Bond Markets in India

Rajesh Chakrabarti
Indian School of Business
Gachibowli, Hyderabad – 500 032
Tel: +91-40-2318-7167
E-mail: rajesh_chakrabarti@isb.edu

Abstract

Bond markets in India have witnessed a sea change since the beginning of economic
reforms in the early 1990s. The government securities market has practically emerged
since the mid-1990s with the deregulation of interest rates and with the central and state
governments accessing markets to finance progressively greater shares of their fiscal
deficits. Trading platforms and settlement mechanisms have improved and new
instruments have been experimented with, with varying degrees of success. In
comparison, the corporate bond market has lagged. With practically no new primary
market issuance of corporate bonds (though with considerable activity in the private
placement segment), the current state of the corporate bond market in India is till nascent
although in the last 2-3 years it has witnessed significant reform activities. The package
of regulatory and infrastructural changes recommended by the Patil committee in 2005, a
large part of which has already either been implemented or in the process of being
completed, is likely to increase the primary and secondary market activity here in the
years to come.The market for asset securitization in India is relatively small compared to
other countries but has demonstrated significant growth in recent years. Asset-backed
securities have led the market with mortgage-backed securities lagging. Corporate loan
securitization is also considerable but mostly in the form of single loan sell-offs rather
than pools of loans as in Collateralized Debt Obligations (CDOs) as securities.
Securitization of trade credit or receivables, an important segment given India’s corporate
financing patterns, is yet to develop.

Electronic copy available at: http://ssrn.com/abstract=1149322

 Bond Markets in India

I. Overview

The Bond market in India started developing in earnest only since liberalization
began in the 1990s when finally interest rates were deregulated and an active market in
government bonds slowly emerged. Between 1994 and 2004, the growth in the overall
bond market in India, relative of GDP (CAGR of 5.5%) has been almost exclusively
driven by that of government bonds (CAGR of 6%) with practically no growth in the
corporate bond market (see Figure 1). Though the third largest market in Asia today, as a
proportion of India’s GDP, the Indian bond market lags most major Asian countries (see
Figure 2). Asset-based securities (ABS) and Mortgage-based securities (MBS) are also
only beginning to form an important component of the debt market in India.

[Figure 1 here] [Figure 2 here]

For the year ending in March 2007, trading in government bonds accounted for
over 99% of total trading in secondary markets (see table 1), and the corporate bond
market has languished over the years. The need for a strong and deep corporate debt
market for financial development and stability of the country is, however, widely
recognized in India today and recent years have witnessed considerable thought and
relatively less action in the area. Several committees have emphasized the need to
develop bond markets with at least one, the Patil Committee, suggesting several steps to
do so. Implementation of these steps has been slow but not wholly absent.
[Table 1 about here]

Table 2 lists the various instruments that constitute the debt market in India – both
the money market and the long-term capital market. Government borrowers include the
central government as the dominant issuer and a few state governments. Commercial
banks (predominantly public sector) and public sector enterprises also issue bonds, some
of which carry tax benefits. Corporations typically issue debentures. In this chapter we
shall restrict our focus to the bond market, i.e. instruments with maturity longer than 1
year, as opposed to the money market that involves shorter-lived debt securities.

[Table 2 about here]

In the remainder of this chapter we shall take a closer look at the various parts of
the bond market in India. The chapter is structured as follows. The next section focuses
on the Government securities market while the third section studies the corporate debt
market. The fourth section looks at the asset securitization industry in India while the
fifth and final section concludes with a discussion of policy issues and new
developments.

Electronic copy available at: http://ssrn.com/abstract=1149322

 II. The Government Securities market

Prior to the 1990’s the market for government securities in India was massively
controlled with captive investors – banks and insurance companies – picking up the
almost entire government issue of government securities with administered coupon rates
to finance the budget deficit leading to its immediate monetization. There was practically
no secondary market in government securities. Artificially low coupon rates for
government securities also “crowded out” private investment as banks charged them
excessive interest rates to make up for the low yield on government securities. The
Statutory Liquidity Ratio (SLR) of banks – the fraction of their deposits bank are required
to invest in government securities – was increased progressively to create a market for
these bonds. On the other hand, the need to contain the effects of monetization of deficit,
compelled the RBI to raise the cash reserve ratio (CRR) as well leaving little funds with
banks for actual lending.
All this began to change with the initiation of economic and financial reforms in
the 1990s. A series of steps have, since then, nursed the emergence of an active market in
government securities in India. Appendix I lists the major events and reforms in this
market since the early 90’s. The RBI and the government have, over time, sought to
improve institutional infrastructure, provide depth and liquidity as well as the market
microstructure, create an enabling regulatory framework and transparency in the market
for government bonds in India. The effects of this are evident in the rise in the amount of
funds that the federal and state governments have mobilized from the market since the
beginning of the reforms (Figure 3, Panel A). Between 1980-81 and 1992-93, the
combined gross market borrowings grew at a CAGR of 15%. In the next 14 years, the
CAGR rose significantly to 19%. Market borrowings are now the dominant source for
financing India’s central gross fiscal deficit (Figure 3, Panel B). Since the beginning of
reforms, the proportion of the central gross fiscal deficit financed through market
borrowing have climbed steadily from about 20% to over 70%. In 1990-91, market
borrowings financed about 20% of the combined gross fiscal deposit of the centre and the
states. By 2004-05 this had more than doubled to 46%.
[Figure 3 here]

Issuance of bonds by public sector companies (PSUs) has also increased

significantly over the years (see figure 4). The annual growth rate since the mid-80’s has
been above 17% though peak levels of borrowings happened in the early 2000s.
[Figure 4 here]

The need to sterilize strong recent foreign fund inflows has given rise the Market
Stabilization Scheme (MSS) since 2004 whereby the RBI issues government securities to
mop up excess liquidity from the market. These are treated as deposits of the central
government with the RBI and therefore reduce RBI’s net credit to the government (which
is currently negative) though the funds are not available to the government for
expenditure, but held in a separate account at the RBI. The ceiling for such securities has
been progressively raised to Rs. 2 trillion in October 2007.
The Regulatory environment

The government securities market functions under RBI’s supervision. Given the
key role of the government securities market in determining the efficacy of the monetary
policy channels of the country, it is hardly surprising that the central bank, RBI, would
take more than a passing interest in this market. The RBI uses central government
securities for its open market operations and the Liquidity Adjustment Facility (LAF).
Besides, the RBI also happens to be the manager of public debt in India – both central
(federal) debt as well as debt of most of the states – though this function is now likely to
be hived off from RBI to the finance ministry.
Section 16 of the Securities Contract (Regulation) Act (SCRA), amended in 2000,
gives RBI its regulatory powers over the government securities market. In 2006, the
Government Securities Act was passed, extended and updated RBI’s powers granted by
the Public Debt Act, 1944 to include lien marking and pledging of government securities
as well as allowing RBI to take steps for computer-based trading of government
securities.

