Submitted by- Group 1

U408002 Abinash Ghosh

U408003 Amitav Das Mohapatra

U408004 Anil Agarwal

U408005 Anshuman Nayak

U408046 Shantanu Das

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 TABLE OF CONTENTS

Executive Summary...................................................................................................4

Introduction..............................................................................................................4

Current Trend of India’s Corporate Bond Market.......................................................5

Historical Development of Corporate Bond Market....................................................6

Reasons for non-existent of Corporate Bond Market...............................................18

Need for an Active Corporate Bond Market..............................................................19

How to Develop Corporate Bond Market .................................................................21

Glossary..................................................................................................................24

References..............................................................................................................24

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Executive Summary

A well-developed capital market consists of both the equity market and the bond market. The
limitations of public finances as well as the systemic risk awareness of the banking systems in
India has led to growing interest in developing bond markets. It is believed that well run and
liquid corporate bond markets can play a critical role in supporting economic development in
India, both at the macroeconomic and microeconomic levels. Corporate debt in developing
countries has traditionally been raised from banks through plain vanilla bank lending. Inspite of a
well developed regulatory and financial system corporate bond markets in India are only 0.4 % of
GDP compared to Korea at 21.1%.1

Therefore, this paper seeks to address the following questions:

• What are the reasons for a lackluster bond market in India?

• What are the potential benefits of an active debt market to the economy?

• What are the prerequisites to the development of bond market?

• How to further deepen and impart greater liquidity to bond market?

Introduction

At the time when trading volumes in equity market have exploded, the debt market is still asleep.
The daily volume of debt traded on the NSE has dropped from Rs 19911.57 crore in August 2003
to a mere Rs 605.23 crore in July 2006. Corporate bonds make up small 3% of this shrinking
market. The lack of active corporate debt market was more of a policy concern than a business
obstacle recently. It is not only India, which has an inactive debt market, but that it is generally
found that the debt market segment of the capital market develops more slowly than the equity
market. As the Patil Committee has documented, just under half the world's corporate bond
market is in the US, and another 15 per cent in Japan 2. Among other countries, the UK has a
long-standing bond market, but the European one is still developing, with financing in many
countries still being bank dominated. Among developing countries, it is perhaps only South Korea
that has a reasonably well-developed bond market.

The limitations of public finances as well as the systemic risk awareness of the banking systems
in developing countries have led to growing interest in developing bond markets. It is believed
that well run and liquid corporate bond markets can play a critical role in supporting economic
development in developing countries, both at the macroeconomic and microeconomic levels.

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Though the corporate debt market in India has been in existence since independence in 1947, it
was only after 1985-86, following some debt market reforms that state owned public enterprises
(PSUs) began issuing PSU bonds. However, in the absence of a well functioning secondary
market, such debt instruments remained highly illiquid and unpopular among the investing
population at large.

Current Trend of India’s Corporate Bond Market

Higher interest rates and lower volatility pushed up the trading volume of corporate bonds three-
fold to Rs 1,60,254 crore during the first half of the financial year ended September 2009, as
against Rs 50,655 crore during the corresponding period of the previous year.

According to the Securities and Exchange Board of India (Sebi) data, the trading volume has
picked up from September last year, when the credit crisis began and banks became averse to
lending.

UP AND ABOVE
Corporate bonds traded (Rs crore)
2008 2009

April 10,072.97 31,593.38

May 10,055.58 30,169.83

June 10,163.58 18,867.98

July 6,536.13 27,614.33

August 4,249.55 24,993.01

September 9,577.41 27,016.45

Total 50,655.22 160,254.98

Note: Traded on BSE,NSE and FIMMDA

Source : Sebi

From over 58,000 trades in the first six months of 2008-09, the trading volumes went up to over
1,81,000 during April-September 2010.

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Historical Development of Corporate Bond Market

• In December 2005, the High Level Expert Committee on Corporate Bonds and
Securitization submits its report giving a plethora of recommendations for the
development of the corporate bond and securitization markets in India. The Government
had set up this committee to look into legal, regulatory, tax and market design issues in
the development of the corporate bond and securitization markets. Implementation of the
recommendations warrants coordinated action by Government, Reserve Bank of India
(RBI) and Securities Exchange Board of India (SEBI).

• In February 2006, Finance Minister in his Budget speech of 2006-07 announces that
the Government has accepted the recommendations of the Report of the High Level Expert
Committee on Corporate Bonds and Securitization and that steps would be taken to create
a single, unified exchange traded market for corporate bonds.

• In March 2006, Chairman, SEBI constitutes an internal Committee to prepare an

action plan for the purpose of implementation of the Budget proposals on development of
the corporate bond market in India.

• In May 2006, the SEBI internal Committee submits its report giving a broad plan for
implementation of budget proposals on development of the corporate bond market in
India.

