The Hindu Business Line : Corporate bond market — Needed, an efficient trading platform

Any liquid market in corporate bonds requires improved disclosure standards, reliable credit rating agencies, good quality paper, an efficient trading platform and a well-functioning clearing and settlement mechanism. This would attract investors willing to take the risk if the returns are commensurate. The report prescribes fiscal policy tightening in both industrial countries and emerging markets.

Developing the corporate bond market has been the hot topic for policy-makers, market participants, researchers, regulators, academics and conference/seminar organisers. To prepare a roadmap for the development of this market, the Government appointed a high-level committee on corporate debt and securitisation in July 2005 under the chairmanship of Dr R. H. Patil. It is important that this segment develops fast and becomes liquid so as to provide investors another option for diversification of risk.

Unified exchange

The Finance Minister, Mr P. Chidambaram, in his Budget speech, accepted the recommendations of the Patil Committee report and stated that the Government would take steps to "create a single unified exchange-traded market for corporate bonds". The internal committee at the Securities and Exchange Board of India recommended having the unified exchange at the Bombay Stock Exchange. In fact, it was reported that the BSE is ready with trading solutions and, subject to regulatory clearance, would commence operations "within a month".

While the news report stated that the Patil Committee had suggested setting up a unified exchange at the National Stock Exchange, the panel had recommended making use of the infrastructure available with the national exchanges for disseminating information related to trading in corporate bonds. The report stated: "As market participants gain experience with trade reporting and the first phase of clearing and settlement systems, efforts should be made to develop online order matching platforms for corporate bonds. Such trading platforms can be set up by the stock exchanges or jointly by regulated institutions like banks, financial institutions, mutual funds, and insurance companies, etc. SEBI would frame specific guidelines for setting up such trading platforms. Any platform, other than the one offered by a stock exchange, would effectively be performing the functions of an exchange to a limited extent and, as such, would need the specific approval of SEBI."

The reasons cited by SEBI for recommending the BSE's case were:

(i) the level of concentration of trading at the NSE in both equity and equity derivatives segments; and

(ii) the conflict of interest as banks and institutions which own NSE would also be traders in the corporate bond segment.

BSE as trading platform

It is widely known that the BSE is on the path of demutualisation and its shareholders' list is likely to get diversified. If SEBI wants the corporate bond platform to remain exclusively at the BSE, then the regulator will have to ban all banks and institutions from subscribing to the shares of BSE. By the same logic, the BSE's shareholding should not remain even with brokers if they want to trade on the exchange. Therefore, the reasons put forth by SEBI in denying a corporate bond trading platform to the NSE do not sound convincing. Investors are free to choose their brokers and exchange platforms to execute deals. Unlike the proposed corporate debt model, there is no compulsion to trade at the NSE, but investors prefer it because of its efficiency.

The NSE is a true form of demutualisation where trading rights, management and ownership are separated and, hence, there is no conflict of interest. In the equity market today, banks and institutions execute deals through the NSE but are treated just like any other institutional investor. Over the years, the corporate debt market has remained truly a private placement one. The issuances jumped 43 per cent in 2005-06, but the secondary market activity has been poor. The deals are bilateral and only a few are reported to the NSE.

Any liquid market in corporate bonds requires a few basic ingredients — improved disclosure standards, reliable credit rating agencies, good quality papers, an efficient trading platform and a well-functioning clearing and settlement mechanism.The disclosure norms were inadequate because the private placement market was the preferred route for corporate bonds. However, things have improved with the new SEBI guidelines, enforcing listing for corporate bonds. The credit rating agencies have been providing information to the market.

Robust primary market

The R. H. Patil Committee report suggested that the rating rationale should be the basis for listing of bonds issued by listed entities. The corporate bond market is dominated by banks and institutions which invest mainly in higher-grade paper, the market for lower quality paper is almost non-existent.

The market has good number of quality paper and if it becomes liquid, it would enthuse issuers to tap the primary market for funds, thereby reducing the pressure on bank credit. The measures suggested by the Committee will help develop a robust primary issuance market.

The secondary corporate bond market is purely a telephone market, where brokers are believed to play a dominant role in bringing together buyers and sellers.

SEBI issued a circular some time ago advising that all non-government securities trades to be executed through the electronic order-matching trading system of the exchanges and banned off-market broker-driven deals in corporate bonds. However, this did not in any way change the market practice as the trading system at the exchange allows setting up counter-party exposures at participant levels.

If a trade is routed through a broker in the OTC market and is required to be put in the exchange for compliance of the SEBI circular, the participants set the required counter-party limits against each other while setting zero limits for other market participants.

This ensures trade with the desired counter-party though other participants may be willing to offer better quotes for the security. This may be a case of complying with SEBI circulars in letter, but not in sprit.

Successful trading platforms

In the current milieu, there is little possibility of efficient price discovery, which is essential for a vibrant market. The Patil Committee cited examples of successful trading platforms such as EUROMTS and EUREX-BOND, which match orders of banks and institutions without going through brokers. These alternative trading systems (ATS) have become highly successful in many countries.

As the Indian market is structured similar to global markets, setting up a system like the EUREX-BOND would help immensely. Taking a cue from the Committee report, there is a need to set up a trading platform that is owned and managed by banks and institutions.

The success of NDS-OM gives credence to the argument that banks and institutions, as the major constituent of the corporate bond market in India, would like to trade among themselves.

An efficient corporate debt market requires a proper order-matching and guaranteed settlement systems. Restricting trading to a single exchange may be counter-productive in the long run.

In the interest of the market development, the choice of setting up the trading platform should be open to all interested parties and the regulator should not play the decider's role. Rather, the regulator's role should be to specify norms for setting up an efficient order-matching system.

(The author is Vice-president, CCIL. The views are personal and not necessarily that of his employer. He can be reached at gcnath@yahoo.com)

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