The following materials collected from a brilliant lecture given by Shri T. Rabi Sankar, Deputy Governor RBI on August 24, 2022 at Bombay Chamber of Commerce and Industry, Mumbai is worth looking at as a baby step in knowing about corporate bonds, a nascent industry which is motivated towards placement of corporate bonds on private basis to top banks, insurance agencies etc., disabling a senior like myself to contribute towards the growth of efficiently run big corporates. Reference of RBI website is given at end of this article.
Happily, let me explain the information given by the eminent speaker whose credentials are world known – the RBI Deputy Governor.
Bonds are easily understood if a Question-and-Answer format is used.
1.0 Can we deal with corporate bonds markets with a purpose? How does it fare with regard to bank financing?
Banks provide short term finance and meet the liquidity requirements of borrowers immediately and also on a wide range level. Once set in motion, it is easily available to industry and the most widely used finance.
But can a longer duration finance with rate of interest which can be afforded on a low level and based on financial rating of corporates rankle the minds of financial experts from corporates?Less rate of interest as compared to banks and on a large scale with long term perspectives like investment on fixed assets, investments on machinery, and any requirement for assets creation which will be used by financial institutions like insurance, pension, and provident funds for lending with great confidence based on credit rating of internationally approved agencies is one of the main features of a corporate bond.
Financial risks are moving away from banks but borne by corporate bonds market. Let me quote from the eminent speaker. “A reasonably developed corporate bond market can play the role of the “spare tyre2”, mitigating financial shocks and preserving financial stability.”
2.0 Can we deal with the regulatory steps taken by SEBI, RBI, and others?
- Reserve Bank of India eminently qualifies as the best facilitator of the development of corporate bond market from the clutches of big financial institutions to a single investor by taking the following steps: Permitting banks to provide partial credit enhancement (PCE) to incentivize a larger investor base; requiring large borrowers to raise a share (about 50%) of their incremental borrowings through market instruments; encouraging FPI investment by raising investment caps, introduction of Voluntary Retention Route etc.
- Let me illumine your minds with mind boggling revolutionary steps of SEBI: Settlement through delivery versus payment (DvP) mode which removes settlement risk; operationalization of a trade reporting platform for enhancing transparency; introduction of an electronic bidding platform (EBP) for primary issuance; consolidation of stock through reissuance; and introduction of request for quote (RFQ) platforms. This effectively explains enormous steps taken by SEBI to popularize the increase of bond market.
The introspection of the Deputy Governor shifted to the current scenario.
Current status To understand the popularity of corporate bonds, the proof of pudding is in its popularity among corporates.
The outstanding stock of corporate bonds has increased four-fold from ₹10.51 lakh crore as at end of FY 2012 to ₹40.20 lakh core as at end of FY 2022 (Chart 1). Annual issuances during this period have increased from ₹3.80 lakh crore to close to ₹6.0 lakh crore (Chart 2). Chart 1 and 2 available from RBI website.
While appreciating the gains made in India, do we stand comparatively favorable with others even in South East Asia?
Admittedly, the size of the corporate bond market in India, scaled by GDP, remains small compared to other major Asian emerging markets such as Malaysia, Korea and China (Chart 4).
Are there new players coming to issue new bonds for infrastructure or other types of capital expenditure?
The new entry of REITs and InvITs pursuant to the Union Budget announcing changes in several Acts including the SEBI Act, 1992, the Securities Contract Regulation Act, 1956 and the SARFAESI Act, 2002 will widen the market.
It is possible that municipalities based on their balance sheet, financial statements, and frank admission of present levels of developments, adherence to repayments and willingness to admit stricter sense of governance and supervision by rating agencies will attract huge investments in near future.
(My observation: In U.S.A. while a large number of state/municipalities float huge bonds, international agencies willingly include them as part of their investment profile. Even bankruptcy of many of them do not dispel the faith of investors since true state of affairs is easily available)
However, the respected Dy. Governor emphasized that the study of 5-year government securities vis-à-vis AAA rated corporate bonds for same tenor indicated that the government yield curve has provided a stable backbone for pricing of corporate bonds. Chart 6 on page 6 covers a period of 2010-2022 years.
Yes, can I have the position as regards the secondary bond market for corporates where you and I can buy,or sell the bonds?
The respected speaker did not speak high of the secondary market on account of the following factors:
- Buy and hold nature of corporate bond holders does not encourage secondary market since private placement of them sets the tone.
- Big corporates have lost contacts with small creditors who used to buy convertible debentures, corporate bonds of fixed tenor etc.
