Article

Corporate bond market: Never ending

issues and challenges!!
Niddhi Parmar
parmar@vinodkothari.com

Vinod Kothari & Company

Corporate Law Services Group

corplaw@vinodkothari.com

July 23, 2016

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 Corporate bond market: Never ending issues and challenges!!

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India has been historically witnessing the underdevelopment scenario of bond market. There
has been lots of buzz going around the Indian corporate bond market. In the earlier write-up
we discussed the changes brought to streamline the regulatory regime surrounding the Indian
bond market1. Recently, the Reserve Bank of India came up with a detailed analysis on
“Corporate Bond Market in India: Issues and Challenges”2.

In India, the equity market is more vibrant and matured as compared to bond market; however,
the same is in contrary to the other economies of the world, where bond market is more
vibrant. In order to boost the Indian market, a High-level Expert Committee on Corporate Bonds
and Securitization3 was formulated under the chairmanship of Dr. R.H. Patil with a mandate to
identify the factors inhibiting the development of an active corporate debt market in India and
recommend policy actions necessary to develop bond insurance in the country. In early 2013,
RBI advised banks to issue subordinated debt for raising Tier-II capital to public investors
through public issuance, to deepen the corporate debt market4. On similar lines the
government official released a statement saying, “We are examining if banks can be mandated
to raise part of their requirements through public issue to retail investors” 5. Further, in the
Union Budget 2016-17, the Finance Minister announced various measures to facilitate
deepening of corporate bond market. He further added that, “the enactment of Insolvency and
Bankruptcy Code would provide a major boost to the development of the corporate bond
market”6.

In this write-up, we intend to discuss the issues and challenges still faced by the corporates at
the time of issuance of bonds in the market.

1
Detailed write-up can be viewed at: https://www.india-
financing.com/images/Articles/Several_changes_bond_markets.pdf
2
Read more at: https://rbi.org.in/scripts/bs_viewcontent.aspx?Id=2783
3
Report can be viewed at: http://finmin.nic.in/reports/Report-Expert.pdf
4
See. http://www.business-standard.com/article/finance/rbi-asks-banks-to-issue-tier-ii-bonds-to-retail-
investors-113012500006_1.html
5
See. http://articles.economictimes.indiatimes.com/2015-02-02/news/58711842_1_tier-ii-capital-
equity-capital-requirement-capital-instruments
6
See. http://www.unionbudget.nic.in/ub2016-17/bs/bs.pdf - Annexure II.
 Corporate bond market: Never ending issues and challenges!!

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Performance of the bond market

The Indian bond market has witnessed its highest peak of public issuance in the year 2013-14
amounting to INR 42382.97 crores and private placement in the year 2015-16 amounting to INR
458073.57 crores. The table below reflects the issuance of bonds and provides a comparison to
understand the highs and lows of the history of the bond market in India.

INR in Crores
Public Issue
45000 42382.97
40000
35610.71
33811.92
35000
30000
25000
20000 16982.05
15000
9451.17 9713.43
10000
5000 1899.38
0
2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Public Issue

Looking at the above figures and as compared to the year 2015-16, the current financial year is
witnessing a dip in the growth during the first quarter. The public issuance of bonds during the
first quarter amounts to INR 1899.38 crores which is much lower as compared to INR 8452.98
(quarterly average of the total amount).

7
Consolidated figure of the bonds listed on BSE, NSE and on both.
 Corporate bond market: Never ending issues and challenges!!

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Private Placement INR in Crores

500000 458073.5
450000 403236.5
400000 361462
350000
300000 261282.7 276054.2
250000 218785.4
200000
134455.76
150000
100000
50000
0
2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Private Placement

The issuance of bonds on private placement basis seems to be stable during the current
financial year.

Issues and challenges

The major investors in the bond market are viz., banks, financial institutions, insurance
companies, mutual funds, pension funds and foreign institutional investors. However, for each
of the aforementioned categories there seems to be restrictive conditions with respect to
participation in the bond market.

Banks:

In order to understand the restrictions on the investment in the corporate bonds, let us first
analyse the two important terms used in the prudential guidelines, i.e., SLR investments and
non-SLR investments.
 Corporate bond market: Never ending issues and challenges!!