The Primary Market

Since 1992, government securities are issued through an auction system with
the issue amount notified but the coupon rate left to the auction process to be determined.
The reverse arrangement, known as tap issuances, has been used once in a while before
2000. While the uniform or “Dutch” auction system has been sometimes used in issuing
government bonds since 2001, the multiple auction system has remained the predominant
method of issuing these bonds. Under the latter system, bidders below a cut-off yield get
allotments at their own bids. This is, therefore, a discriminatory auction system, where
different bidders pay different prices. The uniform or “Dutch” auction system, where the
same clearing price is paid by all who bid above it, is typically used for new and
relatively complex instruments like floating rate bonds, long maturity bonds and bonds
with embedded options where the market has difficulty pricing the issue.
State government securities, on the other hand, are usually sold through tap
issues. Since 2001-02, the umbrella tap tranche has also been used under which the RBI,
with the concurrence of issuing states, issued securities for a group of states disclosing
the identities of group members, the combined targeted amount and the uniform coupon
rate are announced but individual state targets are not disclosed. The pure tap mechanism
that requires an issue to stay open till the target subscription is reached has been modified
to avoid reputation risks for states experiencing under-subscription. The issues remain
open for two days regardless of the extent of under-subscription. Also the identities of
states with under-subscription are not revealed.
Participants in government security auctions comprise, banks, financial
institutions, mutual funds, insurance companies and primary dealers (PDs). The system of
primary dealers (PDs) was introduced in 1996 to facilitate trading in the government
securities market. PDs are institutions beyond certain size (assets exceeding Rs. 10
billion) and fulfill certain stability and profitability conditions. They act as intermediaries
who participate in and underwrite primary auctions and then typically sell the securities
in the secondary market where they act as market makers providing two-way quotes.
Currently there are 18 PDs – 15 of which are banks or bank subsidiaries. (See Table 3 for
the list of PDs). According to the provisions of the Fiscal Responsibility and Budget
Management (FRBM) Act, 2003, the RBI has ceased to participate in the primary auction
from April 1, 2006. Consequently the importance of PDs in the government securities
market has increased. PDs are required to underwrite 50% of all primary issues – divided
equally among all PDs – and the rest of the issue is up to competitive underwriting. Over
the last few years, however, the share of PDs in primary issuances has declined somewhat
(see figure 5). In the late 1990’s a system of satellite dealers – a second-tier of
intermediaries – was also tried but discontinued when it did not seem to contribute to
broaden the market or improve liquidity in the secondary market significantly.
[Figure 5 here]
Investor base

Traditionally government bonds in India have a captive market. They are held
primarily by banks and financial institutions that are mostly mandated to do so (see
Figure 6). Commercial banks were required to hold government securities to fulfill their
Statutory Liquidity Ratio (SLR) commitments that were raised progressively to 38.5%
just before the reforms to provide cheap funds to the government, but have since been
reduced to the current level of 25%. Of late, the Banking Regulation Amendment Act,
2007 has removed the floor level of SLR at 25% allowing for further reductions of SLR.

[Figure 6 here]

Similarly insurance companies are also required to hold government bonds – life
insurance companies a minimum of 25% of their controlled funds and general insurance
companies a minimum of 30% of their total assets. Pension funds must hold at least 20%
of their assets in government securities. Non-government provident funds,
superannuation funds and gratuity funds need to invest 40% of their incremental funds in
government securities and gilt (debt) funds. For deposit-taking non-banking financial
corporations (NBFCs) the mandatory proportion is 10% while for residuary non-bank
financial companies (RNBCs) the requirements are that the entire “aggregate liability to
depositors (ALD)” be invested in directed investments comprising government securities,
rated and listed securities and debt funds.
In recent years, however, commercial banks have generally held government
securities far beyond levels mandated by regulators. This is largely because an era of
lower and decreasing interest rates in the mid-2000s have proved government securities
an easy way to treasury profits for commercial banks. In 2003, for instance, public sector
banks in India ranked a very close second to Turkey among banks in 24 countries in their
holding of government securities as a proportion of their assets. That has now begun to
change as the interest rates have risen.
In recent years, the investor base of government securities has also broadened
beyond the mandatory off-take of financial institutions. Gilt funds, foreign institutional
investors (FIIs) and even retail investors have joined the market. Gilt funds, or
exclusively debt funds, have become an important part of the mutual fund industry and
has even been provided with liquidity support by RBI. FIIs have been permitted to set up
100% debt funds and invest upto 30% of their total investment in equity funds in
government debt. Retail investors can also participate in non-competitive bidding through
banks and PDs at primary auctions.

Instruments

Innovations in the government securities market have also included

experimentations with security design. In the pre-reform period, government securities
were mostly of the standard fixed coupon type. Zero coupon bonds (ZCBs) were
introduced in 1994 followed by floating rate bonds in 1995, though this was suspended
and reintroduced in 2001 only to be discontinued after 2004. Partly paid stock was also
given a try in 1994. Indexed bonds made its appearance in 1997 (only principal indexed)
while discussions are on for the introduction of a fully-indexed bond (both principal and
interest indexed). A bond with call and put options was issued in 2002.
The general market response to many of these innovative instruments, however,
have been lukewarm leading to discontinuing of these issues. The “when issued” market
started in 2006 is also expected to see significant action but has been less than a rage so
far.

The Secondary Market

In recent years, the government securities market has been overshadowed by

almost every other financial market in terms of turnover (see figure 7 panel A).
Nevertheless, liquidity in the secondary market is critical to the development of the
primary market as well. Several important steps have been taken in recent years to
improve the trading environment and to boost liquidity in the government securities
market.
[Figure 7 here]

Trading in government securities had peaked in the early 2000’s (see figure 7
panel B), largely because falling interest rates made government securities an attractive
way to make treasury profits for commercial banks during that period. By 2005,
however, liquidity in India’s government debt market, as reflected by the turnover ratio,
was close to the median of the distribution among markets, though drastically low in
comparison with the leading economies in this metric (see figure 8). In terms of the bid-
ask spreads, though, India had one of the lowest costs.
[Figure 8 here]

