General Management Project

A Study on Governance in Fixed Income Securities

Submitted in partial fulfillment for the award of the degree of

Master of Management Studies (MMS)

(University of Mumbai)

Submitted By
Onkar Adhikari (Roll
No. MMS-16-01)
Batch: 2016-18

Under The Guidance of

Prof. Siddharth Dabholkar

IES Management College and Research Centre

Bandra (W), Mumbai
 IES Management College and Research Centre

(University of Mumbai)

CERTIFICATE

This is to certify that project titled: A Study on Governance in Fixed Income

Securities is successfully completed by Mr. Onkar Adhikari during the IV Semester,
in partial fulfillment of the Master’s Degree in Management Studies recognized by
the University of Mumbai for the academic year 2016-18 through IES Management
College and Research Centre.

This project work is original and not submitted earlier for the award of any
degree/diploma or associateship of any other University/Institution.

Date:
Place: Mumbai

Signature of the Director Signature of the Faculty Guide

Director: Dr. Dinesh Harsolekar Faculty Guide: Prof. Siddharth Dabholkar

 DECLARATION

I hereby declare that this Project Report submitted by me in partial fulfillment of the
award for the Master of Management Studies (MMS), to IES Management College
and Research Centre is a bonafide work undertaken by me and it is not submitted to
any other University or Institution for the award of any degree /diploma/ certificate
or published any time before.

I further certify that I have no objection and grant the rights to IES Management
College and Research Centre to publish any chapter/ project if they deem fit the
journal/ magazine and newspaper etc.

Place: Mumbai Signature:

Date: Name: Onkar Adhikari

Roll No: MMS-16-01

 ACKNOWLEDGEMENT

On the very outset of this report, I would like to extend my sincere & heartfelt
obligation towards all the personages who have helped me in this endeavour.
Without their active guidance, help, cooperation & encouragement, I would not have
made headway in the project.

My deepest gratitude and special thanks to Prof. Siddharth Dabholkar for their
guidance and constant supervision as well as for providing necessary information
regarding the project and also for their support in completing the project. It is my
radiant sentiment to place on record my best regards, deepest sense of gratitude to
my parents, my colleagues, faculty members and my friends who have helped me in
making this project. Their precious guidance was extremely valuable for me without
which this project would not have been complete.

I perceive this opportunity as a big milestone in my career development. I will strive

to use gained skills and knowledge in the best possible way, and I will continue to
work on their improvement, in order to attain desired career objectives.
 Table of Contents

Page
Chapter Particulars
No.

1 Introduction 1

Objectives 3

Limitations 4

2 Literature Review 5

3 Research Methodology 7

4 Results (Findings and Analysis) 8

4.1 Fixed Income Securities: Basic Concepts 9

4.2 Risk Involved in Fixed Income Securities 19

4.3 Credit Rating 24

4.4 Pre-crisis V/s Post-Crisis Bond Market 36

4.5 Bond Regulation 43

4.6 Indian Bond Market- The Way Forward 58

5 Conclusion 74

6 Bibliography 76
 Chapter 1: Introduction
The bond market is a financial market where participants can issue new debt
securities (Primary market) or trade in existing debt securities (Secondary market).
Its primary goal is to provide long-term funding for public and private expenditures.
The bond market has largely been dominated by the United States. Outstanding U.S.
bond market debt is approximately $39.59 trillion according to Securities Industry
and Financial Markets Association (SIFMA).

Bonds have exploded in popularity over the long run, as a long-term trend toward
lower rates has made financing cheaper than ever for government and corporate
borrowers alike. According to some estimates, the global bond market has more than
tripled in size in the past 15 years and now exceeds $100 trillion. By contrast, S&P
Dow Jones Indices put the value of the global stock market at around $64 trillion. In
the U.S. alone, bond markets make up almost $40 trillion in value.

Since Bond Market has been evolving at such a rapid pace, Financial Information
providers like Perfect Information are stressing more importance on sourcing and
indexing Global filings of US Bond market and provide information on debt
securities to clients.

The debt market in India consists of mainly two categories—the government

securities or the G-Sec markets comprising central government and state government
securities, and the corporate bond market. In order to finance its fiscal deficit, the
government floats fixed income instruments and borrows money by issuing G-Secs
that are sovereign securities issued by the Reserve Bank of India (RBI) on behalf of
the Government of India. The corporate bond market (also known as the non-Gsec
market) consists of financial institutions (FI) bonds, public sector units (PSU) bonds,
and corporate bonds/debentures. The G-secs are the most dominant category of debt
markets and form a major part of the market in terms of outstanding issues, market
capitalization, and trading value. It sets a benchmark for the rest of the market. The
market for debt derivatives have not yet developed appreciably, although a market
for OTC derivatives in interest rate products exists. The exchange-traded interest rate

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derivatives that were introduced recently are debt instruments; this market is
currently small, and would gradually pick up in the years to come.

With humongous volumes traded in fixed income securities globally, there is a need
for good governance, and efficient regulatory framework in debt market. Lack of
good governance has caused scams and crisis in the past, more recently global
financial crisis that took place around 2008.

This project will cover the need of governance in fixed income securities, steps taken
by regulatory bodies to ensure transparency in debt market and to fuel growth of debt
market (especially in India where debt market isn’t as developed as U.S. debt
market). We will also see what the requirements are for a corporate to issue fixed
income securities, and what the mandates are for filings of debt instruments.

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 Objectives

 To study the characteristics of various fixed income securities including

structured finance securities.

 To study the existing regulatory framework for Bonds and other fixed income

securities.

 To study the measures taken in regulation of debt market post financial crisis

and its impact.

 To learn about different measures undertaken by regulators to ensure the

compliance by issuers of Fixed Income Securities

 To study the need and importance of Credit Rating in fixed income securities

market.

 To learn about recent developments in Indian debt market regulatory

framework.

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 Limitations

 Regulatory framework in issuance of fixed income securities differs country

wise. It is difficult to compare the regulatory framework of one country with

another.

 Bond market in India is not as developed as it is in U.S. and other developed

economies. Hence, study on certain fixed income securities is limited to those

securities issued in developed Geographies such as U.S. & UK only.

 This topic is very huge and cannot be covered entirely in this project.

 Very less information is available on filings of bonds in India, hence study on

filings of bonds is done for U.S. markets only.

 Project is carried out on few articles & information found on encyclopaedias.

Industry experience in this area of study would be required for in depth

analysis.

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 Chapter 2: Literature Review

According to Barbara Novic (Vice Chairman, BlackRock) and Richie Prager

(Managing Director, Head of trading and liquidity strategies for BlackRock), The
corporate bond market is the world’s largest and deepest source of capital for
companies, with rapidly increasing issuance volumes in recent years. A stable,
wellfunctioning bond market is a critical part of financial market infrastructure,
providing capital for issuers and investment opportunities for a broad array of savers
and investors. Policy makers have recently focused on issues associated with equity
market structure, particularly on the impact of regulatory changes and technological
innovation on equity markets which is driven, in part, by concerns around high
frequency trading. Less attention has been paid to fixed income market structure—
although recently SEC Chair Mary Jo White highlighted the need to consider
whether the current structure of corporate bond markets effectively serves the needs
of investors. Similar concerns have been raised by other regulators.

Mary Jo White, SEC Chairman (June 2014), states It is striking that the dramatic
technological advances that have transformed the equity markets over the past
decade have had only a modest impact on the trading of fixed income securities.

According to K Chaudhari, Raje and Charan Singh (Paper: Corporate Bond Markets
in India, 2014), Recent trends reinforce the need for strong policy measures to
develop the corporate debt markets in India. A study of corporate bond market
experiences across developed and emerging markets such as US, EU, Japan, China,
Malaysia, Korea and New Zealand further underscores the importance of strong
institutional and regulatory framework, along with support from policymakers for
building robust corporate debt markets. A review of literature and an analysis of key
trends in corporate debt market help us identify the issues with the three pillars of
corporate debt markets – institution and regulators, market participants, and
instruments. We find that this lack of depth and efficiency in the corporate debt
market is mainly explained by inadequate infrastructure, illiquidity, regulatory gaps,

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limited investor and issuer base, and absence of benchmark yield curve across
maturities. Finally, we apply the insights from literature review, the trend analysis
and cross-country study to make recommendations to revive the Indian corporate
debt markets. The recommendations span areas such as taxation, legal and
regulatory, public policy, market micro structures, corporate laws, and banking
regulations.

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 Chapter 3: Research Methodology

Type of research: Descriptive research

Method of data collection: Secondary data

The secondary data has been collected from the following sources:

Articles:

“India’s Debt Market- The Way Forward”- published by asifma (July 2017)

Information Provider and Regulatory Websites:

https://www.sec.gov/spotlight/fixed-income-advisory-committee

www.sifma.org/research/statistics.aspx

www.sebi.gov.in/

Other websites and Encyclopaedias:

https://en.wikipedia.org

www.investopedia.com

http://www.asifma.org

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 Chapter 4: Results

Findings and Analysis

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 1. Fixed Income Securities: Basic Concepts

Fixed income refers to any type of investment under which the borrower or issuer is
obliged to make payments of a fixed amount on a fixed schedule. For example, the
borrower may have to pay interest at a fixed rate once a year, and to repay the
principal amount on maturity. Fixed-income securities can be contrasted with equity
securities often referred to as stocks and shares that create no obligation to pay
dividends or any other form of income.

In other words, fixed income is a type of investment in which real return rates or
periodic income is received at regular intervals and at reasonably predictable levels.
Fixed-income investments can be used to diversify one's portfolio, as they pose less
risk than equities and derivative investments. Retired individuals typically tend to
invest heavily in fixed-income investments because of the reliable returns they offer.

There are two main types of investments in the capital markets: debt and equity.
Equity, or company shares, is considered ownership in the company, and investors
receive a return based on share price appreciation and/or dividends. As the name
suggests, a fixed income is a pre-determined amount of income that is paid by an
issuer and earned by an investor. Fixed-income investors do not have an ownership
stake in the company but act as lenders of capital. In exchange for interest, fixed-
income investors lend their money to firms. As a result, they are considered creditors
and often have a higher claim than shareholders in case of bankruptcy or default,
making the investment less risky than equity.

In order for a company to grow its business, it often must raise money – for example,
to finance an acquisition; to buy equipment or land; or to invest in new product
development. The terms on which investors will finance the company will depend on
the risk profile of the company. The company can give up equity by issuing stock, or
can promise to pay regular interest and repay the principal on the loan (bonds or bank
loans). Fixed-income securities also trade differently than equities. Whereas equities,
such as common stock are traded on exchanges or other established trading venues,
many fixed-income securities are traded over-the-counter on a principal basis.

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The term fixed income is also applied to a person's income that does not vary
materially over time. This can include income derived from fixed-income
investments such as bonds and preferred stocks or pensions that guarantee a fixed
income. When pensioners or retirees are dependent on their pension as their
dominant source of income, the term "fixed income" can also carry the implication
that they have relatively limited discretionary income or have little financial freedom
to make large or discretionary expenditures.

Fixed Income as a product:

The most common example of a security that yields a fixed income is a bond. Bonds
are issued by federal governments, local municipalities and major corporations. US
Treasuries pay a fixed income to investors, and include Treasury bonds (T-bonds),
Treasury notes (T-notes), and Treasury bills (T-bills). Corporate bonds include
investment-grade bonds and junk bonds. The former pays a lower fixed income than
the latter because they have a higher credit rating due to their perceived stability.
Junk bonds or high-yield bonds are attractive investments for investors looking for
higher interest or income.

To understand why Treasuries and bonds are fixed income, consider a corporate
bond with 5% annual interest due to mature in 5 years. The company issues this bond
to raise funds for its capital projects. Investors lend money to the company by
purchasing the bonds. In return for the funds lent to it, the firm compensates its
bondholders by paying a fixed interest rate of 5% of the investment amount annually.
The interest rate is also known as the coupon rate. A bondholder that purchased
$10,000 worth of bonds will, thus, receive 5% x $10,000 = $500 every year. This
amount is fixed and represents a steady income to the bondholder.

Bond Basics

A bond is a loan that an investor makes to a corporation, government, federal agency,

or other organization. Consequently, bonds are sometimes referred to as debt
securities. Since bond issuers know you aren’t going to lend your hard-earned money

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without compensation, the issuer of the bond (the borrower) enters into a legal
agreement to pay you (the bondholder) interest.

The bond issuer also agrees to repay you the original sum loaned at the bond’s
maturity date, though certain conditions, such as a bond being called, may cause
repayment to be made earlier. The vast majority of bonds have a set maturity date—a
specific date when the bond must be paid back at its face value, called par value.
Bonds are called fixed-income securities because many pay you interest based on a
regular, predetermined interest rate—also called a coupon rate—that is set when the
bond is issued.

Understanding bond basics is critical to making informed investment decisions about

this investment category. The more you know now, the less likely you will be to
make a decision you later regret.

Bond Maturity

A bond’s term, or years to maturity, is usually set when it is issued. Bond maturities
can range from one day to 100 years, but the majority of bond maturities range from
one to 30 years. Bonds are often referred to as being short-, medium-, or long-term.
Generally, a bond that matures in one to three years is referred to as a short-term
bond. Medium- or intermediate-term bonds are generally those that mature in four to
10 years, and long-term bonds are those with maturities greater than 10 years. The
borrower fulfills its debt obligation typically when the bond reaches its maturity date,
and the final interest payment and the original sum you loaned (the principal) are
paid to you.

