Corporate Bond Market in India

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Why Corporate bond Market is under Developed in India?

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STCI Primary Dealer Limited

Project Report On Corporate Bonds Market in India

Saiyam Adani Arpan Shah Susheel Racherla Hiren Patel

STCI Primary Dealer Ltd

Mr. Siddharth Shah – Head of Fixed Income Sales Mr. Manish Jadhwani – Head of Risk Management

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Executive Summary

Within any country’s capital market, it is essential that there exist a well-developed bond market with a sizeable corporate bond segment alongside the banking system, so that the market mechanism ensures that funds flow in accordance with the productivity of individual investments and the market exerts a competitive pressure on commercial banks’ lending to private business and helps improve the efficiency of the entire capital market. Further, the debt market must emerge as a stable source of finance to business when the equity markets are volatile. However, most countries do not have corporate bond markets comparable in efficiency with their equity markets, as the secondary market for corporate debt is mostly Over-the-Counter (and/or telephonic), rather than exchange traded, and it is extensively dominated by a few institutional investors and professional money managers. The market for non-sovereign debt (particularly, the corporate debt segment) in India also has a number of shortcomings: a primary market structure where private placements, sans mandatory credit ratings, dominate in an overwhelming manner, lack of transparent market making, and a tendency on the part of institutional investors to hold securities to maturity. The secondary market is thus prone to suffer from low liquidity and fragmentation and the consequent pricing anomalies. In this paper, we make an attempt to understand: 1) The structure of the corporate bonds market in India 2) Major reforms in bond market in India 3) Technical terms related to bonds 4) Risks associated with investing in corporate bonds 5) Highlight of Indian corporate bond market and comparison with other countries 6) Comparison of Corporate bonds with G-sec and Equity 7) Private placement, trading and public issue data of corporate bonds 8) Methods of issuing corporate bonds 9) Regulatory framework related to corporate bonds 10) Condition of Indian corporate bond market 11) Steps Taken by SEBI, RBI and FIMMDA to improve corporate bond market

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Introduction
The Bond Market in India with the liberalization has been transformed completely. The opening up of the financial market at present has influenced several foreign investors holding up to 30% of the financial in form of fixed income to invest in the bond market in India. The bond market in India has diversified to a large extent and that is a huge contributor to the stable growth of the economy. The bond market has immense potential in raising funds to support the infrastructural development undertaken by the government and expansion plans of the companies. Sometimes the unavailability of funds becomes one of the major problems for the large organization. The bond market in India plays an important role in fund raising for developmental ventures. Bonds are issued and sold to the public for Funds. Bonds are interest bearing debt certificates. Bonds under the bond market in India may be issued by the large private organizations and Government Company. The bond market in India has huge opportunities for the market is still quite shallow. The equity market is more popular than the bond market in India. At present the bond market has emerged into an important financial sector.

Different types of bond market in India
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Corporate Bond Market Government Bond Market Short Term Corporate Debt (Money) Market Mortgage Backed and Asset Based Securities Market

Major reforms in Bond market in India
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The system of auction introduced to sell the government securities. The introduction of delivery versus payment (DvP) system by the Reserve Bank of India to nullify the risk of settlement in securities and assure the smooth functioning of the securities delivery and payment. The computerization of the SGL. The launch of innovative products such as capital indexed bonds and zero coupon bonds to attract more and more investors from the wider spectrum of the populace. Sophistication of the markets for bonds such as inflation indexed bonds.

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The development of the more and more primary dealers as creators of the Government of India bonds market. The establishment of the a powerful regulatory system called the trade for trade system by the Reserve Bank of India which stated that all deals are to be settled with bonds and funds. A new segment called the Wholesale Debt Market (WDM) was established at the NSE to report the trading volume of the Government of India bonds market. Issue of ad hoc treasury bills by the Government of India as a funding instrument was abolished with the introduction of the Ways And Means agreement.







Corporate Bonds
Corporate bonds are nothing but debt instruments issued by a corporation, the holder of which receives interest from the corporation periodically for a fixed period of time and gets back the principal along with the interest due at the end of the maturity period. E.g. considering that you hold a 10% 5‐ year corporate bond issued by XYZ Co. with Face Value Rs. 100 and interest is paid annually: XYZ Co. will • Pay you Rs. 10 every year for 5 years • Redeem face value of the bond i.e. Rs.100 + Rs. 10accrued interest at the end of 5 years. In India, both public and private companies can issue corporate bonds. A company incorporated in India, but part of a multinational group, can also issue corporate bonds. However, a company incorporated outside India cannot issue corporate bonds in India. A statutory corporation like LIC can also issue corporate bonds. If you are looking for an investment that generates fixed income periodically, corporate bonds may be an ideal investment for you. It normally offers you a higher rate of interest as compared to fixed deposits or postal savings or similar investments. If your bonds are listed, you can also sell it in the secondary market before its maturity. While a bond is usually not designed for capital appreciation; a listed bond may also earn you capital appreciation i.e. you can sell your bond at a price higher than your cost price in the market.