• In May 2006, a copy of the report of the SEBI internal Committee is forwarded to RBI for
their perusal and comments.

• In May 2006, in its Annual Policy Statement for the year 2006-07, RBI announces
constitution of a Working Group to examine the relevant recommendations of the High
Level Expert Committee, having a bearing on Reserve Bank’s responsibilities in regard to
development of the corporate debt market to suggest a roadmap for implementation.

• In July 2006, RBI’s “Working Group to examine recommendations of High Level Expert
Committee on Corporate Bonds and Securitization involving RBI and suggest a roadmap
for implementation” submits its Report.

• In December 2006, Government issues clarifications on regulatory jurisdiction over

corporate bond market as the confusion over the same was attributed to be a reason for
slow progress in implantation of the High Level Expert Committee’s recommendations on
corporate bonds and securitization. After hearing the views of RBI and SEBI and perusing
the provisions in SCRA, SEBI Act and the RBI Act, Finance Minister desired that the
necessary clarifications may be provided to RBI and SEBI so that they could implement

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 expeditiously the announcement in the Budget that steps would be taken to create a
single, unified exchange traded market for corporate bonds.

• In December 2006, SEBI permits BSE to set up a reporting platform from January 1,
2007 to capture all information related to trading in corporate bonds as accurately and as
close to execution as possible. SEBI also announces its intention to permit recognized
stock exchanges having nationwide access to set up corporate bond trading platform
to enable efficient price discovery and reliable clearing and settlement in a gradual
manner. Access to the platform for reporting was given to all market intermediaries. Non-
members of the Exchange were provided connectivity through Virtual Private Network
(VPN).

• In January 2007, Government discusses the relevant issues of regulatory jurisdiction

and market design further and decides as under:

(a) Clarity on the agency responsible for different segments of the corporate debt market

(i) SEBI will be responsible for primary market (public issues as well as private
placement by listed companies) for corporate debt;

(ii) RBI will be responsible for the market for repo/reverse repo transactions in
corporate debt. However. If it is traded on exchanges, trading and settlement
procedure would be determined by SEBI.

(iii) SEBI will be responsible for the secondary market (OTC as well as Exchange)
for the corporate debt;

(iv) The above framework would apply irrespective of the parties (bank or non
bank involved in a transaction;

(v) The views in respect of trading of unlisted securities and derivatives on

corporate debt (other than repo/reverse repo) would be taken as and when the
need arises.

(b) The market design for the secondary market of corporate debt market

(i) OTC as well as exchange based transactions need to be reported to reporting

platforms(s);

(ii) All the eligible and willing national stock exchanges need to be allowed to set
up and maintain reporting platforms if they approach SEBI for the same. SEBI

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 needs to coordinate among such reporting platforms and assign the job of
coordination to a third agency;

(iii) The trades executed on or reported to an Exchange need not be reported to a

reporting platform;

(iv) The participants must have a choice of platform. They may trade on OTC or
any exchange trading platform;

(vi) Existing exchanges could be used for trading of corporate debts. NSE and BSE
could provide trading platforms for this purpose. There is no need to create a
separate infrastructure;

(vii) There would be no separate trading platforms for different kinds of investors.
Institutional and retail investors would trade on the same platform;

(viii) Only brokers would have access to trading platform of an Exchange. Banks
would have the option of becoming a broker or trading through a broker. RBI, may
if considered necessary restrict a bank to trade only on proprietary account as a
broker.

• In January 2007, BSE operationalises its reporting platform to capture information

related to trading in corporate bond market.

• In March 2007, SEBI permits NSE also to set up and maintain a reporting
platform on the lines of BSE. It is also decided that BSE and NSE shall coordinate among
themselves to ensure that the information reported with BSE and NSE is aggregated,
checked for redundancy and disseminated on their websites in a homogenous manner. As
an integral part of development of a data base the two exchanges were advised to provide
data pertaining to corporate bonds comprising, issuer name, maturity date, current
coupon, last price traded, last amount traded, last yield (annualized) traded, weighted
average yield price, total amount traded and the rating of the bond and any other
additional information as the stock exchanges think fit.

• In March 2007, the Fixed Income Money Market and Derivatives Association of
India (FIMMDA) proposes to set up a reporting platform for corporate bonds and also
provide value added dissemination of information on corporate bonds as in the case of
government securities. SEBI decides that till such time that FIMMDA sets up such a

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 platform, it shall disseminate information made available on bond trading by the two
exchanges with appropriate value addition.

• In March 2007, SEBI rationalizes the provisions of continuous disclosures made by

issuers who have listed their debt securities and not their equity shares on the stock
exchanges.

• In March 2007, NSE operationalises its reporting platform for corporate bonds and
starts disseminating information as desired by SEBI.