Callable Bonds

Not all bonds reach maturity, even if you want them to. Callable bonds are common.
They allow the issuer to retire a bond before it matures. Call provisions are outlined
in the bond’s prospectus (or offering statement or circular) and the indenture—both
are documents that explain a bond’s terms and conditions. While firms are not
formally required to document all call provision terms on the customer’s
confirmation statement, many do so. (When you buy municipal securities, firms are

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required to provide more call information on the customer confirmation than you will
see for other types of debt securities.)

You usually receive some call protection for a period of the bond’s life (for example,
the first three years after the bond is issued). This means that the bond cannot be
called before a specified date. After that, the bond’s issuer can redeem that bond on
the predetermined call date, or a bond may be continuously callable, meaning the
issuer may redeem the bond at the specified price at any time during the call period.
Before you buy a bond, always check to see if the bond has a call provision, and
consider how that might impact your portfolio investment strategy.

Terms of Callable bonds are usually mentioned in prospectus under Redemption

Provisions:

Figure 1.1: Snapshot Callable Bond’s Prospectus

Bond Coupons

A bond’s coupon is the annual interest rate paid on the issuer’s borrowed money,
generally paid out semiannually. The coupon is always tied to a bond’s face or par
value, and is quoted as a percentage of par. For instance, a bond with a par value of

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$1,000 and an annual interest rate of 4.5 percent has a coupon rate of 4.5 percent
($45).

Coupon Choices

Say you invest $5,000 in a six-year bond paying 5 percent per year, semiannually.
Assuming you hold the bond to maturity, you will receive 12 interest payments of
$125 each, or a total of $1,500. This coupon payment is simple interest.

You can do two things with that simple interest—spend it or reinvest it. Many bond
investors rely on a bond’s coupon payments as a source of income, spending the
simple interest they receive.

When you reinvest a coupon, however, you allow the interest to earn interest. The
precise term is “interest-on-interest,” though we know it by another word:
compounding. Assuming you reinvest the interest at the same 5 percent rate and add
this to the $1,500 you made, you would earn a cumulative total of $1,724, or an extra
$224. Of course, if the interest rate at which you reinvest your coupons is higher or
lower, your total return will be more or less. Also be aware that taxes can reduce
your total return.

Zero-Coupon Bonds

Bonds that don’t make regular interest payments are called zero-coupon bonds—
zeros for short. As the name suggests, these are bonds that pay no coupon or interest
payment. Instead of getting an interest payment, you buy the bond at a discount from
the face value of the bond, and you are paid the face amount when the bond matures.
For example, you might pay $3,500 to purchase a 20-year zero-coupon bond with a
face value of $10,000.

Federal agencies, municipalities, financial institutions, and corporations issue zeros.

One of the most popular zeros goes by the name of STRIPS (Separate Trading of
Registered Interest and Principal Securities). A financial institution, government
securities broker, or government securities dealer can convert an eligible Treasury
security into a STRIP bond. As the name implies, the interest is stripped from the

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bond. A nice feature of STRIPS is that they are non-callable, meaning they can’t be
called to be redeemed should interest rates fall. This feature offers protection from
the risk that you will have to settle for a lower rate of return if your bond is called,
you receive cash, and you need to reinvest it, also known as reinvestment risk.

Floating-Rate Bonds

While the majority of bonds are fixed-rate bonds, a category of bonds called floating-
rate bonds (floaters) have a coupon rate that is adjusted periodically, or “floats,”
using an external value or measure, such as a bond index or foreign exchange rate.

Floaters offer protection against interest rate risk, because the fluctuating interest
coupon tends to help the bond maintain its current market value as interest rates
change. However, their coupon rate is usually lower than that of fixed-rate bonds.
Because a floating bond’s rate increases as interest rates go up, they tend to find
favour with investors during periods when economic forces are causing interest rates
to rise. Most floater coupon rates are generally reset more than once a year at
predetermined intervals (for example, quarterly or semi-annually). Floaters are
slightly different from so-called variable rate or adjustable rate bonds, which tend to
reset their coupon rate less frequently. (Note: Floating and adjustable-rate bonds may
have restrictions on the maximum and minimum coupon reset rates.)

Bond Prices

Bonds are generally issued in multiples of $1,000, also known as a bond’s face or par
value. But a bond’s price is subject to market forces and often fluctuates above or
below par. If you sell a bond before it matures, you may not receive the full principal
amount of the bond and will not receive any remaining interest payments. This is
because a bond’s price is not based on the par value of the bond. Instead, the bond’s
price is established in the secondary market and fluctuates. As a result, the price may
be more or less than the amount of principal and the remaining interest the issuer
would be required to pay you if you held the bond to maturity.

The price of a bond can be above or below its par value for many reasons, including
interest rate adjustments, whether a bond credit rating has changed, supply and

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demand, a change in the credit-worthiness of a bond’s issuer, whether the bond has
been called or is likely to be (or not to be) called, a change in the prevailing market
interest rates, and a host of other factors. If a bond trades above par, it is said to trade
at a premium. If a bond trades below par, it is said to trade at a discount. For
example, if the bond you desire to purchase has a fixed interest rate of 8 percent, and
similar-quality new bonds available for sale have a fixed interest rate of 5 percent,
you will likely pay more than the par amount of the bond that you intend to purchase,
because you will receive more interest income than the current interest rate (5
percent) being attached to similar bonds.

Bond Yield

Yield is a general term that relates to the return on the capital you invest in the bond.

You hear the word “yield” a lot with respect to bond investing. There are, in fact, a
number of types of yield. The terms are important to understand because they are
used to compare one bond with another to find out which is the better investment.

There are several definitions that are important to understand: coupon yield, current
yield, yield-to-maturity, yield-to-call and yield-to-worst.

Let’s start with the basic yield concepts.

 Coupon yield is the annual interest rate established when the bond is issued.
It’s the same as the coupon rate and is the amount of income you collect on a
bond, expressed as a percentage of your original investment. If you buy a
bond for $1,000 and receive $45 in annual interest payments, your coupon
yield is 4.5 percent. This amount is figured as a percentage of the bond’s par
value and will not change during the lifespan of the bond.
 Current yield is the bond’s coupon yield divided by its market price. Here’s
the math on a bond with a coupon yield of 4.5 percent trading at 103
($1,030).

If you buy a new bond at par and hold it to maturity, your current yield when the
bond matures will be the same as the coupon yield.

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Yields That Matter More

Coupon and current yield only take you so far down the path of estimating the return
your bond will deliver. For one, they don’t measure the value of reinvested interest.
They also aren’t much help if your bond is called early—or if you want to evaluate
the lowest yield you can receive from your bond. In these cases, you need to do some
more advanced yield calculations. Fortunately, there is a spate of financial
calculators available—some that even estimate yield on a before- and after-tax basis.
The following yields are worth knowing, and should be at your broker’s fingertips:

 Yield to maturity (YTM) is the overall interest rate earned by an investor who
buys a bond at the market price and holds it until maturity. Mathematically, it
is the discount rate at which the sum of all future cash flows (from coupons
and principal repayment) equals the price of the bond. YTM is often quoted
in terms of an annual rate and may differ from the bond’s coupon rate. It
assumes that coupon and principal payments are made on time. It does not
require dividends to be reinvested. Further, it does not consider taxes paid by
the investor or brokerage costs associated with the purchase.

 Yield-to-Call (YTC) is figured the same way as YTM, except instead of

plugging in the number of months until a bond matures; you use a call date
and the bond’s call price. This calculation takes into account the impact on a
bond’s yield if it is called prior to maturity and should be performed using the
first date on which the issuer could call the bond.

 Yield-to-Worst (YTW) is whichever of a bond’s YTM and YTC is lower. If

you want to know the most conservative potential return a bond can give you
—and you should know it for every callable security—then perform this
comparison.

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Bonds and Interest Rates

Three Cardinal Rules:

 When interest rates rise—bond prices fall.

 When interest rates fall—bond prices rise.
 Every bond carries interest rate risk.

Interest rate changes are among the most significant factors affecting bond return.

To find out why, we need to start with the bond’s coupon. This is the interest the
bond pays out. How does that original coupon rate get established? One of the key
determinants is the federal funds rate, which is the prevailing interest rate that banks
with excess reserves at a Federal Reserve district bank charge other banks that need
overnight loans. The Federal Reserve (or “the Fed”) sets a target for the federal funds
rate and maintains that target interest rate by buying and selling U.S. Treasury
securities.

When the Fed buys securities, bank reserves rise, and the federal funds rate tends to
fall. When the Fed sells securities, bank reserves fall, and the federal funds rate tends
to rise. While the Fed doesn’t directly control this rate, it effectively controls it
through the buying and selling of securities. The federal funds rate, in turn,
influences interest rates throughout the country, including bond coupon rates.

Another rate that heavily influences a bond’s coupon is the Federal Reserve Discount
Rate, which is the rate at which member banks may borrow short-term funds from a
Federal Reserve Bank. The Federal Reserve Board directly controls this rate. Say the
Federal Reserve Board raises the discount rate by one-half of a percent. The next
time the U.S. Treasury holds an auction for new Treasury bonds, it will quite likely
price its securities to reflect the higher interest rate.

What happens to the Treasury bonds you bought a couple of months ago at the lower
interest rate? They’re not as attractive. If you want to sell them, you’ll need to

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discount their price to a level that equals the coupon of all the new bonds just issued
at the higher rate. In short, you’d have to sell your bonds at a discount.

It works the other way, too. Say you bought a $1,000 bond with a 6 percent coupon a
few years ago and decided to sell it three years later to pay for a trip to visit your
ailing grandfather, except now, interest rates are at 4 percent. This bond is now quite
attractive compared to other bonds out there, and you would be able to sell it at a
premium.

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 2. Risk Involved in Fixed Income Securities

Interest Rate Risk

Remember the cardinal rule of bonds: When interest rates fall, bond prices rise, and
when interest rates rise, bond prices fall. Interest rate risk is the risk that changes in
interest rates in the U.S. or the world may reduce (or increase) the market value of a
bond you hold. Interest rate risk—also referred to as market risk— increases the
longer you hold a bond.

Let’s look at the risks inherent in rising interest rates.

If you bought a 10-year, $1,000 bond today at a coupon rate of 4 percent, and interest
rates rise to 6 percent, two things can happen.

Say you need to sell your 4 percent bond prior to maturity. In doing so, you must
compete with newer bonds carrying higher coupon rates. These higher coupon rate
bonds decrease the appetite for older bonds that pay lower interest. This decreased
demand depresses the price of older bonds in the secondary market, which would
translate into you receiving a lower price for your bond if you need to sell it. In fact,
you may have to sell your bond for less than you paid for it. For this reason, interest
rate risk is also referred to as market risk.

Rising interest rates also make new bonds more attractive (because they earn a higher
coupon rate). This results in what’s known as opportunity risk—the risk that a better
opportunity will come around that you may be unable to act upon. The longer the
term of your bond, the greater the chance that a more attractive investment
opportunity will become available, or that any number of other factors may occur
that negatively impact your investment. This also is referred to as holding period risk
—the risk that not only a better opportunity might be missed, but that something may
happen during the time you hold a bond to negatively affect your investment.

Bond fund managers face the same risks as individual bondholders. When interest
rates rise—especially when they go up sharply in a short period of time—the value
of the fund’s existing bonds drops, which can put a drag on overall fund

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performance. Since bond prices go up when interest rates go down, you might ask
what risk, if any, do you face when rates fall? The answer is call risk.

Duration Risk

If you own bonds or have money in a bond fund, there is a number you should know.
It is called duration. Although stated in years, duration is not simply a measure of
time. Instead, duration signals how much the price of your bond investment is likely
to fluctuate when there is an up or down movement in interest rates. The higher the
duration number, the more sensitive your bond investment will be to changes in
interest rates.

Duration risk is the name economists give to the risk associated with the sensitivity
of a bond’s price to a one percent change in interest rates.

Call Risk

Similar to when a homeowner seeks to refinance a mortgage at a lower rate to save

money when loan rates decline, a bond issuer often calls a bond when interest rates
drop, allowing the issuer to sell new bonds paying lower interest rates—thus saving
the issuer money. For this reason, a bond is often called following interest rate
declines. The bond’s principal is repaid early, but the investor is left unable to find a
similar bond with as attractive a yield. This is known as call risk.

With a callable bond, you might not receive the bond’s original coupon rate for the
entire term of the bond, and it might be difficult or impossible to find an equivalent
investment paying rates as high as the original rate. This is known as reinvestment
risk. Additionally, once the call date has been reached, the stream of a callable
bond’s interest payments is uncertain, and any appreciation in the market value of the
bond may not rise above the call price.

Refunding Risk and Sinking Funds Provisions

A sinking fund provision, which often is a feature included in bonds issued by

industrial and utility companies, requires a bond issuer to retire a certain number of
bonds periodically. This can be accomplished in a variety of ways, including through

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purchases in the secondary market or forced purchases directly from bondholders at a
predetermined price, referred to as refunding risk.

