The Planning era began since 1951 and DFIs were increasingly encouraged to finance the project funding needs of the Indian corporate sector. The Government of India and RBI facilitated the concessional rates for corporate sector by giving the following to the DFIs: Access to low cost funds Permission to issue bonds with government guarantee Allocations from budget With the onset of economic reforms, the budgetary support and government guarantee to DFIs was withdrawn. The DFIs converted themselves into commercial banks to have access to the public deposit mechanism and served as source of long term finance to the Indian corporate sector. Primary issuance market, in the corporate debt market, is dominated by non-banking finance companies and relatively small amount of funds are raised through issuance of debt papers by manufacturing and other service industries. The following are some of the different types of corporate debt securities issued: Non-Convertible Debentures Partly-Convertible Debentures/Fully-Convertible Debentures (convertible in to Equity Shares) Secured Premium Notes Debentures with Warrants Deep Discount Bonds PSU Bonds/Tax-Free Bonds The sections herein explain the following: Significance of a vibrant corporate bond market Prerequisites for the development of corporate debt market Reasons for under-development of the corporate bond market in India
Significance of a well developed corporate bond market
1. Reduce dependence on banks for long term finance Due to regulatory constraints and absence of proper incentives to opt for corporate debt, the corporate sector in India prefers the banks as a source of long term finance. The East Asian crisis showed the pitfall of excessive reliance on bank financing.
2. Create a source of long term financing Developing countries like India will have opportunities for long term investments, especially in infrastructure projects. Banks, having short term liabilities, may not be able to continue and meet the growing needs of a developing country with long term financing requirements. A vibrant bond market gives access to such long term debt. The ability of raise funds has a long lasting effect of the growth of the economy of a country. Hence creating a more stable source of long term finance is crucial.
3. Cheaper source of finance Corporates with good credit rating lose out on the opportunity to raise funds directly from the market. As the corporate debt market develops and becomes liquid, the cost of raising funds will also reduce and also bring stability.
Less complex regulatory framework for public issues The main deterrence to corporate in issuing debt securities to the public is the lengthy and rigorous procedure that entails it. Thus the regulatory framework needs to be simplified and made more conducive and issuer friendly to good credit rated companies.
Reduction in time and cost of issuances The time required and the costs incurred in making public issues must be reduced to incentivise the corporate sector.
Reduction of corporate sector dependence on banks The mindset of the Indian Corporate sector to depend on banks to finance their long term investment needs must change.
Legal Structure There must a robust legal structure in place to encourage innovative financial products that would cater to various risk-return appetite of a diverse set of investors.
Market Infrastructure The market must be made more conducive to the trading, reporting and settlement of trades in the corporate bond market. Transparency must brought in through efficient price discovery process.
Presence of rating agencies Credible rating agencies must be present in the market to give information about the credit worthiness of the issuer and the debt securities
Developed Government securities market The G-Sec market needs to be well-developed as the price and yield of corporate bonds are marked on the basis of the benchmark G-Sec prices and yields.
Reasons for slow development of Indian corporate debt market
Lengthy regulatory requirements and disclosures The regulatory requirements for public issues were rigorous in terms of quality and type of disclosures
Utilization of funds The utilization of funds raised through public debt securities was required approval and was mandatorily needed to be disclosed to the retail investors.
Minimum Investment Grade Bonds had to have a certain minimum investment grade for it to be issued in the primary market. Those below this minimum investment grade were not allowed to be issued to the public. This clause was removed as per circular to amend the DIP (Disclosure and Investor Protection) Guidelines, 2000.
Risks Involved The offer document must contain the issuerâ€™s perception of risk on matters such as assets and debtors, dilution risk (changes in credit quality of pool of assets), currency, interest and other risks.
Disclosures Disclosures regarding the public offer, the debt instruments, the issuer, the originator, the servicer, the Trustees, the transaction structure and cash flows. The rigorous norms that have to be followed for issuing bonds make this process lengthy and burdensome process as compared to raising funds from the banks or other institutions or through private placement option
Listing of debt securities
Filing on stock exchanges: The firm needs to make an application to one or more recognized stock exchanges for listing of their debt securities.
Draft offer documents: The firm needs to file draft offer documents with the designated stock exchange and have it posted on the websites (if any) of the company, lead merchant banker and the designated stock exchanges.
Excessive dependence on bank loans and private placement The Corporate prefers bank loans to finance its long term investment needs to issuing debt securities in the primary market. Also, they can raise funds in the primary market through public issue of bonds or through the private placement route. The Indian corporate sector still prefers private placement as the firms find issuance of public debt securities is a lengthy and rigorous task. Also, the cost of issuance exceeds the cost of private placement. Another factor is that more funds can be raised through the private placement route.
Non-transparency The corporate bond market was non-transparent as there was no system to enable efficient price discovery and allow comparison of prices quoted by seller and strike the best deals.
Non-availability of information Till 2007, there was no information available on the trading activities in the corporate debt market. To improve this, SEBI, in 2007, permitted BSE and NSE to set up reporting as well as trading platforms to get real time information of trade volume, trading prices and other trading activity related data. Trading on OTC market could be reported through the reporting tool of NSE or BSE.
Advertisements The public issue needs to be accompanied by advertisements in a national daily with wide circulation informing the public about the issue and giving truthful information.
Credit Rating Earlier, bond issuers had to obtain rating from two separate credit rating agencies increasing the cost of issuances. This clause has been amended since 2007 to obtain rating from just one rating agency.
Minimum Subscription The issuer may decide on a minimum amount of debt it seeks to raise from the public and it must be mentioned in the offer document. In the event of non-receipt of the minimum subscription, the money needs to be refunded to the applicants. Thus all costs involved for issuance like merchant banker charges, advertisement costs will have to be incurred with no result.
Dematerialization of instruments Also, the issuer has to enter into an arrangement with a registered depository for dematerialization of the securitized debt instruments that are proposed to be issued to the public.
Auditing expenses An auditor and a valuer may be appointed to look into the books of accounts of the entity and for proper valuation of asset pools. The expenses of such an audit may be borne by the originator.
Fees Application fees, registration fees, annual fees, filing fees for offer documents.
Settlement and Clearing System There was no settlement and clearing system in place for the corporate bonds. The settlement on BSE is done on a rolling basis using BOLT (BSE Online Trading) whereas NSE uses its NSCCL (National Securities Clearing Corp. Ltd) platform to settle corporate bonds trades. However, majority of the transaction is in the OTC market with bilateral settlement.
Investor diversity Most of the investors do not have a long term view in mind. The household which could form a major part of the investor base is practically absent in the corporate debt market in India.