• In April 2007, SEBI permits both BSE and NSE to have in place corporate bond trading
platforms to enable efficient price discovery and reliable clearing and settlement facility in
a gradual manner. To begin with, the trade matching platform shall be order driven with
essential features of OTC market. It is also announced that eventually a system of
anonymous order matching shall be established. BSE and NSE were advised to make use
of the existing infrastructure available with them for operating the trade matching
platforms for corporate bonds with necessary modifications. The exchanges were also
advised that on stabilization of the trade matching system, they may move to an
anonymous order matching system for trading of bonds within an appropriate period
of time. Accordingly, both the exchanges will indicate to SEBI an expected date on which
they could move to anonymous order matching system for trading in corporate bonds.
With the introduction of anonymous order matching platform, the clearing and
settlement facility shall be provided by BSE and NSE with a multilateral netting facility
for trades executed on the platform. It is also simultaneously decided that orders executed
through trading platforms of either BSE or NSE shall not be required to be reported again
on the reporting platforms.

• In April 2007, SEBI while permitting both the exchanges viz. BSE and NSE to set up
trading platforms advises them that the stock exchanges may provide their services for
clearing and settlement of corporate bonds traded or the entities trading in listed
corporate debt securities may settle their trades bilaterally.

• In April 2007, SEBI decides to reduce the shut period in corporate bonds to align it
with that applicable for Government Securities.

• In April 2007, SEBI decides to reduce tradable lots in corporate bonds in respect of all
entities including Qualified Institutional Investors to Rs.1 lakh and advises exchanges to
have a limited segment for transactions in similar market lots.

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• In April 2007, SEBI decides to make it mandatory for all new issues of corporate bonds
to have an actual day count convention similar to that followed in respect of dated
Government Securities.

• In April 2007, SEBI makes amendments to the listing agreement for debentures to
ensure that services of ECS (Electronic Clearing Service), Direct Credit, RTGS (Real Time
Gross Settlement) or NEFT (National Electronic Funds Transfer), are used for payment of
interest and redemption amounts as per applicable norms of the RBI along with other
existing facilities.

• In April 2007, SEBI makes amendment to the listing agreement for debentures to ensure
that no material modification shall be made to the structure of the debentures issued in
terms of coupon, conversion, redemption or otherwise without prior approval of the stock
exchanges where they are listed. The stock exchanges shall also ensure that such
information relating to modification or proposed modification is disseminated on the
exchange website.

• In June 2007, SEBI puts up Draft Regulations for “Public Offer and Listing of
Securitized Debt Instruments” on its website for public comments. SEBI Draft
Regulations provide for a system of special purpose distinct entities which could offer
securitized debt instruments to the public or could seek listing of such instruments. The
Draft document also elaborates on the permissible structure for the special purpose
distinct entity, conditions for their assignment of debt or receivables from any originator,
procedure for launching of schemes, obligation to redeem securitized debt instruments,
credit enhancement and liquidity facilities which could be availed by the entity, conditions
for appointing servicers, procedure to be followed for public offer of securitized debt
instruments, their listing, rights of investors, inspection and disciplinary proceedings and
action in case of default.

• In July 2007, BSE and NSE trading platforms become operational. Initially, trade
matching platforms at BSE and NSE are order driven with the essential features of OTC
market.

• In August 2007, SEBI starts placing information on secondary market trades (both
exchange and OTC trades)on its website on the basis of data provided by the two
Exchanges.

• In August 2007, SEBI makes it mandatory that the companies issuing debentures and
the respective debenture trustees/stock exchanges shall disseminate all information

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 regarding the debentures to the investors and the general public by issuing a press release
and also displaying the details on their respective websites, in the event of:

Default by issuer company to pay interest on debentures or redemption amount;

Failure to create a charge on the assets;

Revision of rating assigned to the debentures.

• In August 2007, SEBI makes it mandatory to make public, information/reports on

debentures issued including compliance reports filed by the companies and the
debenture trustees by placing them on websites of the companies and the debenture
trustees. The same is also required to be submitted to the stock exchanges for
dissemination through their websites.

• In August 2007, SEBI grants approval to FIMMDA for starting Corporate Bond Trade
Reporting Platform.

• In September 2007, FIMMDA reporting platform becomes operational as the third

reporting platform after BSE and NSE. Accordingly, for reporting of OTC trades the
concerned parties could opt to report their trades on any one of the three reporting
platforms.

• In September 2007, SEBI advises BSE and NSE to confirm their preparedness for
going in for introduction of repos in corporate bonds so that it could request RBI to
issue appropriate guidelines for the purpose as suggested by the High Level Expert
Committee on Bonds and Securitization.