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Investing in Corporate Bonds
The company which is planning to raise funds through corporate bonds will offer a public issue or a private placement. A private placement is usually made to institutional investors and not to retail investors. A public issue means an offer will be made to the public in general to subscribe to the bonds. In a public issue, the company has to issue a prospectus before issuing the bonds. A prospectus is nothing but a document containing details about the company and the bonds to be issued. After the public issue, these bonds are listed on a recognized stock exchange in India. Hence such types of bonds are called listed bonds.

Primary and Secondary Markets

In case of listed bonds, an investor can buy the bonds through 2 avenues: • Through the public offering by the company • Through the exchange the public offering by the company is referred to as primary market and the trading of the shares subsequently through the exchange is called secondary market. You can buy bonds through either of these markets. If you buy the bonds through the public offering, you will be buying the bonds directly from the company and if you buy the bonds through the secondary market, you will be buying the bonds not from the company, but from sellers who wishes to sell the bonds held by them. When you buy the bonds through a public offering, you usually buy it at the face value of the bond. However, the issuer may also issue the bond at a premium or a discount. When you buy the bonds from the exchange, you have to pay the market price, which may be higher or lower than the face value.

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Technical Terms
Fixed/ Floating Interest rate A corporate bond may offer a fixed or floating rate of interest and accordingly you may earn a fixed or varying amount of interest periodically. Fixed rate bond will pay you a fixed amount periodically as per the interest rate set out when the bonds we reissued. This interest is determined as a % of the Face Value of the bond. Such fixed interest payments are sometimes also called coupon payments. Floating rate bond has its interest rate pegged to a benchmark rate i.e. (Benchmark rate) +/‐ (some %). The bench mark rate may be Government bond /MIBOR. As the benchmark rate changes, the interest rate on the bond will vary accordingly. Hence, a floating rate bond is considered to be relatively risky since your return is dependent on the movement of the benchmark rate. Periodicity of interest payments An investor in corporate bonds receives his interest payments periodically. The interest may be received yearly or half‐ yearly or quarterly or even monthly depending upon the period set at the time of issue. The interest payment dates are usually specified in the prospectus. On the maturity date, the issuer pays back the investor face value of the bonds held by him along with the interest accrued on the same. Interest payments are sometimes classified as cumulative or non‐ cumulative.In case of cumulative interest repayments, if the issuer is unable to pay the investor the interest on the due date, the interest gets accumulated and can be paid on the next scheduled payment date. This clause is beneficial to the issuer since he can adjust his cash flows accordingly. However it is not beneficial to the investor since he loses the time value of money. However, a cumulative interest repayment is always a better option for the investor as compared a noncumulative bond since in case of non‐cumulative bonds; the interest gets forfeited, if not paid by the issuer on the due date. Maturity date Maturity date is the date on which the bond matures i.e. issuer repays the face value of the bond along with the accrued interest to the investor and dissolves himself of all the obligations attached to the bond. The issuer is bound to buy back the bond on the maturity date. The maturity date determines whether the bond is long term, short term or medium term. The maturity date is usually mentioned explicitly in the prospectus. However, some bonds have certain options (call or put options) which may allow the issuer to buyback the bonds before the due date or the holder to sell the bonds back to the issuer before the due date. This may reduce the term of the bond and hence it is essential that you analyze the effect of exercising of such options on your cash flows before buying such bonds.

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Secured/Unsecured bonds If the company in whose bonds you have invested is wound up (closes down), it’s important for you to Know where you stand when the company repays its debts. The order in which the Company repays its Debts depends upon the ranking of the bonds based on the security Bonds are either secured against assets or unsecured. If the bonds are secured, in the event of winding up of the company, it would sell off the assets against which the bonds were secured and repay the investor. However, all secured assets do not have the same ranking. When the company repays its assets, it has to follow the following order in repayment of its dues: 1. Statutory and tax dues 2. Secured bonds (senior) 3. Secured bonds (subordinated) 4. Unsecured bonds 5. Preference shares 6. Equity shares

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Capacity of the firm to Repay When you invest in corporate bonds, you need to ensure the company is in a position to repay your principal and the interest due to you. Hence, you need to analyze the company well before investing in its bonds. You can analyze the health of the company by checking its business model, its financials, by employing ratios, by meeting its management and in several other ways. The most common way of analyzing the ability of a company to pay its debts is by analyzing its financial statements. You need not be bogged down by the huge data that is provided in the annual reports. However, along with the ratios, check the maturity pattern of the existing loans of the company and verify whether there is a significant amount of debt maturing soon and which may have to be rolled over. In addition, verify whether the company has been a defaulter in the past or has rolled over its debt or has breached its loan agreement or whether there are/were any lawsuits against the company.

Convertible/Nonconvertible Bonds Bonds which can be converted into equity shares at a later date are called convertible bonds. Such conversion can occur at a price predetermined at the time of issue of bond or at the prevailing market price. On the same lines, bonds which cannot be converted into equity shares are called non‐convertible bonds. Convertible bonds are in fact hybrid securities i.e. they carry the features of both equity and debt. Till the investor holds the bond, he receives interest periodically. However, once it is converted into equity shares, the investor enjoys benefits as an equity shareholder. This gives the bondholder both a fixed income investment with coupon payments as well as the potential to benefit from an increase in the company’s share price. Since convertible bonds carry the additional option of conversion into equity share, the interest rate is usually less as compared to a non‐convertible bond. Some bonds are compulsorily convertible into equity shares after a particular period or on a particular date. Such bonds are called compulsorily convertible bonds.

