Bond rush

Retail bond offers are showing renewed buoyancy after muted activity for the last three years. Rating agency ICRA has forecast that mop-ups through retail non-convertible debentures (NCDs) in FY19 may surpass the record sums of FY14. As much as ₹20,000 crore is likely to be raised through this route in the first quarter of this fiscal, mainly by NBFCs. Fast-growing loan books, capital constraints for banks which have crimped their lending to NBFCs and high yields demanded by institutional investors seem to have pushed NBFCs to the public market for funds. From a macro perspective, this is welcome. Public issues usher in more transparency and retail investors get to diversify into higher-yielding debt at a time when bank deposit rates are lagging market interest rates.

However, there are three aspects to this retail bond rush that are discomfiting and may need regulatory attention. One, compared to the market for privately-placed bonds where blue-chip borrowers rule the roost, the public NCD market is dominated by lower-rated issuers. In recent years, the RBI has clamped down on NBFCs sourcing funds through public deposits by allowing only high investment-grade firms and setting strict fund-based limits. This has prompted high-risk issuers to take the retail NCD route. Retail investors, given their lack of knowledge and bargaining power, are unlikely to demand a sufficient risk premium from lower-rated issuers. Here, SEBI can consider anchor investors or a mandatory institutional quota in NCD issues, to facilitate better price discovery. Two, most retail investors base their decision to buy an NCD solely on coupon rates. The higher the spread over prevailing bank deposit rates, the more their enthusiasm for an offer. But high-yielding NCDs also carry elevated default risk. SEBI has steadily raised the disclosure bar in recent years. They are now required to file a detailed prospectus disclosing the objects of the issue, credit ratings, risk factors, security backing and NCD terms. They are also mandated to keep the stock exchanges updated on material events and timely servicing of debt. But as most retail investors skip reading the prospectus, simplified risk disclosures in NCD advertisements and application forms would be useful.

The most investor-friendly feature of NCDs, as compared to term deposits, is their ability to provide free exit to their investors through the secondary market route. While retail NCDs are required to be compulsorily listed on the exchanges, many of these bonds trade only sporadically and are often mis-priced, thus sealing off this exit route for investors. SEBI has recently floated a discussion paper which moots a formula-based pricing mechanism to facilitate liquidity and ongoing price discovery for NCDs. But it is the breadth and diversity of active players in any market that ultimately decides its liquidity. The RBI, SEBI and other policy-makers must focus on improving this aspect.

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