India: Corporate Bonds In India

Corporate Bonds are Bonds issued by private or public sector companies in order to borrow funds from the market. The Indian Companies Act, 1956 has not made any distinction between Corporate Bonds and Debentures. The term Debentures has been defined as follows1 "debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not." Corporate Bonds can be issued by way of Public issue where the retail investors as well as institutions can participate in the issue or by way of Private Placement where only a limited number of investors participate in the issue. Corporate Bonds unlike equity shares don't guarantee an ownership in the Company but give regular income in the form of Interest. Corporate Bonds are generally issued for a period of 1 year to 20 years and they can also be Listed.

Corporate Bonds are differentiated on the basis of Maturity i.e. Short Term, Long Term or Medium Term; Coupon i.e. Fixed Rate, Floating Rate or Zero Coupon; Option i.e. Call Option or Put Option and Redemption i.e. Single redemption or Amortizing Bonds.

ADVANTAGES OF CORPORATE BONDS

Some of the advantages of Corporate Bonds are

  • Corporate Bonds are useful for meeting the long term capital requirements of the corporate sector especially in those scenarios when the equity market is not working well or the Company doesn't wants to issue equity or preference shares.
  • The principal amount is safe as compared to investment in Equity Shares also there is regular income in the form of interest.
  • Issue of Corporate Bonds is beneficial for Infrastructure Companies as they require Capital for a long period as compared to other sectors.
  • Corporate Bonds help in reducing the overall cost of borrowings as compared to cost of borrowings from the Banks.
  • Long Term Capital can be effectively raised through issue of Bonds.
  • The rating of Bonds helps the investor to take an informed decision.
  • Rate of Interest is higher as compared to Bank Deposits.
  • In case of Listed Bonds there is Liquidity of Investment and Capital appreciation.

Although, Corporate Bonds have their own advantages they have not been able to get much popularity in the Indian markets. Some of the reasons for the slow growth of Corporate Bonds in India are

  • Investors have a feeling that investment in Banks or Government securities is safer as compared to investment in Corporate Bonds.
  • Issue of Bonds to Public at general involves procedural formalities and is time consuming on the other hand is borrowings from banks or a private placement is less complicated.
  • Banks are sometimes more interested in giving loans to Corporate rather then investing in the Bonds issued by Corporate.
  • Corporate Bonds issued by private sector Companies don not qualify for meeting the Statutory Liquidity Requirement(SLR) of the Banks which refrains the Banks from investing in Bonds issued by private Sector Companies.
  • The secondary market for Corporate Bonds is also not much developed as Institutional Investors like insurance Companies, Provident fund authorities and Banks hold the Corporate Bonds till their maturity which reduces their supply in the secondary market.

With a view to develop Corporate Bonds Market in India some of the measures which have been taken by the regulatory bodies are:

SEBI amended the SEBI (Disclosure and Investor Protection) Guidelines, 2000 in 20072. The Text of the Circular read as follows

  1. Requirement of Credit Rating: For public/ rights issues of debt instruments, SEBI (Disclosure and Investor Protection) Guidelines, 2000 presently stipulate credit rating to be obtained from not less than two credit rating agencies. With a view to reduce the cost of issuance of debt instruments, it has now been decided that credit rating from one credit rating agency would be sufficient.
  2. Below Investment Grade debt instruments: SEBI (Disclosure and Investor Protection) Guidelines, 2000 currently require that the debt instruments issued through a public/rights issue shall be of at least investment grade. In a disclosure based regime, it should be left to the investor to decide whether or not to invest in a non-investment grade debt instrument. Given this, and in order to develop market for debt instruments, it has been decided to allow issuance of bonds which are below investment grade to the public to suit the risk/return appetite of investors.
  3. Removal of Structural Restrictions: Further, in order to afford issuers with desired flexibility in structuring of instruments to suit their requirements, it has been decided that structural restrictions currently placed on debt instruments such as those on maturity, put/call option on conversion, etc shall be removed.

Also, in October 20093, SEBI issued a Circular vide which it was decided that trades in corporate bonds between specified entities, namely, mutual funds, foreign institutional investors/ sub-accounts, venture capital funds, foreign venture capital investors, portfolio mangers, and RBI regulated entities as specified by RBI shall necessarily be cleared and settled through the National Securities Clearing Corporation Limited (NSCCL) or the Indian Clearing Corporation Limited (ICCL) with effect from 1st December, 2009.