• In October 2007, SEBI obtains confirmations from BSE and NSE on their preparedness
for introduction of repos in corporate bonds. Since repos in corporate bonds falls under
the regulatory purview of RBI, SEBI has requested RBI to initiate action as required.

• In November 2007, SEBI issues letters indicating no objection to entities which had
approached SEBI for setting up of electronic systems to facilitate price discovery and
bringing about transparency into corporate bond trading. The systems will help display of
buy sell quotes of counter parties involved so that the buyers and the sellers in the
corporate bond market could strike deals at best prices before they go in for order
matching either at the exchange or bilaterally.

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• In December 2007, SEBI vide circular dated December 03, 2007 amends the provisions
pertaining to issuances of Corporate Bonds under the SEBI (Disclosure and Investor
Protection) (DIP) Guidelines, 2000. The Changes to the Guidelines are as below:

(a) For public/ rights issues of debt instruments, issuers now need to obtain rating
from only one credit rating agency instead of from two. This is with a view to reduce
the cost of issuances.

(b) In order to facilitate issuance of below investment grade bonds to suit the risk/
return appetite of investors, the stipulation that debt instruments issued through
public/ rights issues shall be of at least investment grade has been removed.

(c) Further, in order to afford issuers with desired flexibility in structuring of debt
instruments, structural restrictions such as those on maturity, put/call option, on
conversion, etc have been done away with.

• In January 2008, SEBI frames Draft Regulations on Issue and Listing of Debt Securities
and the places on same on the SEBI website along with a consultative paper for Public
Comments. Salient features of the draft regulations include rationalization of disclosure
requirements, enhanced responsibilities of merchant bankers for exercising due diligence
and mandatory listing of private placement of debt issued as per exemption under S.67(3)
of the Companies Act. The paper also makes provisions for e-issuances of corporate debt
and proposes introduction of rationalized listing requirements for debt of a listed issuer.

• In February 2008, In addition to the letters indicating no objection communicated to

three entities in November 2007, a similar letter indicating no objection has been
communicated to a fourth entity that had approached SEBI for setting up a similar
electronic system that will help display buy sell quotes of counter parties involved so that
the buyers and the sellers in the corporate bond market could strike deals at best prices
before they go in for order matching either at the exchange or bilaterally.

• In February 2008, Finance Minister in his Budget speech of 2008-09 announces that
as announced in the Budget Speech of 2006 about taking steps to create an exchange-
traded market for corporate bonds, both BSE and NSE have created platforms for trading
in corporate bonds. The Finance Minister proposed to move forward by taking some more
measures to expand the market for corporate bonds such as:

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 • take measures to develop the bond, currency and derivatives markets that will
include launching exchange-traded currency and interest rate futures and developing a
transparent credit derivatives market with appropriate safeguards;

• enhance the tradability of domestic convertible bonds by putting in place a

mechanism that will enable investors to separate the embedded equity option from the
convertible bond and trade it separately; and

• encourage the development of a market-based system for classifying financial

instruments based on their complexity and implicit risks.

The Finance Minister also announced that supplementing the measures announced in
respect of the corporate debt market, it was proposed to exempt from TDS, corporate
debt instruments issued in demat form and listed on recognized stock exchanges.

• In March-April 2008, SEBI reviews a large number of public comments received on the
Draft Regulations on Issue and Listing of Debt Securities and the consultative paper which
were placed on the website in January 2008. The draft regulations are being finalized.

• In April 2008, on the lines as proposed in the consultative paper placed on the SEBI
website in respect of draft Regulations for issue and listing of debt securities, SEBI
discussed with stock exchanges, BSE and NSE on simplifying and rationalizing the listing
agreement for debentures. The underlying philosophy for the same is:

(a) where the equity of a company is listed, and such company wishes to issue debt
instruments (whether by way of public offering of private placement), as large amount
of company related information is already in public domain and material developments
are available as per the equity and listing agreement on a nearly continuous basis
minimal incremental disclosures are sufficient; and

(b) where the equity of the issuer is not listed, and such a company raises debt capital
(whether by way of public offering of private placement) detailed disclosures, (fewer than
equity securities disclosures though), are required

• In April-May 2008, SEBI discussed with the stock exchanges BSE and NSE on
introduction of mandatory clearing and settlement for trades in corporate bonds. This is in

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 line with the discussions had with RBI in December 2007 towards preparing the market for
introduction of Repos. The policy is under consideration of SEBI.

• In May 2008, SEBI receives a draft Listing Agreement for debt securities prepared by
BSE and NSE in consultation with SEBI. The draft is presently under consideration at SEBI.
The said draft listing agreement suggests only one listing agreement for debt securities
irrespective of whether the equity of the issuer is already listed or not and whether debt
securities have been issued by way of a public issue or a private placement. The
applicability of clauses has been demarcated in the listing agreement as below:

(a) Part A of the debt listing agreement would be applicable in case the issuer has
equity shares already listed on the exchange and has complied with the covenants
appearing in the equity listing agreement. In such a case, the issuer may comply with
minimal disclosure requirements specified in clauses 1 to 4 of the agreement. It is
specified that in case the equity of the issuer is delisted from the exchange at a later
date, the issuer is mandated to comply with Part B of the agreement.