Put& Call Options Some bonds have embedded options which either allow the issuer to buyback the bonds before the maturity or the holder of the bonds to sell the bonds to the issuer before the maturity. Such options are explicitly stated in the offer document at the time of the issue of the bonds .Bonds which give the issuer right to buy back the bonds before its maturity are called callable bonds. Callable bonds usually come with an initial lock‐in period. Since investing in such bonds exposes the Investor to the additional risk of buyback they usually offer a higher rate of interest as compared to bonds without such options. Bonds which give the investor the right to sell the bonds back to the issuer before the maturity of the bond are called puttable bonds. Since such bonds give the investor a right to sell before maturity, they usually offer a lower rate of interest as compared to bonds without such options.

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Risks involved in investing in corporate bonds
Though corporate bonds are less risky as compared to investments such as shares, they have their own risks. Some of the risks that you will be faced with if you invest in a corporate bond are listed below:

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Indian Corporate Debt Market
India has been distinctly lagging behind other emerging economies in developing its long-term debt market (LTDM). The equity market has been more active, developed and at the centre of media and investor attention. Traditionally, larger corporate have used bank finance, equity markets and external borrowings to finance their needs. Small and medium enterprises face significant challenges in raising funds for growth.

Comparison with other countries
In India, the proportion of bank loans to GDP is approximately 36%, while that of corporate debt to GDP is only 4% or so. In contrast, corporate bond outstanding is 70% of GDP in USA, 147% in Germany, 41% in Japan, & 49% in South Korea. The size of the Indian corporate debt market is very small in comparison to both developed markets, as well as some of the major emerging market economies. For a sample of eight Indian corporates that featured in Forbes 2000, corporate bonds account for only 21% of total long term financing. In contrast, corporate bonds account for nearly 80% of total long term debt financing by corporates in the four developed economies of USA, Germany, Japan and South Korea1. In these countries, the share of corporate bonds is close to 87% for corporates graded above BBB and 66% for the rest. Corresponding figures in major emerging economies such as South Africa, Brazil, China and Singapore, are 57% and 33% for corporates rated above BBB and those rated at BBB or below respectively. Drawing on the cross sectional experience of G7 countries since the 1970s, it is estimated that the overall capitalization of the Indian debt market (including public-sector debt) could grow nearly fourfold over the next decade. This would bring it from roughly USD 400 billion, or around 45% of GDP, in 2006, to USD 1.5 trillion, or about 55% of GDP, by 2016. This growth, if not crowded out by public sector debt, could result in increased access to debt markets for Indian corporates.

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Comparison with the G-Sec Market and Equity Market
In India the long-term debt market largely consists of government securities. The market for corporate debt papers in India primarily trades in short term instruments such as commercial papers and certificate of deposits issued by Banks and long term instruments such as debentures, bonds, zero coupon bonds, step up bonds etc. In 2011, the outstanding issue size of Government securities (Central and State) was close to Rs. 29 lakh crores (USD 644.31 billion) with a secondary market turnover of around Rs. 53 lakh crores (USD 1.18 trillion). In contrast, the outstanding issue size of corporate bonds was close to Rs. 9 lakh crores (USD 200 billion). Moreover, the turnover in corporate debt in 2011 was roughly Rs. 6 lakh crores (USD 133 billion) whereas in 2011, the Indian equity market turnover was roughly Rs. 47 lakh crores (USD 1.04 trillion.)

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Default Risk and Credit Rating of Corporate Bonds
Credit analysis involves analyses of information on companies and their bond issues in order to estimate the ability of the issuer to live up to its future contractual obligations—the conclusions are given in the form of ratings. Ratings take into consideration factors like the likelihood of default (particularly under adverse circumstances) provisions of the debt obligation, protection offered by and the relative position of the debt obligation in case of bankruptcy, etc. Though various rating agencies use different symbols, generally: Triple-A denotes the highest safety category Double A denotes high safety Single-A denotes adequate safety Triple B represents moderate safety Double B is inadequate safety Single B denote risk prone C denotes substantial risk and D denotes defaulted paper
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Except for triple A, in other categories use of + or—suffixes indicate above average or below average credit quality within that letter grade. Paper with ratings up to BBB—is considered to be investment grade, while those below that are regarded as non-investment-grade or junk-bond quality. A credit rating system is an essential component of any well-functioning corporate bond market, as it encourages the most efficient allocation of capital raised by debt issues. Such a system (i) augments the quality and quantity of information on issuers, (ii) provides the measurement of the relative risk of bonds in question, (iii) provides bond issuers an incentive for financial improvements, and alleviates a loss of liquidity due to security fragmentation. Thus, a credit rating system essentially facilitates the “transferability” of corporate bonds. Investors will demand a higher interest rate, commonly known as a risk premium, to compensate for the higher credit risk implied by a lower rating; this differentiation of interest rates on the basis of risk in turn helps ensure the efficient allocation of resources by investors while further encouraging companies to improve their financial performance. A well functioning credit rating system also encourages greater transparency, increased information flows, and improved accounting and auditing practices. In addition, the limited number of creditworthiness symbols alleviates issuer based fragmentation of bonds and allows for the bundling of bond issues of the same or very similar creditworthiness into a single category from among the universe of issues. This creates the ground for interchange ability of bond issues by different issuers and facilitates arbitrage activities, which in turn can make the bond market more liquid