Holders of bonds subject to sinking funds should understand that they risk having
their bonds retired prior to maturity, which raises reinvestment risk. Unlike other
bonds subject to call provisions, depending upon the sinking fund provision, there
may be a relatively high likelihood that the bondholders will be forced to redeem
their bonds prior to maturity, even if market-wide interest rates remain unchanged.

It is important to understand that there is no guarantee that an issuer of these bonds

will be able to comply strictly with any redemption requirements. In certain cases, an
issuer may need to borrow funds or issue additional debt to refinance an outstanding
bond issue subject to a sinking fund provision when it matures.

Default and Credit Risk

If you have ever loaned money to someone, chances are you gave some thought to
the likelihood of being repaid. Some loans are riskier than others. The same is true
when you invest in bonds. You are taking a risk that the issuer’s promise to repay
principal and pay interest on the agreed upon dates and terms will be upheld. U.S.
Treasury securities (for example, a Treasury bond, bill or note) and other bonds
backed by the “full faith and credit of the U.S. government,” are generally deemed to
be risk-free. However, most bonds face a possibility of default. This means that the
bond obligor will either be late paying creditors (including you, as a bondholder),
pay a negotiated reduced amount or, in worst-case scenarios, be unable to pay at all.

Inflation Risk

This is the risk that the yield on a bond will not keep pace with purchasing power (in
fact, another name for inflation risk is purchasing power risk). For instance, if you
buy a five-year bond in which you can realize a coupon rate of 5 percent, but the rate
of inflation is 8 percent, the purchasing power of your bond interest has declined. All
bonds but those that adjust for inflation, such as TIPS, expose you to some degree of
inflation risk.

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Liquidity Risk

Some bonds, like U.S. Treasury securities, are quite easy to sell because there are
many people interested in buying and selling such securities at any given time. These
securities are liquid. Others trade much less frequently. Some even turn out to be “no
bid” bonds, with no buying interest at all. These securities are illiquid.

Liquidity risk is the risk that you will not be easily able to find a buyer for a bond
you need to sell. A sign of liquidity, or lack of it, is the general level of trading
activity: A bond that is traded frequently in a given trading day is considerably more
liquid than one which only shows trading activity a few times a week. Investors can
check corporate bond trading activity—and thus liquidity—by using FINRA’s
Market Data Center. For insight into municipal bond liquidity, investors can use
trade data found on the Municipal Securities Rulemaking Board’s website.

If you think you might need to sell the bonds you are purchasing prior to their
maturity, you should carefully consider liquidity risk, and what steps your broker
will take to assist you when liquidating your investment at a fair price that is
reasonably related to then-current market prices. It is possible that you may be able
to re-sell a bond only at a heavy discount to the price you paid (loss of some
principal) or not at all.

Event Risk

In the 1980s, buyouts, takeovers and corporate restructurings became prevalent. With
such upheavals often came swift, and very often negative, changes to a company’s
credit rating. To this day, mergers, acquisitions, leveraged buyouts, and major
corporate restructurings are all events that put corporate bonds at risk, thus the name
event risk.

Other events can also trigger changes in a company’s financial health and prospects,
which may trigger a change in a bond’s rating. These include a federal investigation
of possible wrongdoing, the sudden death of a company’s chief executive officer or
other key manager, or a product recall. Energy prices, foreign investor demand and

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world events also are triggers for event risk. Event risk is extremely hard to
anticipate and may have a dramatic and negative impact on bondholders.

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 3. Credit Rating

Ratings are a way of assessing default and credit risk. The Securities and Exchange
Commission (SEC) has designated 10 rating agencies as Nationally Recognized
Statistical Rating Organizations (NRSROs). They are: A.M. Best Company, Inc.;
DBRS, Inc.; Egan-Jones Ratings Co.; Fitch, Inc.; HR Ratings de México, S.A. de
C.V.; Japan Credit Rating Agency, Ltd.; Kroll Bond Rating Agency, Inc.; Moody’s
Investors Service, Inc.; Morningstar Credit Ratings, LLC; and Standard & Poor’s
Ratings Services. These organizations review information about selected issuers,
especially financial information, such as the issuer’s financial statements, and assign
a rating to an issuer’s bonds—from AAA (or Aaa) to D (or no rating).

Each NRSRO uses its own ratings definitions and employs its own criteria for rating
a given security. It is entirely possible for the same bond to receive a rating that
differs, sometimes substantially, from one ratings agency to the next. While it is a
good idea to compare a bond’s rating across the various NRSROs, not all bonds are
rated by every agency, and some bonds are not rated at all.

Risk from A to D

The credit quality of bonds is based primarily on the likelihood of possible default,
resulting in investors losing their principal. Rating agencies sift through data
provided by the bond issuers, and other public and non-public data, to evaluate the
likelihood of default for a bond assigned with a particular rating, while also applying
other risk factors in assigning a specific rating. The chart below describes common
bond ratings and includes a general description of each*. For precise ratings
descriptions, visit the respective ratings agency websites.

What is an 'Investment Grade'?

An investment grade is a rating that indicates that a municipal or corporate bond has
a relatively low risk of default. Bond rating firms, such as Standard & Poor's and
Moody's, use different designations consisting of upper- and lower-case letters 'A'
and 'B' to identify a bond's credit quality rating. 'AAA' and 'AA' (high credit quality)
and 'A' and 'BBB' (medium credit quality) are considered investment grade. Credit

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 ratings for bonds below these designations ('BB', 'B', 'CCC', etc.) are considered low
credit quality, and are commonly referred to as “High Yield” or "Junk Bonds".

Not Perfect

Rating agencies don't always get it right. Enron was rated investment grade by the
NRSROs just days before bankruptcy, and WorldCom was rated investment grade
only three months before filing for bankruptcy. More recently, the collapse of the
subprime mortgage market uncovered weaknesses in the ratings of many residential
mortgage-backed securities that were linked to subprime mortgages.

Following table shows the ratings used by well-known Credit Rating Agencies:

Rating Description Rating by Credit Rating Organizations

INVESTMENT GRADE

AM Best: aaa

Highest credit quality with minimal risk of default. DBRS, Egan-Jones, Fitch, Japan, R&I,
Extremely strong capacity to meet financial Realpoint, S&P: AAA
commitments.
LACE: A+, A

Moody's: Aaa

AM Best: aa

Superior to very high credit quality and very low DBRS, Egan-Jones, Fitch, Japan, R&I,
risk of default. Very strong capacity to meet Realpoint, S&P: AA
financial commitments.
LACE: B+

Moody's: Aa

High to upper-medium credit quality with some risk AM Best: a

factors that could contribute to default. Bonds in this
category are still considered to be in little danger of DBRS, Egan-Jones, Fitch, Japan,
default risk. Moody's, R&I, Realpoint, S&P: A

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 LACE: B

AM Best: bbb

Adequate to medium credit quality, with acceptable DBRS, Egan-Jones, Fitch, Japan, R&I,
levels of risk. Could be susceptible to default risk in Realpoint, S&P: BBB
the long term, or there may be other adverse
conditions present which reduce credit quality. LACE: B–, C+

Moody's: Baa

Rating Description Rating by Credit Rating Organizations

NON-INVESTMENT GRADE

AM Best: bb

Questionable to speculative financial security, with DBRS, Egan-Jones, Fitch, Japan, R&I,
additional factors that may contribute to default, Realpoint, S&P: BB
such as ability to meet debt obligations, especially
during periods of economic recession. LACE: C, C–

Moody's: Ba

AM Best: b

Speculative to highly speculative financial security,

DBRS, Egan-Jones, Fitch, Japan,
with low expectation that issuer will meet debt
Moody's, R&I, Realpoint, S&P: B
obligations.

LACE: C, C–

AM Best: ccc

Very highly speculative with high risk of default. DBRS, Egan-Jones, Fitch, Japan, R&I,
Realpoint, S&P: CCC

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 LACE: D, E

Moody's: Caa

AM Best: cc

DBRS, Egan-Jones, Fitch, Japan, R&I,

Very highly speculative with danger of default, or Realpoint, S&P: CC
default probable, or may have recently occurred.
LACE: D, E

Moody's: Ca

AM Best: c

DBRS, Japan, Moody's, R&I, Realpoint: C

Very highly speculative, often accompanied by
bankruptcy petitions; default imminent or has Fitch: C+, C, C–
recently occurred.
LACE: D, E

S&P, Egan-Jones: C+, C, C–

AM Best: d

Default and/or in arrears, meaning a portion of a DBRS, Egan-Jones, Fitch, Japan,

serial bond remains unpaid at maturity. Issuer has not Realpoint, S&P: D
met scheduled payment of interest or principal or
made clear it will miss such payments. LACE: D, E

Moody's, R&I: No Rating

Credit Ratings are vital to bond issuers and investors

Rating agencies look closely at bonds to judge the likelihood that the issuer will be
able to repay, with various rating scales using different methods to make their
estimates. S&P, for instance, sets AAA as its highest broad rating, and after that,
ratings of AA, A, BBB, BB, and so on down to D represent decreasing credit quality.
All ratings between AA and CCC also allow for plus or minus symbols to attach to
the end of the rating, indicating bonds at the top or bottom end of that rating range
respectively.

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The big line in the sand for the bond market is the gap between BBB- and BB+,
which separates high-quality investment-grade debt from lower-quality high-yield or
junk bond debt. Higher bond ratings typically have less chance of default, and so
issuers can pay lower interest rates and still get demand.

Credit Rating Agencies and the Subprime Crisis

Credit rating agencies are the firms which rate debt instruments/securities according
to the debtor's ability to pay lenders back — played a significant role at various
stages in the American subprime mortgage crisis of 2007-2008 that led to the Great
Recession of 2008-2009. The new, complex securities of "structured finance" used to
finance subprime mortgages could not have been sold without ratings by the "Big
Three" rating agencies — Moody's Investors Service, Standard & Poor's, and Fitch
Ratings. A large section of the debt securities market — many money
markets and pension funds — were restricted in their bylaws to holding only the
safest securities — i.e securities the rating agencies designated "triple-A". The pools
of debt the agencies gave their highest ratings to included over three trillion dollars
of loans to homebuyers with bad credit and undocumented incomes through
2007. Hundreds of billions of dollars' worth of these triple-A securities were
downgraded to "junk" status by 2010, and the writedowns and losses came to over
half a trillion dollars. This led "to the collapse or disappearance" in 2008-9 of three
major investment banks (Bear Stearns, Lehman Brothers, and Merrill Lynch), and
the federal governments buying of $700 billion of bad debt from distressed financial
institutions.

Impact on the crisis

Credit rating agencies came under scrutiny following the mortgage crisis for giving
investment-grade, "money safe" ratings to securitized mortgages (in the form of
securities known as mortgage-backed securities (MBS) and collateralized debt
obligations (CDO)) based on "non-prime"—subprime or Alt-A -- mortgages loans.

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Demand for the securities was stimulated by the large global pool of fixed income
investments which had doubled from $36 trillion in 2000 to $70 trillion by 2006—
more than annual global spending—and the low interest rates from competing fixed
income securities, made possible by the low interest rate policy of the US Federal
Reserve Bank for much of that period. These high ratings encouraged the flow of
global investor funds into these securities funding the housing bubble in the US.

Mortgage-related securities

Ratings were/are vital to "private-label" asset-backed securities — such as subprime

mortgage-backed securities (MBS), and collateralized debt obligations (CDO),
"CDOs squared", and "synthetic CDOs" — whose "financial engineering" make
them "harder to understand and to price than individual loans".

Earlier traditional and more simple "prime" mortgage securities were issued and
guaranteed by Fannie Mae and Freddie Mac -- "enterprises" sponsored by the Federal
government. Their safety wasn't questioned by conservative money managers. Non-
prime private label mortgage securities were neither made up of loans to borrowers
with high credit ratings nor insured by a government enterprise, so issuers used an
innovation in securities structure to get higher agency ratings. They pooled debt and
then "sliced" the result into "tranches", each with a different priority in the debt
repayment stream of income. The most "senior" tranches highest up in priority of
revenue—which usually made up most of the pool of debt—received the triple A
ratings. This made them eligible for purchase by the pension funds and money
market funds restricted to top-rated debt, and for use by banks wanting to reduce
costly capital requirements under Basel II.

The complexity of analyzing the debt pool mortgages and tranche priority, and the
position of the Big Three credit rating agencies "between the issuers and the
investors of securities", is what "transformed" the agencies into "key" players in the
process, according to the Financial Crisis Inquiry Report. "Participants in the
securitization industry realized that they needed to secure favourable credit ratings in
order to sell structured products to investors. Investment banks therefore paid
handsome fees to the rating agencies to obtain the desired ratings."

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According to the CEO of a servicer of the securitization industry, Jim Callahan of
PentAlpha,

"The rating agencies were important tools to do that because you know the people
that we were selling these bonds to had never really had any history in the mortgage
business. They were looking for an independent party to develop an opinion,"

From 2000 to 2007, Moody's rated nearly 45,000 mortgage-related securities- more
than half of those it rated—as triple-A. In contrast only six (private sector)
companies in the United States were given that top rating.

By December 2008, there were over $11 trillion structured finance securities
outstanding in the US bond market debt.