Trading infrastructure and settlement mechanism

Traditionally the government securities market in India has been an inter-

institutional wholesale market. Currently there are multiple platforms on which
government securities are traded. At the heart of a government security transaction lies
the RBI’s Subsidiary General Ledger (SGL) account, which is a facility provided to large
banks and financial institutions. These institutions can open constituent SGL accounts to
their clients – other players authorized by RBI. Currently almost all government
securities are traded in dematerialized form. All trades in government securities are
reported to the RBI-SGL for settlement.
The Delivery versus Payments (DvP) system introduced in 1995 and managed by
RBI’s Public Debt Offices allows for synchronized transfer of securities and cash
payments. The DvP facility is available to all holders of SGL accounts, like banks,
financial institutions, insurance companies and PDs. The DvP mechanism has evolved
over time from DvP-I (gross settlements for both cash and securities) to DvP-II (gross for
securities and net for cash) to DvP-III (net-net) over a settlement cycle since 2004. The
settlement cycle in the government securities market is standardized to T+1 since May,
2005. The Clearing Corporation of India Ltd. (CCIL), established in 2002, acts as the
clearing house and a central counterparty for trades in government securities among its
members (numbering 154 in 2007).
There are two major competing platforms for trading government securities – the
RBI operated Negotiated Dealing System (NDS) and its associated Negotiated Dealing
System – Order Matching (NDS-OM) and the Wholesale Debt Market (WDM) at the
National Stock Exchange (NSE). Both are electronic venues. Trades at the NDS are
directly settled through the CCIL. NSE’s WDM segment provides an automated screen
based platform through its NEAT (National Exchange for Automated Trading) system.
Trading here can be done in both a continuous market or in the negotiated market. Here
trades are settled between participants so there is counter-party risk involved. Participants
have the option of setting counter-party exposure limits. Here outright trades have a
settlement cycle of T+2 days. As Table 4 shows, the WDM segment of NSE still has a
rather small share of the overall government securities trade.
[Table 4 here]

There are two major kinds of trades in the government securities market –
outright transactions and repo (repurchase) transactions. A repo trade is essentially a
mechanism to borrow and lend funds using government securities as collaterals. Here the
borrower sells securities to the lender with a commitment to repurchase the same security
(at a higher price, which takes care of the interest on the “loan”) within a specified period
(usually less than 14 days). A large part of the trading in government securities is
motivated by short term liquidity needs of financial institutions and therefore, usually
takes the form of repo trades. Figure 9 shows the breakdown between outright and repo
trades in recent years. In the last three years, repo trades have dominated outright
transactions significantly.
[Figure 9 here]

If we consider non-repo transactions outside the NDS-OM, however, the share

of the WDM segment of NSE in the total government security transactions increase
significantly. Among all non-repo deals outside the NDS-OM, about three-quarters of the
transaction happened at the WDM during the most active period, 2001 to 2004 a figure
that has come down to a little over half by 2006-07 (see figure 10).
[Figure 10 here]

For non-repo transactions, dated central government securities are the most
popular among the various debt securities accounting for two-thirds to above 90% of total
trading (see Figure 11). Trading volume in these dated bonds, however, has peaked in
2003-04 and has declined significantly since then as has their share of total trade
volumes. As mentioned before, the rising interest rate regime in recent years has been the
major reason behind this drop in volume.
[Figure 11 here]

The WDM at NSE

The market capitalization of the WDM segment of the NSE stood at close to
Rs. 18 trillion in March 2007 (roughly 45% of the Indian GDP). Compare this with the
market capitalization of Rs. 34 trillion for the equity segment of NSE. The security type-
wise breakdown of market capitalization is provided in Table 5 Panel A.
[Table 5 here]

A more detailed breakdown of turnover at the WDM of NSE (Table 5 Panel B)

shows the government securities as the dominant group with about 70% share of trading.
Other securities like PSU and Institutional bonds and bank bonds and CDs trade far less,
but their combined trade volumes is still comparable to the entire turnover in corporate
bonds.
The composition of market participants according to type of institutions is
given in Table 5 Panel C. As expected, banks and trading members of the WDM – of
which there were 63 in 2007, with 50 accounting for total trading – account for most of
the trading while mutual funds and financial institutions are not frequent traders.

In terms of the distribution of turnover across securities, about 40% of the

action at the WDM is captured by the top 5 securities (see Figure 12 Panel A). The
corresponding figure for the equities segment is about 17%. The turnover distribution
across participants, however, is not too bad with top 5 players accounting for roughly a
quarter of the action (Figure 12 Panel B).
[Figure 12 here]

Yields and maturities of government bonds

Yields on government securities, determined by the monetary policy

stance affecting the short-rate coupled with the yield curve, have followed a U-shaped
pattern since liberalization reaching a trough in 2003-04 and rising since then (Figure 13).
The reversal of the interest rate trend since 2003-04 have posed significant challenges for
commercial banks as the value of their government security investments – which, as has
already been observed, was considerably high – fell sharply. Banks have tried to wiggle
some room for themselves in this situation, with help from RBI, by juggling the rules of
the game a bit. Banks need to classify their investment portfolios into three categories: (i)
held to maturity (HTM); (ii) available for sale (AFS); and (iii) held for trading (HFT).
These categories have with progressively mark-to-market norms – the HTM category
securities need not be marked-to-market, but those under AFS and HFT are to be marked-
to-market at year-end and monthly, respectively or more frequently. In 2004, RBI
changed the limit of HTM category from 25% of total investment in government
securities to 25% of total demand and time liabilities allowing banks to mark to market a
smaller proportion of their holdings.
[Figure 13 here]

Over the same period time, the maturity profile of government bonds has
also exhibited a U-shaped pattern reaching a trough in 1998-99. As a matter of conscious
policy, the average maturity of new government issues have been raised steadily since
1997-98 with the share of bonds with ten years or longer maturity rising from 0 in 1997-
98 to 74% in 2005-06. Figure 14 shows the evolution of the maturity profile of
outstanding stock of central government securities since liberalization. The weighted
average maturity of dated securities issued in 2006-07 was 14.75 years.
[Figure 14 here]

By 2005 India’s average central government bond maturity was already amongst
the longest in the world (see Table 6).
[Table 6 here]

The yield curve in India is difficult to establish largely because of thin trading and
poor price discovery at longer horizons. Nevertheless, with the issuance of 30-year paper
in 2002-03, it is possible, in principle, to sketch an yield curve for India. This is typically
rather flat. The NSE publishes a daily zero coupon yield curve (ZCYC) derived using the
Nelson-Siegel model.

III. Corporate Bond Market

The corporate bond market in India is minuscule in comparison with all other
financial markets and several steps have been contemplated and taken in recent years to
improve the situation but with limited effects so far. Trading in and market capitalization
of corporate bonds in India remain anemic. India’s corporate debt market capitalization,
at a paltry 5% of its GDP in 2006, pales before that in countries like Thailand (22%),
Korea (72%) and Malaysia (78%). Multiple committees have looked into the issue of
development of a robust corporate bond market in India, the most important of them
being the Patil Committee Report that has made several important recommendations.
Appendix II summarizes these recommendations.
Several of these recommendations have already been acted upon while action
on others is awaited. Appendix III provides a list and timeline of government action in
developing the corporate bond market and securitization following the Patil Committee
Report. It also lists ongoing initiatives under consideration as of March 2008. The
government’s eagerness in stimulating the corporate debt market comes, in a large part,
from its view that the debt market is critical for the private sector to raise close to the half
a trillion dollar investment expected of it in infrastructure over the Eleventh Five-Year
Plan.