Private Placement
The convenience of structuring of issues to match the needs of issuers with those of investors coupled with savings in terms of time and cost has contributed to rapid growth of the market for private placement. The rationale for investing in the private placement market lies in the convenience and flexibility to the issuers as well as investors. This route is generally preferred by corporates wishing to issue securities with complex or non-standard features, as deals can be tailor-made to suit the requirements of both issuer and investor. Many companies may prefer private placements if they wish to raise funds quickly to take advantage of interest rate change in volatile market conditions. This market is also preferred by new entrants who do not have track record of performance and hence are unsure about generating adequate public response for their public issues. Again corporates may prefer this route if the general market environment is not conducive for floating public issues. The investors also have advantages in subscribing to private placements, particularly, when there is no adequate supply of good public issues to match the amount of investible funds available, investors look for bonds at attractive rates in the private placement market. Further, the private placement market provides investors with securities with more or less fixed/predictable cash inflows, which help the investor to match the expected stream of returns with the expected cash outflows. No regulatory compliance is another important reason why corporate issuers prefer this route and avoid public issues. In the private placement market, it is not mandatory to obtain rating on debt instruments, even though some issues are accompanied by rating. The issuer is also not required to make fair disclosure of all The credit ratings obtained.

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Private Placement data for Corporate Bonds in India for 2011-2012

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Trading in Corporate Bonds (Rs. in cr)

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Public Issue Data of Corporate Debt

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Corporate Bond Issuance
One way corporations raise capital for financing expansion projects is by offering corporate bonds in the market. These corporate bonds are debt instruments and usually pay semi-annual interest earnings to investors. A company can offer a corporate bond to the market through the use of an investment bank. The process involves determination of adequate collateral for issuance of bonds, valuation of assets that will be collateralized, preparation of a bond contract, fulfillment of legal requirements, and marketing of the corporate-bond offering. 1. Prepare a document for the corporate offering. This document will be presented to various investment banks and should include information regarding the amount that the corporation expects to raise; the collateral that can be provided to secure the corporate bonds and any other pertinent information that may help investment banks evaluate the proposal. 2. Select the most suitable investment bank amongst the banks that have expressed interest in the offering. The most suitable investment bank is not always the one offering the lowest fees for their services. During the selection process you must take into account the level of industry expertise an investment bank can offer. 3. Obtain an independent evaluation for the price of the property or assets that your company plans to provide as collateral for the corporate bond issuance. This is a legal requirement aimed at protecting the integrity of both the corporation and the investment bank.

4. Prepare an indenture for the corporate bond issuance. The indenture is a contract that lists the rights and obligations of all the parties involved in the transaction. The indenture also lists the group of banks that are underwriting the bond issuance; the banks are known as a syndicate. The underwriting of corporate bonds means that if a part of the issuance remains unsold in the market, the banks will purchase the remaining amount in accordance with the proportion they guaranteed in the agreement. The investment banks will charge an underwriting fee for this process.

5. Offer the corporate bonds to the market through various marketing tools with the help of your investment bank. The investment banks will usually sell a major proportion of the offering to their institutional clients who have similar requirements. The corporate bond offering will also be featured in various finance newspapers to attract the high-end investor. Finally, brochures are provided to all the parties interested in buying the corporate bonds.

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Methods of Issuing Corporate Bonds
When a company wants to build a new factory or office building, or acquire another company, the cost of doing so is generally higher than can be accommodated by a bank loan. At such times, the company gets its funding through issuing debt privately or to the public. Private issuance is called a private placement of debt, and a public issuance is called a debt underwriting. Underwriting The company engages an investment banking firm to handle the issue. The investment banker performs financial due diligence on the company, advises on the structure of the issue and prepares the legal documents. Then the investment banker underwrites the issue by buying it from the company, to be sold by a syndicate of investment bankers assembled to distribute the issue to their clients.

Pre-Sale Distribution The investment banker is the lead underwriter and book-running manager of the syndicated offering, and gathers several other investment banking firms to participate either by contributing money to the purchase of the securities from the company or by just participating in the selling group. Those providing money receive management fees on top of the commission, but the selling group only receives the sales commission. Prior to the pricing of the issue the securities brokers at all the participating firms go out to their clients and take orders for the bonds. This is called the pre-sale distribution. Pricing Once enough buying interest has been established, the lead underwriter prices the issue according to market conditions at the time of pricing and anticipated secondary market interest. If the issue is oversold, it will be priced slightly rich. If it is difficult to get buying interest, the issue will be priced cheap. After the pricing, all transactions are made final within a few minutes and the back office takes over the receipt of funds and delivery of the certificates.

Private Placements A private placement of debt is usually a smaller issue that is not syndicated but sold privately to one or more institutional clients of the investment banker. Private placement buyers of this type are generally insurance companies that are buying securities to match specific payout dates, so they don't care that private placements are somewhat illiquid. That means that they are not easily sold into the secondary market.