CDOs

Rating agencies were even more important in disposing of the MBS tranches that
could not be rated triple-A. Although these made up a minority of the value of the
MBS tranches, unless buyers were found for them, it would not be profitable to make
the security in the first place. And because traditional mortgage investors were risk-
averse (often because of SEC regulations or restrictions in their charters), these less-
safe tranches were the most difficult to sell.

To sell these "mezzanine" tranches, investment bankers pooled them to form another
security—known as a collateralized debt obligation (CDO). Though the raw material
of these "obligations" was made up of BBB, A−, etc. tranches, the CRAs rated
70% to 80% of the new CDO tranches triple A. The 20–30% remaining mezzanine
tranches were usually bought up by other CDOs, to make so-called "CDO-Squared"
securities which also produced tranches rated mostly triple A by rating agencies. This
process was disparaged as a way of transforming "dross into gold" or "ratings
laundering" by at least some business journalists.

Trust in rating agencies was particularly important for CDOs for another reason—
their contents were subject to change, so CDO managers "didn't always have to
disclose what the securities contained". This lack of transparency did not affect

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demand for the securities. Investors "weren't so much buying a security" as they
"were buying a triple-A rating", according to business journalists Bethany
McLean and Joe Nocera.

Still another structured product was the "synthetic CDO". Cheaper and easier to
create than original "cash" CDOs, these securities did not provide funding for
housing. Instead synthetic CDO-buying investors were in effect providing insurance
(in the form of "credit default swaps") against mortgage default. Synthetics
"referenced" cash CDOs, and rather than providing investors with interest and
principal payments from MBS tranches, they paid insurance premium-like payments
from credit default swap "insurance". If the referenced CDOs defaulted, investors
lost their investment, which was paid out as insurance. Because synthetics referenced
another (cash) CDO, more than one—in fact numerous—synthetics could be made to
reference the same original. This multiplied the effect if a referenced security
defaulted.

Here again the giving of triple-A ratings to "large chunks" of synthetics by the rating
agencies were crucial to the securities' success. The buyer of synthetic tranches (who
often went on to lose his investment) was seldom an analyst "who had investigated
the mortgage-backed security", was aware of deteriorating mortgage
underwriting standards, or that the payments they would receive were often coming
from investors betting against mortgage-backed security solvency. Rather, "it was
someone who was buying a rating and thought he couldn't lose money."

Downgrades and writedowns

By the end of 2009, over half of the collateralized debt obligations by value issued at
the end of the housing bubble (from 2005-2007) that rating agencies gave their
highest "triple-A" rating to, were "impaired"—that is either written-down to "junk"
or suffered a "principal loss" (i.e. not only had they not paid interest but investors
would not get back some of the principal they invested). The Financial Crisis Inquiry
Commission estimates that by April 2010, of all mortgage-backed securities Moody's
had rated triple-A in 2006, 73% were downgraded to junk.

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Mortgage underwriting standards deteriorated to the point that between 2002 and
2007 an estimated $3.2 trillion in loans were made to homeowners with bad credit
and undocumented incomes (e.g., subprime or Alt-A mortgages) and bundled into
MBSs and collateralized debt obligations that received high ratings and therefore
could be sold to global investors. Higher ratings were believed justified by
various credit enhancements including over-collateralization (i.e., pledging collateral
in excess of debt issued), credit default insurance, and equity investors willing to
bear the first losses. But as of September 2008, bank writedowns and losses on these
investments totaled $523 billion.

Rating agencies lowered the credit ratings on $1.9 trillion in mortgage backed
securities from the third fiscal quarter (1 July – 30 September) of 2007 to the second
quarter (1 April - 30 June) of 2008. One institution, Merrill Lynch, sold more than
$30 billion of collateralized debt obligations for 22 cents on the dollar in late July
2008.

The net worth of financial institutions owning the newly downgraded securities
declined, requiring the institutions to acquire additional capital, to maintain capital
ratios, which in turn often lowered the net worth value of the institutions above and
beyond the low of value of the downgraded securities. Adding to the financial chain
reaction were regulations—governmental or internal—requiring some institutional
investors to carry only investment-grade (e.g., "BBB" and better) assets. A
downgrade below that meant forced asset sales and further devaluation.

Criticism

In the wake of the financial crisis of 2007–2010, the rating agencies came under
criticism from investigators, economists, and journalists. The Financial Crisis Inquiry
Commission (FCIC) set up by the US Congress and President to investigate the
causes of the crisis, and publisher of the Financial Crisis Inquiry Report (FCIR),
concluded that the "failures" of the Big Three rating agencies were "essential cogs in
the wheel of financial destruction" and "key enablers of the financial meltdown". It
went on to say- “The mortgage-related securities at the heart of the crisis could not
have been marketed and sold without their seal of approval. Investors relied on them,

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often blindly. In some cases, they were obligated to use them, or regulatory capital
standards were hinged on them. This crisis could not have happened without the
rating agencies. Their ratings helped the market soar and their downgrades through
2007 and 2008 wreaked havoc across markets and firms."

U.S. Securities and Exchange Commission Commissioner Kathleen Casey

complained the ratings of the large rating agencies were "catastrophically
misleading", yet the agencies "enjoyed their most profitable years ever during the
past decade" while doing so. The Economist magazine opined that "it is beyond
argument that ratings agencies did a horrendous job evaluating mortgage-tied
securities before the financial crisis hit."

Economist Joseph Stiglitz considered "the rating agencies as one of the key culprits.
They were the party that performed the alchemy that converted the securities from F-
rated to A-rated. The banks could not have done what they did without the
complicity of the rating agencies." In their book on the crisis- All the Devils Are
Here journalists Bethany McLean and Joe Nocera criticized rating agencies for
continuing "to slap their triple-As on subprime securities even as the underwriting
deteriorated and as the housing boom turned into an outright bubble" in 2005, 2006,
2007.

Legal actions

Dozens of suits involving claims of inaccurate ratings were filed against the rating
agencies by investors. Plaintiffs have included by collateralized debt obligation
investors (the state of Ohio for losses of $457 million, California state employees for
$1 billion), the bankrupt investment bank Bear Stearns (for losses of $1.12 billion
from alleged "fraudulently issuing inflated ratings for securities"), bond insurers. The
US government is also a plaintiff (suing S&P for $5 billion for "misrepresenting the
credit risk of complex financial products").

SEC actions

On 11 June 2008 the U.S. Securities and Exchange Commission proposed far-
reaching rules designed to address perceived conflicts of interest between rating

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agencies and issuers of structured securities. The proposal would, among other
things, prohibit a credit rating agency from issuing a rating on a structured product
unless information on assets underlying the product was available, prohibit credit
rating agencies from structuring the same products that they rate, and require the
public disclosure of the information a credit rating agency uses to determine a rating
on a structured product, including information on the underlying assets. The last
proposed requirement is designed to facilitate "unsolicited" ratings of structured
securities by rating agencies not compensated by issuers.

On 3 December 2008, the SEC approved measures to strengthen oversight of credit

rating agencies, following a ten-month investigation that found "significant
weaknesses in ratings practices," including conflicts of interest.

Aftermath

In 2006, the Credit Rating Agency Reform Act was passed, intending to break the
dominance of the "big three" agencies – Standard & Poor’s, Moody’s, and Fitch —
by making it easier to qualify as a “nationally recognized” ratings agency.

However, in 2013, McClatchy Newspapers found that "little competition has

emerged in rating the kinds of complex home-mortgage securities whose implosion
led to the 2007 financial crisis". In the 12 months that ended in June 2011, the SEC
reported that the big three issued 97% of all credit ratings, down only 1% from 98%
in 2007. Critics have complained that the criteria to designate a rating agency as "a
nationally recognized statistical rating organization” was written by a "yet-to-be-
identified official of one of the big three ratings agencies", and is so difficult that it
has "prevented at least one potential competitor from winning approval and have
dissuaded others from even applying". Former Federal Reserve chairman Paul
Volcker complained in a September 2013 article on banking and the shortcoming of
post-crisis financial reform, that "no meaningful reform of the credit-rating agencies
has been undertaken".

In the spring of 2013, Moody’s and Standard & Poor’s settled two "long-running"
lawsuits "seeking to hold them responsible for misleading investors about the safety

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of risky debt vehicles that they had rated". The suits were filed in 2008 and had
sought more than $700 million of damages. Settlement terms were not disclosed in
both cases, and the lawsuits were dismissed "with prejudice", meaning they cannot
be brought again. Other lawsuits are still outstanding as of September 2013.

In the dozens of suits filed against them by investors involving claims of inaccurate
ratings the rating agencies have defended themselves using a First Amendment
defense (based on the precedent of New York Times Co. v. Sullivan). This maintains
a credit rating is an opinion protected as free speech and requires plaintiffs to prove
actual malice by the agency However, some wonder if the defense will ultimately
prevail.

According to columnist Floyd Norris at least one rating agency—S&P -- responded

to the credit crisis by first tightening up its standards and sacrificing market share to
restore its reputation, after which it loosened standards again "to get more
business", tripling its market share in the first half of 2013. This is because,
according to Norris, for rating franchises to be worth anything, they must seem to be
credible to investors. But once they overcome that minimal hurdle, they will get
more business if they are less critical than their competitors.

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 4. Pre-crisis V/s Post-Crisis Bond Market

Investors must now think differently about how to navigate fixed income markets:
from trading in a new market structure, to re-assessing liquidity, to determining
which products will best deliver a desired outcome.

The rise of a modern, networked bond market

 The traditional principal-based fixed income market is transforming into a

hybrid principal/agency market.
 Driving this change are the entrance of new market participants and the
emergence of all-to-all trading technologies that offer an alternative means to
trade bonds: from bilateral and voice-driven to multi-dimensional and
electronic.
 The transition to a hybrid model is a challenge for investors, but may result in
a more connected, diverse and modern bond market with more trading
participants.

Liquidity needs to be re-examined

 Challenges post-crisis have forced traditional bond dealers to fundamentally

rethink their business models.
 Broker dealer inventories have fallen, although the magnitude of the decline
may be debated. At the same time, however, the size of the investment grade
corporate bond market has tripled over the past decade to ~$7.5 trillion in
debt outstanding.
 Inventories have recovered somewhat recently, but relying solely on the old
model will likely not suffice. Investors need to think about how best to access
liquidity across products and asset classes, using a broader, more robust suite
of liquidity measures and exposure vehicles.
 Not all investors have the same liquidity needs and the degree of liquidity
required in part dictates the type of instrument employed for portfolio
construction.

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 The pre-crisis bond market: Over-the-counter and opaque

Liquidity

Prior to the 2008/2009 fnancial crisis, broker-dealers enjoyed a relatively low cost of
balance-sheet funding and capital, enabling them to warehouse risk for extended
periods of time. As a result, dealers were willing to make markets in signifcant size
in both cash bonds and associated derivatives. Volumes were generally robust and
liquidity was perceived as relatively deep across most asset classes. As Figure 4.1
illustrates, as a largely principal trading market, the concept of liquidity was highly
correlated with the inherent riskiness of an asset class. As an example, U.S.
Treasuries were perceived to have a low degree of idiosyncratic risk and therefore
considered highly liquid relative to speculative grade corporate bonds, which were
perceived to have a high degree of idiosyncratic risk. Liquidity was often represented
by the one dimensional metric of bid/ask spread, which tended to reasonably capture
a dealer’s risk appetite and ability to either hedge or ofoad risk. Market structure
Bond trading was conducted almost exclusively in decentralized, over-the-counter
(OTC) markets, where investors negotiated directly with broker-dealers. Trading was
bilateral and voice driven. Electronic RFQ platforms were just taking root, serving
predominantly more liquid products such as U.S. Treasuries, Agencies and Agency
MBS. Even with the advent of reporting systems like the Trade Reporting and
Compliance Engine (TRACE), transparency generally remained challenged.

Figure 4.1: Pre-crisis liquidity framework

Products

In addition to traditional cash bonds, investors traded a variety of derivative

instruments across interest rates and credit. Interest rate futures, swaps and options

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markets were generally robust. In credit, the immediate pre-crisis period saw
investors able to source or hedge exposure to individual companies through bespoke
single name credit default swaps (CDS). Over time, standards and documentation for
CDS became harmonized across dealers. Counterparty exposure, however, was still
managed through bespoke, bilateral collateral posting arrangements between dealers
and individual clients. While the move towards standardization in CDS helped
facilitate growth in the CDX index contract, many other derivative exposures were
often bespoke, complex structures that frequently employed significant degrees of
leverage.

The post-crisis bond market: Regulation and reorganization

The global regulatory reforms enacted in the wake of the financial crisis have
catalysed change in fixed income markets. Notwithstanding the current debate
around the appropriate size and scope of post-crisis regulation, the effects have been
profound, impacting liquidity, market structure and fixed income product
availability.

Liquidity

The onset of the crisis resulted in a sharp and immediate reduction in balance sheet
and market liquidity as many broker-dealers and other market participants struggled
with funding and capital adequacy challenges.

While liquidity recovered somewhat in the immediate aftermath of the crisis, the
introduction of post-crisis regulation (Figure 4.2) among other things has resulted in
higher funding and capital costs for banks and regulated broker-dealers.