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SLR investment – every bank is required to maintain certain portion of their deposits in liquid
assets. These liquid assets can be cash, gold or government securities. SLR is maintained by the
bank to control the expansion of bank credit and the ratio is determined by the Reserve Bank of
India. Currently, the prescribed statutory liquidity ratio for banks is 21 per cent 8 of their
deposits.

Non-SLR investments – Other than granting loans, the banks are allowed to invest in capital
market instruments such as stocks and bonds issued by public and private sector companies
and commercial papers. Further, banks were also permitted to invest in mutual fund schemes.

The prudential norms issued by RBI for Classification, Valuation and Operation of Investment
Portfolio by Banks9 provides for restriction on non-SLR investments. Para 1.2.9 of the prudential
norms provides for an restriction on bank’s investment in unlisted non-SLR securities which
shall not exceed 10 per cent of its total investment in non-SLR securities as on March 31, of the
previous year, and such investment should comply with the disclosure requirements as
prescribed by SEBI for listed companies. The aforementioned capped percentage shall also
include investment by banks in long term bonds issued by other banks for financing of
infrastructure and affordable housing. Even though, if banks invest in non-SLR debt securities
which are not listed, such banks are still required to ensure the disclosure standards prescribed
by SEBI. (Para 1.2.1 (ii)).

Further, if the investment is on account of investment in Securitisation papers issued for

infrastructure projects, and bonds/debentures issued by Securitisation Companies and
Reconstruction Companies set up under the Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and registered with the
Reserve Bank then an additional cap of 10 per cent is permitted on such investment. (Para
1.2.10).

Insurance Companies:

8
See. https://www.rbi.org.in/home.aspx - reserve ratio.
9
Refer. https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9904#12
 Corporate bond market: Never ending issues and challenges!!

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The Insurance Regulatory and Development Authority in consultation with the Insurance
Advisory Committee amended the Insurance Regulatory and Development Authority
(Investment) Regulations, 2000 (hereinafter referred to as “Investment Regulations”) by way of
an Insurance Regulatory and Development Authority (Investment) (Fifth Amendment)
Regulations, 2013 (hereinafter referred to as “Fifth Amendment Regulations”) dated February
16, 201310. The investment restrictions are as follows:
 Regulation 9 of the Fifth Amendment Regulation provides for substitution in the Investment
Regulations wherein the corporate bonds or debentures rated not less than AA or its
equivalent and P1 or equivalent ratings for short term bonds, debentures, certificate of
deposits and commercial paper, by a credit rating agency, registered under SEBI (Credit
Rating Agencies) Regulations, 1999 would be considered as ‘Approved Investments’.
 Such insurance companies shall not invest less 75 per cent in debt instruments in case of life
insurers, and not less than 65 per cent in case of general insurers, should be in sovereign
debt having AAA rating for long term and P1+ or equivalent for short term instruments.

Mutual Funds:

Clause 1 of seventh schedule of the Securities and Exchange Board of India (Mutual Funds)
Regulations, 199611 read with regulation 44 (1) provides for restriction on investments as
follows:

 Mutual fund scheme shall not invest more than 10 per cent12 of its NAV in debt
instruments comprising money market instruments and non-money market instruments
issued by a single issuer which are rated not below investment grade by a credit rating
agency authorised to carry out such activity under the Act. The aforementioned
investment limit may be extended with prior approval of the board of trustees and

10
Refer.
https://www.actuariesindia.org/syllabus/IRDA%20(Investment)%20(Fifth%20Amendment)%20Regulatio
ns,%202013.pdf
11
Read more at:
http://www.sebi.gov.in/cms/sebi_data/commondocs/mutualfundupdated06may2014.pdf
12
Clause 1 was substituted by Securities and Exchange Board of India (Mutual Funds) (Amendment)
Regulations, 2016 dated February 12, 2016. See.
http://www.sebi.gov.in/cms/sebi_data/attachdocs/1455513505225.pdf
 Corporate bond market: Never ending issues and challenges!!

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board of directors of the asset management company; however, in any case the same
shall not go beyond 12 per cent of the NAV of the scheme. Further, such investments
can be made in mortgaged backed securitised debts which are rated not below
investment grade by CRA registered with the Board.
o Such limits shall not be applicable for investments in G-sec, T-bills and
collateralised borrowing and lending obligations.
o The existing schemes shall conform to such limit with in an appropriate time as
may be specified by the Board.
 Mutual fund scheme shall not invest more than 10 per cent of its NAV in unrated debt
instruments issued by a single issuer and the total investment in such instruments shall
not exceed 25 per cent of the NAV of the scheme.
o All such investments shall be made with the prior approval of the board of
trustees and the board of directors of the asset management company.