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The process of Issuance of Bonds includes certain expenses that are incurred by the issuer, and are better known as the Costs of Issuance. The Costs of Issuance that is covered by the issuers during the sales of bonds includes all of the following expenditures: Fees paid to the consultants: o o o o o o o Fees and charges towards legal expenses Trustee’s fees Printing costs Discounts on bonds or notes Costs of credit ratings The execution and safekeeping fees and charges of bonds or notes Fees for filling and recording the issuance of bonds.

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Tax Free Bonds V/S Tax Saving Bonds
At Present in Indian Market, Various Financial Institutes and Other Authorities are issuing various types of bonds such as Tax Free Bonds, Tax Saving Bonds. The Major Players in Tax Free Bonds are NHAI, Power Finance Corporation (PFC), Indian Railway Finance Corporation (IRFC) whereas in Tax Saving Bonds - L&T and IDFC are major players. The basic difference between Tax Free Bonds and Tax Saving Bonds is:   Tax free Bonds yields Interest which is not taxable in the hands of Investor whereas in case of Tax Saving bonds it is chargeable to Tax in hands of Investor Investor gets Deduction under Section 80CCF if he invests in Infrastructure Tax Saving Bonds up to Rs. 20,000 whereas same is not available in case of Tax free Bonds.

Tax Free Bonds: Recently National highway Authority of India (NHAI) has launched Tax free Infrastructure bond. The said bond is listed in NSE and BSE having “AAA” rating which represents highest safety and stability. It is for the very first time where NHAI has been allowed to raise Rs. 10,000 Cr. Through Tax free bond with a coupon rate of 8.2 % for 10 year and 8.3 % for 15 years which will be majorly used in acquiring land for various projects. It is needless to mention here that NHAI is allowed to raise fund through 3 Years 54EC bonds. The said bond has no minimum Lock-In-Period and investor can use exit routes by selling off the bonds on Stock Exchanges. Power Finance company (PFC) also opened its issue on 30th December, 2011. It is offering rates similar to NHAI. PFC’s offer for bonds is last on 16th January, 2012.

Tax Saving Bonds: Tax Saving Bonds – are instruments used for Individual Income Tax savings. They have not been as popular as some of the other Tax saving instruments, but are ideal for people who have low risk appetite and are looking to preserve their income in the longer run and also accrue benefit of tax savings. In Union Budget 2010-2011, a new section 80CCF was inserted under the Income Tax Act, 1961 – to provide for income tax deductions for subscription to long-term infrastructure bonds. These long term infrastructure bonds offer an additional window of tax deduction of investments up to 20,000. Recently L&T and IDFC have come up with an Issue for Tax-saving bonds. There is Minimum Lock-In-period for 5 years in Tax Saving Bonds. Investor can sell it on stock exchanges post Lock-In/ buy back offers. The interest rates are 9%. L&T infrastructure bond assigned to credit rating as “AA+”, However IDFC infrastructure bonds have got the highest credit rating of “AAA”.

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Tax saving instruments under 80C
1. Contribution to Provident Fund 2. Contribution to Public Provident Fund 3. Payment of life insurance premium 4. Investment in pension plans 5. Investment in Equity Linked Saving Schemes of mutual funds 6. Investment in Infrastructure Bonds 7. Investment in National Savings Certificate 8. Pension Funds – Section 80CCC 9 5-Yr bank fixed deposits (FDs) 10. Senior Citizen Savings Scheme 2004 (SCSS): 11.5-Yr post office time deposit (POTD) scheme 12. NABARD Rural Bonds 13. Unit linked Insurance Plan

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Regulatory Framework

FIMMMDA- Fixed Income Money Market and Derivatives Association of India
The Fixed Income Money Market and Derivatives Association of India (FIMMDA), an association of Commercial Banks, Financial Institutions and Primary Dealers, was incorporated as a Company under section 25 of the Companies Act,1956 on June 3rd, 1998. FIMMDA is a voluntary market body for the bond, money and derivatives markets. FIMMDA has set up the corporate bond reporting platform known as FTRAC as well as clearing system known as CBRICS.

CBRICS – Corporate Bond Reporting and Integrated Clearing System

FIMMDA reporting platform launched a reporting Platform for Corporate Bonds in 2007. Pursuant to the RBI and SEBI circular to bring reporting in Commercial Papers (CP) and Certificate of Deposits (CD) under the reporting ambit, the platform has been modified to accept reporting of deals for CP/CD instruments. This platform is intended to enable RBI and SEBI intermediaries to report their transactions in corporate bonds, CP and CD on a single platform. This platform shall also provide information on reported trading volumes, yields, prices, information about instruments and its attributes.

1. RBI regulated Entities All RBI-regulated entities shall report their OTC transactions in CDs and CPs on the FIMMDA reporting platform within 15 minutes of the trade for online dissemination of market information. Detailed procedure in this regard would be advised by FIMMDA.

