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  • Bhamini Tanwani, Vanshika Manglani

Democratizing the Debt Market: Analyzing the Implications of the New Vanilla Bonds

[Bhamini and Vanshika are students at Hidayatullah National Law University.]


The Securities and Exchange Board of India (SEBI) vide a board meeting dated 30 April 2024 reduced the face value of certain debt securities to INR 10,000 from the earlier value of INR 1,00,000. This is aimed at increasing participation of non-institutional investors in the corporate bond market, thereby creating a market that is easier to access, offers greater protection, and operates more efficiently, benefiting both institutional investors and individual retail investors alike. SEBI has been making consistent efforts to create such environment in the Indian securities market and this move is one such example.


Through this article, the authors analyze this reduction and its possible implications on the securities market, while also highlighting the continuous efforts of SEBI to improve the debt securities market.


SEBI’s Regulatory Regime: A Timeline


The Indian bond market has traditionally been an exclusive market, with participation restricted to a few institutional players. It was difficult, and in most cases, financially unviable for retail players to invest, owing to the high face value of bonds.  In 2022, SEBI undertook an initiative to make the debt securities market more accessible and diverse. This endeavor involved revising the face value of debt securities (NCDs) and non-convertible redeemable preference shares (NCRPs).


Through a circular dated 28 October 2022, SEBI implemented the said revision, reducing the minimum denomination of privately placed debt securities and NCRPs to INR 1,00,000, from the prior denomination of INR 10,00,000 per debt security. In the period that followed this revision, retail participation in the debt market increased. It was seen that non-institutional investors contributed to 4% of the total debt which amounted to a 3% increase in a share which was less than 1% of the total debt.


Attributing this increase to the lesser face value, SEBI decided to reduce it further. This was proposed through a consultation paper dated 9 December 2023. The paper intended to further reduce the face value of debt securities from INR 1,00,000 to INR 10,000. Along with this reduction, it also mandated appointment of a merchant banker by the issuer to carry out due diligence, not just for public issue but also for privately placed securities. Upon receipt of suggestions on the paper, SEBI approved this proposal in its board meeting dated 30 April 2024 and released that denomination of face value for privately placed debt securities and NCRPS shall be INR 10,000 at the option of the issuer. Such NCDs and NCRPS shall be plain vanilla, interest / dividend bearing instruments wherein credit enhancements shall be permitted.


Potential Benefits


Increased funding for the issuer company


The lower face value will enable the issuer company to get the necessary funding by exposing them to a larger market. This will make the access to funds easier with diversified risk spread amongst investors.


Increase in retail participation


Initially bonds were issued for INR 10,00,000, this high price acted as a major deterrent for the retail investors. They preferred investing in the units of mutual funds or other securities which had lower investment cost and yielded similar results. A smaller ticket size shall ensure that more and more investors invest in the bonds, resulting in increased participation in the bond market and diversification of investors. This would also improve the liquidity of the bonds as it would become easier to buy and sell these bonds in the secondary market.


Credit enhancements


When the consultation paper was released, it was proposed that these bonds shall be plain vanilla bonds with no credit enhancements. However, in the recent board meeting, SEBI permitted the issuance of such bonds with credit enhancements. Credit enhancement simply means increasing the credit worthiness to reduce the risk for investors. When bonds will be issued accompanied by these enhancements, it will boost the investor confidence and they will be willing to take more risks.


Potential Challenges


The recent amendment by SEBI is indeed a positive measure as it serves the dual benefit of increasing retail investor participation and also helping the issuer companies with their financial requirements. However, it also poses certain challenges.


Increased compliance


The companies issuing bonds are now required to appoint a merchant banker. Now though the merchant banker would carry the due diligence process, this would increase the compliance burden of the companies. They are required to obtain registration under the SEBI (Merchant Bankers) Regulations 1992, which is subject to certain compliances The appointment of merchant bankers is indispensable while issuing bonds but this may also act as a deterrence for the companies to issue bond at such low face values with added compliance. The authors therefore suggest that certain exemptions and relaxations be granted to a company issuing bonds at a lesser face value as prescribed.


Low risk appetite


SEBI aims to enhance retail participation in the bond market, but the retail investors usually have a very low risk appetite. Risk appetite means the amount of risk an individual or an organization is willing to take. The retail investors usually have a low-risk appetite owing to limited income. The risk appetite has a direct bearing on an individual's investment decisions. The investors prefer conservative options like small savings which offer higher returns and tax exemptions.


Lack of awareness


One of the key reasons for low popularity of bond market is lack of awareness among the public. Till date, the public is of the opinion that fixed deposits, mutual funds are a better and safer option for investment. This is a result of lack of proper advertisement and awareness programs. The understanding of the bond market and how it operates is very crucial for increasing investments.


In the opinion of the authors, this can be done by launching a dedicated facility for investment in a corporate bond similar to an “RBI Retail Direct Scheme” launched for facilitating investment in a government bond. This will act as the one stop solution for the investors and will increase the participation of the retail investors and also improve the accessibility to the bond market.


Lack of liquidity


One of the major factors for less participation in the bond market is the highly illiquid nature of these bonds. This leads to investors being stuck with the investment for a considerable period of time with little to no exit options. As more investors trade bonds in the secondary market, it would eventually increase the investment in primary market and help in diversifying the risk. The investors can also easily exit due to presence of participants in the secondary market. Not only this, high activity of a bond in the secondary market will significantly impact its valuation which will help in price discovery.


In the opinion of the authors, SEBI should introduce a framework for market making in corporate bonds similar to the one it issued in 2021. The market makers are basically firms, individuals, organizations which quote both the bid price and ask price for the security thereby creating demand and supply. This will help in solving the problem of liquidity of bonds.


Recently, SEBI introduced a framework for Corporate Debt Market Development Fund. This will act as a backstop facility for the debt market. Backstop facility is a last resort option for unsubscribed portion of debt securities. This would help the entities with their liquidity issues. Thus, this backstop facility will boost investor confidence.


Development of secondary market

 

The corporate bond market can only improve if efforts are being made to develop the secondary market. A strong and deepened secondary market will incentivize the investors in the primary market and also help the issuers with access to funds. To put it simply, the investors will have a cushion to fall back on enabling them to take risks


Conclusion


Following SEBI’s decision, the Indian securities market is expected to undergo significant changes. Such an action has a potential to democratize a space which was previously limited to institutional buyers and was considered highly inaccessible. This move has several advantages. Among other things, it is expected to broaden the investor base, leading to a more resilient and diverse market. Retail investors now have a reasonable opportunity to enter the debt market which wasn’t the case previously. Credit enhancements also act as additional assurance and bolster investor confidence, thereby encouraging them to take more risks.


These potential advantages also come with a set of challenges that require attention. Some of them include the increased compliance burden on the issuer, stemming from appointment of a merchant banker for even privately placed securities. This necessitates careful management and the government can mitigate these challenges by providing certain exemptions to such issuers. Initiatives such as dedicated investment facilities and awareness campaigns can help in bridging the gap.


In conclusion, while this change brings in a new era of inclusivity and diversity in the debt securities market, it is also important to address the potential challenges effectively to build a stronger economy.

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