(b) Part B of the debt listing agreement would be applicable for issuers who do not have
their equity listed on the stock exchange or do not otherwise satisfy the requirements to
make disclosures as per Part A. Clauses 5 to 21 of the agreement would be applicable for
such issuers.

• In May 2008, SEBI gathers information from depositories NSDL and CDSL on transfers in
Corporate Bonds on a monthly summary basis and starts placing the information on
transfers in corporate bonds at depositories on its website.

• In May 2008, SEBI sets up an Advisory Committee named “Corporate Bonds and
Securitization Advisory Committee” (CoBoSAC) for making recommendations to SEBI on
developing the market for corporate bonds and securitized debt instruments further.

• In May 2008, the SEBI (Public Offer and Listing of Securitized Debt Instruments)
Regulations, 2008 are notified in the Official Gazette dated May 26, 2008.

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• In June 2008, the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 are
notified in the Official Gazette dated June 06, 2008.

• In July 2008, the first meeting of the newly set up Corporate Bond and Securitization
Advisory Committee (CoBoSAC) was convened under the Chairmanship of Dr RH Patil. The
Committee deliberated on streamlining mechanisms for reporting, clearing and settlement
and on developments in the Corporate Bond Market to date. The Committee, after
deliberation recommended implementation of mandatory DvP-III clearing and settlement
on exchanges with RTGS. In the meantime, it was recommended to set up a sub-group
that would look into issues related to trade reporting.

• In August 2008, SEBI placed the draft simplified listing norms for ‘debt securities’ as
defined in the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 prepared in
consultation with BSE and NSE on the SEBI Website for public comments.

• In September 2008, SEBI discussed the public comments received on the draft
simplified listing agreement for debt securities. Same are being incorporated into the
agreement. Additional comments received from issuers are also being examined.

• In October 2008, the second meeting of CoBoSAC was convened, Inter alia, the
Committee stressed on the importance of stock exchanges having RTGS access in order to
introduce clearing and settlement through the stock exchange clearing houses. Also, the
SEBI proposal on electronic issuances was discussed in detail at the meeting.

• In December 2008, the third meeting of CoBoSAC was convened. The committee, inter
alia, discussed the analysis on privately placed bonds, the report of the sub-group on
reporting of corporate bond trades and the policy clarifications that needed to be
communicated to the merchant bankers of the proposed issue by Tata Capital Limited.

• In December 2008, SEBI communicated its clarifications on policy issues to the

merchant bankers to the proposed public issue by Tata Capital Limited who had sought

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 clarifications under the recently notified SEBI (Issue and Listing of Debt Securities)
Regulations, 2009.

• In February 2009, the first public issue of non-convertible debt securities under the Debt
Regulations was made by Tata Capital Limited. The issue opened on February 02, 2009
and closed on February 24, 2009. The size of the issue was set at Rs.500crore with a
green shoe option up to Rs.1000crore. Since the issue was over subscribed, the issuer
exercised the green shoe option. The final issue size, thus stands at Rs.1500crore.

• In May 2009, RBI sent a communiqué to SEBI outlining the norms for granting RTGS
access to the clearing corporations of stock exchanges so as to facilitate DVP-I based
trade for trade settlement for the funds leg of corporate bond trades. The clearing
corporations of NSE and BSE submitted their applications for the same through SEBI.

• In May 2009, SEBI put in place the simplified listing agreement for debt securities. As
was proposed in the draft for public comments, issuers with listed equity who are already
subject to detailed disclosure requirements, now have to make minimal disclosures while
issuers of listed debt alone make reasonably elaborate disclosures but less than those
required under the equity listing agreement. The simplified listing agreement has two
parts A & B. Issuers with equity listed need to comply with the brief disclosures as per part
A while those with unlisted equity or non compliance otherwise with the Equity Listing
Agreement would require compliance with Part B of the simplified listing Agreement.

• In May 2009, the fourth meeting of CoBoSAC was convened. The committee, inter alia,
discussed the analysis on reporting of Corporate Bonds prepared by NSDL and learnings
from the recent issue by Tata Capital Limited. CoBoSAC also reviewed the preparedness of
the clearing houses at NSE and BSE for the RTGS based clearing and settlement.

• In June 2009, the applications made through SEBI by the clearing corporations of NSE
and BSE for access to the RBI RTGS system were forwarded to RBI for its consideration.