2. SEBI Regulated Entities SEBI Regulated entities (u/s 12 of the SEBI Act) shall report their OTC, transactions in CDs and CPs on the FIMMDA reporting platform within 15 minutes of the trade for online dissemination of market information with effect from August 16, 2010. (SEBI Circular: CIR/IMD/DF/6/2010 dated July 30, 2010

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FTRAC
F-TRAC means FIMMDA’s Internet based Trade Reporting and Confirmation for Capturing/ reporting of trades in (i) Certificates of deposit and/or commercial papers transactions in primary and/or secondary market (ii) Outright corporate bonds trades in secondary market (iii) Repo transactions in corporate bonds. In this F-TRAC platform only secondary market transaction is being reported.

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Indian Corporate Bond Market Condition
Now that we have established there is a need for a vibrant and liquid corporate bond market in India. Let us analyze the reasons that impede its growth. Major factors inhibiting its development are: Regulatory restriction on institutional investors 1. Banks:
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They are prevented from investing in unrated debt instrument. They are also restricted to invest only 10% of their total non - SLR investments in unlisted debt papers. Further only investment grade securities are eligible for subscription by banks. This prevents banks from investing in bonds of lower rated.



2. Insurance Companies and Pension Funds: Internationally institutional investors like insurance companies and pension funds play an important role in the corporate bond market as the investment time horizon for these institutional investors and the bonds are long. In India, the involvement of insurance companies in corporate debt market so far has been limited. Insurance companies and pension funds have huge potential to play a bigger role and contribute to the sophistication and deepening of the bond market in India. 3. Chicken And Egg Problem: There is a lack of supply of suitable long term bonds which suit the need of insurance and pension firms. Also there is lack of demand due to regulatory restrictions on investment in corporate bonds. Non Uniform stamp duty: Stamp duties are typically 0.375% for debentures and, as they are strictly ad-valorem, there is no volume discount. The rate of duty varies depending upon location (various states have set their own rates). Currently, if the bond is being sold in one (state) jurisdiction, but the asset has to be securitized in another, then the stamp duty as applicable in the latter is levied. Majority Issues being Private Placements and not Public Issues: Public issues are bonds offered to a wide range of investors and which conform to the regulatory standards required of public issues of bonds. They require a prospectus approved by SEBI, and have to be open at a fixed price for a month to allow investors particularly retail investors to subscribe. Private placements can be made to a maximum of 50 “Qualified Institutional Buyers” (professional investors). TDS in Corporate Bonds: In case of corporate bonds, TDS is deducted at source for resident and on non-resident investors as per prevalent tax laws. Absence of sub-investment grade securities: In developed markets like USA, UK, Japan there is a vibrant market for sub investment grade securities. While in India regulatory restrictions prevent institutional investors from investing in such securities. This limits issuance of lower rated bonds.

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Low Retail Participation: Indian retail investors have not shown interest in the corporate bond market. This may be due an illiquid secondary market and the low confidence (low risk appetite) in the corporate world. Retail investors prefer PF and Post Office schemes and other alternate investment avenues. Less investor knowledge and awareness about such products may be one of the reasons for their low participation. Absence of Market Makers: There is a need for general market for corporate bonds to be developed for the market participants. Market Makers can address the issues of price discovery and liquidity in the corporate debt segment.

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Recent Measures
The size of the Indian corporate bond market at 11.8 per cent of GDP is lower than the average for emerging East Asia and for Japan at 17.2 per cent and 19.8The finance ministry is readying a big booster dose for corporate bonds market that includes allowing banks to count their top-rated private sector bond purchases towards the mandatory investments and a reduction in funds that companies have to keep aside every year to redeem debentures issued. The ministry has initiated talks with the RBI and the corporate affairs ministry to facilitate these changes that could ignite bank interest in corporate bonds and encourage companies to raise funds through debentures, which accounted for lowly 3.9 per cent of their funds needs in 2010-11.Banks have to invest 23 per cent of their deposits in government securities, which is called the statutory liquidity ratio or SLR. If their investment in AAA-rated corporate bonds is counted towards SLR, as proposed by the finance ministry, banks will get that much more room to invest in private sector debt, encouraging blue chip companies to come out with more issues. Manufacturing and infrastructure companies have to create a reserve of up to 50 per cent of the value debentures issued through public issue. The finance ministry now wants this fund to be reduced to 25 per cent of the debentures issued to encourage companies to raise corporate bonds and also free up funds required for their servicing for investments. The Government has decided to allow select companies to issue tax-free bonds in the rest of the financial year. The notification mentions that a total of Rs 53.5 thousand crore be raised through issue of tax-free infrastructure bonds in the current financial year that ends in March. The first issues to hit would be IIFCL, PFC and REC. The yield for the investors pre tax and post tax is expected to be 7.67%, 8.55% (@10.3% tax bracket), 9.66% (@20.6% tax bracket)& 11.1% (@30.9% tax bracket) for AAA/AA+ rated bonds The list of such companies is as under: 1. National Highway Authority of India (NHAI) : Rs 10000 crore 2. Indian Railway Finance Corporation (IRFC): Rs 10000 crore 3. India Infrastructure Finance Company Limited (IIFCL): Rs 10000 crore 4. Housing and Urban Development Corporation (HUDCO): Rs 5000 crore 5. National Housing Bank (NHB) : Rs 5000 crore 6. Power Finance Corporation (PFC) : Rs 5000 crore 7. Rural Electrification Corporation (REC) : Rs 5000 crore 8. Jawaharlal Nehru Port Trust : Rs 2000 crore 9. Dredging Corporation of India : Rs 500 crore 10. Ennore Port Limited: Rs 1000 crore Minimum 75% of the aggregate amount of allotted bonds is to be issued through public issue. 40% of the issue shall be earmarked for retail investors. When issuing through private placement

