RBI, Sebi make another bid at deepening corporate bond markets
5 min read.Updated: 19 Aug 2016, 04:07 AM ISTIra Dugal
RBI, Sebi don't want to accept corporate bonds as collateral at RBI's LAF window for now, but may eventually allow to help the market leapfrog
The banking and capital market regulators are proposing a series of measures to try and deepen the country’s corporate bond market, which continues to remain shallow despite years of effort.
The regulators, however, have stopped short of immediately accepting corporate bonds as a collateral at the central bank’s Liquidity Adjustment Facility (LAF) window, although they intend to move in that direction eventually. This was one measure that analysts felt could help the market leapfrog.
Even so, a working group of officials from the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi), which released its report on Thursday, recommended a number of measures that could incrementally help strengthen the bond markets in India.
“...considering the importance of developing this (the corporate bond) market, particularly as going forward the corporates have to reduce their reliance on bank lending and move, accordingly, to market mechanism for accessing resources, the group agreed on a set of implementable recommendations," said the report. Explaining the urgent need to deepen the corporate bond market at this stage, the working group cited the RBI’s plan to wean large corporates away from bank borrowings.
In a paper in March, RBI had suggested restricting the share of bank borrowings of large corporates and pushing them to market-linked borrowings.
According to the working group report, RBI would finalize this plan by September, subject to market conditions.
However, any substantial shift towards market borrowings will need a corporate bond market that has far more depth and liquidity than it currently has.
To do this, one step recommended by the group is that an electronic dealing platform with a central counter party facility be introduced for repo operations in corporate bonds. This will make corporate repo operations, which are currently all conducted in the over the counter market, more transparent.
“FIMMDA may consult market participants to develop a commonly acceptable market repo agreement for execution among the market participants by end September 2016," said the working group report which also talks of “tripartite repos". A tripartite repos agreement is a three-party agreement where a party other than the buyer and seller is involved to facilitate settlement among other things. FIMMDA is Fixed Income, Money Markets and Derivatives Association of India.
If repo in corporate bonds picks up, RBI, as a next step, may consider accepting such bonds as collateral at its LAF window. It currently only accepts government securities as eligible collateral to lend to banks.
“Depending upon the development of the repo market in some form, the Reserve Bank may explore the possibility of accepting corporate bonds as collateral subject to suitable risk management framework in terms of rating and haircut," said the working paper.
At first, corporate bonds will only be accepted as collateral for overnight borrowings from the RBI’s window and at a later stage, they may be accepted for longer term borrowings. The working group, however, does not give any timeline over which this will happen.
“Accepting corporate bonds at the LAF window would have been a big step, but it is encouraging to see that they intend to move in that direction even if not immediately," said Karthik Srinivasan, senior vice-president and co-head of financial sector ratings at ICRA Ltd.
To improve the acceptability of lower rated bonds to institutional buyers, the working group has also recommended that the limit to which banks can offer partial credit enhancement to corporate bonds be enhanced.
At present, banks are allowed to provide such enhancement to the extent of 20% of the bond issue size. However, there have been hardly any such deals.
The working group is now recommending that the upper limit for credit enhancement by the banking system as a whole may be enhanced to a higher limit. But no single bank will be allowed to have an exposure of more than 20% of the bond issue size, said the report.
“Conceptually, this could have some impact, as an investor may be able to look at a wider gamut of issues if their ratings are enhanced. But we will have to see what the final rules look like and the increase in the limit for partial credit enhancement," said Srinivasan.
Soumya Kanti Ghosh, chief economic adviser at State Bank of India said that an increase in the limit for individual banks may have been more useful to improve the effectiveness of the partial credit enhancement mechanism.
Another step that could help improve the level of transparency in the bond market is attempts to strengthen credit rating agencies. Sudden downgrades in ratings have stranded investors and raised questions around the reliability of ratings.
To address these concerns, the working group says that RBI may consider allowing rating agencies access to the Central Repository of Information on Large Credits (CRILC) database based on “legal feasibility and other relevant factors". CRILC was set up by RBI in 2014 to collect, store and disseminate data about large credit to lenders. This database is so far accessible to only RBI and banks.
“CRAs (credit rating agencies) may be mandated to strictly adhere to the regulatory norms with regard to timely disclosure of defaults on the stock exchanges and their own website. They may also publish the credit rating transition matrix more frequently," the report added.
Both Srinivasan and Ghosh agreed that this could help rating agencies improve quality, but the RBI would need to tread carefully because of the legalities of sharing private data.
As a way to improve liquidity, regulated entities like banks, primary dealers and brokers will be encouraged to act as market makers to deepen the corporate bond market, said the report, adding that RBI may also allow trading members in the debt markets to act as market makers.
The Indian funding market has always been dominated by banks, although in the past two years, banks have started losing some market share to bond markets. Indian banks have lost nearly five percentage points in market share to the bond market over the past two years, said a 12 January report from research house Ambit Capital Pvt. Ltd.
Even so, the share of the bond markets in overall financing activity dismally low.
“In developed countries and emerging markets, corporate bond markets have more than ~50% share in credit offtake vs merely 23% share in India," said Ambit Capital in its report.
Srinivasan of ICRA says that while volumes in the corporate bond market have picked up in the past two years, there is no single button that regulators can press to help the market develop more quickly. “Things will pick up but it will happen over time," said Srinivasan, while explaining that the market continues to be faced with fundamental supply-demand issues as there are not enough investors in the markets and many companies still tend to prefer to stick to bank loans rather than market borrowings.
To ease some of the taxation related concerns, the working group recommends that the stamp duty on debentures should be made uniform across states and be linked to the tenor of securities within an overall cap. The final decision on this, however, rests with the central and state governments.