Primary Market
The corporate fund-raising levels using the bond markets have remained low
in comparison to total fund-raising, particularly given the spurt in equity raising in recent
years (see Table 7). Market debt issues accounted for a meager 0.1% of total sources of
funds of a large sample of select non-financial firms in India. In contrast, bank credit
accounted for a third of the total funding. Interestingly enough, even foreign borrowings
(External Commercial Borrowings) accounted for over 20% of total funds flow. As for
market issues, equity issues stood at a staggering 49 times the total debt issues.
[Table 7 here]

The total debt raised in recent years has, however, been a multiple of the
equity raised. But most of it (all of it in the last two years) has come from private
placement of debt, rather than through the debt market. Only about 8% of India’s total
existing corporate debt is publicly placed.
[Table 7 here]
Reasons for the huge preference for private placements lies, largely in the costs
and delays associated with public issues and the very little perceived liquidity benefits
and therefore improvement in rates from such an exercise. It is estimated that a private
placement costs between 0.25% and 0.5% of the issue amount in arranger’s fees and
takes about 7 to 15 days to complete. In contrast, public placement costs can add up to
about 3% of the total amount. This includes fees for brokers, underwriters and lead
arranger (1-1.5%); annual renewal of ratings (0.2-0.3%); annual listing fee (about
0.01%); a fixed initial listing fee of Rs. 7500; listing expenses (0.05%-0.1%) and some
extra costs in printing, advertising and distribution. Both routes involve stamp duty,
rating, listing and trustee fees. It typically takes about 60 days to complete the placement.
Hence unless borrowers get a rate improvement of 2.5% or face issue size constraints in
the private placement market, their preference for private placement of debt is perhaps
understandable.
Companies are also reluctant to get credit rating done for issuing bonds. Recently
the mandatory number of credit ratings for a bond issue has been reduced from two to
one.

Secondary Market
Trades in corporate bonds can happen in one of three possible modes – bilateral
trade between participants settled by cheques and transfer of securities through
depositories (the OTC market); through a broker where the trade is recorded at the
exchange where the broker is registered; or at the Wholesale Debt Market (WDM)
segment of the NSE like government securities. A major recent development in the
corporate bond trading area is the institution of a mandatory trade reporting platform.
First the Bombay Stock Exchange (BSE) and then the NSE since March 2007 and finally
the Fixed Income Money Market and Derivatives Association of India (FIMMDA) since
September 2007, have set up and maintain corporate bond reporting platforms. SEBI
made it compulsory for market participants to report all corporate bond deals,
aggregating Rs.100,000 or more to the BSE (or NSE or FIMMDA) from January 1, 2007,
within 30 minutes of closing the deal. Settlements have to be reported within one trading
day from completion of trades. The BSE operates of the corporate bond reporting
platform from 10 a.m. to 5.30 p.m. on all trading days and access is given to all market
intermediaries for reporting. As the systems stabilize, NSE and BSE are expected to
move to anonymous order matching system for corporate bonds. With this the clearing
and settlement facility should be provided by BSE and NSE with multilateral netting. For
counting days for interest accrual purposes, the actual/actual convention is now
mandatory for all new issues.
Trading in corporate bonds has been low even when compared to their low
capitalization. This is a market that is marked by illiquidity explaining, at least in part, the
aversion of suppliers of security for this market. The trading volumes in the three markets
since January 2007 are reported in Figure 15.
[Figure 15 here]

Roadblocks in the development of the corporate bond market

Several impediments have been identified as stultifying the growth of corporate

bond markets in India and the RBI and government have either acted upon them or are
considering action.
Tax is deducted out of interest payments and a TDS (Tax Deduction at Source)
certificate is issued to the registered owner. Insurance companies and mutual funds are
exempt from this TDS. Previously TDS applied to government securities as well, till the
RBI convinced the government that it was making the government securities market
inefficient. The fact that different players are treated differently on this front, also poses
challenges for a computerized trading system for corporate bonds.
This roadblock is about to be removed. The finance minister has announced in his
budget speech of 2008-09 the proposal to exempt corporate bonds from the TDS.
The stamp duty levied on the either at the time of issue of a financial security
and/or its transfer. It is a state duty – states have the right to amend the Indian Stamp Act
– and it differs from state to state but is generally believed to be rather exorbitant in India.
For debentures, the Indian Stamp Duty stipulates a rate of 0.375% (ad valorem), over
seven times the rate on promissory notes. Rationalization of stamp duty across states is
essential for the market to develop. In comparison, Malaysia and Singapore have no
stamp duty for debentures and relatively nominal rates for mortgages. Reduction of stamp
duty is imperative in bringing down issuance costs.
The Patil committee recommended a uniform stamp duty pattern of 0.05% of face
value for corporate bonds with maximum stamp duty caps that increased progressively
with maturity – Rs. 1 million for bonds with maturity less than a year, Rs. 1.5 million for
bonds with maturity between 1 and 3 years; Rs. 2 million for bonds with maturity 3 to 5
years and Rs. 2.5 million for longer maturity bonds. Consensus across states is currently
being attempted to reduce and rationalize stamp duty rates, with the general argument
being that greater activity with lower rates are likely to boost, rather than shrink, tax
revenues for the states.
There are too many small issues in the debt market in India which makes it
sensible for borrowers to go the private placement route. Corporates tap the market as
and when their need for fund arises. Also, in part, this stems from the procedural
complications in making public issues.
Lack of centralized information on bond trading, prices and defaults poses a
stumbling block. This is however partially addressed through the introduction of central
trading platforms at NSE and BSE and through mandatory reporting of trades to these
platforms.
Lack of uniformity in market practices like lot size and conventions for coupon
calculations as well as lack of multilateral trading and central counterparty mechanism
has been cited as problems. These are gradually being fixed.
Lack of market makers, prepared to provide two-way quotes at all times in the
corporate bond market, has also stilted market development.
The market for corporate bonds is rather limited. Financial institutions like
provident and pension funds, typical holders of corporate bonds, are not allowed to hold
anything below top-rated corporate security for safety reasons. This has led to an
overwhelming proportion of corporate bonds issued to belong to the top-rated category
(see Table 9) Only scheduled co-operative banks are allowed to invest in private-sector
bonds. Debt based mutual funds are also focused on government securities. FIIs typically
use corporate debt only for short-term parking of funds and also have quantity restrictions
in holding corporate bonds.
[Table 9 here]

The biggest problem in stimulating the corporate bond market has perhaps been
the restriction on these bonds being used as collateral for repo transactions. In March
2008, the Finance Minister announced plans to end such restrictions, so it is expected to
happen soon. It is generally expected that this measure would significantly increase
trading and liquidity in the secondary corporate bond market.
Overall the corporate bond market in India is still in a nascent stage. However
with the widespread realization of the need to improve the quality of this market and the
series of recent measures being taken by the government, the regulator and the central
bank, it can be hoped that the situation will improve considerably in the near future.