Fixed income trading, traditionally reliant on bank or broker-dealer balance sheets,

has been especially impacted. Higher funding and capital costs have resulted in a
reduction in traditional risk warehousing, given challenges in attaining ROE targets.
Market liquidity has also been impacted by a retrenchment in the repo financing
market for individual bonds.

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As a result, cash bond trading has migrated to more of a hybrid principal/agency
model. Agency trading, in which buyers and sellers are located and matched by
banks and broker-dealers, has played a more prominent role as opposed to facilitating
trades more through principal risk taking.

Figure 4.2: Global regulatory and legislative development overview

Source: SEC, SIFMA, ESMA, as of 6/30/17
At the same time, corporate bond issuance has increased rapidly as companies moved
to take advantage of historically low interest rates and improve their maturity profits.
This trend has flooded the market with record levels of new issues, but the result has
been increased fragmentation.

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 The next generation bond market: An era of technological transformation

As these trends gather pace, we believe the coming years will see a transformation in
fixed income similar in many respects to that experienced in equities in the 2000s.

Market structure

The momentum behind the electronifcation of bond markets should continue, with
significant increases in electronic trading, all-to-all networks, alternative trading
protocols, central limit order books (CLOBs), and dark pools, which should impact
not only cash bonds, but standardized vehicles as well.

Traditional banks and broker-dealers will likely remain at the center of the fixed
income market as they continue to adapt their business models, investing in trading
infrastructure and automation (including algorithmic trading and artificial
intelligence), and embracing new trading practices and venues. However, while
principal risk taking will remain in some form, it is unlikely to revert to pre-crisis
levels of activity as the new hybrid agency/ principal model becomes entrenched.

Moreover, advances in technology may allow traditional asset managers to play an

increasing role as price makers with respect to trading through crossing networks, a
shift requiring changes in behaviour as well as the adoption of technology.

Non-bank principal trading firms and ETF marketmakers will likely continue to
increase their presence as liquidity providers. We believe such entities have become
increasingly active in bond ETFs and the underlying cash bond markets, and will
continue to branch into derivative markets as well.

The trend towards transparency on both a pre-trade and post-trade basis and the
resulting increase in data will continue due to regulation and the momentum behind
electronic trading. This proliferation of trade data will allow for greater innovation in
automated market making activity and liquidity provision analytics.

Page | 40
Liquidity

It can be said that the liquidity and regulatory environments will continue to be
interconnected. Depending on the political landscape over time, regulatory burdens
may ebb and flow, but the overall trends towards product standardization and
transparency are likely to continue. In aggregate, liquidity should stabilize for
individual cash bonds as the ecosystem continues to adapt and evolve. However,
rules-based instruments which reference market benchmarks (i.e., derivatives and
ETFs) may see the largest gains in trading volume as investors discover the liquidity
and diversification benefits they can offer. Similarly, the derivatives and lending
markets that reference bond ETFs themselves are likely to deepen as adoption
increases, potentially offering further sources of liquidity for investors. Most
importantly, relying solely on bid/ask spreads may no longer be an adequate
indicator of liquidity. Investors should consider a multi-dimensional approach that
takes into account volume, immediacy, depth, resiliency, vehicle and trading venue.

Finally, scale economies will be key as data infrastructure costs will likely be
prohibitive, leading to potential consolidation among data / pricing / index service
providers. Data itself will become increasingly important with data providers seeking
to protect and monetize the value of that data.

Products

Experts believe that index/basket exposure vehicles will serve as building blocks and
play an increasing role in how investors construct fixed income portfolios. The
trajectory may be similar to what was observed in the transition from individual
equities to indexed equities through futures, swaps and ETFs. In the future, the
offering of these vehicles in fixed income will likely be much more refined and
granular, moving from broad indices into constituent sub-indices. This will allow
investors to access fixed income exposures that are highly targeted by sector,
industry, size, quality or a number of other factors or characteristics.

The creation/redemption process for bond ETFs could become much more
sophisticated, robust and fuid due to enhancements in technology and widespread

Page | 41
acceptance of the vehicle. Importantly, the creation/redemption process itself could
serve as a conduit for bundling and unbundling of fixed income risk as well as
optimizing liquidity across venues. This dynamic would afford investors more
flexibility to navigate risk and liquidity by actively moving between individual cash
bond and portfolio ETF exposures. The growth in borrow availability and in the
liquidity of derivatives referencing ETFs can further increase the role of bond ETFs
in the ecosystem.

Traditional derivative markets are likely to continue to trend towards cleared,

benchmark reference products. Most derivative structures, even the more bespoke
ones, may ultimately be electronically traded and cleared. CDX will continue to be
augmented with more bond-like derivative exposures such as index TRS given that
such products are more closely hewn to the cash bond market.

Further, experts believe that the number and type of paired, complimentary
derivative and ETF exposures (e.g., iShares, iBoxx $ High Yield Corporate Bond
ETF (HYG) and iBoxx $ Liquid High Yield TRS) will continue to grow in order to
increase fungibility between the cash and synthetic markets. Derivatives on bond
indexes and on bond ETFs themselves could be the dominant link between funded
and unfunded exposure. Such a dynamic is already starting to occur in index TRS
and credit ETF options.

With the growth of new instruments, portfolio managers will need to be more
agnostic, starting with their desired outcome before determining the optimal
exposure vehicle across cash bonds, derivatives or ETFs.

Understanding how these instruments are traded and behave relative to one another
will be key in implementing efficient investment strategies.

Page | 42
 5. Bond Regulation

Bonds are bought and sold in huge quantities in the U.S. and around the world. Some
bonds are easier to buy and sell than others—but that doesn’t stop investors from
trading all kinds of bonds virtually every second of every trading day. Bonds are big
players on the global financial stage. U.S. bond market debt (generally referred to as
“the bond market”) exceeds $35 trillion—making it by far the largest securities
marketplace in the world. The term “bond market” is a bit misleading, because each
type of bond has its own market and trading systems. Thus it is important to know
who regulates this vast financial arena.

FINRA is among a number of organizations that oversee bond issuers’ and dealers’
activities. Here is a breakdown of regulators and their responsibilities:

 FINRA licenses brokers and brokerage firms that sell stocks, bonds and other
securities; writes rules to govern their conduct; conducts regulatory reviews
of brokerage firm business activities; and disciplines violators. If you believe
you have been the subject of unfair or improper business conduct by a
brokerage firm or broker, you may file a complaint online at the
www.finra.org/complaint.
 The SEC registers and regulates stocks, bonds, and other securities and
companies that issue securities. The SEC also regulates mutual fund products
and companies, and financial advisers. If you believe that you were defrauded
or encountered problems with the issuer of a bond, a mutual fund company or
a financial adviser, you may file a complaint at the SEC Complaint Center:
www.sec.gov/complaint.shtml.
 The Municipal Securities Rulemaking Board (MSRB) develops rules
regulating securities firms and banks involved in underwriting, trading and
selling municipal bonds. Responsibility for examination and enforcement of
MSRB rules is delegated to FINRA for all securities firms, and to the Federal
Deposit Insurance Corporation, the Federal Reserve Board and the
Comptroller of the Currency for banks.

Page | 43
  State securities agencies enact and enforce state rules and regulations, and
register and regulate securities sellers and securities sold in their states.

Where to find information related to Bonds and other debt securities?

FINRA Market Data

An array of bond information is available in the Market Data section of the FINRA
website. The section provides data on equities, options, mutual funds and a wide
range of bonds—corporate, municipal, Treasury, agency bonds and securitized
products. Market Data Center is the sole source for real-time bond pricing
information and trade data. Furthermore, it offers a full profile for every exchange-
listed company, including company description, recent news stories and Securities
and Exchange Commission filings, and an interactive list of domestic securities the
company issues. In addition, the site includes U.S. Treasury Benchmark yields,
market news, an economic calendar and other information indicating current market
conditions. You can find all of this information at www.finra.org/marketdata.

Using FINRA’s Bond Market Data

The Bonds section of FINRA’s Market Data brings individual investors visible real-
time pricing on corporate and other bond market transactions by providing investors
with a means to obtain market information. Bond Market Data includes the price and
other information from executed transactions in investment grade, non-investment
grade and convertible corporate bonds as reported to TRACE, as well as data for
municipal, Treasury, agency bonds and securitized products. In addition, descriptive
information and credit ratings on individual bonds are available.

Page | 44
 Figure 5.1: FINRA’s Security Search Tool

You can find information of any Bond or other Debt Security by entering CUSIP
number in search criteria on FINRA’s website. You can also search by entering
issuer’s name and narrow the search by selecting security type in quick search.

Page | 45
 Filings of Bond

Global Filings refer to the legal documents that a listed company has to fill with a
regulatory authority like stock exchanges or government departments or market
regulators (like SEBI in India, Securities and Exchange Commission in U.S.). The
word ‘Global’ is used as the company (Perfect Information Pvt Ltd) tracks and
sources these documents for companies all over the world.

Different type of Prospectus:

BASE PROSPECTUS (PROGRAMME): This is usually a large, general document,

which describes the intention to issue various securities (tranches) up to a certain
total amount (programme amount), but does not have tranche specific details of these
securities. It is often called an ‘issuance programmes’ (E.g.: Medium term note
programme, GMTN programme). It also often contains a template of a pricing
supplement for the securities issued under this programme.

SUPPLEMENTARY BASE PROSPECTUS: This is normally a smaller document as

compared to its base prospectus and is issued in case of any amendments to the initial
base prospectus. This document has no tranche specific details of the securities.

PRICING SUPPLEMENT: This tends to be a smaller document, which contains the

terms and conditions of a specific tranche (amount, coupon, maturity date, ISIN etc.)
which are issued under a programme. Final terms are considered as pricing
supplements. They always makes reference to the base prospectus, e.g.: "issued
under the Medium Term Note Programme…" or "must be read in conjunction with
the Base.

STANDALONE PROSPECTUS: This is usually a larger document, which combines

the legal information of a base prospectus and the details of the security as in a
pricing supplement into one. It can be used to provide information of more than one
issued bonds simultaneously.

Below is a snapshot of Pricing Supplement Equity Linked Note issued by HSBC Bank
PLC:

Page | 46
 Figure 5.2: Snapshot of Pricing Supplement of Equity Linked Note

DOCUMENT FLOW FOR PROGRAMME:

 Base prospectus/Prospectuses/Listing Particulars/Offering Circular/Offering

Memorandum/ Information Memorandum are usually large, general
documents, which describes the intention to issue certain total amount
(programme amount) in form of various securities (tranches), but does not
have tranche specific details in the document. It is often called an ‘issuance
programmes’ (E.g.: Medium term note programme, GMTN programme). It
also often contains a template of the pricing supplement for the securities
issued under this programme.
 Supplementary Prospectuses are issued only in case of any amendments to
the base prospectus. They always give reference to their respective base
prospectuses.
 Pricing Supplement/Term Sheets/Final Terms and Conditions tend to be a
smaller documents, which contains the terms and conditions of a specific

Page | 47
 tranche (amount, coupon, maturity date, ISIN etc.) which are issued under a
programme. They always give reference to their respective base prospectus
and supplements. (see the following snapshot of a Term Sheet)

Figure 5.3: Snapshot of Term Sheet

Comparison of different types of prospectus:

BASE SUPPLEMENTARY
PRICING STANDALONE
PROSPECTUS BASE
SUPPLEMENT PROSPECTUS
(PROGRAMME) PROSPECTUS

Use document Use document date, Use document Use document

Issue date date, typically typically mentioned on date, typically date, typically
mentioned on the the front page. mentioned on the mentioned on the
front page. front page. front page.
Maturity date No No Yes Yes
Currencies Yes Yes Yes Yes
Market of Yes No Yes Yes
Only the total Only the total amount Yes, the amount Yes, the amount
Transaction amount of the for the security to for the security to
of the programme Is
size programme is be issued is be issued is
shown.
shown. disclosed. disclosed.
No, but the ISIN in No, but the ISIN in the Yes, you need to
the final terms final terms needs to be use statsmonkey
ISIN needs to be linked to link the final Yes
linked to this
to the base document. terms to the base
prospectus. and supplement.
Coupon No No Yes, if fixed rate. Yes, if fixed rate.
Transaction
Yes Yes/no Yes/no Yes
Parties

Page | 48
 Type of Issuances and Regulations play a big role in filings and thus governance of
fixed income securities. These rules and regulations state the conditions attached to
an issued security. Investor must be aware whether he/she is eligible to subscribe for
a particular issue.

TYPES OF ISSUANCES/OFFERINGS
Public Offers and
Includes all offers of publicly listed securities.
Listed Securities
Private Placements
and unlisted Includes offers of securities which won’t be listed in any regulated market.
Rule 144A: Offers of securities listed outside of the US or private placements in
compliance with rule 144A of the SEC which allows placing securities to
Qualified Institutional Buyers (QIBs) in the US without subjecting the issuer to
the SEC registration and disclosure procedures.
International Offers
Regulation S: A regulation by the SEC to control U.S. securities sold outside the
United States. It allows publicly-traded companies to not register stocks sold
outside the U.S.
Dual Listings: Listing of securities on more than one exchange so as to increase
liquidity of the security and investor demand.

