[Shalin Ghosh is a 2nd year B.A.,LL.B. (Hons.) student at Maharashtra National Law University, Mumbai]
The Securities and Exchange Board of India (“SEBI”), through a consultation paper released on 9 December 2023, proposed a slew of reforms to spur the growth of the Indian corporate bond market. One of those reforms concerns permitting companies to issue non-convertible debentures (“NCDs”) and non-convertible redeemable preference shares (“NCRPSs”) at a reduced face value of Rs. 10,000 as against the present value of Rs. 1 lakh. While SEBI’s proposal, aimed at improving retail participation in the corporate bond market, marks a positive development for both non-institutional investors and the overall bond market, certain structural and implementational aspects must be deliberated upon to bring about an appreciable and meaningful impact on the corporate bond market.
This post aims to discuss the rationale behind the proposal and provide an overview of the change suggested by SEBI. It shall also delve into the broader implications of the move on the corporate bond market and analyze the challenges and solutions concerning the intended stakeholders.
Brief Background
The prevalence of a high-ticket size for NCDs and NCRPSs acted as a major deterrent for non-institutional investors, inhibiting their access to the market. Retail investors must typically allocate 5-10% of their portfolio in the bond market to derive appreciable gains. While an earlier SEBI circular slashed the face value from Rs. 10 lakh to Rs. 1 lakh, diversification across various types of bonds was still challenging as investors would require an overall bond portfolio worth around Rs. 25 lakh to even invest Rs. 5 lakh in the corporate bond market. This posed a significant entry barrier as such investments would only be possible for individuals whose income fell within the Rs. 25 lakh and Rs. 30 lakh bracket. The income tax records for the financial year 2022-23 indicate that there are only 500,000 people who fall in this income bracket.
According to SEBI’s data for the period from July to September 2023, non-institutional investors subscribed to nearly 4% of the total amount raised as compared to the general average of less than 1%. The recent consultation paper notes that the increase in non-institutional investor participation can be attributed to the earlier directive reducing the corporate bond face value from Rs. 10 lakh to Rs. 1 lakh and the mainstreaming of online bond platforms (“OBPs”) with the aggregate volume of trading on OBPs amounting to nearly Rs. 333 crores by 1,974 investors.
In this backdrop and to facilitate greater participation of non-institutional investors in the corporate bond market, SEBI proposed to allow companies to issue NCDs and NCRPS at a reduced face value of Rs. 10,000. It was further suggested that, in case of such issuances, the issuer must engage a merchant banker to conduct due diligence for the private placement of NCDs or NCPRSs, including disclosures in the private placement memorandum. The consultation paper also states that, to protect the interests of non-institutional investors, the instruments must maintain a straightforward structure, being plain vanilla, interest, or dividend-bearing, without incorporating credit enhancements or complex obligations.
Implications and Challenges
The implementation of the proposals will significantly impact both issuers and retail investors. A lower face value enhances accessibility for retail investors and broadens their investment base beyond traditional fixed income instruments like fixed deposits, offering opportunities for better returns. It will also lead to a diversification of the portfolios of retail investors which have been dominated by conventional investment avenues like equity instruments and government securities. Increased participation from non-institutional investors can also potentially democratize the corporate bond market and help attract a more diverse investor base.
From an issuer’s standpoint, a diverse investor base is critical for ensuring consistent demand in the market. A variety of investors having diversified risk appetites, tenors and investment objectives promotes active trading which fosters liquidity and leads to cost-effective borrowings. Unlike institutional investors who may have specific requirements or limitations on investment tenors, retail investors are more flexible. Consequently, issuers can tap into retail demand for longer tenors that may be in limited supply from institutional investors. This aligns with the business needs of issuers, enabling them to secure funding for projects or operations with long-term horizons. Additionally, the diversification resulting from increased retail participation can help reduce reliance on a confined set of institutional investors, mitigating vulnerabilities to short squeezes in the institutional space.
SEBI’s proposal also has positive cascading impacts on the robustness of the overall bond market. A diverse investor participation brings different perspectives and information to the market facilitating a more comprehensive assessment of the intrinsic value of bonds. This diversity contributes to a more accurate price discovery process. An increase in the number of actively traded bonds would help build market depth, enhancing the overall resilience and stability of the credit market. The increased liquidity and trading activity stemming from the low face value could potentially lead to lower bid-ask spreads. A narrow spread indicates a small difference between the buying and selling prices, reducing the transaction costs for customers, thereby making markets more attractive.
Increased retail participation can also have positive macroeconomic impacts. The rising rate of mergers and acquisitions and capital expenditure across sectors has warranted a greater capital infusion. A robust and liquid debt market assumes a pivotal role as a support to the larger banking system. It addresses fundamental corporate needs by providing an essential support for capital investment and long-term asset creation. Increased activity and robustness in the corporate bond market can help both private and public companies to raise capital for infrastructure expansion without excessively relying on banks. This can reduce levels of non-performing assets thereby easing the strain on the banking sector.
There are, however, certain aspects which SEBI must ponder over while implementing this proposal. A major reason behind the lack of popularity of bonds among retail investors is primarily due to competition from alternative instruments, several of which carry tax concessions. These include government-backed small savings schemes like National Savings Certificates and Savings Bonds which are specifically aimed at retail investors. The effective returns provided by these instruments often exceed those on marketable securities like bonds which lack similar tax concessions. Another implementational hurdle is the overdependence of retail participation on intermediaries who charge a high fee in exchange of distribution, thereby increasing the cost of issuance.
One of the most pressing challenges confronting the corporate debt market is an underdeveloped secondary market. According to SEBI, the value of the outstanding stock of corporate bonds is nearly Rs. 41 trillion, significantly higher than the secondary corporate bond market’s settled value amounting to Rs. 11.73 trillion. A well-developed secondary market enhances liquidity and by increasing the active trading of bonds, widens the primary market issuer base, and leads to a more robust price discovery mechanism. This aspect assumes importance, considering that the low liquidity in the corporate bond market has resulted in limited exit options and the payment of high illiquidity premiums for retail investors, hampering their participation in the bond market.
Conclusion
While SEBI’s proposal is a positive development and a step in the right direction, the regulator must also weigh the highlighted challenges and concerns to efficiently implement the proposal. It could consider seeking the introduction of tax concessions up to a certain defined threshold for individuals directly investing in the corporate bond market, which could provide a fillip to direct retail participation. The problem of high and non-standardized fees charged by intermediaries for purposes like opening accounts can be remedied by the introduction of a uniform and reasonable cost which would boost transparency and retail investments. The liquidity concerns in the secondary corporate bond market could be addressed by introducing market makers, which are entities similar to primary dealers in the government securities market.
As outlined in a consultation paper released by SEBI in November 2021, market makers can play a significant role in this regard as they help enhance market liquidity by absorbing temporary imbalances in demand and supply, thereby cushioning the impact of shocks on market volatility. Further, market makers also quote prices to assist investors in valuing assets, improving liquidity conditions in the secondary bond market. This would usher in a robust secondary market with better price discovery, improved liquidity premium and a reduced cost of debt.
– Shalin Ghosh