IV. Securitization

Securitization refers to the process of creation and transfer of securities backed by

a pool of usually non-tradable assets. Typically bank loans of various kinds, mortgages
and receivables are the typical asset classes that are securitized. A securitization exercise
generally involves four major steps: (i) creation of a Special Purpose Vehicle (SPV) to
hold title to the assets to be securitized; (ii) the transfer of ownership of these assets from
the “originator” (usually a bank) to the SPV; (iii) fund-raising by the SPV, usually with
the help of an arranger / investment banker, by issuing securities sold to investors; and
(iv) payment by the SPV to the originator for the underlying securities transferred. The
securities created either representing beneficial interest in the underlying assets (“pass
through securities”) or a senior or subordinated interest in the cash flows realized from
the underlying assets (“pay through securities”).
Other issues connected with securitization include administration of the assets,
including continuation of relationships with “obligors” (borrowers of the loan
securitized), suitable credit enhancements to support timely interest and principal
repayments, ancillary facilities to cover interest rate / foreign exchange risks, guarantee,
etc. and formal rating from one or more rating agencies. These involve other parties like a
bank or insurer in the role of a credit enhancer, swap counterparties providing cover for
interest/forex risk, if necessary, apart from the credit rating agencies and legal counsel
and other service providers.
The USA accounts for over three-quarters of the asset securitization market
worldwide. One of the most popular class of instruments are the Collateralized Debt
Obligations (CDOs). CDOs allow banks to pass mortgages over to investment banks who
pool them and create securities against them (mortgage-backed securities, MBS) which
trade, over the counter, largely among institutional players worldwide. Typically these
come in different risk categories or “tranches” depending upon the quality of the
mortgages backing them. While the investment-grade bonds are sold to institutions
worldwide, the riskiest ones are often passed over to hedge funds and special investment
vehicles (SIVs), frequently floated by the investment bank engineering the CDOs. The
net effect is a transfer of credit risk – the risk of home-owners defaulting on mortgages –
from banks which originate the mortgages to global institutions that operate across
different segments of the financial world.
The impetus for securitization came from the savings and loan crisis of the late
80’s when several mortgage issuers collapsed, leading to a credit crunch and full-blown
recession in the USA. Securitization provides liquidity to institutions holding these loans
as assets and also helps transfer and distribute risks – primarily credit risk – throughout
the financial landscape.
However, determining the underlying quality of the asset is a key part of this
exercise – a step in which credit rating agencies play a pivotal role. Widespread failure of
proper assessment and due diligence here can lead to potentially economy-wide crises as
evidenced by the recent sub-prime crisis. A casualty of widespread securitization has
been the due diligence of mortgage providers. If a bank does not have to live with the
consequences of the loans it makes, it tends to be careless about its quality – “moral
hazard” at its worst. Secondly the quality of mortgage backed securities is difficult to
assess, even for sophisticated institutional investors. With increasing opacity in a market
inhabited by private equity players and hedge funds and marked with over the counter
trading, pricing these assets appropriately and figuring out the counter-party risk become
increasingly difficult.

Securitization in India
The market for securitization has remained nascent in India though the first
securitization deal – an auto loan securitization done by Citibank in 1991 – was done in
the early 1990s. In particular, the mortgage-backed securities (MBS) market appears to
be virtually absent in India compared to other countries.
Indian domestic structured finance has, however, witnessed considerable growth
in recent years. Issuance volume more than doubled in 2007 to USD14.6 billion from
USD6.7 billion in 2006. India remains mostly a domestic market with mostly small
transactions. The average issuance per transaction was USD36 million in 2007, slightly
less than USD41 million in 2006 (see Figure 16).
[Figure 16 here]

Both the number of transactions as well as total volume has risen steadily over the
years. Volumes dropped in 2005-06 in anticipation of upcoming regulatory changes.
Asset-backed securities have remained the mainstay accounting for close to two-thirds of
the total issue volume over the years. This category includes loans for two-wheelers, cars
and utility vehicles, commercial vehicles and construction equipment as well as personal
loans. Car and utility vehicle loans dominate, accounting for over 40% of ABS issuance
in 2006-07, followed by loans for new commercial vehicles and construction equipment
(about 28%) and two-wheeler loans (slightly over 11%). Residential mortgage-backed
securities (RMBS), on the other hand, lagged significantly, both in terms of number of
deals as well as relative volume, though the average size of RMBS deals has risen sharply
over the years and is larger than the average for other categories. Individual corporate
loan securitization (“loan sell-offs” or LSOs) have risen over five-fold during 2006-07.
These are mostly short-term loans with less than year in maturity, loans that are generally
securitized immediately (often within a day). Companies have preferred to borrow and
have the loans securitized by banks rather than issue bond themselves because of greater
disclosures and procedural delays in the latter option. On the other hand pools of
corporate loans in the form of Collateralized Debt Obligations (CDOs), a key asset class
abroad with considerable diversification benefits, has not seen much activity in India.
An important part of the asset securitization industry in India is the securitization
of non-performing assets (NPAs) with Indian banks. With the passage of the
Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest (SARFAESI) Act in 2002, and the institution of the Asset Reconstruction
Company of India Limited (ARCIL), banks have successfully transferred large parts of
their NPAs to ARCIL. The size of the total distressed asset market in India is estimated to
be about Rs. 1.7 trillion, with annual additions to the tune of Rs. 200 billion, just from
scheduled commercial banks. While a fraction of it is actually securitized, management
and recovery of these assets can and should be effectively handled by ARCIL and other
asset reconstruction companies that may come up in the near future.
Transferable securities in the form of pass-through certificates (PTCs) have
remained the dominant form of securitization in India and issuance of notes or bonds as a
securitized product is not considered very likely. PTCs can have a specific coupon rate,
they may be “structured” and they may have different payback periods. Like in most
countries around the world, the market is an over the counter (OTC) market. Trading in
these securities has been inhibited by the fact that the Securities Contract (Regulations)
Act (SCRA), the 1956 law that drives financial security listing in India, did not consider
these securitized assets as appropriate for listing and public trading. The SCRA has
recently been amended in 2007 to allow for PTCs to be listed and traded and therefore
also held by foreign institutional investors (FIIs) thus widening their investor base.
The move to Basel II by Indian banks, expected to be completed (at least in part)
by 2009, is likely to give another impetus to the asset securitization market since such
securities generally invite lower risk weighting than the underlying assets themselves.
Besides SEBI has now issued the guidelines for Real Estate Investment Trusts (REITs)
and the real estate sector is expected to witness substantial growth in securitization, with
the launch of Real Estate Mutual Funds (REMFs).
Currently accounts receivables (trade credit) of companies are not securitized and
it is not clear that the existing RBI guidelines would allow such securitization. Given that
the share of trade credit as a source of finance more than doubled from 7.25% in 2000 to
16% in 2005 and in the latter year constituted the biggest external funding source (even
larger for SME’s at 26%) securitizing trade credit would make a significant difference
particularly to the SMEs, by cutting down their working capital needs.
The high-level committee on Financial Sector Reforms suggests a negotiable Bill of
Exchange (BoE) issued by a buyer against goods received, that the supplier can get
discounted with any financial intermediary, as the model for the instrument of
securitization of trade credit. A market or electronic exchange in such bills can be
developed in lines of the Mexican development bank, NAFIN. NAFIN created an
electronic system where any small firm could present receivables on a number of large
firms to it, that can be presented and accepted electronically by the latter. The accepted
receivables, can then be auctioned off in the market, and the proceeds paid out to the
small firms.
Refinancing small banks and cooperatives can also benefit from increased
securitization, so that standardized loans made by small banks or cooperatives could be
packaged and sold, with safeguards in place to avoid the occurrence of something like the
sub-prime crisis.

