidity.
5. SEBI, the primary regulator of the corporate bond market, has taken significant
steps over the years to improve the market microstructure for corporate bonds -
settlement through delivery versus payment (DvP) mode which removes settlement
risk; operationalisation of a trade reporting platform for enhancing transparency;
introduction of an electronic bidding platform (EBP) for primary issuance;
consolidation of stock through reissuance; introduction of request for quote (RFQ)
platforms and many more. RBI has also been taking measures to develop the
corporate bond market - permitting banks to provide partial credit enhancement (PCE)
to incentivise a larger investor base; requiring large borrowers to raise a share (about
50%) of their incremental borrowings through market instruments; encouraging FPI
investment by raising investment caps, introduction of Voluntary Retention Route; etc.
As entity regulators, RBI, IRDAI and PFRDA have encouraged their regulated entities
to invest in corporate debt securities.
The Current Status
Having gone through the various measures and efforts taken for the development of
the corporate bond markets, let me now spend a few moments introspecting on the
progress made.
A. Resource mobilisation - the primary market
6. The growing size of the corporate bond market and the number of issuances
every year are important indicators of the success of the development efforts of the
Government and regulators. Over the years, there has been a steady increase in
mobilisation of resources through the corporate bond route. The outstanding stock of
corporate bonds has increased four-fold from ₹10.51 lakh crore as at end of FY 2012
to ₹40.20 lakh core as at end of FY 2022 (Chart 1). Annual issuances during this period
have increased from ₹3.80 lakh crore to close to ₹6.0 lakh crore (Chart 2).
Chart 1: Corporate Bonds Chart 2: Corporate Bonds
Outstanding (₹ crore) Issuance (₹crore)
45,00,000 9,00,000
8,00,000
40,00,000
7,00,000
35,00,000
6,00,000
30,00,000 5,00,000
4,00,000
25,00,000
3,00,000
20,00,000
2,00,000
1,00,000
15,00,000
10,00,000
5,00,000
Private Placement Public issuance
Source3 Source4
7. The long-term trend of the share of corporate bonds in the flow of resources to
the commercial sector in India is reassuring. Data from RBI's Handbook of Statistics
for the Indian economy shows that ratio of "gross private placements by non-financial
entities" - a broad proxy for issuances by corporate bonds by non-financial entities -
to non-food credit has increased from 0.09 in 2010-11 to 0.50 in 2020-21 (Chart 3).
Chart 3: Flow of Resources to Commercial Sector in India
14.0 0.60
12.0
0.50
10.0
0.40
crore)
8.0
0.30
lakh
6.0
(in 0.20
4.0
₹
0.10
2.0
0.0
0.00
Non-Food Credit [A]
Gross private placements by non-financial entities [B]
Ratio [B/A] [RHS]
Source: RBI
8. Admittedly, the size of the corporate bond market in India, scaled by GDP,
remains small compared to other major Asian emerging markets such as Malaysia,
Korea and China (Chart 4). But the market is growing steadily (Chart 5) and reasonably
given the traditional bank dominance.
Chart 4: Corporate Bond Outstanding (as per cent of GDP)
in Major Asian Economies
100
80
60
40
20
0
KR MY CN TH IN VN JP PH ID
Data as on March 2022
Sources5
Chart 5: Corporate Bond Outstanding as a share of
GDP
250 0.20
200 0.18
150 0.16
Crore)
100 0.14
Lakh
₹(
50 0.12
- 0.10
Corporate Bond Outstanding [A] GDP [B] A/B [RHS]
Source: RBI & SEBI6
9. The growing size of the corporate bond market is accompanied by growing
diversity of issuers and markets. We now have issuances by new types of entities e.g.
REITs and InvITs pursuant to the Union Budget announcing changes in several Acts
including the SEBI Act, 1992, the Securities Contract Regulation Act, 1956 and the
SARFAESI Act, 2002 to provide a legal framework for these entities to issue corporate
debt securities. The SEBI issuance of regulations on the issue and listing of municipal
debt securities has enabled market-based financing of infrastructure projects. Of
course, more will need to be done to put in place conducive conditions for this sector
to develop through, for example, greater transparency in city budgets, credible
accounting and financial statements, independent audits and monitorable
performance criteria. Also reassuring are the early signs of the development of a
market for distressed corporate debt securities including debt securities issued as part
of corporate insolvency processes.