SEBI vide circular no. SEBI/HO/IMD/DF2/CIR/P/2016/35 dated February 15, 201613 provided
revision in the prudential limits for sectoral exposure as follows:
 The limit of 30 per cent sectoral exposure in debt oriented mutual fund scheme and an
additional exposure of 10 per cent limit over and above the limit of 30 per cent in the
financial service sector pertaining to housing finance companies (HFCs) only has been
reduced to 25 per cent and 5 per cent, respectively. The extract of the amendment is as
below:

“Mutual Funds/AMCs shall ensure that total exposure of debt schemes of mutual
funds in a particular sector (excluding investments in Bank CDs, CBLO, G-Secs,
TBills, short term deposits of scheduled commercial banks and AAA rated
securities issued by Public Financial Institutions and Public Sector Banks) shall not
exceed 25% of the net assets of the scheme;
Provided that an additional exposure to financial services sector (over and above
the limit of 25%) not exceeding 5% of the net assets of the scheme shall be
allowed only by way of increase in exposure to Housing Finance Companies
(HFCs);

13
See. http://www.sebi.gov.in/cms/sebi_data/attachdocs/1455532308090.pdf
 Corporate bond market: Never ending issues and challenges!!

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Provided further that the additional exposure to such securities issued by HFCs
are rated AA and above and these HFCs are registered with National Housing
Bank (NHB) and the total investment/ exposure in HFCs shall not exceed 25% of
the net assets of the scheme.
XX”

Foreign Institutional Investors:

SEBI vide circular no. CIR/IMD/FIIC/8/2014 dated April 07, 201414 came up with the changes in
investment conditions/ restrictions for FII/ QFI investment in debt securities. The circular states
as follows:
 The overall government debt investment limit for FIIs/ QFIs shall be US$ 30 billion -
o US$ 20 billion (INR 99,546 crores) shall be available on demand and the eligible
investors may invest only in dated securities of residual maturity of one year and
above, and existing investment in Treasury Bills will be allowed to taper off on
maturity/sale;
o US$10 billion (INR 54,023 crores) shall be available on demand for FIIs registered
with SEBI as Sovereign Wealth Funds, Multilateral Agencies, Endowment funds,
Insurance Funds, Pension Funds and Foreign Central Banks. Eligible investors
may invest only in dated securities of residual maturity of one year and above.
 The corporate debt investment shall be capped at US$ 51 billion (INR 244,323 crores)
which shall be available on demand and the eligible investors may invest in Commercial
Papers only up to US$ 2 billion which shall be within the limit of US$ 51 billion.
o US$ 1 billion for QFIs;
o US$ 25 billion for FIIs; and
o US$ 25 billion for FIIs in long term infra bonds15.

The FIIs/ QFIs were permitted to invest in “Credit Enhanced INR Bonds” up to an equivalent of
US$ 5 billion within the overall Corporate Bond limit of US$ 51 billion vide circular RBI/13-
14/368 dated November 11, 2013. However, SEBI vide its circular CIR/IMD/FIIC/ 19 /2013 dated

14
See. http://www.sebi.gov.in/cms/sebi_data/attachdocs/1396874476837.pdf
15
See. http://www.sebi.gov.in/cms/sebi_data/attachdocs/1364824242052.pdf
 Corporate bond market: Never ending issues and challenges!!

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November 28, 201316 laid down a condition that aggregate investments by FIIs/QFIs in such
bonds shall not be more than 90% of the US $ 5 billion limit, i.e., US $ 4.5 billion.

