SEBI mulls framework for market making to deepen bond markets

SEBI mulls framework for market making to deepen bond markets

Subject: Economy

Section: Capital markets

Concept:

• With over 98 per cent of corporate bonds being private placements, leading to a shallow secondary market, Sebi is planning to come out with a framework for market-making to help markets become more vibrant and funds cheaper, a Sebi member said.
• In this regard, Sebi is exploring a market-making framework that’ll be applicable to every listed issuer who has issued non-convertible debt and has outstanding privately issued NCDs of Rs 500 crore ore more.
• The central bank data also show that as much as 80 per cent of issuances in FY22 were AAA-rated, and 15 per cent were AA-rates, leaving just 5 per cent for high-yielding junk papers, which is one of the reasons for low trading volume or lack of liquidity in the secondary market.

G-Sec vs Corporate bonds

• The current outstanding stock of government securities is Rs 84.71 lakh crore across 100 instruments as of June 2022 while trading volume in G-Secs was Rs 126.6 lakh crore in FY22 which is about seven-times of the trading in corporate bonds.

Corporate bonds

• Most companies prefer issuing debt instruments to raise capital for their operation because debt is a safer option as it doesn’t affect the shareholders of the company directly.
• Corporate bonds or debentures provide companies with an economical alternative to raise funds.
• Any company can issue corporate bonds, which are also called Non-Convertible Debentures (NCDs).
• When we purchase a bond, the company is borrowing money from us.
• The company repays the principal after the maturity period as mentioned in the agreement.
• The buyer will receive the interest (fixed income) – known as the coupon.
• Corporate bonds tend to pay a higher yield than Government bonds since corporate bonds have default risk, while Treasuries are guaranteed if held to maturity.
• Bond yield is the return an investor realizes on a bond.

Primary and Secondary market

• The primary market is where securities are created, while the secondary market is where those securities are traded by investors.
• In the primary market, companies sell new stocks and bonds to the public for the first time, such as with an initial public offering (IPO).
• The secondary market is basically the stock market and refers to the New York Stock Exchange, the Nasdaq, and other exchanges worldwide.

Challenges in corporate bond market

• The Indian corporate bond market has been ‘small’ in size despite many structural reforms.
• Further, the Indian bond market has been dominated by sovereign bonds and the corporate bond market has had a smaller share (27 per cent) during the last decade.
• Persistent supply as well as demand side issues like crowding out by government securities, private placement, higher interest rates, information asymmetry, etc.
• The recent credit defaults of NBFCs may spill over to the banking sector and hurt the corporate bond market.
• Financial illiteracy: According to a survey, over 76 per cent of adults in India do not even understand the basic financial concepts like interest rate, inflation, and exchange rate.
• Though some of the people are financially literate, they are not necessarily digitally savvy.
• The Indian corporate bond market is dominated by a few institutional investors and professional fund managers.
• Further, it is mainly concentrated in the financial services sector (72.1 per cent) rather than the manufacturing sector.
• Liquidity crunch: Over 90 per cent of the trading in the secondary market takes place in respect of the corporate bonds with ‘AA’ rating and above.
• The first rating for a bond is a AAA while the second highest is AA. This is followed by an A-rating. Anything that falls in the A-class is considered to be high quality, which means the debt issuer has a very strong likelihood of meeting its financial obligations.
• Also, insurance and pension funds hold the bonds till maturity. As a result, the market is shallow, with the absence of market makers, lack of liquidity, and consequent pricing anomalies.