While the Indian corporate bond market has become more active in the private placement segment in the past few years, the market's overall development has been ad hoc. This situation seems set for a much needed change, with the Reserve Bank of India (RBI) under its current governor, Raghuram Rajan, actively promoting the migration of long-term infrastructure debt and structured debt from the loan markets to the bond market.
The reason for this is two-fold: (1) the significant asset-liability mismatch makes bank funding of infrastructure projects unviable for most banks; (2) bond financing deepens debt markets by enabling capital markets participants (such as pension funds and insurance companies) to lend directly to borrowers. Such participants are generally considered to be better placed to evaluate and to assume longer term risk. Additionally, bonds have the perceived advantage of being more liquid than loans, in that trading of bonds is generally less complicated than syndication or down-selling of loans.
The growth of the Indian corporate bond market has coincided with the downturn in credit growth (i.e. bank lending), and bond-based financing as well as commercial paper-based financing through institutional investors has replaced bank lending to a substantial extent. While the RBI and the Securities and Exchange Board of India (SEBI) have introduced measures such as enabling infrastructure debt funds and rationalizing the entry route for foreign portfolio investors to invest in debt securities, in the absence of government-backed measures so far, these regulatory steps haven't been as successful as intended. The government's 2016-17 budget seeks to remedy this by recognizing the need for deepening the bond market and by introducing specific measures for this purpose.
As insurance companies and pension funds can only invest in highly rated bonds, the budget proposes that the Life Insurance Corporation of India will establish a dedicated fund with the specific purpose of "raising the credit rating of bonds floated by infrastructure companies". This will enable companies and special purpose vehicles in the infrastructure sector to access funds by issuing credit enhanced bonds to long-term investors such as insurance companies and pension funds. If this proposal is extended to refinancing of bank debt, it will not only bridge the funding gap that the infrastructure sector is currently facing, but will also allow banks to "de-stress" and clean up their balance sheets.
The budget gives a specific mandate to the RBI to "issue guidelines to encourage large borrowers to access a certain portion of their financing needs through market mechanism instead of the banks". While this is a landmark initiative, more important is the budgetary mandate to both the RBI and SEBI to jointly develop a "complete information repository" for both primary and secondary debt market segments. This not only provides the required signal to financial sector regulators to accelerate the development of the corporate bond market, but also recognizes that only by providing complete transparency will investors gain enough confidence to participate in the bond market. This is crucial because without an active secondary market for trading of bonds, there will be no market-based price discovery mechanism and the proposed development of the corporate bond market will fizzle.
Adding to the above are twin mandates to SEBI to develop an electronic auction platform for primary debt offers so as to create an "enabling eco-system" for private placement of bonds, and to the RBI to develop an electronic platform for the repo market in corporate bonds. The repo market functions like a tertiary market for corporate bonds, and encourages investors and companies to move away from plain vanilla instruments such as fixed deposits to investment in bonds. This makes the parallel development of the repo market critical, and by recognizing this, the government has shown that it is capable of foresight and vision. As the framework for a repo market exists already, the RBI may just need to fine-tune it, along with the Ministry of Finance.
The introduction of measures by the budget to develop the corporate bond market is laudable. However, participants await implementation (hopefully swiftly) of these proposals by way of legislation so that work can begin. Though the budget has made the right noises and has taken the steps in the right direction, these are just initial measures that only lay the groundwork for the development of the corporate bond market. Unless other incremental measures – such as rationalizing the taxation structure for bond issues, providing clarity on taxation of repo transactions and secondary trading of bonds, developing the credit default swap market, and enacting the insolvency and bankruptcy code – are introduced, the bond market may just plateau at a particular level and not achieve the scale (and thus fulfil its purpose) that it is intended to achieve.
This article was first published in the April 2016 issue of the India Business Law Journal (IBLJ) Journal.
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