Provident Fund:

A new pattern of Investment was issued vide notification no. HO/IMC/132/Pattern2015 dated
June 9, 201517 with was made applicable with effect from May 29, 2015.
 Debt instrument and related investments – Min 35% and up to 45%
o Listed debt securities issued by bodies corporate, incl. banks and PFI which have
a minimum residual maturity period of 3 year from the date of investment.
o Basel III Tier-I bonds issued by scheduled commercial banks under RBI guidelines
 In case of initial offering of the bonds the investment shall be made only
in such Tier-I bonds which are either listed or are proposed to be listed
 Investments shall be made in such bonds of a schedule bank from the
secondary market or from subsequent placement only if the existing Tier-
I bonds are listed are regularly traded
 The total portfolio invested shall not be more than 2 per cent of
the total portfolio of the fund
 In case of initial offering the investment shall not exceed 20 per cent of
the initial offering and the aggregate value of such bonds held by the
fund shall not exceed 20 per cent of such bonds issued.
o Units of debt mutual funds regulated by SEBI
 Investment shall not exceed 5 per cent of the accretions invested in the
year and the portfolio investment shall not exceed 5 per cent of the total
portfolio of the fund at any point of time.

However, as per the newspiece dated March 18, 2016, the finance minister had approved the
proposal mooted by the labour minister for holding back investments in corporate bonds up to
15 per cent in view of volatility of the stock market and invests the same in G-Secs, “amid a

16
See. http://www.sebi.gov.in/cms/sebi_data/attachdocs/1385638825625.pdf
17
See. http://www.epfindia.com/site_docs/PDFs/Circulars/Y2015-
2016/IMC_InvestmentPattern_ExEstt_8004.pdf
 Corporate bond market: Never ending issues and challenges!!

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surge in the number of loan defaults by corporates, retirement fund body EPFO will cut exposure
in corporate bonds and park more funds in the secure government securities.”18

Legal framework

India is considered to be more “regulators-friendly” than to be “business-friendly”. World Bank,

in its Doing Business Report 201619, has placed India at 130 out of the 189 countries for ease of
doing business. From recovery perspective, the corporate bonds are deemed risky and the
procedural requirement is too lengthy. In case of resolving insolvency, the World Bank has
placed India at 136 out of 189 countries. Delay in resolving the dispute is a key hindrance for
the financial entities looking to invest in the corporate bonds. Various trial and error with
respect to regulations were ensured by the regulators; however, the success of the same was
either limited or there was a mix success. There is a need for strong and faster process of
deciding insolvency, winding up and liquidation. The Sick Industrial Companies Act led to
establishment of Board of Industrial and Financial Reconstruction for revival and rehabilitation
of sick undertaking; however, the success was limited. The Corporate Debt Restructuring
scheme introduced by RBI for safety of money given by banks and financial institutions, this
scheme had a mix success. The Recovery of Debts Due to Banks and Financial Institutions Act
led to establishment of Debt Recovery Tribunals were established to avoid delays with courts in
the enforcement for debt but unfortunately the success was very limited. In the year 2002 the
SARFAESI Act was introduced for enforcement of security interest without courts intervention
and the success was high. However, the need for a uniform code led to enactment of the
Insolvency and Bankruptcy Code, 2016 - In case of Insolvency Resolution and Liquidation for
Corporate Persons - National Company Law Tribunal shall be the adjudicating authority and for
individuals and partnership firms - Debt Recovery Tribunal shall be the adjudicating authority.
The success of both the authorities will be determined in the years to come.

18
See. http://economictimes.indiatimes.com/wealth/invest/epfo-to-invest-more-in-government-bonds-
amid-corporate-loan-defaults/articleshow/51460223.cms
19
See. http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-
Reports/English/DB16-Full-Report.pdf
 Corporate bond market: Never ending issues and challenges!!

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Conclusion

Based on the recommendations of the H. R. Patil Committee, the government is in the process
of incorporating various measures to intensify the corporate debt market and to curtail the
issues and challenges faced by the industry. The enactment of the Insolvency and Bankruptcy
Code, 2016 might bring reforms with respect to delay in resolving the matter. If the Code
succeeds in achieving its objective, one may expect the end of never ending issues and
challenges and boost in the corporate bond market.

Read articles on:

1. Several changes in and around the Indian bond market - https://www.india-
financing.com/images/Articles/Several_changes_bond_markets.pdf
2. Our various write-ups on bond market can be viewed at: https://www.india-
financing.com/staff-publications.html/capital-markets.html
3. Our various write-ups on Bankruptcy Code can be viewed at: http://www.india-
financing.com/component/content/article/325.html
4. Read other articles on Companies Act, 2013 at: http://www.india-
financing.com/component/content/article/281.html