10. There are other factors which testify to the development of the corporate bond
market in the country and to its increasing resilience. A well-developed government
securities market provides the backbone for the development of other rate markets
such as corporate bond market. Corporate bonds are generally priced off the
sovereign yield curve and resilient markets are characterised by stable credit spreads
over benchmark yields of government securities. A comparison of the yields of 5-year
government securities and AAA rated bonds of 5-year tenor over the last decade or
so in the country clearly indicate that the government securities yield curve has
provided a stable backbone for pricing of corporate bonds in the country (Chart 6).
Trends in the variations of credit spreads has also been reassuring - the spreads have
widened during times of stress and volatility, domestic or global, in testimony to the
maturity of the corporate bond market in pricing.
Chart 6: 5Y G-Sec and 5Y AAA Bond Yield Movement
13.00 250
200
11.00
(%)
150
9.00
Points
100
Cent
7.00
50
Basis
Per
5.00
0
3.00 -50
Spread,RHS 5Y G-Sec 5Y AAA Corporate Bond
Source: Bloomberg
11. Another reassuring trend about the evolution and maturity of corporate bond
markets has been its ability to innovate and adapt. Thus, when concerns about the
credit quality of business firms and their ability to withstand the disruptions of
lockdowns were dominating discourse in the early days of the pandemic, the corporate
bond market innovated with bonds featuring conditional credit risk premium entailed
to harmonise the interests of issuers preferring to lock in the low interest rates
prevailing then with that of investors' concerns about credit quality. Similarly, while
corporate bonds in India are predominantly issued as fixed coupon bonds, during the
calendar year 2021, increased issuances of floating rate bonds with coupons linked to
money market and government securities benchmarks were witnessed, indicating
efforts by investors to hedge against any increase in domestic interest rates. These
are important metrics testifying to the resilience of the market in particular is ability to
function well in times of stress.
B. Liquidity metrics - Developing the secondary market
12. The second important metric to assess the development of a corporate bond
market is the development of secondary bond markets. Have secondary market
trading volumes grown over the years? Undoubtedly, they have (Chart 7). The total
settled value of secondary market trades during FY 2010-11 was ₹4.50 lakh crore
which rose to ₹14.37 lakh crore for FY 2021-22. Clearly, secondary trading has not
risen in consonance with the size of the market.
Chart 7 :Secondary Market Trading in Corporate Bonds
10,000 1,000
8,000 800
6,000 600
Crore
4,000 400
₹
2,000 200
- -
Avg. daily traded volume Avg. daily trades (RHS)
* Data for FY 2022-23 is upto June 2022
Source7
13. But let us pause before passing judgement in this matter. A 2019 report on
"Establishing Viable Capital Markets" by the BIS Committee of Global Financial
System, based on a survey of a sample set of jurisdictions, concluded that the degree
of liquidity concerns in the corporate bond markets of the surveyed advanced
economics (barring the US) and emerging market economies were similar, on
average. The challenges in development of liquidity in bond markets are thus clearly
not unique to the corporate bond markets in India. Comparable data on turnover ratios
of corporate bond markets of different jurisdictions are not readily available but
approximate assessments do not indicate that the Indian corporate bond market lags
its peers in respect of secondary market liquidity.
14. Let me spend a moment to look at the underlying issues. As on June 30, 2022,
the outstanding stock of corporate bonds stood at ₹39.58 lakh crore8. The number of
instruments outstanding was 29,745. The average size of an outstanding corporate
bond instrument was, therefore, ₹133 crore - a small amount not conducive to
development of liquidity in the secondary market. Compare this with the current
outstanding stock of government securities at ₹84.71 lakh crore in 100 instruments9.
The two markets are not comparable and it is not my intention to compare them. There
is a single issuer in the government securities market - the government, compared to
5,394 issuers, as on June 30, 2022, in the corporate bond market. Replicating the
experience of the Government bond market in the corporate bond market is not a
realistic objective. SEBI has been progressively making efforts to nudge the market
towards re-issuances in a bid to reduce fragmentation and improve liquidity in
corporate bond markets - limiting the number of corporate bonds that could mature
in any financial year. The constraint is that a corporate does not have the tools
available to a Government to meet the rollover risk implicit in bunched up repayment
obligations that result from consolidation through reissuance. Other factors that
contribute to the limited activity in the secondary market are the "buy and hold" nature
of investors and the predominance of private placement.