Some of the measures taken by Reserve Bank of India to develop the corporate debt market are as follows4 :

  1. To promote transparency in corporate debt market, a reporting platform was developed by FIMMDA and it was mandated that all RBI-regulated entities should report the OTC trades in corporate bonds on this platform. Other regulators have also prescribed such reporting requirement in respect of their regulated entities. This has resulted in building a credible database of all the trades in corporate bond market providing useful information for regulators and market participants.
  2. Clearing houses of the exchanges have been permitted to have a pooling fund account with RBI to facilitate DvP-I based settlement of trades in corporate bonds.
  3. Repo in corporate bonds was permitted under a comprehensive regulatory framework.
  4. Banks were permitted to classify their investments in non-SLR bonds issued by companies engaged in infrastructure activities and having a minimum residual maturity of seven years under the Held to Maturity (HTM) category;
  5. The provisioning norms for banks for infrastructure loan accounts have been relaxed.
  6. The exposure norms for PDs have been relaxed to enable them to play a larger role in the corporate bond market.
  7. Credit Default Swaps (CDS) have been introduced on corporate bonds since December 01, 2011 to facilitate hedging of credit risk associated with holding corporate bonds and encourage investors participation in long term corporate bonds.
  8. FII limit for investment in corporate bonds has been raised by additional US$ five billion on November 18, 2011 taking the total limit to US$ 20 billion to attract foreign investors into this market. In addition to the limit of US$ 20 billion, a separate limit of US$ 25 billion has been provided for investment by FIIs in corporate bonds issued by infrastructure companies. Further, additional US$ one billion has been provided to the Qualified Financial Institutions (QFI).
  9. The terms and conditions for the scheme for FII investment in infrastructure debt and the scheme for non-resident investment in Infrastructure Development Funds (IDFs) have been further rationalised in terms of lock-in period and residual maturity; and
  10. Further, as a measure of relaxation, QFIs have been now allowed to invest in those MF schemes that hold at least 25 per cent of their assets (either in debt or equity or both) in the infrastructure sector under the current US$ three billion sub-limit for investment in mutual funds related to infrastructure.
  11. Revised guidelines have been issued for securitisation of standard assets so as to promote this market. The guidelines focus on twin objectives of development of bond market as well as provide investors a safe financial product. The interest of the originator has been aligned with the investor and suitable safeguards have been designed.
  12. Banks have been given flexibility to invest in unrated bonds of companies engaged in infrastructure activities within the overall ceiling of 10 per cent;
  13. Bank has issued detailed guidelines on setting up of IDFs by banks and NBFCs. It is expected that IDFs will accelerate and enhance the flow of long-term debt for funding the ambitious programme of infrastructure development in our country.

Further, Reserve Bank of India in January, 20135 permitted credit Default Swap, an insurance against default, on unlisted but rated corporate bonds even for issues other than infrastructure companies.

VALUATION OF CORPORATE BONDS

Corporate Bonds command a higher price in those cases when interest rates have declined and if the original bonds have been issued at a interest rate which is higher then the rate of interest which is being offered on the newly issued Bonds and the value of Bonds falls in those cases when the interest rates rise and the rate of interest offered on new bonds is higher than the one available on the Old Bond.

CONCLUSION

Corporate Bonds are a good source to raise long term funds with lower borrowing cost as compared to Bank Loans. Corporate Bonds market in India is at a growing stage and measures are being taken by the regulatory bodies to boost the growth of Corporate Bonds market in India by making necessary amendment in the rules and regulations. There is also a need to create awareness among retail investors in order increase the investment in Corporate Bonds.

Footnotes

1 Section 2(12) of Indian Companies Act, 1956

2 Circular No. SEBI/CFD/DIL/DIP/29/2007/03/12 dated 3rd December, 2007

3 Circular No. SEBI/IMD/DOF-1/BOND/Cir-4/2009 dated 16th October, 2009

4 www.rbi.org.in - Corporate Debt Market: Developments, Issues & Challenges, dated 15th October, 2012

5 Reserve Bank of India Notification No. RBI/2012-13/366, IDMD.PCD.No.10 /14.03.04/2012-13 dated 7th January, 2013

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