Regulator permits companies to sell junk bonds for debt needs

Regulator permits companies to sell junk bonds for debt needs

Mumbai: Capital market regulator Securities and Exchange Board of India (Sebi) on Monday allowed Indian corporations to sell bonds rated below investment grade.

The move will give local investors access to high-yielding debt securities that carry more risk. Sebi earlier had stipulated that “debt instruments issued through public or rights issues shall be of at least investment grade." But in order to boost the now flagging corporate debt market in India, Sebi has said “it should be left to the investor to decide whether or not to invest in a non-investment grade debt instrument."

This means corporations with a weak credit history can now tap the market directly for their debt needs. Earlier, the corporations used to approach banks for those requirements.

In developed markets, high-yielding debt instruments without an investment grade are called “junk bonds". These bonds carry a credit rating of BB and lower, because they have a higher risk of default. Typically, these bonds also give higher returns as opposed to investment grade bonds, making them attractive to investors. There bonds are also tradable in markets, such as the US. Hedge funds, which have a stronger risk appetite, typically invest in junk bonds. In the recent past, however, junk bonds were affected by the subprime crisis in the US, where loans were made to borrowers with poor credit history. These bonds have struggled as subprime mortgage defaults triggered massive losses at financial institutions, eroding investors’ appetite for risk. These bonds have given return of 0.7%—their worst performance since 2002, according to estimates by multinational financial institutions.

Companies planning to sell bonds now need to receive only one debt rating, compared with two earlier. This will reduce the cost of debt sales, Sebi said. The regulator also dropped restrictions on bond sales, including those on maturity periods. Rating agencies say that a single rating could give a skewed opinion of the risk involved. Chetan Modi, representative director of Moody’s India Ltd, said, “Although this move can bring down the cost of issuance for a corporation, an issuer can choose to publish a favourable rating to a bond issuance that may not reflect the risk of the instrument. Credit rating from two rating agencies give a more balanced view on the risk."

R.H. Patil, the chairman of the high-level expert committee on corporate bonds that was appointed by the Union government in July 2005, said on Monday, Sebi has only made “peripheral changes," which would not benefit the weakening market. Patil said the market regulator has not addressed the primary issue of why corporations are preferring private placement over the corporate bond market. “The public issue guidelines are onerous," he added.

The Patil committee report had recommended the creation of online order matching platforms to facilitate trading in corporate bonds. Sebi has been tasked with framing guidelines to set up such a platform. The ministry of finance has also said that steps will be taken to create a single unified exchange-traded market for corporate bonds.

While Sebi’s most recent move is directed towards the deepening of the bond markets, treasury experts in India said there may not be any takers for debt instruments that are below investment grade, just yet.