Sebi proposes market making mechanism in corporate bond market

By: |
November 16, 2021 9:47 PM

Market makers are entities that quote both a buy and a sell price for corporate bonds in order to create liquidity in the secondary market. Generally, stock brokers double up as market makers.

The bonds are offering XIRR (Extended Internal Rate of Return) of 10.50 per cent. (Representative image)The bonds are offering XIRR (Extended Internal Rate of Return) of 10.50 per cent. (Representative image)

Sebi on Tuesday proposed a market making mechanism in the corporate bond market in a bid to enhance liquidity in the secondary market for such bonds. Market makers are entities that quote both a buy and a sell price for corporate bonds in order to create liquidity in the secondary market. Generally, stock brokers double up as market makers.

In a consultation paper, the regulator suggested that registered stock brokers or merchant bankers can act as market makers in the corporate bond market subject to minimum net worth requirements. To ensure the capital adequacy of a market maker, Sebi proposed that only those stock brokers or merchant bankers that have an additional net worth of Rs 10 crore over-and-above the requirements of their respective Sebi’s rules should be permitted to act as market makers.

The proposed framework should be applicable to listed issuers which have listed their non-convertible debt securities and their outstanding value of such debt securities should be at least Rs 500 crore as on the last date of the previous financial year. It should also be applicable for all prospective issuances, irrespective of the rating assigned thereof, according to Sebi.

The regulator said that responsibilities of issuers and market makers should be on a comply or explain basis for one financial year to start with. “Market making is a significant cog in the wheel which will not only enhance liquidity but also provide a fillip to facilitate market efficiency and functioning,” Sebi said.

Further, the watchdog noted that a vibrant secondary market in corporate bonds can come about if market making mechanism is introduced. This, in turn, will give issuers an opportunity to gain from improved liquidity premium, better price discovery and consequent lowering of the cost of debt.

At present, the Indian corporate bond market, both issuances and trading are limited to only a small number of highly rated papers. About 86 per cent of the outstanding bonds is in just the top three categories of AAA, AA+ and AA.

With regard to responsibilities of a market maker, Sebi proposed that such an entity should be responsible for making market, through trades, only on the Request for Quote (RFQ) platform through their proprietary accounts.
It should provide two-way quotes during such minimum time frame, which could be 75 per cent of the time during market hours on a trading day and should be present in the best buy or sell order quotes for top five orders. This will ensure that a balance is maintained between the supply and demand in the bond market.

Also, the market maker should be responsible for guarantee execution of orders at quoted yield and quantity for quotes given by it. Besides, it should be responsible to ensure successful completion of the settlements. “For each below AAA-rated ISIN that market maker makes, it can make market in maximum two AAA-rated ISINs, on a half yearly basis. The said requirement can be fulfilled by it across issuers with whom it enters into an arrangement with,” Sebi said in the consultation paper.

Further, such market makers will have the option of selecting ISINs across varied maturity buckets — 1-3 years, 3-5 years, 5-7 years and over 7 years. ISINs (International Securities Identification Numbers), which has 12 characters, is used for uniquely identifying securities like stocks, bonds warrants and commercial papers. The regulator has also suggested risk management as well as governance framework for market makers.

With regard to obligations of issuers, Sebi has proposed that issuers should make arrangements for market making corresponding to at least 25 per cent of the amount to be raised (through fresh issuances – new/ old ISINs) during each quarter. Accordingly, the issuer can identify ISINs, for which market making activity will be arranged, based on criteria — rating buckets, tenors and liquidity.

For such identified ISINs, the issuer should appoint at least two market makers before listing. The details of the market making arrangement should be disclosed accordingly in the offer document.

“The issuer shall continue to make arrangements for market making in such identified ISINs for at least 5 years from the date of issuance or the tenure of the bond, whichever is earlier,” Sebi said.

During this period, if the issuer and/ or market maker decide to discontinue their arrangement, due to contractual issues or otherwise, both the parties should ensure that their respective obligations are fulfilled. According to Sebi, a market maker may create initial inventory of bonds for market making, directly from the market or with the assistance of the issuer. The issuer may make funds available to the market maker in lieu of the ISIN-wise inventory as per mutually agreed terms and conditions. The regulator suggested that stock exchanges can provide incentives or relaxations in transaction charges for market makers.

In respect of disclosures, Sebi proposed that exchanges should disseminate the information pertaining to total quantity traded by the market maker in a particular ISIN, and minimum, maximum and median spread at which the market maker has provided the quote, among others, at the end of each trading day. Comments on the consultation paper have been sought till December 16.

Sebi plans to facilitate liquidity in the secondary market for corporate bonds through a multi-pronged strategy. This includes introduction of market making along with facilitating an active corporate bond repo market and a backstop facility as proposed in the Union Budgets for 2019-2020 and 2021-2022, respectively.

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