• In June 2009, SEBI issued a circular clarifying the applicability of regulations/ guidelines
of SEBI on privately placed convertible debt securities. The issue of debt securities that
are convertible, either partially or fully or optionally into listed or unlisted equity shall be
guided by the disclosure norms in terms of SEBI (Disclosure and Investor Protection)
Guidelines, 2000. The issue and listing of non-convertible debt securities, whether issued
to the public or privately placed shall be done in accordance with the provisions of the
SEBI (Issue and Listing of Debt Securities) Regulations, 2008.

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 • In July 2009, SEBI issued a circular to all Mutual Funds, AMFI, Stock Exchanges and
FIMMDA, making it mandatory to report inter-scheme transfers of Corporate Bonds by
Mutual funds on either of the reporting platforms of BSE, NSE or FIMMDA.

• In August 2009, the reporting of inter-scheme transfers of Corporate Bonds by Mutual

Funds was started. The data is also updated on the SEBI Website at link.

During the last fiscal year from April 2008 to March 2009, secondary market trades (both OTC
and exchanges) stood at Rs.148,752crore (Rs.96,119crore in 2007-08) whereas primary
issuances by corporates in the form of private placement during the current fiscal stood at
Rs.207,164crore (Rs.128,602crore in 2007-08) as per information collected from BSE and NSE.
Private placement also includes issuances pursuant to offers made to 50 persons or more under
exemption provided under S.67(3) of the Companies Act. During the same period, transfers in
Corporate Bonds executed at NSDL and CDSL stood at Rs.436,357crore (Rs.2,87,587crore in
2007-08).

During the Current fiscal year from April to August 2009, secondary market trades (both OTC
& exchanges) stood at Rs.123,753 crore. During the same period, transfers in Corporate Bonds
executed at NSDL and CDSL stood at Rs.206,330crore.

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Reasons for non-existent of Corporate Bond Market

The debt market suffers from several infirmities:

• Over regulated financial market: The problem was with regulated interest rates, which
were determined by administrative fiat and not by the market. The RBI administratively
fixed interest rates charged by DFIs and commercial banks and even rates that corporate
entities could offer on their bonds were fixed by the finance ministry, which used to
regulate the capital markets till SEBI was set up. Usually the interest rates on bonds and
the interest rates of the DFIs were such that the corporate units did not have much
attraction to raise funds from the market. The debt-equity norms on bond funds were
more rigorous than the ones that the institutions allowed in respect of their term loans.
Another highly discouraging factor was the high level of stamp duty that the state
governments levied on secondary market transactions in bonds.

• Problems with commercial banks: Indian banks also have to live with several policy
constraints. One major area of concern for them continues to be the priority sector
lending, which is mandated to account for 30% of their total advances. On account of
regional and political pressures on banks their NPA levels in priority sector advances are
quite high. With much smaller size of average account, the operating costs of priority
sector advances to small-scale industry, agriculture, small road transport operators, etc.
which are mandated by the government, are very high for the banks.

• Diversity of investor base: A diverse investor base fosters trading activity.

Different investors have a variety of investment horizons, risk appetite and needs, which
would also diversify the instruments available. Different investors tend to hold different
opinions leading to different valuations and hence more trading. In India, this diversity
seems to be lacking. Corporate bonds are generally held by government controlled
provident funds, insurance companies and banks. Tendency on the part of these
institutions to hold these securities till maturity and consequent reduction in supply is also
a problem. Investors like fixed income funds, hedge funds are dormant in the market. Also
the ease of entrance for foreign investors would also do well for the corporate bond
market.

• Market opaqueness: Ex-post transparency encourages competitive pricing which in turn

boost investor's confidence and hence leads to more trading and higher liquidity in the
market.

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 • Flow of timely information: A key factor influencing the effectiveness of risk controls is
the promptness with which relevant information is available. A payments system that
operates in real time, for example, should provide participants with real-time information
on their settlement balances, and where applicable, their positions against risk
management limits. A system that does not operate in real time should provide relevant
information as frequently and as promptly as necessary for good decision-making.
Corporate bond market in India has very limited flow of timely information about issuers.
In more developed markets like US, Japan, flow of information and relevant news is done
through various means. Quarterly Financial reports, profit reporting, financial press and
information services report on major deals and transactions and important corporate
events; news and analysis from credit rating agencies, etc can lead to increase in better
information flow in the market.

• Public offering of bonds being expensive, time consuming and procedure oriented,
corporate have been finding it easier to either borrow from banks or make a private
placement of their bonds.

