Private placement of corporate bonds increased from Rs. 20,548 crores during 2007-2008 to Rs. 414,799 during 2023–2024, showing an unimaginable increase of 20.18 times. Non-convertible debentures issued from 2008-9 till 2023-24 stood at 324 non-convertible debentures for Rs. 283,281 crores.
This shows the enormous confidence of the investor in the debt market. Let us learn the updated guidelines from SEBI’s master circular issued on 19.10.2023.
We may also revise our basic understanding of the corporate bonds market from the publication of SEBI known as the “Investor Guide for Corporate Bonds Market.”
What are corporate bonds?
Corporate bonds are debt instruments issued by a corporation to those holders who receive interest from the corporation periodically for a fixed period and get back the principal along with the interest due at the end of the maturity period.
Let me explain with an example.
Presuming you hold a 10% 5‐year corporate bond issued by XYZ Co. with Face Value Rs. 100, and interest is paid annually:
XYZ Co. will
Pay you Rs. 10 every year for 4 years Redeem the face value of the bond, i.e., Rs. 100 + Rs. 10 accrued interests at the end of 5 years.
The words corporate bonds and debentures mean the same as per our Companies Act, 1956, modified periodically. In India, both private as well as public companies can issue corporate bonds.
Why invest in corporate bonds?
If an investor needs a fixed income for a fixed period, corporate bonds fill the requirement. Generally, the bonds give better returns compared to bank fixed deposits. The bank’s deposits are insured up to Rs. 5 lakhs by DICGC, an RBI-owned subsidiary.
The said company is to be chosen based on a good rating given by a government-approved rating agency.
Comparison between a company share and a corporate bond
You become a part owner of the company if you own the company share. This gives a dividend at the end of the year if declared by the management. The company share may show appreciation or reduction in value depending upon the demand for the share in the share market. One can buy the company share either at the time of the initial public offer in the share market or in the secondary market which shows variance in values. Prosperous company shareholders can get appreciation in share value, rights issue, or bonus shares over a period. Considered as the riskiest investment, a company share has made millionaires or paupers depending upon the financial performance of the company. The risk-taking attitude of investors did play its role.
Yes, like a company share, a corporate bond is allotted in the initial offering in the primary market or in the secondary market if it is registered on the stock exchange. It is considered less risky as compared to a company share.
If the company closes down, how does one get the money back in case of a share or a corporate bond? Shareholders get the last priority in getting their payments towards company shares, while corporate bondholders stand first in getting their payments but after meeting the statutory dues of the company. This has been explained a bit more in the coming paragraphs.
One keeps in mind certain technical words as understood before investing in corporate bonds either in the initial public offering or in the secondary market.
They are…
Fixed or floating interesting rates
A fixed-rate bond will pay you a fixed amount periodically as per the interest rate set out when the bonds were issued. This interest is calculated as a % of the Face Value of the bond. Those fixed-interest payments are also called coupon payments. A 10% 5‐year corporate bond with interest paid semiannually is an example.
Now, the next question is, what is a floating interest rate?
A corporate bond offering a 10 yr. government bond/MIBOR + 2% with interest paid semiannually will earn you a varying amount of interest depending upon the prevailing MIBOR rate. If MIBOR is 7%, the investor gets 9%.
You have understood correctly if the second method is an ideal one if the investor wants to risk his return with MIBOR.
What is then the periodicity of interest payments?
An investor in corporate bonds receives his interest payments periodically. The interest may be received yearly or half‐yearly or quarterly or even monthly depending upon the period set at the time of issue. The interest payment dates are specified in the prospectus. On the maturity date, the issuer pays back the investor the face value of the bonds held by him along with the interest accrued on the same if the investment was a cumulative one. Interest payments are sometimes classified as cumulative or non‐cumulative.
Cumulative bondholders want interest to be paid at the time of maturity to increase wealth creation.
Maturity date:
Maturity date is the date on which the bond matures, i.e. the issuer repays the face value of the bond along with the accrued interest to the investor and dissolves himself of all the obligations attached to the bond. The issuer is bound to buy back the bond on the maturity date.
Since the maturity date is specifically mentioned in the offer documents, it can be short term/medium term or long term. Some bonds do have options, either call or put options.
An example.
A 12% 10-year corporate bond with interest paid quarterly issued on 2nd January 2010 has a maturity of 10 years and will mature on 1st January 2020.
Interesting. What is secured or unsecured? Some bonds are issued secured and others as unsecured,
Bonds are either secured against assets or unsecured. If the bonds are secured, in the event of the winding up of the company, it would sell off the assets against which the bonds were secured and repay the investor. However, all secured assets do not have the same ranking.