C. Development of complementary markets
15. It is well-established globally that well-functioning related markets - derivatives
and repo markets - complement and supplement the development of liquidity in the
cash market by enabling investors and market-makers to better manage risks and fund
positions.
16. The primary risks associated with holding corporate bonds are interest rate risk
and credit risk. The interest rate derivative market is reasonably liquid, particularly the
overnight indexed swaps market. Markets for other interest rate derivative products
like swaptions are developing. Recent regulatory efforts seek to harmonize on-shore
and off-shore markets by, on the one hand, allowing non-residents to access the
domestic market, and on the other hand, permitting domestic market makers to access
the offshore market. Interest rate derivatives are also trading on exchanges though
volumes are small.
17. The absence of a market for credit derivatives, despite regulatory initiatives for
more than a decade, is a concern. To a certain extent, there is a chicken and egg
problem here. The dominance of top rated issuances reduces the need to manage
credit risk, while development of a Credit Default Swap (CDS) market is essential for
the issuances of lower rated bonds. Two recent developments offer hope for the future
development of the CDS market. The passage of the Act for Bilateral Netting of
Qualified Financial Contracts, 2020, pursuant to which the Reserve Bank has notified
CDSs, along with other OTC derivatives, as qualified financial contracts for netting. In
February this year, RBI expanded the issuer (protection seller) and participant base
for CDSs to include all major non-bank regulated entities viz., primary dealers, NBFCs,
insurance companies, pension funds, alternate investment funds and mutual funds in
addition to banks and foreign investors.
18. The market for repo in government securities is one of the most liquid markets
in the country. But repo in corporate bonds has not taken off. Market feedback
suggests that issues related to the lack of a trading platform like the one available for
repos in government securities, lack of a central counterparty, high margin
requirements, etc. have impeded the development of the market for repos in corporate
bonds. SEBI is trying to facilitate the setting up of a repo clearing corporation. We keep
our fingers crossed that going forward we will see this market too start to develop.
Issues, concerns and challenges
19. Let me now turn to some of the micro-structure issues of the corporate bond
market in the country, which pose concern or which need to be addressed if the market
has to take the leap to the next level of development and fulfil its potential as the major
avenue for resource mobilisation in the country.
A. Rating profile
20. First, as is well known the market is dominated by highly rated issuers. But let
us look at the dimension of the problem. In FY 2021-22, ratings were assigned to 1,235
corporate debt securities amounting to ₹22.55 lakh crore10. Of these, 278 or 22.5%
were rated AAA and 358 or 29% were rated AA. 66 issuances or 5.3% of issuances
were non-investment grade. While these numbers themselves are skewed in favour
of highly rated issuances, the skew is much more pronounced when looked at in value
terms - 80% of issuances in value terms were rated AAA and another 1.5% were rated
AA. While we can discuss the reasons for this trend, it is clear that the corporate bond
market largely meets the needs of highly rated corporates.
B. Mode of issuance
21. The second issue relates to the mode of issuance. The large bulk of corporate
bond issuances every year is through the private placement route rather than through
public issuances. In FY 2021-22, the amount of money raised through public
issuances of corporate bonds was ₹11,589 crore - just about 2% of the amount of
money raised through private placement at ₹5.88 lakh crore11. The advantages of a
public issuance in terms of transparency and efficiency of price discovery are well
understood. SEBI has been making efforts to make the private placement process
more transparent and efficient, for example, through the introduction of the Electronic
Bidding Process on stock exchanges. Nevertheless, there is an overwhelming
preference for private placement. A hard look at the underlying issues including the
reasons for issuers preferring to eschew the public issuance process is perhaps called
for.
C. Investor profile
22. Third, let us look at the investor base. The investor base for corporate bonds
is, as can be expected given the market microstructure, largely dominated by domestic
institutions - insurance companies, banks and mutual funds (Chart 8). Retail
participation in corporate bonds remains low - this in fact is a global trend. What is
somewhat unique in India is that investors in debt oriented mutual funds - which is the
avenue through which globally the retail investor participates in debt markets - are
also largely institutional. Foreign participation in corporate debt, has also not been
favorable to secondary market activity.