- However, some efforts by RBI to popularize government securities deserves appreciation.
- It was quoted that the market for repo in government securities had been contributing towards liquidity in the market, while similar domestic one for corporate bonds did not exist.
- The corporate market for bonds had consistently met the requirements of AAA rated companies than smaller rated ones. Let us look at the figures quoted by the august speaker. “First, as is well known the market is dominated by highly rated issuers. But let us look at the dimension of the problem. In FY 2021-22, ratings were assigned to 1,235 corporate debt securities amounting to ₹22.55 lakh crore. Of these, 278 or 22.5% were rated AAA and 358 or 29% were rated AA. 66 issuances or 5.3% of issuances were non-investment grade. While these numbers themselves are skewed in favor of highly rated issuances, the skew is much more pronounced when looked at in value terms – 80% of issuances in value terms were rated AAA and another 15% were rated AA.”
- It is sad to note the fact that In FY 2021-22, the amount of money raised through public issuances of corporate bonds was ₹11,589 crore – just about 2% of the amount of money raised through private placement at ₹5.88 lakh crore.
- SEBI had been making efforts to make the private placement process more transparent and efficient, for example, through the introduction of the Electronic Bidding Process on stock exchanges but the results had been discouraging.
- Facts quoted on investor profile was equally dismaying. Who dominated the investor base for corporate bonds? Mention of insurance companies, banks, mutual funds etc. was sad.
- It was not encouraging to note from the speech that no mention was made for seeking remedies for retail participation in corporate bonds. Non offering of corporate bonds for retailers was the main reason.
- It was interesting to know that there had been increasing instances of domestic corporates tapping the global markets for raising funds and that tapping international markets to raise Environmental, Social & Governance (ESG) funding had been growing while domestically such issuances did not exist.
- I would like to quote “Going by international experience, beyond the regulatory measures, there is a need to create conducive conditions for ESG bonds – greater transparency, credible checks against greenwashing including through arrangements for independent audits, and a robust taxonomy for the market and bonds. The announcement in this year’s Union Budget referring to mobilization of resources via ‘Green Bonds’ is also expected to enable a price anchor for ESG bonds in due course.”
- Conclusion by Dy. Governor: “Efforts need to focus on improving complementary– repo and derivative – markets, diversify the investor base, both domestic and global, and improve access of borrowers at the lower end of the credit spectrum. Beyond this, market development and improvements will remain a continuous exercise. As much as we need to take these steps, it will serve us well to temper our expectations on the degree of liquidity in secondary corporate bond markets.”
My observations
We, the small investors from India do not get any good corporate bond from any AAA rated company and the regulating authorities do not offer any compelling reason why even after 75 years of existence, the position could not be improved. While a big government bank bothers to fill up the requirements of any big corporate, the small investor is an onlooker to the events. The covered speech did not give any encouraging news on corporate bonds. The government banks would continue to offer huge increase in credit rate for small borrowers while offering not so comparative increase in deposits. No one ever bothers to question this dichotomy and offer any solution. But as small corporate investor in bonds, we should persist with our demands for more offering of corporate bonds from top rated companies.
Let us hope that SEBI will succeed in its efforts in opening up of corporate bond market to a small investor over a period of time.
Reference
Corporate Bond Markets in India – Challenges and prospects
Do you know?
Investing in corporate bond is a sort of arrangement where an investor works as a creditor and the particular corporate as a debtor for a period of 3-5 years with the assumption that the capital will be safe and regular income will be paid as interest.
The interest rate risk and credit risk: The credit rating agencies do help the investor by rating them with the highest rate as AAA. One can reasonably recollect the concept” too big to fail” which enabled almost the big corporates to get away with their failure in assessing the risk in housing sector or the recent failures in China for various builders. This is to caution that too much investment on corporate bonds is not the only way
However, reading the rating agencies reports do help an average investor. The return offered in good corporate bond is higher than the bank interest and most of the top Indian corporates have repaid their bond holders in the last 2 decades.
Calculating the value of a floating corporate bond which goes down with the increase of bond interest and vice versa is beyond the scope of this article. In most of the developed countries, a corporate bond is one of the most popular modes of investment since very little interest is paid by a normal banker for its deposit holders.
As concluded by the deputy Governor, with very little corporate bond market for retailers as on date, the future will be much better with more offerings.
Disclaimer: The contents of this article are for information purposes only and do not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc. before acting because of the above write up. The possibility of other views on the subject matter cannot be ruled out. By use of the said information, you agree that Author/Tax Guru is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors, or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional
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