Let us learn as to how the payments are done in the case of the dissolution of the company? The order is reproduced below:
When the company repays its assets, it has to follow the following order in repayment of its dues: 1. Statutory and tax dues 2. Secured bonds (senior) 3. Secured bonds (subordinated) 4. Unsecured bonds 5. Preference shares 6. Equity shares. (order of priority)
What are convertible or non-convertible bonds?
Bonds which can be converted into equity shares at a later date are called convertible bonds. Such conversion can occur at a price predetermined at the time of issue of the bond or at the prevailing market price. On the same lines, bonds which cannot be converted into equity shares are called non‐convertible bonds.
One investor is expected to understand, analyze, and equate with the expectations of his investment return requirements at the time of investing in bonds.
Some may use the services of a qualified and approved investor advisor.
Let me now explain the main guidelines issued by SEBI for bonds updated vide its circular dated October 19, 2023. The whole text is available on the website of SEBI.
The new framework is applicable from April 1, 2024, for large corporates (LC) following April-March as the financial year while those with January-December financial year will have the effective date as January 1, 2024.
These are applicable for listed entities only.
These instructions are applicable for LCs with long-term borrowings of Rs. 1000 Crores or more.
What are long-term borrowings?
External commercial borrowings, inter-corporate borrowings, grants, deposits, or any other funds received from the government of India, borrowings on account of interest capitalization or borrowings arriving on account of mergers acquisitions and takeovers fall under the category of long-term borrowings and a credit rating of “AA”/ “AA+”/AAA.
An entity qualifying as a large entity shall raise not less than 25% of its qualified borrowings by the way of issuance of debt securities in the financial years subsequent to the financial year in which it is identified as an LC.
A qualified LC shall meet the mandatory requirement of qualified borrowings in a FY over a contiguous block of 3 years.
What are the responsibilities of Stock Exchanges?
As per regulations 33 and 52 of LODR regulations, the stock exchanges shall determine the list of LCs for fiscal year entities by June 30, or March 31 for calendar year entities respectively.
SEBI has emphasized that Limited Purpose Clearing Corporation (LPCC) shall make necessary infrastructure and system for LCs to comply with its revised instructions and also ensure proper coordination is for its implementations.
My observations on SEBI revised instructions
One might have noticed recent happenings in SEBI listed companies that distracted the stock markets, sometimes drastically downwards affecting millions of investors not privy to the inner happenings of the business corridor. SEBI has been trying its best to update its systems up to international expectations of OECD/US systems and governance standards.
I came across a study from the OECD website along with SEBI on “Company groups in India” which does incorporate various ways in which industrial groups are formed and sometimes to obviate the instructions of SEBI and other regulatory bodies.
Let me throw some highlights from the above study of OECD/SEBI. It is important for investors as minority shareholders to uphold their rights at the time of need.
(The report presents an overview of company groups in India, including group structures (e.g., hierarchical structures and cross-shareholdings), promoters, and related party transactions. It also covers the legal and regulatory approaches to addressing issues relating to company groups. The quantitative analysis of the report is primarily based on the Prowess dx dataset that covers financial data for over 40,000 listed and unlisted companies as well as data on shareholding patterns for over 5 000 listed companies. To prepare this report, Securities and Exchange Board of India (SEBI) and the OECD conducted a focused survey of selected listed companies that are part of company groups.)
Some statistical highlights
As of December 2020, out of the 100 largest listed companies by market capitalization, approximately 40 India listed companies had three or more layers of subsidiaries/step-down subsidiaries, surpassed by Singapore and Malaysia and followed by Thailand, Indonesia, and Viet Nam.
Another possible structure is a cross-shareholding, where companies own each other’s stock. Among the top 500 listed companies in terms of market capitalization, the number of listed companies having cross-shareholding relationships with other companies has been stable since 2013, ranging between 61 and 70.
The complex set up of large corporations was the subject of the discussions recently held in the parliament over group holdings of a certain group and the complications faced by SEBI to answer some issues raised in the parliament.
Some more steps taken by SEBI recently were as under:
SEBI revisited its definition of a material subsidiary, its enhanced monitoring by the audit committee which includes independent directors to have an independent view of their own, to mandate disclosures in respect of loans/guarantees/comfort letters/security provided by the listed entity directly or indirectly to promoter/ promoter group entities, directors, KMPs or any entity controlled by them through the periodical reporting to SEBI and other regulatory bodies.
Thus, we may continue to have timely supervision of these company groups to protect the interests of minority shareholders which include me, yourself and the whole individual investing public.
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