Muddy Waters of Regulating Online Bond Platforms
[Pritha is a student at Institute of Law, Nirma University.]
In recent years, there has been a significant increase in online bond platforms in India. These markets account for trillions of rupees and offer immense scope of improvement, specifically in the non-institutional space. Previously, these platforms were either unregulated or managed through their own set of different rules and regulations resulting in an un-uniform state of affairs and inadequate disclosures which prevented investors from investing in the bond market.
In a rather progressive move, the Securities and Exchange Board of India (SEBI) has recently amended the Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities Regulations) 2021 (NCS Regulations) to insert a new Chapter VIA which specifically deals with online bond platforms (OBPs).
The framework provides partial relief to the investors by removing the prevailing ambiguity surrounding the online bond market and, at the same time, protecting the interests of such investors who regularly invest in the market. However, it does not go far enough to transform the existing structure of the bond market so as to synchronise with the increasing affinity of investors in the bond market. The framework comes as a welcome but a static acceleration in the right direction, with much wiggle room for further improvements. This article discusses the new amendment and its implications, and makes suggestions that could better deal with the existing issues in regulating online bond trading platforms.
What is Online Bond Trading?
Simply stated, bonds are investments that provide investors with high returns in exchange for lending money to borrowers, who are typically governments or businesses. OBPs provide investors, especially non-institutional investors, a way to access the bond market. Bonds can either be issued on the primary market, where fresh debt is issued, or they can be traded on the secondary market, where investors can buy debt that has already been issued through brokers or other intermediaries. A company promises investors through the issuance of a bond that it will pay interest at a specific rate for a predetermined duration of time. Bond trading offers stability by significantly reducing risk in portfolios, in contrast to volatile stock markets.
SEBI in its NCS Regulations has defined an OBP as an “..electronic system that is not a recognised stock exchange or an electronic book provider and where listed or prospectively listed debt securities are provided. An individual owning or operating such a platform is referred to as the online bond platform provider.”
The New Regime
Registration as ‘stock brokers’
In accordance with the new amendment, SEBI has incorporated Regulation 51A to the NCS Regulations, which requires OBPs to register as 'stock brokers' with the SEBI. The SEBI has granted OBP a three-month deferral to implement the rules beginning on the day this regulation takes effect.
The circular released by SEBI states that such an entity shall be an incorporated Indian company and shall register as a stockbroker on the stock exchange's debt segment after which it shall only offer listed securities and securities that are being proposed to be listed.
An entity would have to submit an application to the stock exchange as per Annex-A of the circular to perform the duties of an OBP after becoming registered as a stockbroker in the debt segment of a stock exchange.
The entity will have to make sure that its application complies with all rules for roles and responsibilities, technology, operating and complete risk management framework, Know Your Client (KYC) for onboarding investors and sellers, the risk profile of investors, transparency, and disclosure along with the necessary due diligence. It would also have to abide by the registration requirements as updated from time to time by the SEBI.
The Unattended Issues in the New Framework
Indian bond platform anticipates drawing in more investors as a result of the introduction of the new framework. Investors would benefit greatly from these simplified procedures since it eliminates confusion caused by the existence of numerous bond platforms, each with its own set of policies and grievance procedures. However, there are still some aspects of the framework which lie in the grey area:
No mention of advertising through social media and by celebrities
Annex-C of the framework, which prescribes the Advertisement Code for the OBPs, has possibly missed out on the increasing indulgence and dependency on social media in daily lives. According to a study, near about 80% of investors depend on social media for knowledge on investment in the course of their work. The new framework, however, does not contain any provision for social media advertising. Furthermore, it expressly prohibits celebrities from appearing in any advertisements involving the bond market. While the rationale behind such a move is unclear, enabling social media advertising might have made it easier for these OBPs to connect with their retail investors and attract investors to invest in such markets.
One possible alternative to such an embargo could have been taken from the example of the United States wherein initiatives have been launched to address investors' lack of knowledge by specifically emphasizing the possible interface of online and print media with the bond markets to improve their bond information.
Restriction on unlisted debt platforms
Under the new framework, the platforms are not allowed to market unlisted bonds under the new rules. The newly added provision's clear language essentially forbids the sale of bonds that are not listed. However, contrarily, SEBI allows foreign portfolio investors to invest in unlisted debt platforms but excludes it from the ambit of the new amendment. Since debt trading platforms include both listed and unlisted debts, this deregulated unlisted debt market could make matters extra cumbersome. Although the move was made to protect investors from the risks associated with unlisted debts, prohibiting investment in unlisted bonds will have a counter-effective result on the investors leaving them with fewer investments.
Instead of a blanket ban on the transaction of unlisted bonds, SEBI could have explored the possibility of introducing a separate guideline as has been implemented in Kuala Lampur where there is a separate framework in place for unlisted bonds wherein investors are protected from any risks arising out of any transaction involving unlisted bonds. Similarly, SEBI could have balanced the interests of both ends by introducing a different set of guidelines for the unlisted bond platforms wherein the risks of investing in an unlisted bond could have been highlighted along with sanctions and rules for investor protection and grievance redressal. Furthermore, a checklist for the investors could have been provided to ascertain their readiness to invest in the unlisted bond market requiring that an investor must fulfil a minimum of certain criteria to be eligible for such investment. This would allow investors to have greater access to the bond market.
Setting a minimum transaction limit of INR 2,00,000 and the problem of liquidity
Despite the bond market growing exponentially in the past few years, SEBI has set a minimum transaction size limit of INR 2,00,000 for investing through such OBPs, however, those investing in lesser value often face the risk of lesser liquidity due to low yield.
With the growing popularity of digital ledger technology (DLT) and crypto assets, integration of DLT and OBPs can revolutionize the existing system. DLTs function like a virtual ledger where transactions are recorded in a difficult-to-tamper-with record that is accessible to all parties, encrypted, and duplicated in their computer networks.
SEBI could have ventured into the integration of DLTs which could have helped with the liquidity problem by tokenization of the bonds at source, against which the investors can transact in real-time without any intermediary intervention and using smart contracts (executed automatically on meeting certain pre-programmed steps) through which certain order and pricing data can be shared using bilateral smart protocols thereby increasing the pre-trade data available through which liquidity can be improved. DLT can thus remove the existing impediments in the Indian bond market thereby enabling smaller players to enter a productive investment with negligible fixed costs.
The new amendment has the potential to significantly improve India's standing in terms of online bond trading platform regulations. However, in order to make sure that these regulations are effective, SEBI must maintain a careful balance between safeguarding investors while at the same time fostering a conducive environment for the bond markets to thrive. By incorporating the changes as suggested above, SEBI can eliminate the existing inconsistencies under the new amendment which, although motivated by the right concerns, may end up being detrimental in the long run.