RBI had, recently, announced measures to further deepen the debt market following the recommendations of the working group on development of corporate debt markets (Khan Committee). The working group has suggested a timeline for implementation of various recommendations based on discussions with the government and the regulator. As some of the other recommendations get implemented, the corporate bond landscape could undergo further changes, both with regard to market design and depth.
RBI measures include far reaching changes such as the large exposure framework and framework for enhancing credit supply for large borrowers through market mechanism. While these measures are primarily intended to de-risk banking system exposure, the same would over time lead to more market issuances by corporates. This may enhance the potential supply of market issuances, but the ability of this supply to be absorbed, especially for lower rated entities would depend on the success of some of the other initiatives/reforms in the works. Mutual funds have increasingly been investing in sub-AAA credits, but given the increasing appeal towards credit funds other category of investors have been restrained by the directed investment patterns. Adequate flexibility in the mandated investment pattern would be one pre-requisite for smoother absorption of market-based borrowings. In this context, the permission for banks to provide higher partial credit enhancement would enable a higher rating than the standalone ratings, making a potentially larger pool of issuances eligible for the regulated investment category. A well-functioning bankruptcy regime would be another pre-requisite. It is expected that as the revised large exposure framework takes effect in some shape over the coming years, some of the other pre-requisites in terms of changes in regulations and institutions for resolution will be established.
The other significant measure relates to the proposal to allow RBI to accept corporate bonds as collateral under the LAF operations. In this case, departure from the convention which, apparently, follows international practice needs to be well-designed. It is most likely that RBI would restrict LAF collateral to highly-rated bonds. However, it is difficult to say whether the central bank would follow market ratings or ownership criteria. In case ratings approach is followed, would there be a selective acceptance of collateral given the recent trend of aggressive ratings/rating shopping tendencies? While moral hazard and reputation issues always come into play when central bank operations step in to the unconventional zone, RBI is likely to stick to the basic central bank dictum of “Lending against High quality collateral” in letter and in spirit unlike the monetary policy operations in advanced markets. Far more important is the step to set up of an electronic dealing platform for repo in corporate bonds. This should enable ease of transactions, and should hopefully provide a seamless platform for market repos in corporate bonds as documentation and legal technicalities could be eased as against the existing bilateral repo framework. Providing a market based mechanism for corporate bond repo should take preference. In this context, the regulators would take lessons from the still nascent term-money market in India, which has failed to take off partly due to an over-reliance on overnight repo funding from RBI over the years.
It is essential that new measures are implemented according to timelines and long pending issues are settled at the earliest. Especially, as some of these come across as basic requirements like following uniform market conventions such as day count, holidays as well as encouraging more of re-issuances to build up benchmark securities across the curve.
The author is head-fixed income,
SBI Mutual Fund. Views are personal