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STCI Primary Dealer Limited

India proposed to double the maximum amount foreign investors are allowed to invest in corporate bonds to $40 billion, with the entire additional investment to be eligible only in bonds issued by infrastructure companies. The proposal will "enable the flow of funds to the infrastructure sector. The Indian Government has recently allowed Qualified Foreign Investors (QFIs) to invest directly in the Indian market. The proposed new investment route is aimed at improving investor confidence in the Indian market. This initiative is expected to significantly stimulate foreign investment in India. Investment through the QFI route was initially introduced by the Securities Exchange Board of India (SEBI) in August 2011. The QFIs are permitted to invest, in addition to the units of mutual funds and shares of listed Indian companies, in the following debt securities: a. Listed and to be listed non-convertible bonds (NCDs); b. Listed and to be listed bonds of Indian companies; and c. Listed units of mutual fund debt schemes. QFI investment in corporate bonds A budget proposal for QFIs is being introduced, allowing QFIs to invest in corporate bonds and mutual fund debt schemes. A separate sublimit of USD 1 billion has been also created for the purposes of QFI investment in such corporate bonds and mutual fund debt schemes. This provision may positively influence foreign inflows, primarily with regards to foreign investors interested in debt investments, for example high net worth individuals (HNIs) who are enticed by the high level of interest rates and returns that debt investments offer. The QFI route shall provide a direct alternative to the foreign investors who were previously forced to invest in non – convertible debentures listed on the stock exchange through the foreign institutional investments route. The Press Release doesn't clarify however, whether QFIs would be allowed to invest in unlisted corporate bonds. Removal of 5 day limit Previously if the funds of QFI were not invested within five working days of the receipt of the funds, and simply remitted in the Indian rupee account of the QFI, they were required to be transferred to the designated overseas bank account of the QFI. This rule caused many administrative inconveniences and loss, due to the exchange rate fluctuations. According to the Press Release, The Ministry has now decided to remove the 5 day limit rule allowing the QFI to have the freedom to retain the funds in their account in India, reducing the high cost of transfer of funds and other losses, for example due to the exchange rate.

Freedom to open a separate account Before May 2012, the QFIs were allowed to invest only through the rupee pool bank account of their Qualified Depository Participant (QDP). The Press Release now permits QFIs to open a separate individual non-interest bearing rupee bank account with authorized dealer banks in India to undertake transactions under this route.

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STCI Primary Dealer Limited

Steps Taken by SEBI, RBI and FIMMDA
Government, SEBI and other stakeholders have initiated several measures to develop the corporate debt market. Reserve Bank of India has also taken various initiatives in this regard. Some of these are recounted below:

1. To promote transparency in corporate debt market, a reporting platform was developed by FIMMDA and it was mandated that all RBI-regulated entities should report the OTC trades in corporate bonds on this platform. Other regulators have also prescribed such reporting requirement in respect of their regulated entities. This has resulted in building a credible database of all the trades in corporate bond market providing useful information for regulators and market participants. 2. Clearing houses of the exchanges have been permitted to have a pooling fund account with RBI to facilitate DvP-I based settlement of trades in corporate bonds. 3. Repo in corporate bonds was permitted under a comprehensive regulatory framework. 4. Banks were permitted to classify their investments in non-SLR bonds issued by companies engaged in infrastructure activities and having a minimum residual maturity of seven years under the Held to Maturity (HTM) category; 5. The provisioning norms for banks for infrastructure loan accounts have been relaxed. 6. The exposure norms for PDs have been relaxed to enable them to play a larger role in the corporate bond market. Credit Default Swaps (CDS) have been introduced on corporate bonds since December 01, 2011 to facilitate hedging of credit risk associated with holding corporate bonds and encourage investors participation in long term corporate bonds.

7.

8. FII limit for investment in corporate bonds has been raised by additional US$ five billion on November 18, 2011 taking the total limit to US$ 20 billion to attract foreign investors into this market. In addition to the limit of US$ 20 billion, a separate limit of US$ 25 billion has been provided for investment by FIIs in corporate bonds issued by infrastructure companies. Further, additional US$ one billion has been provided to the Qualified Financial Institutions (QFI). 9. The terms and conditions for the scheme for FII investment in infrastructure debt and the scheme for non-resident investment in Infrastructure Development Funds (IDFs) have been further rationalized in terms of lock-in period and residual maturity.

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10. Further, as a measure of relaxation, QFIs have been now allowed to invest in those MF schemes that hold at least 25 per cent of their assets (either in debt or equity or both) in the infrastructure sector under the current US$ three billion sub-limit for investment in mutual funds related to infrastructure. 11. Revised guidelines have been issued for securitization of standard assets so as to promote this market. The guidelines focus on twin objectives of development of bond market as well as provide investors a safe financial product. The interest of the originator has been aligned with the investor and suitable safeguards have been designed. 12. Banks have been given flexibility to invest in unrated bonds of companies engaged in infrastructure activities within the overall ceiling of 10 per cent. 13. Bank has issued detailed guidelines on setting up of IDFs by banks and NBFCs. It is expected that IDFs will accelerate and enhance the flow of long-term debt for funding the ambitious programme of infrastructure development in our country.