V. Conclusions

Bond markets in India have witnessed a sea change since the beginning of
economic reforms in the early 1990s. The government securities market has practically
emerged since the mid-1990s with the deregulation of interest rates and with the central
and state governments accessing markets to finance progressively greater shares of their
fiscal deficits. The RBI has stopped participating in the primary market and the market
has therefore become much more liberated from government interference. Trading
platforms and settlement mechanisms have improved and new instruments have been
experimented with, with varying degrees of success. Banks have found government
securities lucrative during the downward swing of the interest rate cycle in the early-to-
mid 2000s but liquidity has dropped since the reversal of interest rates in recent years.
In comparison, the corporate bond market has lagged. With practically no new
primary market issuance of corporate bonds (though with considerable activity in the
private placement segment), the current state of the corporate bond market in India is till
nascent although in the last 2-3 years it has witnessed significant reform activities. The
package of regulatory and infrastructural changes recommended by the Patil committee
in 2005, a large part of which has already either been implemented or in the process of
being completed, is likely to increase the primary and secondary market activity here in
the years to come.
The market for asset securitization in India is relatively small compared to other
countries but has demonstrated significant growth in recent years. Asset-backed securities
have led the market with mortgage-backed securities lagging. Corporate loan
securitization is also considerable but mostly in the form of single loan sell-offs rather
than pools of loans as in Collateralized Debt Obligations (CDOs) as securities.
Securitization of trade credit or receivables, an important segment given India’s corporate
financing patterns, is yet to develop.
 References

ICRA, 2007, Update on Indian Structured Finance Market

McKinsey Global Institute, 2005, Accelerating India’s Growth Through Financial Sector
Reforms

National Stock Exchange, 2007, Indian Securities Markets — A Review

Patil Committee Report, 2005, Report of High Level Expert Committee on Corporate
Bonds and Securitization, Ministry of Finance, Government of India

Rajan Committee, 2008, Draft Report of the Committee on Financial Sector Reforms,
Planning Commission, Government of India

Reserve Bank of India, 2007, Report on Currency and Finance 2005-06

 Appendix I
Major Developments in the Indian bond markets in recent years
 Recent Developments in the Government Securities Market in India (Contd.)

Source: RBI, 2007

 Appendix II
Recommendations of the Patil committee on corporate bonds and securitization
December 23, 2005

Objective: This report highlights the need for a corporate bond and securitization market
in India and proposes a framework for the development of this market. Given the virtual
absence of this market in India, the report makes detailed recommendations for the
development of primary and secondary bond markets, as well as measures to promote
securitization and to raise debt for infrastructure financing. The report contends that the
GOI, RBI and SEBI should be able to take co-ordinated measures to deal with the
complex issues identified by the committee in this report.

Recommendations / proposed initiatives:

A. Development of primary bond market

Levy a uniform stamp duty linked to bond tenor, across all states, on secured
and unsecured debentures and corporate bonds, with an overall cap. Cap should
also consider re-issuance of securities.
Eliminate TDS on corporate bonds, in line with GOI securities.
Simplifying listing and disclosure requirements for companies, but with an
emphasis on rating rationale.
Permit banks to issue bonds of maturities of over 5 years for ALM purpose (as is
currently allowed for the infrastructure sector).
Design a suitable framework with the necessary support mechanisms and allow
repos in corporate bonds to facilitate efficient market-making by intermediaries such
as banks, primary dealers and investment banks.
Enhance the scope of investment by provident / pension / gratuity funds and
insurance companies in corporate bonds. Make bond ratings the basis of such
investments rather than the category of issuers.
Encourage retail investors to participate in the corporate bond market through
stock exchanges and mutual funds.
Allow a higher limit for FIIs on a yearly basis in corporate bonds, subject to RBI
review.
Consider investment in corporate bonds as part of total bank credit while
computing credit-deposit ratio for banks.
Consolidating the bond issuance process to create large floating stocks, which
would enhance liquidity in the market.
Stock exchanges should maintain centralized database of all bonds issued by
corporates, which would also track rating migration.

B. Development of Secondary Market

Use the existing infrastructure of national stock exchanges to establish a system

to capture all information related to trading in corporate bonds and disseminate it to
the market in real time.
SEBI should make suitable changes in regulations to provide direct access to
regulated institutions such as banks, insurance, companies, mutual funds etc to the
trade reporting system.
 Set up a separate trading platform for institutional investors and platform for non-
competitive bidding and order collection, which would enable investors to buy a
limited portion of the issue.
Establish recognised clearing and settlement agencies to provide clearing and
settlement services by initially offering delivery-versus-payment I (DVP I) and then
eventually migrating in a reasonable time frame to DVP III.
Introduce repos on corporate bonds.
Introduce tripartite repo contracts in corporate bonds, securities lending and
borrowing and other mechanisms for reducing settlement risk.
Order matching trading system: SEBI should frame guidelines to develop online
order matching platforms set up by the stock exchanges or jointly by regulated
institutions like banks, financial institutions, mutual funds, insurance companies etc.
Need for more than one category of member i.e. members who will trade on their
own account and / or members who will do agency business.
Unified market convention – 30 / 360 day count convention for corporate bonds
in line with GOI securities and also an actual / actual basis convention for interest
payments across all fixed income securities.
Introduce revised and approved exchange traded derivative products which have
been pending for a long time.
Reduce minimum market lot for trading to Rs. 1 lakh from Rs. 10 lakh.
Introducing the concept of bond insurance.