Need for an Active Corporate Bond Market

• Infrastructure financing: Infrastructure financing in India does not entirely depend on

the growth of the bond market, it does provide an opportunity for developing the
corporate bond markets. Infrastructure projects are generally are of long gestation periods
and financing these through bank loans is not feasible. This is because banks accept
deposits for 5-10 years and thus cannot give 30-year loans, as this would create asset
liability mismatch. But a bank would be perfectly comfortable buying a 30-year bond if a
liquid market exists in case it needs an exit route. On the other hand an insurance firm or
a pension fund would be perfectly comfortable holding on to a long tenure bond but even
they would like the flexibility to sell which a vibrant secondary market would provide.

• Securitization: Another important and a related issue for the infrastructure financing is
the need for a market in securitized products. In India, the need for asset securitization is
being felt in three major areas - Mortgage Backed Securities (MBS), Infrastructure Sector
and other Asset backed securities (ABS). The essence of securitization is an instrument
which is easily marketable and without an active debt market securitization of assets may
not take off in India.

• Private Players can also access the debt market to finance long-term projects such as
special economic zones (SEZ). With expanding domestic demand and export growth,

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 growth in industrial investments will undoubtedly accelerate leading to greater demand for
bond financing.

• A developed debt market will inter alia facilitate fund-raising for infrastructure and provide
an incentive to FIIs to stay invested in India if and when the down cycle in the equity
market takes place, thereby marginalizing systemic risk posed by today's inflow of
portfolio money.

• One of the causes of the Asian financial crisis was over-dependence of Asian
corporations on short-term foreign funds and mismatch of currencies. Before the crisis,
Asian banks were dependent on short-term foreign currency (similar to external
commercial borrowings in India) funds and corporations were dependent on short-term
funds from such banks. Such dependence on short-term foreign currency funds was the
reason for the rapid outflow of capital from Asian countries as soon as confidence in these
countries started to fade. If bond markets had been more developed in Asia and if
domestic bond markets, denominated in their own currencies, had worked efficiently the
impact of the crisis would have been softened or entirely prevented. The development of
local currency bond markets has been seen as a way to avoid crisis, with these markets
helping to reduce potential currency and maturity mismatches in the financial system. The
Tarapore committee also recommends the development of an active debt market as a
prerequisite for capital account convertibility3

• Apart from its fundamental role of achieving allocative efficiency, a well-developed

government bond market strengthens the monetary policy implementation framework by
equipping a central bank with market-based indirect instruments.

• A vibrant corporate debt market would allow corporates to get a standardized rate and
fees instead of individually negotiating these with a syndicate of banks for loan finance.
But corporates don't have a choice of issuing significant amount of bonds in India. As a
result incremental bank credit is up from Rs 2.5 lakh crore in 2004-05 to Rs 3.7 lakh crore
in 2005-064. Sooner than later, banks may find that their entire appetite for lending is
soaked up by top tier corporates. If there is no market for bonds where they can
sell/securities the loans, banks may find their ability to lend to smaller corporates
impaired. Once large and well-run enterprises develop a preference for financing through
bond markets, commercial banks will get the message and divert more of their resources
to financing SME business.

• Quasi government agencies such as municipalities: Growing urbanisation will need

large urban infrastructure investment and hence the associated need for funds could be a

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 potential candidate for bond issuance. In India too there is a huge potential for municipal
bonds with about 35 cities that have a population of greater than 1 million and about 400
cities with population exceeding 1,00,000.

• The emergence of the Pension fund industry has certain obvious forward linkages with
the capital market of any country. Given the nature of returns required from pension fund
investments, the debt market assumes an even more important role in assuring fixed
returns. In light of this excessive addiction to safety, most pension funds in India invest
heavily in Government securities. Further, investment restrictions imposed by statutory
bodies only exacerbate pension fund investment in other sections of the capital market
like corporate bonds and equity.
However, due to growing fiscal concerns, Government is favoring defined contributory
schemes. This along with the entry of private pension funds requires other investment
avenues to enhance their risk return universe. This is likely to create greater demand for
corporate bonds.

How to Develop Corporate Bond Market

• Investor base needs to be broadened:FII's need to be given higher limits for

investments in corporate bonds since this is one major investor class, which can bring
volumes to the corporate bond markets. Some of the foreign funds do feel that, despite
the recent hike in the limit up to which FIIs can invest in corporate bonds (USD 1.5
billion)5, this amount is too small for taking any active interest in this market
meaningfully.
The investment guidelines for the provident and pension funds need to be rationalized and
they should be allowed to invest on the basis of rating rather than in terms of category of
issuers. This may encourage these funds to invest in high quality corporate bonds.

• Widening the issuer base: Currently banks are allowed to issue bonds of maturities over
5 years only for financing infrastructure sector. Since banks are one of the leading issuers
of bonds, they should be allowed to issue bonds of maturities over 5 years subject to their
asset liability matching norms. The development of an interest rate derivatives markets is
a major prerequisite to facilitate this.