Retail bonds are a type of corporate bonds with small denomination designed for
Retail Offers retail investors. According to the LSE, to be considered retail bonds these
securities need to have a minimum denomination of less than EUR50K.
Tender offer: The tender offer is a public, open offer or invitation to all debt
holders to tender all or part of their securities at a specified price during a
Tender and specified time. Often used as a mechanism for capital restructuring or
Exchange Offers refinancing. Exchange offer: Offer made to Debt holders to exchange their
existing debt securities for another class of debt or equity securities. Often aimed
to extend maturities, reduce debt outstanding or convert debt into equity.

Rule 144A:

Rule 144(a) is a Securities and Exchange Commission (SEC) rule modifying a two-
year holding period requirement on privately placed securities to permit qualified
institutional buyers to trade these positions among themselves. This has substantially
increased the liquidity of the securities affected because institutions can trade these
securities among themselves, sidestepping limitations imposed to protect the public.
BREAKING DOWN 'Rule 144A':

The purpose of Rule 144(a) is to provide a mechanism for the sale of privately placed
securities that do not have, and are not required to have, an SEC registration in place,
creating a more efficient market for the sale of said securities. To sell restricted or
controlled securities under Rule 144(a), certain conditions must be met.

Rule 144(a) Holding Requirements: While a two-year holding period is not required,
a minimum six-month holding period applies to a reporting company, and a
minimum one-year holding period applies to issuers not required to meet reporting
requirements. This holding period begins on the day the securities in question were
bought and considered paid in full.

Public Information Requirement: A minimum level of public-accessible information

is required of the selling party. For reporting companies, this issue is addressed as
long as they are in compliance with their regular reporting minimums. For
nonreporting companies, basic information regarding the company, such as company
name and the nature of its business, must be publicly available.

Regulation S:

Regulation S is a "safe harbor" that defines when an offering of securities is deemed

to be executed in another country and therefore not be subject to the registration
requirement under section 5 of the 1933 Act. The regulation includes two safe harbor
provisions: an issuer safe harbor and a resale safe harbor. In each case, the regulation
demands that offers and sales of the securities be made outside the United States and
that no offering participant (which includes the issuer, the banks assisting with the
offer and their respective affiliates) engage in "directed selling efforts". In the case of
issuers for whose securities there is substantial U.S. market interest, the regulation
also requires that no offers and sales be made to U.S. persons (including U.S. persons
physically located outside the United States).
 Process of Global filings also involves recording information about various
announcements and transaction filings not only when issue takes place but also
thereafter whenever important actions are announced or any important event takes
place.

ANNOUNCEMENTS AND TRANSACTION FILINGS

Periodical communications made by the company to the public or
shareholders. This may range from RNS announcements to 8-k
Notices announcements in the US to any other filings that are concerned with the
offering of securities but which are NOT a prospectus/offering circular/offer
booklet or which disclose the results of an offer.

Preliminary Preliminary Prospectuses and Offering Circulars are first draft prospectuses
Prospectuses and prepared and circulated to investors by the issuer prior to listing the securities.
Offering Circulars Generally do not include pricing of the offered securities.

Prospectuses,
Circulars, Memoranda Includes listing and offer prospectuses and any other listing documentation.
and Particulars
Supplementary Supplementary prospectuses include any updates or amendments to the main
Prospectuses listing prospectus and should be read in conjunction with it.
Pricing Supplements
Brief documents describing the pricing details and key terms of a particular debt
and Term Sheets issue.
Listing document generally shorter than a prospectus including all relevant
Terms and Conditions
terms and conditions of a debt issue.
This classification is used to disclose the results of the offering. They will look
Results exactly the same as the classification ‘notices’ but instead of giving details on
an upcoming offer, it will provide details on the results of said offer.

OTHER ANNOUNCEMENTS

Announcements relating to the rate of interest used by commercial banks as a

Banking Base Rates
basis for deciding their lending rates.

Credit Ratings Announcements of new or changed credit ratings.

Announcements related to debt covenants which consist of lending clauses to
Covenants adhere to by the issuer. Typically pre-set financial ratios and restrictions to
take on additional operational and financial risks.
Interest Rates Announcements relating to the interest rates paid by borrowers.
Cancellations and
Announcements related to cancellations from listing or other delisting procedures.
Delisting
Redemptions,
Maturities and Announcements related to security redemptions, maturities and repayments.
Repayments

There are many parties involved when a bond is issued in the market. These
transactions parties have different roles to play and for an investor it is important to
know which company plays what role. Hence, providing information about such
transaction parties is an important task for issuer. SEC in U.S. and SEBI in India
ensure that information on these parties has been provided by the issuer of Bond and
other fixed income securities in order to govern the filings of those securities.

TRANSACTION PARTIES
Terms Description
Issuer is a legal entity that issues, registers and sells securities for the purpose
Issuers
of financing its operations.
A person or entity that agrees to be responsible for another's debt or
Guarantor
performance under a contract, if the other fails to pay or perform.
Appointed qualified professionals in charge of auditing the financials and
Auditors
calculations run in connection with a particular issue of securities.
Auditors to the Appointed qualified professionals in charge of auditing the issuer’s business
Issuer/Guarantors records. Typically over a multi-year period.
Appointed agent responsible for pricing an investment product, calculating its
Calculation Agent
value at different points in time.
Collateral Appointed agent that produces and distributes note holder reports, performs
Administrator various compliance tests regarding the composition and liquidity of the asset
Party responsible for calculating collateral valuations, delivering and receiving
Collateral Manager
collaterals, handling margin calls etc.
Part of the distribution syndicate, the co-managers assist the lead managers in
Co-Managers
assessing and distributing new bond issues.
Dealers Approved financial institution trading stocks and securities on behalf of the
issuer.
 An organization, such as a bank or trust company that acts on behalf of
the issuer performing various financial duties such as redemption of bonds
Fiscal Agent or coupons, handling tax issues, replacing lost or damaged securities and
performing various other finance- related tasks.
Lead the distribution syndicate in public offers and is responsible for managing
Lead Manager
the entire issue process. This includes bookrunners, global coordinators
and lead managers.
Legal Advisers Law firms offering legal assistance in the context of security offers.
A financial institution such as a commercial bank or a trust company, with
fiduciary powers by a bond issuer to enforce the terms of a bond indenture
Trustee (contract between a bond issuer and a bond holder). A trustee manages the
interest payments and represents the interests of the bond holders if the
issuer defaults.

Listing Agent Legal advisor assisting the issuer with the admission to listing securities on the
exchange.
Agent responsible for receiving a bond’s interest payments from the
Paying Agent
issuer and distributing them to the bond holders.
Principal Paying Agent Principal agent responsible for receiving a bond’s interest payments from the
issuer and distributing them to the bond holders.
An investment bank or trust company keeping records of registered
Registrar
bond and shareholders.
Entity involved in swap transactions with the issuer. Swap is an exchange of
Swap Counterparty
one security for another to change its key terms including maturity,
currency, type of security etc.

Importance of ISIN/CUSIP in Global Filings

CUSIP Number:

CUSIP numbers are a 9 digit code that is given to US and Canadian securities for
identification purposes. CUSIP numbers are issued to a variety of company entities
and formations, as well as a variety of securities. Assignments for CUSIPs include
stocks, bonds, notes equities, classes of shares for both companies and funds,
onshore and offshore CUSIPs such as in the United States or the Cayman Islands and
much more.
International Securities Identification Number (ISIN):

The ISIN standard is used worldwide to identify specific securities such as bonds,
stocks (common and preferred), futures, warrant, rights, trusts, commercial paper and
options. ISINs are assigned to securities to facilitate unambiguous clearing and
settlement procedures. They are composed of a 12-digit alphanumeric code and act to
unify different ticker symbols “which can vary by exchange and currency” for the
same security. In the United States, ISINs are extended versions of 9-character
CUSIP (Committee on Uniform Security Identification Procedures) numbers; ISINs
can be formed by adding a country code and check digit to the beginning and end of
a CUSIP, respectively.

There are three parts to an ISIN as exemplified by US-049580485-1 (the dashes don't
count, they are there to add clarity). The code can be broken down as follows:

A two-letter country code, drawn from a list (ISO 6166) prepared by the
International Organization for Standardization (ISO). This code is assigned
according to the location of a company's head office. A special code, 'XS'•. is used
for international securities cleared through pan-European clearing systems like
Euroclear and CEDEL. Depository receipt ISIN usage is unique in that the country
code for the security is that of the receipt issuer, not that of the underlying security.

A nine-digit numeric identifier, called the National Securities Identifying Number

(NSIN), and assigned by each country's or region's . If a national number is
composed of less than nine digits, it is padded with leading zeros to become a NSIN.
The numeric identifier has no intrinsic meaning it is essentially a serial number.

A single check-digit. The digit is calculated based upon the preceding 11

characters/digits and uses a sum modulo 10 algorithm and helps ensure against
counterfeit numbers.
Use of ISIN/CUSIP:

ISINs were once considered only a secondary form of security identification, used
exclusively for clearing and settlement. In recent years, some European countries
have adopted ISINs as their primary security identifier. An offering memorandum or
an prospectus is often required to obtain an ISIN. ISIN's are implicitly used in the
U.S. and Canada because they are built upon CUSIP numbers. Over time, most
countries appear willing to adopt ISIN numbering either as a primary or secondary
identifier to administer ISINs. CUSIP (owned by the American Bankers Association
and operated by Standard & Poor's) and its work with a CUSIP number. Similarly in
the U.K., the Stock Exchange Daily Official List (SEDOL). Universal acceptance of
ISIN is important in meeting the goal of global straight-through processing (GSTP),
which is the electronic handling of the trade clearing and settlement without manual
intervention.

ISIN v/s CUSIP

Codes are developed to convert a word, phrase, or letter into another form and used
in communication, rules, signals, security, and other purposes. Every facet of human
undertaking utilizes codes. Government agencies use them and so do financial
institutions. Two such codes being used in trade and finance are the ISIN and
CUSIP.

The International Securities Identification Number (ISIN) is an alpha numeric code

that contains 12 characters. The ISIN code has a country code composed of two
letters, a national security identifier composed of nine alphanumeric characters, and
one check digit. Its purpose is for the uniform identification of securities that are
traded and settled. It is used on shares, options, debt security, derivatives, and futures
trading. It is being used in most parts of the world especially in Europe.

The country code being used, ISO 3166-1 alpha-2, is provided by the International
Organization for Standardization (ISO). The national security identifier is provided
by the National Numbering Agency (NNA) of each country.
The check digit is derived using the “Modulus 10 Double Add Double” technique
wherein letters are converted to numbers by adding their position in the alphabet to
nine. Odd and even numbers are segregated then the first group is multiplied by two.
The products of the first group and the second group are added and the ten’s modulus
of the sum is taken. The result is then subtracted from ten and the ISIN check digit is
realized.

The Committee on Uniform Security Identification Purposes (CUSIP), on the other

hand, is a North American alphanumeric code that has nine characters used for
securities trade clearing and settlement. It is used primarily in the United States of
America. It contains the base which is the first six characters that identifies the issuer
and assigned in alphabetical sequence, the seventh and eighth characters that
identifies the issue, and the ninth character which is the check digit. The check digit
is calculated by converting letters to numbers according to their position in the
alphabet. All second digits are then multiplied by two to come up with the CUSIP
check digit.

Summary:

 “ISIN” stands for the “International Securities Identification Number” while

“CUSIP” stands for the “Commitee on Uniform Security Identification
Purposes.”
 ISIN is being used to identify securities that are traded and setled
internationally while CUSIP is used in securities that are traded, cleared, and
setled in North America particularly in the USA.
 ISIN contains twelve alphanumeric characters while CUSIP contains nine
alphanumeric characters.
 ISIN includes a two character country code which is provided by the ISO
while CUSIP does not.
 ISIN has nine alphanumeric characters which are the national security
identifier while CUSIP has six characters that identify the issuer and two
characters that identify the issue.
  Both contain check digits that are located at the end of the code and while
the ISIN check digit is derived by converting letters to numbers by adding
their position in the alphabet to nine, in CUSIP they are converted by
assigning them their ordinal positions in the alphabet.