C. Development of Securitized Debt Market

Establish affordable rates and levels of stamp duty on debt assignment, PTCs
and security receipts (SRs).
Provide an explicit tax pass through treatment to securitization SPVs and NPA
securitisation SPVs on par with the tax pass through treatment applied to SEBI-
registered venture capital funds.
Modify the mutual fund regulations to permit wholesale investors (to be defined
to mean an investor who invests not less than Rs. 50 lakhs in the scheme) to invest
in and hold units of a closed-ended passively managed mutual fund scheme whose
sole objective is to invest its funds into PTCs and SRs of the designated MBS SPV
trust / NPA securitization trust.
No withholding tax requirement on interest paid by the borrowers (whose credit
exposures are securitized) to the securitization trust. Similarly, no withholding tax
requirements on distributions made by the securitization trust to its PTC and / or SR
holders.
Notify PTCs and other securities issued by securitization SPVs /Trust as
“securities” under SCRA.
Amend the definition of “Security Receipt” under SARFAESI act enabling the SR
to also be an evidence of the right of its holder to the cashflows from realization of
the financial asset involved in securitization (as differentiated from a right in the
financial asset itself).
Permit large sized NBFCs and non-NBFCs corporate bodies established in India
with net own funds in excess of, say, Rs. 50 crores, to invest in SRs as qualified
institutional buyers (QIBs) and also allowing private equity funds registered with
SEBI as venture capital funds to invest in SRs within the limits that are applied for
investment by venture capital funds into corporate bonds.
Credit enhanced collateralized debt obligations (CDO) and collateralized loan
obligations (CLO) should be included as approved investment avenues for important
market participants such as insurance companies and provident funds. Further,
these participants should be allowed to provide credit enhancements for such CLOs
and CDOs.

D. Specialized Debt Funds for Infrastructure Financing

Enable registration of Rupee Debt Funds within the SEBI Venture Capital
framework and allow qualified institutional buyers (QIBs) to commit capital to the
corpus of close-ended infrastructure debt capital funds.
Registered funds could be required to invest a maximum of a third of the
investment funds in listed debt securities, in line with SEBI registered VC funds.
Rupee debt funds should be given the option to list themselves on Indian stock
exchanges after a period of one year from financial closure.
SEBI registered debt funds should receive the same tax treatment as VC funds.
Bank’s investment in registered debt funds should not be subject to “capital
market” exposure limits applied by RBI on equity investments and further these
investments should be accorded the same risk weight as applicable to normal
infrastructure credit.
IRDA, the Central Board of Trustees of the EPFO and the PERDA should permit
insurance companies, provident and gratuity funds and pension funds respectively to
invest / commit contributions to SEBI registered infrastructure debt funds.
RBI in consultation with SEBI may permit foreign debt to participate without any
upper limit, to invest / commit contribution to rupee denominated infrastructure debt
funds registered with SEBI.
Ensure that interest rates paid on small savings instruments are aligned with
market rates. The resultant fiscal savings could be used to provide tax benefits for
municipal bonds and for credit enhancements to bonds issued by SPVs for
infrastructure development.
Municipal bonds may be given fiscal support by way of bond insurance or
providing credit enhancements so that municipalities are encouraged to issue such
bonds for development of urban infrastructure either on stand alone or on pooled
basis.
 Appendix III
Developments in the Corporate Bonds and Securitization Markets-An Update
(As on 10th March, 2008)

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 2006-7 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 the 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 implementation 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
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. The
access to the platform for the purpose of 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 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;

(v) 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;

(vi) There would be no separate trading platforms for different kinds of

investors. Institutional and retail investors would trade on the same platform;

(vii) 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 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.

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
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:

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

(ii) Failure to create a charge on the assets;

(iii) 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.
As at end September, 2007 as per information collected from BSE and NSE, primary
issuances by corporates in the form of private placement during the current fiscal stood at
Rs. 68,457 crore whereas secondary market trades (both OTC and exchanges) stood at
Rs.41,925 crore. Private placement also includes issuances by Public Financial Institutions
and NBFCs under Section 67(3) of the Companies Act, which provides exemption from
restricting the issue to less than 50 investors, these issues thus being “deemed public issues”.

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, letters indicating no objection have been issued by SEBI to entities
which have 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.

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 framed the Draft Regulations on Issue and Listing of Debt
Securities and the same is placed on the 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:

• 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.

During the fiscal year from April 2007 to March 2008, secondary market trades (both
OTC and exchanges) stood at Rs.96,119crore whereas primary issuances by corporate in the
form of private placement during the current fiscal stood at Rs.128,602crore 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.

Work in Progress

1. Simplification of debt issuance process:

SEBI is in the process of simplification of debt issuance process with a view to reducing
costs and enhancing transparency. In January 2008, SEBI framed the Draft Regulations
on Issue and Listing of Debt Securities and placed the same on the SEBI website along
with a consultative paper for Public Comments. The draft regulations are being finalized
taking into account the public comments. In addition to these regulations, the listing
conditions for debt are also being rationalized.

2. Shelf Prospectus for listed corporate entities

With a view to abridging the disclosure requirements for already listed entities companies
Section 60A of the Companies A ct 1956 is also being amended by the Government.

3. Rationalization of Stamp Duty

SEBI has suggested to the Government on the need for rationalization of stamp duty
with a view to developing the corporate debt and securitization markets in the country.
The proposals/suggestions given by SEBI are being examined by the concerned entities
in the Government. Further, the Finance Minister in his Budget speech of 2008-09 stated
that though stock exchanges provide national electronic trading platforms for securities
there is no seamless national market for securities because of differences among States
on the scope and applicability of rates of stamp duty and proposed to request the
Empowered Committee of State Finance Ministers to work with the Central Government
to create a truly pan Indian market for securities that will expand the market base and
enhance the revenues of the State Governments.

Source: SEBI
Table 1: Relative size of Government and Corporate bond markets in India

Source: National Stock Exchange, 2007.

Table 2: Issuers, Instruments and Investors in the Indian Debt Market

Source: National Stock Exchange, 2007.

 Table 3: List of Primary Dealers in Government Securities Market

ABN AMRO Securities (India) Pvt. Ltd. ICICI Securities Primary Dealership Ltd

Bank of America N.A. JPMorgan Chase Bank, N.A.

Bank of Baroda Kotak Mahindra Bank Limited

Citibank N.A., Citibank Center PNB Gilts Ltd.

Corporation Bank SBI DFHI Ltd

Deutsche Securities (India) Pvt.Ltd. Standard Chartered Bank,

DSP Merrill Lynch Ltd. Securities Trading Corporation of India Ltd

Canara Bank HDFC Bank Ltd.,

Hongkong and Shanghai Banking Corporation Ltd IDBI Capital Market Services Ltd.