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Steps taken during the year 2012-13 to develop corporate Bond market:
1) To permit banks to take limited membership in SEBI – approved stock exchanges for the purpose of undertaking proprietary transactions in corporate bond markets. 2) To enhance liquidity in corporate bond markets, the insurance regulatory and development authority (IRDA) has permitted insurance companies to participate in repo market. the IRDA has also permitted insurance companies to become users of credit default swap .

3) In consultation with the technical advisory committee on Money, Foreign Exchange, and Government Securities Markets, it has been decided to reduce minimum haircut requirement in corporate debt repo from existing 10%/12%/15% to 7.5%/8.5%/10% for AAA/AA+/AA- rated corporate bonds , respectively. 4) Mutual Funds have been permitted to participate in CDS in corporate debt securities, as users. Mutual Funds can participate in CDS for for eligible securities as reference obligations, constituting from within the portfolio of only fixed maturity plans schemes having tenor exceeding one year.

5) Revised guidelines on CDS for Corporate bonds by RBI provide that in addition to listed corporate bonds, CDS shall also be permitted on unlisted but rated corporate bonds even for issues other than infrastructure companies. 6) Users shall be allowed to unwind their CDS- bought position with original protection seller at mutually agreeable or Fixed Income Money Market and Derivatives Association of India price. If no agreement is reached ,the unwinding has to be done with original protection seller at FIMMDA price.

7) CDS shall be permitted on securities with original maturity up to one year like CPs, certificates of deposit, and non convertible debentures with original maturity less than one year as reference / deliverable obligations. 8) In November 2012,the limits of FII investment in G-Secs and corporate bonds( non-infra category) have been further enhanced by 5 billion each , taking the total limit prescribed for FII investment to US $ 25 billion in G-Secs and US$ 51 billion in corporate bonds(infra + noninfra). 9) The government is incentivizing corporate bond markets for attracting retail and High Net worth Individuals toward this segment for enabling issue of long term funds in cost effective manner.
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STCI Primary Dealer Limited

How it can be improved?
There is a need for developing an efficient and vibrant corporate bond market. To meet the needs of firms and investors, the bond market must therefore evolve. The policy recommendations should focus on designing a self-sustaining ecosystem for investors, issuers and market makers. The following reforms are recommended: 1. Life Insurance Co.’s: Minimum investment required in respect of approved securities (GOI, State Government & Securities granted by either GOI or State Government) should be reduced. Minimum investment requirement should be investment grade only i.e. BBB –which is followed in United Kingdom. IRDA (Insurance Regulatory And Development Authority) should allow insurance funds to trade in Govt. securities (currently they are required to hold until maturity) to improve liquidity and depth to secondary bond market.

2. Pension Firms: In order to accelerate the flow of pension funds into infrastructure, Upper limit for investment in Government securities or Government guaranteed securities or gilt funds be reduced. PFRDA should allow pension funds to trade in Govt. securities (currently they are required to hold until maturity) to improve liquidity and depth to secondary bond market.

3. Foreign Institutional Investors: Income Tax Department, Ministry of Finance should do away with or decrease withholding tax rate to encourage investments in bonds. Same has been done to attract off-shore funds into IDF (Infrastructure Debt Funds) by reducing withholding tax on interest payments on the borrowings from 20% to 5%. Republic of Korea had also scrapped this tax leading to threefold increase in FII investment.

4. Rationalizing Stamp Duty: There should be a uniform low rate across all states and that the maximum amount payable should be capped. Fix stamp duties based on tenor and issuance value to encourage public offerings of corporate debt. Department of Revenue (DOR) and State Government need to act on it.

5. Creation of Market Makers in Corporate Bond Market: There is a need to set up institutions that will perform the function of buying/ selling bonds. (By creating a network of dealers which provide two-way quotes). As India already has an established system of Primary Dealers, it should utilize the same for good corporate bond.

6. Risk Mitigation Steps: To address the risks associated with investment in corporate bonds, GOI had introduced CDS (Credit Default Swaps), IRF (Interest Rate Futures) and Repos on corporate bonds but they have not taken off. Initiatives should be taken to popularize these instruments.
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Conclusion

A vibrant bond market can ease financing constraints both in terms of cost of funds as well as ease of access to funds. Considering the size of Indian market, India’s proportion of corporate bonds is insignificant. Policy and regulatory measures need to be taken to increase the breadth and depth of corporate bond market in India. Measures need to be taken for domestic insurance and pension firms and Foreign Institutional investors to invest in corporate bonds. There should be uniformity in the stamp duty levied across the states. Initiatives should be taken to encourage public issues and not private placements. Risk management tools like Interest rate Futures, Credit Default Swap and Repo in Corporate bonds should be popularized. A liquid corporate bond market can play a critical role in supporting economic development as it supplements the banking system to meet the requirements of the corporate sector for long-term capital investment and asset creation.

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References
www.rbi.org.in/ www.sebi.gov.in/

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