Corporate bond market to flourish in a big way

The Reserve Bank of India (RBI), in its annual policy statement for 2010-11, has initiated several measures to develop the corporate bond market.

Considering that the long-term bonds issued by companies engaged in infrastructure activities are generally held by banks for a long period and not traded, it has been proposed to allow banks 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. At present, banks? investments in non-SLR bonds are classified either under held for trading (HFT) or available for sale (AFS) category and subjected to ?mark to market? requirements.

At the same time, since there is a time lag between issuance and listing of the security, banks may not be able to participate in primary issues of non-SLR securities. Hence, it is proposed that investment in non-SLR debt securities (both primary and secondary market) by banks where the security is proposed to be listed on the exchange may be considered as investment in listed security at the time of making investment.

If such security, however, is not listed within the period specified, the same will be reckoned for the 10% limit specified for unlisted non-SLR securities. In case such investment included under unlisted non-SLR securities lead to a breach of the 10% limit, the bank would not be allowed to make further investment in non-SLR securities for both primary and secondary market, including unrated bonds issued for financing infrastructure activities till such time the limit is reached.

?These steps taken by the RBI will help the corporate bond market grow in a big way. More and more infrastructure and other companies will come forward to issue long term corporate bonds. This will improve the efficiency and volumes in the market,? noted Hitesh Shah, assistant VP at AK Capital Services.

These steps will incentivise banks to invest in long-term bonds. Fixed Income Money Market and Derivatives Association of India (FIMMDA) is working on the development of reporting platform and also on the global master repo agreement to operationalise the repo in corporate bonds.

FIMMDA has also been requested to start work on developing a platform similar to its existing platform for corporate bonds. Eventually, once the reporting system stabilizes, a settlement mechanism similar to the one introduced for the OTC corporate bonds may be put in place, the RBI said.

To facilitate the development of an active repo market in corporate bonds, the guidelines for repo transactions in corporate debt securities were issued on January 8, 2010. Repo in listed corporate debt securities rated ?AA? or above was allowed from 1 March, 2010.

The central bank has also proposed to introduce a reporting platform for all secondary market transactions in certificate of deposits and commercial paper.

Further, in a bid to enhance the financial markets, the RBI has also proposed to introduce interest rate futures (IRFs) on 5-year and 2-year notional coupon bearing securities and 91-day treasury bills.

The RBI-SEBI Standing Technical Committee will finalise the product design and operational modalities for introduction of these products on the exchanges. The IRF contract on 10-year notional coupon bearing Government of India security was introduced on 31 August, 2009.

The central bank has also proposed to issue the final guidelines on the issuance of non-convertible debentures (NCDs) of maturity less than one year by the end of June 2010.

The RBI had constituted an internal working group to finalise the operational framework for introduction of plain vanilla over-the-counter (OTC) single-name credit default swaps (CDS) for corporate bonds for resident entities subject to appropriate safeguards. The group is in the process of finalising a framework suitable for the Indian market, based on consultations with market participants and study of international experience. Accordingly, it is proposed to place the draft report of the internal working group on the RBI?s website by end of July 2010.

?Instruments like CDS and IRFs are important tools in the development of the financial markets. Introduction of the CDS will help in market efficiency. Those companies with a relatively lower rating can use the CDS, thereby providing greater transparency to the corporate bond market. The proposal on NCDs will induce more companies to come forward to tap the market,? said Shah.

The central bank has also said that they will be issuing final guidelines on forex derivatives by the end of June 2010.

In order to expand the menu of tools for hedging currency risk, it has been also decided to permit the recognised stock exchanges to introduce plain vanilla currency options on spot dollar/rupee exchange rate for residents. Currently, residents in India are permitted to trade in futures contracts in four currency pairs on two recognised stock exchanges. The risk management and operational guidelines will be finalised by the RBI-SEBI Standing Technical Committee.

The RBI has also proposed to set up a working group with its members, the CCIL and market participants to work out the modalities for an efficient, single point reporting mechanism for all OTC interest rate and forex derivative transactions.