Table 4: Turnover of Government Debt Securities

Source: NSE, 2007

 Table 5: The WDM at NSE

Panel A
Security-wise breakdown of market capitalization at the WDM of NSE

Panel B
Security-wise breakdown of turnover at the WDM of NSE

Panel C
Turnover by Participant Type at the WDM of NSE

Source: NSE, 2007

 Table 6

Source: BIS, 2007

 Table 7

Source: RBI, Annual Report, 2007

 Table 8
Resources raised from the market by the corporate sector

Source: NSE, 2007

 Table 9
Rating Distribution of Existing Indian Corporate Bonds

Panel A:
Corporate Bonds - Outstanding Issues (Aug 25, 2005)

Panel B:
Corporate Bonds (Structured Obligations) - Outstanding Issues (Aug 25, 2005)
 Figure 1
Growth of India's Bond Market
40
Corporate Debt
35 Government Debt

30
Percentage of GDP

25

20

15

10

0
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Years

Source: McKinsey, 2006

Figure 2
Size of Debt Market Relative to GDP

Japan

Malaysia
Government Debt
Singapore Corporate Debt

South Korea
Countries

China

Thailand

India

Philippines

Indonesia

0 20 40 60 80 100 120 140 160 180 200

Percentage of GDP (in 2004)

Source: McKinsey, 2006

 Percentage Gross Borrowings (in Rs. trillion)

10%

20%

30%

40%

50%

60%

70%

80%

0.5

1.5

2.5
0%

2
1980-81

Source: RBI
1980-81
Source: RBI

1981-82
1981-82
1982-83
1982-83
1983-84
1983-84

Market borrowing as a percentage of Central Gross Fiscal Deficit

1984-85
1984-85
1985-86
1985-86
1986-87
1986-87
1987-88
1987-88

Market Borrowings of the Governments in India

1988-89
1988-89

1989-90 1989-90

1990-91 1990-91

Figure 3 Panel A
Figure 3 Panel B
1991-92 1991-92

1992-93 1992-93

Years
1993-94 1993-94
Years

1994-95 1994-95

1995-96 1995-96

1996-97 1996-97
1997-98 1997-98
1998-99
1998-99

Central
1999-00
1999-00
2000-01
2000-01
2001-02
2001-02
2002-03

States
2002-03
2003-04
2003-04
2004-05
2004-05
2005-06
2005-06
2006-07 RE
2006-07
2007-08 BE
 Figure 4
Bonds Issued by the Public Sector Companies

180

Tax-free bonds Taxable bonds

160

140
Bonds issued (Rs. Billion)

120

100

80

60

40

20

0
1985-86

1986-87

1987-88

1988-89

1989-90

1990-91

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07
Years

Source: RBI Figure 5

Role of Primary Dealers in Government Securities Markets

90 Share in Primary Subscription

Share in Turnover (Outright)
80
Share of G-Secs in Total Assets of PDs

70

60
Percentage

50

40

30

20

10

0
2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 (P)
Years

Source: Mohan, 2007

 Figure 6

Source: RBI, 2007

 Figure 7, Panel A
Turnover in Financial Markets in India

0.9
Money Market
0.8 Government Securities Market
Foreign Exchange Market (Inter-bank)
Average Daily Turnover (Rupees Trillion)

Equity Market (cash segment)

0.7
Equity Derivatives at NSE

0.6

0.5

0.4

0.3

0.2

0.1

0
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
Years

Source: Mohan, 2007

Figure 7, Panel B
Turnover in Government Securities

120 400

350
100

300

80
250

60 200

150
40

100

20
50

0 0
1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

Per cent of GDP Per cent of Stock (right scale)

Source: Mohan, 2007

 Figure 8

Source: BIS, 2007

 Face Value of Transactions in Government Securities

40

35 Outright Repo

30
Face Value (Rs. Trillion)

25

20

15

10

0
2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
Years

Source: NSE, 2007

Figure 9
Share of WDM in Non-RepoTransactions of Government Securities
(Excludes NDS-OM Transactions)
100%
All G-Sec
90% Central & State G-Sec
T-Bills
80%

70%
Share of WDM (%)

60%

50%

40%

30%

20%

10%

0%
1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
Years

Source: NSE, 2007 and author’s calculations

 Figure 10
Security-wise breakdown of transactions

18
T-Bills
State Govt Securities
16
Central Govt. Securities

14
Total SGL Non-Repo Turnover

12
(Rs. Trillion)

10

0
1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
Years

Source: NSE, 2007

 Figure 11
The Wholesale Debt Market at NSE
Panel A

Share of top "N" Securities in the WDM Market

100

90
Share of top 'N' securities (%)

80

70

60 top 100
top 50
50 top 25
top 10
40
top 5
30

20

10

0
1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07
Years

Panel B

Share of top 'N' Participants in WDM

100

90

80
Share of top 'N' participants

70

60 top 100
top 50
50 top 25
top 10
40 top 5

30

20

10

0
1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

Years

Source: NSE, 2007

 Figure 12

Trends in Weighted Average Yields in Government Securities

14

Centre States
12

10
Percent

4
1990-91

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06
Years
Source: RBI, 2007
Figure 13
Trend in maturity profile of Central Government Securities

100%

90%

80%

70%
Over 10 years
Maturity Profile

60%

50%

40% 5-10 years

30%

20% Under 5 years

10%

0%
1990-91

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

Years

Source: RBI, 2007

 Rs. Billion

100

150

200

250

300

350
50
0
Trade Amount (Rs. billion)
1981-82

100

120

140

160
20

40

60

80
0

Source: RBI
1982-83
Source: SEBI

Jan-07 1983-84

1984-85
Feb-07

Source: RBI
1985-86

Corporate Bond Issues as part of New Capital Issues

Mar-07 1986-87

1987-88
Apr-07
1988-89

Trading in Corporate Bonds

May-07 1989-90

1990-91
Jun-07
1991-92

Figure 15

Figure 14
Jul-07 1992-93

1993-94
Months

Years
Aug-07

Total New Capital Issues

Debenture issues
1994-95

Sep-07 1995-96

1996-97
Oct-07
1997-98

Nov-07 1998-99

1999-00
Dec-07
2000-01

Jan-08 2001-02

2002-03
Feb-08
2003-04

Mar-08 2004-05

2005-06
BSE

NSE

FIMMDA

2006-07 P
 Figure 16
Trends in Securitization in India

Panel A
Number of structured finance deals

250

ABS RMBS All deals

200
Number of transactions

150

100

50

0
2002-03 2003-04 2004-05 2005-06 2006-07
Years
Source: ICRA, 2007
Panel B
Structured Finance Issuance Volumes in India

400

350

Others
300
Values (Rs. billion)

250
PG

200 CDO/LSO

150 RMBS

100 ABS

50

0
2002-03 2003-04 2004-05 2005-06 2006-07
Years
PG: Partial Guarantee; CDO/LSO: Collateralized Debt Obligations/Loan Sell-Off

Source: ICRA, 2007