Chart 8: Share in Outstanding Corporate Bonds (%) - As at end of
FY2022
5.49%
13.54%
10.51%
24.51%
27.57%
2.49%
15.89%
Bank Body Corporate
Foreign Portfolio Investor (Corporate) Mutual Fund
Qualified Institutional Investors Trust
Others
Source: SEBI
23. The profile of the investor base for the corporate bond markets has had
implications for some of the issues and concerns I have flagged earlier. I talked of the
limited access of lower rated issuers to the corporate bond market for mobilising
resources. Part of the answer does lie in the investor base in the market which is
closely regulated and has a preference for highly rated issuances, perhaps justifiably
so. The economic profile, mandate and / or regulatory environment of these entities
often incentivises "buy and hold" kind of participation in corporate bond market. With
a large investor base with this profile, the challenges of developing liquidity in the
secondary market or of developing liquid repo and derivative markets are
compounded. To take an example, insurance and pension funds are one of the most
active participants of credit derivative markets globally - both as buyers and sellers of
protection. Without participation of these entities, it may be difficult for the credit
derivatives market to develop in the country.
24. The question that arises is that what measures may be considered to widen the
investor base to enhance accessibility of lower rated issuers and liquidity in the
corporate bond market. Given the rise in retail investments in the domestic equity
market, can this category, which is conspicuous by its absence in the corporate bond
market, be offered incentives to broaden the investor base in the market? What can
be done to attract foreign investment in our markets? What can be done by way of
incentives for regulated entities to participate more actively in risk markets, without
compromising on prudential considerations? These are questions which need
deliberations by all stakeholders - Government, regulators and the participants of the
corporate bond markets themselves.
D. Specialised Bonds
25. In the last couple of years, there have been increasing instances of domestic
corporates tapping the global markets for raising funds. To a large extent, this is only
to be expected given the large pool of liquidity and benign interest rate environment
that was prevailing internationally. This is also an inevitable result of greater integration
of the domestic economy with the rest of the world. But there are a couple of trends
which require closer examination.
26. A number of our corporates have been tapping international markets to raise
Environmental, Social & Governance (ESG) funding while domestically such
issuances have been low. I know a lot of efforts are ongoing but there is perhaps a
need for us to look closely at what are the factors impeding the development of the
domestic market for ESG bonds and what needs to be done to attract the growing
global pool of ESG funds to the country. Going by international experience, beyond
the regulatory measures, there is a need to create conducive conditions for ESG
bonds - greater transparency, credible checks against greenwashing including through
arrangements for independent audits, and a robust taxonomy for the market and
bonds. The announcement in this year's Union Budget referring to mobilisation of
resources via 'Green Bonds' is also expected to enable a price anchor for ESG bonds
in due course.
27. There is a limited investor base for capital bonds issued by banks in India. This
has resulted in Indian banks accessing global markets for raising capital. While any
issuer, including banks, will naturally search for the market where they can most
efficiently raise funds, there is a need perhaps to look at factors which are impeding
domestic appetite for such bonds and whether the factors are aligned to international
norms / standards.
E. Price Transparency
28. The importance of high-quality and timely information on financial markets is
basic to the development of the market. Most of you will be aware that in the domestic
government securities market, information about every single trade is disseminated in
near-real time ensuing the highest standards of transparency. There has been
feedback from market participants about the need for improving the timeliness and
integrity of data on primary and secondary market transactions in the corporate bond
market. This is arguably a low hanging fruit which we can aspire for. It has also been
highlighted that there is a need for adoption of uniform valuation methodology across
investors. Valuation by an independent benchmark administrator would be ideal.
Conclusion
29. Let me conclude now. We have made impressive progress in the development
of the corporate bond markets - the market is large and growing; the issuer base is
expanding; product diversity and sophistication are developing; secondary volumes
are low but growing; and market infrastructure is the best in the world. Efforts need to
focus on improving complementary- repo and derivative - markets, diversify the
investor base, both domestic and global, and improve access of borrowers at the lower
end of the credit spectrum. Beyond this, market development and improvements will
remain a continuous exercise. As much as we need to take these steps, it will serve
us well to temper our expectations on the degree of liquidity in secondary corporate
bond markets. If international experience is anything to go by, the best we can achieve
may be well short of the liquidity we are used to in Government bond markets or equity
markets.
Thank you.