The regulators in India continue to make changes to streamline the regulatory regime surrounding the Indian bond market. Lately, there has been a number of changes which is likely to cause a positive impact, which otherwise has been performing well during the last one year. There seems to be some effort from the government to push all the regulators towards a common goal. There are three changes, of which two have already come and one is expected to come, that we are bullish about, first, issue of debt securities through electronic book building mechanism, second, changes in the deposit rules for the companies to allow issuance of listed unsecured corporate bonds and third, RBI’s draft notification to allow FPIs to invest in corporate bonds. Let us discuss each of the above separately.
Issue of debt securities through electronic book mechanism
Securities and Exchange Board of India (SEBI) vide circular CIR/IMD/DF1/48/2016 dated on 21 April 2016
had provided a mandatory framework for issue of debt securities by private placement with an issue size excess of Rs500 crore through an electronic book mechanism (EBM). One such requirement of the circular stated that EBM shall be provided by the recognized stock exchanges after approval from SEBI. Accordingly, SEBI has granted its approval to NSE and BSE to act as EBP. By this, all the issuers of debt securities and market participants shall mandatorily make such private placement offer only through the EBM for their issuances with effect from 1 July 2016.
The old mechanism through which debt securities were issued on private placement basis in primary market lacked transparency. However, the EBM will enable efficient price discovery, reduction in times and cost, transparency among other things.
Changes in the Deposit Rules
Until recently, the Companies (Acceptance of Deposits) Rules, 2014 barred the corporates from issuing unsecured debt instruments. However, the Ministry of Corporate Affairs (MCA) vide notification dated 29 June 2016 issued the Companies (Acceptance of Deposits) Amendment Rules, 2016 (Amendment Rules)
thereby providing relaxation with respect to issuance of corporate bonds.
The Amendment Rules has addressed this issue by excluding listed unsecured non-convertible debentures (NCDs) from the definition of deposits. Earlier, corporates, other than financial entities, were allowed to issue either secured bonds or bonds compulsorily convertible into equity within a period of five years from the date of issuance, anything apart from the said were treated as deposits.
There is however a disconnect with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations 2015), which requires the maintenance of 100% asset cover for discharging the principal amount at all the times, except in case of unsecured debt securities issued by regulated financial sector entities eligible for meeting capital requirements as specified by respective regulators. Therefore, unless necessary changes are made in the Listing Regulations 2015, the non-financial entities will not be able to take the benefit of this change.
The situation, however, will not be any different for the financial entities, since, they were allowed issue unsecured bonds in accordance with the directives issued by their regulators.
The guidelines framed by Reserve Bank of India (RBI) allow the non-banking financial companies (NBFCs) to issue unsecured NCDs with a maturity of more than one year and with the minimum subscription amount being Rs1 crore per investor. This is why the bond market in India has been mainly dominated by the NBFCs during the last few years and the same can be viewed in the figure below.
In many of the developed countries bonds are issued without creation of security interest, subject to certain compliances, so as to enable easy raising of funds by the corporates. Most corporates, other than NBFCs, do not have assets to create charge in favour of bond or debenture holders, as the assets are already charged in favour of banks. It is counter intuitive to expect a corporate to issue secured bonds; if the corporate had security to offer, it may be easier to access bank loans. It is when companies exhaust their security interests that they opt for bonds. Bonds are an incremental, additional source of funding, and not the first source of borrowing for most companies.
Investments by Foreign Portfolio Investors (FPIs)
Another significant change that is all set to come is that the foreign portfolio investors (FPI) will now be allowed to make investments in unsecured corporate bonds and securitized debt instruments. RBI issued a draft circular on 17 June 2016 laying down new norms for FPI investments. The draft circular states that the FPIs will now be able to invest in primary issues of NCDs or bonds by public companies issued in demat form. However, the funds so raised cannot be invested for real estate activities, purchase of land, investing in capital markets or on-lending to other entities. Once put to effect, this circular can turn out to be a huge boost for the Indian capital markets.
Each of the changes that we discussed in this article has come from different regulators and all of them facilitate is likely to facilitate the growth of the Indian capital markets. This entire episode can be summed to say that the heydays of the Indian capital market are soon to come.
(Abhirup Ghosh is a Senior Manager in Financial Services Division at Vinod Kothari Consultants Pvt Ltd. Saurabh Dugar also works in the same firm.)