• Development of derivatives market: Derivatives play a very crucial role in reallocating

and mitigating the risks of corporate, banks and other financial institutions. There have
been apprehensions regarding legality of OTC derivatives with section 18A of the
Securities Contracts (Regulation) Act, 1956 (SCRA), making only derivatives contracts that

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 are executed on exchanges legal and valid. Exchange traded derivatives have their own
role to play in the debt market - but by their very nature they have to be standardized
products. OTC derivatives, on the other hand can be customized to the requirements of
the trading entities. Thus both OTC and exchange traded derivatives are essential for
market development. Certain modifications need to be made to the act to ensure legality
of OTC derivative transactions.

• Governments should develop the repo market, such that investors can have more
alternatives to finance their short-term capital needs.

• Market making: Market making should be encouraged for promoting the corporate debt
market. This requires incentivising large financial intermediaries like primary dealers to
take up this job. One way is to encourage the investment bankers involved in the
placement of the bonds.

• Listing norms to be eased: For already listed entities, there listing norms should be
simpler; they should be allowed an abridged version of disclosure. However, companies
which are not listed and which are opting for the private placement mode should be
subjected to stringent disclosure norms.
The practice of suspension of trading/delisting of securities in case of non-compliance with
listing norms by an issuer needs to be replaced by heavy penalties on the promoters and
directors of the erring company.

• Developing a trade reporting system: There is an urgent need to put in place a

mechanism that captures all the information relating to trades in corporate bonds,
disseminate the same and keeps a data base of trade history. Various regulators should
direct the regulated entities to report all the transactions done by them to the trade
reporting system.

• Trading, clearing and settlement mechanism: A robust trading platform would go a

long way in enabling efficient price discovery in corporate bonds as also in creating depth
and vibrancy to the market. An efficient clearing and settlement system would further the
development of corporate bond markets by reducing the counter party risk and settlement
risk. As the corporate bond market develops and expands, diversifying and expanding
investor interest will need institutional measures for credit enhancement. We are fortunate
in India to have built up first-rate credit rating institutions.

• Specialized debt funds for infrastructure financing: As recommended by the High

Level Expert Committee on Corporate Bonds and Securitization, there is a case for

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 creation of specialized Debt Funds to cater to the needs of the infrastructure sector. Such
Debt Funds registered with SEBI should be given the same tax treatment as the one
extended to venture capital funds.

• Developing a market for debt securitization: Apart from reducing the stamp duty on
debt assignments, pass through certificates and security receipts; the government should
also endeavor to resolve the uncertainty in taxation issues pertaining to securitized paper.

• Cost of Issuance: Cost of issuance in term of rating, listing, disclosure and marketing
requirements makes the public issue of bond expensive making private placement a
preferred alternative for most issuers. If the corporate bond market is to develop, a great
deal of attention will have to be given to minimize the issuance cost and the time taken to
make public issue. There is a need to rationalize and reduce the stamp duty.

• Bond Insurance: To increase liquidity for the bonds of less-known or infrequent issuers,
there is a need to encourage the insurance industry to market bond insurance, which is
quite common in developed markets. In fact, in the US four companies focus mainly on
bond insurance.

• Standardization: Standardized trading and settlement processes should enhance liquidity

by reducing transaction costs and may see the materialization of demand for arbitrage and
hedging transactions thus improving market liquidity.
Some fundamental ingredients are missing in the Indian microstructure, like
standardization of the day count convention, quotes, and yields. For instance, for dated
government securities the market follows the 30/360-day count convention the corporate
bond market does not follow any specific convention, leading to confusion in calculating
accrued interest.

• A certain percentage of interest income and capital gains from Debt Instruments for
certain individuals say Non resident Indians and institutions such as pension funds be
exempt from tax to give an initial fillip to the bond markets.

• Bonds issues by AAA rated corporates and PSU's could be used by banks to fulfill their SLR
requirements thereby increasing the attractiveness of such bonds.

• Since the G-sec market in India is of considerable size the corporate and government bond
markets could have the same market infrastructure: they could share the same
dealers, the same reporting system and the same real-time gross settlement system as
there are important economies of scale in such infrastructure. Similar systems are used in
bond markets in Kuala Lumpur6.

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Glossary

• FIMMDA: Fixed Income Money Market and Derivatives Association of India.

• OTC: Over the counter

• SEBI: Security and Exchange Board of India

• NSDL

• CDSL

• NSE: National Stock Exchange

• BSE: Bombay Stock Exchange

• RTGS: Real Time Gross Settlement

• NEFT: National Electronic Funds Transfer

• ECS: Electronic Clearing Service

References

• http://www.nseindia.com/, Website of the national stock exchange.

• http://www.bis.org/ , Website of the Bank of International Settlements.

• http://www.rbi.org.in/ , Website of Reserve Bank of India

• http://www.sebi.gov.in, Website of SEBI

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