Prospectus may contain more than one security ofered by the issuer. ISIN/CUSIP
st
numbers of such securities in ofering are mentioned mostly on the 1 page of the
prospectus:

Figure 5.3: Snapshot of Term Sheet

 6. Indian Bond Market - The Way Forward

Over the last five years, India has been considered a key growth economy in Asia
and one of the “markets to be in” for foreign investors, as the country consistently
recorded annual GDP growth rates in excess of 7% (till the most recent post-
demonetization period), making it the fastest growing G-20 economy for a period of
time. In short, India is now considered an emerging success story, more so after the
new government signalled its intent to carry out (and has implemented) several
reforms, many of them centred on the ease of doing business. However, there are
some economic and financial infrastructure bottlenecks that need to be eased to
further encouraging foreign investments. Weak corporate balance sheets, need for
further tax and labour reforms, high NPLs and low credit growth in an uncertain
global economic environment, have taken some of the shine off the India growth
story. The implementation of a consistent and coordinated policy to further develop
the Indian financial markets would confer great benefits to India and its citizens. A
more structured approach would enable a much safer and more appealing market for
issuers and investors and ultimately result in a stronger economy for India. At a more
micro level, we do note that the Indian authorities have recognized that a robust bond
market is critical for growth of any country and India is no different. A developed
bond market significantly increases the depth of the financial markets as it helps in
serving the needs of both the private and public spheres better. This assumes a role of
even greater significance given the context that bank balance sheets are now
extremely weak, thus impeding loan growth, but some of that growth has now shifted
to the bond markets, whose development (particularly in the corporate bond area) has
accelerated over the last few years. Hence, it comes as no surprise that the Indian
regulatory and monetary authorities recognize this and have been taking continuous
steps to deepen the fixed income market in India. In consequence, the total domestic
bond market has grown from around USD 1.0tn at the end of 2012 to approximately
USD 1.5tn by March 2017, with government securities (both Central and State)
accounting for USD 1.06tn (Source: Livemint data and ASIFMA estimates). More
significantly, corporate bonds as a percentage of GDP have grown from around 5.0%
in 2012 to around 14% in 2016 (Source: ASIFMA and Livemint), although this level
of penetration is still considerably lower than that of Malaysia, where the corporate
bonds to GDP ratio is in excess of 40%. At a greater level of detail, the following are
the types of bonds that are issued in the Indian domestic bond markets:

1. Government bonds and Treasury Bills (T-Bills): issued directly by the

government of India, the so called G-Secs; T-Bills are shorter-dated
securities, up to one-year in duration;
2. Borrowing by state governments: State Development Loans (SDLs), which
are dated securities issued by single states within India for meeting their
market borrowing needs;
3. Corporate bonds (including Public Sector Unit (PSU) bonds – issued by
sovereign/quasisovereign entities and bonds issued by banks/financial
institutions): this market has room to develop further. While the value of
corporate bonds outstanding has expanded from single digit to double digit
percentages as a proportion of GDP, there is a long way to go;
4. Masala bonds – these are INR-denominated bonds issued offshore and are a
form of offshore borrowing – this is a product that has been legalized
relatively recently;
5. Securitised Debt Instruments: These are issued either in the form of
debentures or PassThrough Certificates – Foreign investors have recently
been given access to this market and moreover, tax treatment of these
instruments has been made more advantageous.
6. Municipal bonds: these are bonds issued by Urban Local Bodies (ULBs) for
financing specific projects, typically linked to infrastructure; the framework
for the issuance of these instruments was recently announced by SEBI and
the first issuance was done recently.
7. Gold Sovereign Bonds: This is again a product introduced relatively recently,
to help make India’s large gold holdings in private hands, more liquid besides
being put to more productive uses.
8. Green bonds: The framework for green bonds issuance was introduced in
India in 2016 and a few transactions, mostly by financial institutions, have
been completed.
The ultimate objective of RBI has been to ensure complete transparency and
increasing liquidity across the curve, thereby helping in better discovery of prices for
both government and corporate bonds. Clearly articulated steps have been taken by
RBI over the course of last three to four years to ensure this is achieved. Further, to
make the market more vibrant, RBI has also been introducing new products and
encouraging more types of investors to actively contribute to the bond market. That
said, more needs to be done to bring the Indian fixed income markets on par with the
more developed regional bond markets. In the following sections, we will outline
how bond markets have evolved in India in last few years and set out
recommendations on how this market could be further improved.

Strengthening of Funding Markets

While the Indian repo market has seen significant changes since 2013, notably the
introduction of mandatory trade reporting on the National Dealing System (NDS) of
the CCIL, India has still yet to adopt the “classic repo” framework advocated by
ASIFMA in our 2013 India bond market roadmap. For more on the legal framework
governing the Indian repo market, please see the “Legal & Regulatory” section.
Turning to the evolution of the repo markets themselves, the liquidity operations by
RBI have moved to a term repo framework post October 2013. Earlier the banking
system was entirely dependent on the fixed rate LAF window where liquidity at a
fixed rate (repo rate) was provided by RBI and excess liquidity was taken out
through the use of fixed rate (reverse repo). In October 2013 term repos were
announced for the first time wherein 7day and 14day term repos were announced
through a variable rate auction mechanism. Over the last three years we have seen
increased use of variable rate of term repo and term reverse repo facilities across
tenors from 2d-128d for managing banking system liquidity. According to RBI’s
annual report with the institution of the revised liquidity management framework, the
role of term repo auctions under the liquidity adjustment facility (LAF) has become
significant. Normal 14-day and fine tuning term repos of varying tenors ranging from
2 to 56-day accounted for about 90 per cent of the average net liquidity injection
under the LAF during the year.
FPI Participation

The participation of FPIs have increased over the last three years as RBI provided a
calendar for opening up limits in government bond markets and SDLs on a quarterly
basis. The RBI in its monetary policy statement in September 2015 laid down a
medium term framework for FPI limits in consultation with the government. The
limits would be increased in phases to 5% of the outstanding stock by March 2018.
For more details on FPI participation in the Indian bond markets, see the section of
FPI access channels below.

Figure 6.1 Year wise FPI investments in Debt [Source: NSDL]

Over the last three years we have seen reduced ownership in government bonds by
commercial banks. This has been as a result of SLR cuts by RBI. The SLR or
“Statutory Liquidity Ratio” is a requirement for all regulated banking entities to
invest a certain proportion of their total assets in G-Secs. This ratio has varied over
the years but in recent years, the trend has been down. SLR rates have been reduced
by 25 bp every quarter starting from April 2016. One of our key advocacy points has
been for a reduction in the SLR, which has indeed come down over the years to
20.8% currently, from levels in excess of 38% a few years ago. Nevertheless, the
continuing large government fiscal deficits will tend to limit the extent to which
SLRs can fall. On the other hand RBI has gradually opened FPI limits which have
increased FPI participation and ownership since the last three years. FPI holdings
have increased from 1.4% in September 2013 to 3.13% in December 2016.

Figure 6.2 FPI % Holdings in G-Sec [Source: RBI]

Figure 6.3 Holdings patterns in G-Sec (Dec 2016) [Source: RBI]

Securitisation and Covered Bond Market

A well-regulated securitisation system is commonly recognized as an efficient

financing mechanism for mortgage financing, credit cards, auto loans and even
infrastructure enhancements and municipal expansion. Covered bonds and high
quality securitisations are a means of tapping the capital markets for funding, backed
by pools of good quality assets. Under the securitisation model, loans are issued by
an originator (typically a commercial bank), and then aggregated and packaged into
multiple securities with different characteristics of risk and return that appeal to
different investor classes.

The development of securitisation of non-performing assets in India received a major

boost over the 2002-05 period, following the enactment of the Securitisation and
Reconstruction of Financial Assets & enforcement of Securities Interest Act
(SARFAESI), 2002 (‘the Act’) 1. The Act encompasses the areas of: securitization of
financial assets; reconstruction of non-performing financial assets; recognition to any
security interest created for due repayment of a loan as security interest under the
Securitisation Act, irrespective of its form; banks and financial institutions have the
power to enforce the security without intervention of the courts; setting up the
Central Registry for registration of the transaction of securitisation, reconstruction
and creation of security interests. One specificity and problem with securitisation in
India is that securitisations follow a trust structure i.e. the assets are transferred by
way of sale to a trustee, who holds it in trust for the investors. In this situation, a trust
is not a legal entity in law but it is entitled to hold property that is distinct from the
property of the trustee. Therefore, the trust performs the role of the Special Purpose
Vehicles (SPV), without having the legal status of an SPV

Market developments in past decade:

Growth in Residential Mortgage Backed Securities (RMBS), Mortgage-Backed

Securities (MBS) and Collateralized Debt Obligations (CDOs) fueled the rapid
growth of the securitisation market through 2005, as new classes of investors and
issuers gained confidence in the stability of and prospects for the further
development of the market. Furthermore, investor familiarity with the underlying
asset classes, stability in the performance of past pools and the relatively short tenor
of issuances also helped boost the market. After a brief dip in 2006, caused by the
tightening of capital requirements, strong growth in ABS and CDO volumes boosted
the Indian securitization market through the first half of 2009, when the aftereffects
of the global financial crisis did have a negative impact. Even so, the absence of
transactions involving complex derivatives and CDS in the Indian context meant that
Indian securitization volumes did stay relatively robust, in the immediate aftermath
of the financial crisis. The structured issuance volumes have grown considerably in
the last few years in India. ABS is the largest product class driven by the growing
retail loan portfolio of banks and other Financial Institutions (FIs), investors’
familiarity with the underlying assets and the short maturity period of these loans.
The MBS market has been rather slow in taking off despite a growing housing
finance market due to the long maturity periods, lack of secondary market liquidity
and the risk arising from prepayment/repricing of the underlying loan. During
FY2014, the overall securitisation market (including rated bilateral transactions) in
India shrunk further by 5% over the previous year, in value terms. The number of
transactions was also lower by 4% in FY2013 than that in the previous fiscal year.
While the number and volume of ABS transactions declined by about 14%, the
number of RMBS transactions more than doubled in FY2014, (an increase of 75% in
value terms).

Figure 6.4: Trends in securitisation issuance by value per financial year [Source: ICRA]
Recent Developments:

India’s growth is expected to remain stronger than the global average and more
robust than the median for similarly rated sovereigns. India will have long-term
funding needs which could be provided by the securitisation market to finance
housing, infrastructure and urbanization projects. The legal framework for
securitisation is at a nascent stage in India as it is restricted to certain institutions
namely, banks and financial institutions only. Amendments to the Securities
Contracts Regulation (SCR) Act are certainly futuristic steps and well-deserved
appreciation must be given towards these steps. It is hoped that in the future, more
and more transactions may be included under the Act so that the market matures and
reaches an advanced stage like the UK or the US, as this process will support
economic growth. Development of the market for securitisation in India will need
efforts of the Central Government, State Governments, RBI and SEBI, has permitted
mutual funds to invest in these securities. To galvanize the market, FPIs can also be
allowed to invest in a wide range securitised debt instruments – a process that has
already begun. FPIs are already familiar with these instruments in other markets and
can, therefore be expected to help in the development of this market. However the
measures taken in India are still incomplete and more dedicated efforts would be
necessary for a robust growth of asset securitisation market in India. There are
several issues facing the Indian securitisation market such as:

Stamp duty: In India, stamp duty is payable on any instrument which seeks to
transfer rights or receivables. Therefore, the process of transfer of the receivables
from the originator to the SPV involves an outlay on account of stamp duty, which
can make securitization commercially unviable in states that still have a high stamp
duty. A number of states have reduced their stamp duty rates, though quite a few still
maintain very high rates ranging from 5-12 per cent. To the investor, if the
securitized instrument is issued as evidencing indebtedness, it would be in the form
of a debenture or bond subject to stamp duty, and if the instrument is structured as a
Pass Through Certificate (PTC) that merely evidences title to the receivables, then
such an instrument would not attract stamp duty. Some states do not distinguish
between conveyances of real estate and that of receivables, and levy the same rate 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, which may going forward be made uniform across states as also
recommended by the Patil Committee.

Foreclosure Laws: Lack of effective foreclosure laws also prohibits the growth of
securitization in India. The existing foreclosure laws are not lender friendly and
increase the risks of MBS by making it difficult to transfer property in cases of
default.

Taxation related issues: Some ambiguity remains in the tax treatment of MBS, SPV
trusts, and NPL trusts. However, one positive development is that the taxation
structure has been changed from distribution tax at SPV level to taxation in the hands
of investors, thereby increasing total after-tax returns. This has led to a boost in
securitization/ABS issuance through FY2017.

Legal Issues: Investments in PTCs are typically held-to-maturity. As there is no

trading activity in these instruments, the yield on PTCs and the demand for longer
tenures especially from mutual funds is dampened. Till recently, PTCs were not
explicitly covered under the Securities Contracts (Regulation) Act, definition of
securities. This was however amended with the Securities Contracts (Regulation)
Amendment Act, 2007 passed with a view to providing a legal framework for
enabling listing and trading of securitized debt instruments. This will bring about
listing of PTCs which in turn will support market growth, which will hopefully help
to resolve the “lack of liquidity” issue. Securitisation requires a stable and
predictable operating environment. India must establish clear legislative, legal and
regulatory guidelines for market participants, incentivize the development of high
quality data for proper risk assessment, and increase foreign participation. To this
end the regulators have carried out an amendment to the rules governing investment
by FPIs in India by expanding the list of areas in which FPIs can invest: These
include:

Securitised debt instruments, including (i) any certificate or instrument issued by a

special purpose vehicle (SPV) set up for securitisation of asset/s with banks, FIs or
Non-bank Financial Companies (NBFCs) as originators; and/or (ii) any certificate or
instrument issued and listed in terms of the SEBI “Regulations on Public Offer and
Listing of Securitised Debt Instruments, 2008”. On reading of the above text, it is
quite clear that FPIs will be able to invest in both listed and unlisted certificates/
instruments issued by SPVs set up for securitisation of assets. Here it is also
important to note that the originators of the assets should be either banks, FIs or
NBFCs.

In February 2017, SEBI explicitly permitted FPIs to invest in securitized debt

instrument (SDI). The SDIs include (i) certificate or instrument issued by a special
purpose vehicle set up for securitization of assets where banks, financial institutions
or non-banking finance companies are originators; and/or (ii) certificate or
instrument issued and listed in terms of the SEBI (Public Offer and Listing of
Securitsed Debt Instruments) Regulations, 2008.

Rates and Credit Market Infrastructure (including Ratings)

One of the most important elements for a robust credit/fixed income market is an
independent credit ratings industry, which renders a bond market attractive and
accessible. While India has seen the creation of a number of local ratings agencies
(such as CRISIL, ICRA & CARE) and the entry of the international ratings agencies
through acquisition or via the creation of standalone local entities, more remains to
be done. To this end, it is gratifying that SEBI intends to announce a ratings agency
framework with greater supervision. A well-supervised and established credit rating
industry will provide investors with more transparency with respect to the types of
securities they are trading. In particular, one of the reasons why investors are not
willing to participate in the bond market is the mismatch between the price of the
bonds and the actual and real risk they carry. To create a more attractive environment
for investments, the credit rating industry must adhere to international best practices.
By doing so, investors can take advantage of an international standardized rating,
which will in turn make the market more transparent and reliable which will attract
both domestic and foreign investors. With the premise that the government is able to
halt the tendency of rising interest rates, banks must also start to recognize mark-to-
market losses. By doing so, they would be compelled to trade securities, rather than
holding them to maturity. The more advanced the trading in the secondary market is,
the more necessary is the establishment of a solid risk management function. If banks
can actually develop an independent risk management function, they can become
involved in the trading of corporate bonds, at every level of the yield curve. This
would give the option of access to the bond market for some corporations whose
issued bonds carry a low rating and high yield. This is the stage where an appropriate
risk management function kicks in, assessing the bank exposure to a certain type of
security and taking further action to hedge and balance out the exposure. Nurturing a
thorough market infrastructure system also entails meeting the need for international
settlement and financing of local bonds. This will help the Indian financial system to
be further embodied within the international system. Local bonds will then have a
wider range of potential investors, competing with each other and therefore allowing
more efficient and less costly financing. Also, this openness will attract foreign firms
and give them the opportunity to participate in the market and to reuse the bonds in
their funding efforts. To further integrate the Indian financial market within the
international marketplace, CCPs such as the CCIL have now been internationally
recognized by the European Securities and Markets Authority (ESMA) in order to
provide clearing services for all market participants. This is a positive development,
since it signals that CCIL will now comply with international practices, thus being
even more attractive to foreign investors. ASIFMA has long supported CCIL’s
application for recognition and is glad to note that this objective has now been
attained, at least partially. One point worth noting is that recognition of CCIL by the
Commodities and Futures Trading Commission (CFTC) in the US, is still
outstanding. The trading and clearing of government securities and corporate bonds
by CCIL, the clearing agency for G-Secs, and NSCCL, the clearing arm of the
National Stock Exchange (NSE) of India, has been functioning smoothly, thereby
giving more credit to the clearing system as a whole. The use of clearing systems for
the reporting of usage of not just cash bonds/securities but also derivatives
instruments such as futures, CDS and other swaps is an encouraging step, since the
focus will then be on the reporting of risk, rather than the restriction of derivatives
usage. Also, tailoring the use of these derivatives instruments in line with the usage
of similar instruments globally will encourage usage and acceptability. Nonetheless,
bridging the local settlement system with ICSDs (Euroclear/Clearstream), would
constitute a further step in the development of the bond market, as they allow easier
movement of global collateral across borders via their “collateral highway”.
Combined with offshore settlements, this could create the basis for using local bonds
as collateral in the event that market participants need access to USD cash, as we
have seen recently.

The Current Overall Bond Market Legal and Regulatory Framework, Netting,
Bankruptcy and Resolution

Given that a well-developed bond market is vital for the health of the economy,
endeavours have been made by the financial regulators in India for promoting
exactly that objective in an orderly manner. In India, bonds are largely governed by
the provisions of the Companies Act, 2013; notifications and regulations issued by
the RBI and regulations and circulars issued by SEBI. On the overall policy front, the
Ministry of Finance (MOF), through various departments, acts as the premier policy
maker with respect to financial legislation, capital markets regulation and taxation. In
addition, the MOF, through the recent establishment of the Public Debt Management
Office (PDMA) is also taking on a bigger role in managing the country’s internal
debt. The Companies Act, 2013 inter alia makes provisions for the mode of issuance
of bonds (private placement or public issue). RBI, inter alia is charged with the
responsibility of regulating the issuance of and investments in bonds by banks and
non-banking finance companies, foreign investments in India and modes of raising
capital offshore and money markets. SEBI, the capital markets regulator of India,
concerns itself with issuance and listing of bonds on the stock exchanges and
regulating intermediaries The Indian regulators are working in tandem to develop a
bond market which complements the banking system in India and provides an
alternative source of finance to corporates for long term investments.

Concrete Steps for Attracting Foreign Investment

The role of foreign investments in the bond market cannot be emphasized enough.
Recent benefits given to the FPIs show the commitment of the Indian regulators
towards attracting foreign investments in the Indian bond market.

a. FPI limits for investment in government securities has been enhanced to INR
1877bn; and
b. In February 2017, SEBI finally permitted FPIs to invest in unlisted corporate
debt securities in the form of non-convertible debentures/bonds issued by
public or private Indian companies This is subject to minimum residual
maturity of three years and end-user restriction on investment in real estate
business, capital market and purchase of land.
c. SEBI has released a consultation paper dated 28th June 2017 for easing of
access norms for investments by FPIs. SEBI vide this consultation paper inter
alia proposes to rationalize the foreign portfolio investment route by
untangling the procedures to attract more funds.

Protection of Investors ‘a must’

For the development of the bond market, confidence of the investors is sine qua non.
Realizing the importance, the Indian regulators have taken concrete steps to instill
the faith of investors in the bond market.

a. Securities and Exchange Board of India (Listing Obligations and Disclosure

Requirements) Regulations, 2015 (“LODR Regulations”) In September 2015,
SEBI notified the LODR Regulations providing for disclosures to be made by
a listed entity if it has outstanding listed debt . Chapter V of the LODR
Regulations contains detailed provisions with respect to compliances for
listed debt securities. These provisions aim to increase transparency in the
market and enable investors to make informed decisions.
b. Netting With increasing multiplicity and complexity of transactions, the
concept of netting has gained tremendous momentum. Netting gives the
investors a right to off-set giving them more confidence to remain in the
market. This affirmation is particularly relevant for banks and investment
managers who are significantly exposed to counterparty risk if exposures are
grossed up and not netted. Thus, these types of institutional investors set
limits to reduce the level of exposure in the market, hampering liquidity even
further in the secondary market. In the recent past, enforceability of netting
has been doubted by certain segments of the markets as regards sovereign
owned entities. Concrete steps have been taken under the new Insolvency
framework to give formal recognition to the concept of netting in India.
i. The Insolvency and Bankruptcy Code, 2016 (“IB Code”): The IB
Code is the Government of India’s response to resolve the growing
crisis faced by banks in India as regards impaired debt and low
recovery rates. The inimitable feature of the IB Code is that it has an
overriding effect over all other legislations – Central or State. This is a
first for any Indian legislation. The concern as regards netting has
been partly addressed by the enactment of the IB Code. Section 36 of
the IB Code stipulates that any assets of the corporate debtor that
could be subject to mutual dealings and set-off would not form part of
liquidation estate of the corporate debtor. Further, the Insolvency and
Bankruptcy Board of India (Liquidation Process) Regulations, 2016
states that “where there are mutual dealings between the corporate
debtor and another party, the sums due from one party shall be set-off
against the sums due from the other to arrive at the net amount
payable to the corporate debtor or to the other party”.
ii. Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill)
The MOF introduced the draft FRDI Bill in September 2016. After
taking feedback from key stakeholders, a revised draft is to be placed
before the Indian Parliament in the monsoon session of 2017. It
proposes to establish a special resolution regime to be administered by
Resolution Corporation. This will cover financial service providers
such as banks, insurance companies, financial market infrastructure
entities, payment systems. As regards netting of financial entities, the
FRDI Bill proposes to establish a special resolution regime for
financial service providers. The FRDI Bill will be amending the
Reserve Bank of India Act, 1934 and providing a statutory basis to
 netting for all classes of counterparties. It is expected that the
Resolution Corporation will protect the stability and ensure the
resilience of the financial system. Once implemented, the FRDI Bill
together with the IB Code will go a long way in giving comfort to the
investors by unambiguously implementing the principle of netting,
ultimately leading to a flourishing bond market.

Indian Bond Market: The Road Map Ahead

SEBI has been making ongoing efforts in strengthening the Indian bond market.
Through its various initiatives, SEBI, intends to create a more transparent and liquid
bond market in India.

 Re-issuance and Consolidation of Bonds: SEBI vide its circular dated 30 June
2017 has made provisions for re-issuance and consolidation of debt securities
issued on private placement basis. As per the circular, an issuing company
will be permitted a maximum of 17 International Securities Identification
Numbers (ISINs) maturing per financial year that shall include 12 ISINs for
plain vanilla debt securities and 5 ISINs for structured debt/market linked
debentures. An issuer issuing only structured/market linked debt securities
has been permitted 12 ISINs in a financial year. This may however, cause
some practical difficulties to issuers who are used to doing multiple issuances
in a year. Same ISIN may be granted to only those debt securities having a
common maturity and coupon. This may limit the number of issuances an
issuer can make in a financial year. While the proposed amendments are
expected to increase liquidity in the market, this will need to be weighed with
the clubbing of liabilities for the issuer.
 Electronic Book Provider (EBP) Mechanism: The use of the EBP mechanism
is currently mandatory for all private placements of debt securities with an
issue size of INR 5bn. With its consultation paper dated 22nd May, 2017,
SEBI has expressed its intention of making EBP mechanism mandatory for
all private placement of debt securities with an issue size of INR 500mn.
SEBI proposes to provide an option of direct bidding to non-institutional
investors. Currently, only institutional investors have a choice of either
participating through an arranger or entering bids on proprietary basis on their
own. Though the purpose of SEBI for introducing the consultation paper is
achieving better and transparent price discovery through the bidding process,
having a threshold as low as INR 500mn shall increase the cost of fund
raising for small and medium size issuers and may thereby discourage small
issuers from the corporate bond market.
 Chapter 5: Conclusion
The existing debt limit rules have multiple nuances making the process of pre-trade
due diligence and limit monitoring of available limits quite complex for the foreign
investors. The monitoring of limits is particularly complex on account of multiple
categories and subcategories of limits and nuances pertaining to reinvestment
eligibility. The practice of auction of limits when overall FPI utilization is more than
90% of the total limit under the general category (non long term) also adds to the
complexity.

The custodians are required to ensure that the cumulative value of the purchase
trades of their respective clients in a given day does not exceed the threshold of 90%
utilization (90-N) and 100% utilization (100-N) for General Category limits and
Long Term Category limits respectively. This results in uncertainty and potential
commercial impact to FPIs when utilization approaches the thresholds, as ‘in flight’
trades that fail the (100-N) & (90-N) are not reported on NDS-OM by the custodian.
Also, this check performed by the custodians is error prone due to the manual nature
of such monitoring.

The utilization of reinvestment eligibility is calculated by FPIs and Custodians

manually and is reported daily to NSDL. NSDL consolidates the positions based on
reporting by the custodians and hosts the cumulative utilization on its website daily.
The multiple legs in the process and the manual intervention in the process heighten
the risk of incorrect calculation of cumulative utilization.

Recently, FPIs have been allowed to access real time anonymous order matching
platform NDS OM-Web Module for trading in government debt. However for FPI
trades executed on this platform custodians cannot perform checks such as the
monitoring of (100-N) and (90-N) threshold and adherence to residual maturity,
restrictions applicable to FPIs. e. There is also an ask from FPIs to increase the time
window available to avail of reinvestment facility upon sale or maturity of their debt
holdings.
There is also an ask from FPIs to increase the time window available to avail of
reinvestment facility upon sale or maturity of their debt holdings.

For the development of the bond market, confidence of the investors is sine qua non.
Realizing the importance, the Indian regulators have taken concrete steps to instill
the faith of investors in the bond market.

Securitisation requires a stable and predictable operating environment. India must

establish clear legislative, legal and regulatory guidelines for market participants,
incentivize the development of high quality data for proper risk assessment, and
increase foreign participation. Securitisation in U.S. Bond Market is highly regulated
after Financial Crisis in 2008. Two securities that played major role in the crisis,
CDO and MBS still continue to attract investors because of the highly regulated and
monitored Fixed Income Securities market in U.S. Credit Rating agencies should
also be cautious while rating structured securities as they play major role in the
growth and development of these securities. Along with market regulators, CRAs
play major role in safeguarding the interest of investors by providing timely and
accurate information to them.
 Chapter 6: Bibliography
Literature review:

“Corporate Bond Market In India: A Study and Policy Recommendations” by Kanad

Chaudhari, Meenal Raje, Charan Singh (Feb 2014)

“Corporate Bond Market Structure: The Time for Reform Is Now” by BlackRock
(Sept 2014)

Articles:

“India’s Debt Market- The Way Forward”- published by asifma (July 2017)

Information Provider and Regulatory Websites:

https://www.sec.gov/spotlight/fixed-income-advisory-committee

www.sifma.org/research/statistics.aspx

www.sebi.gov.in/

Other websites and Encyclopaedias:

https://en.wikipedia.org

www.investopedia.com

http://www.asifma.org