SEBI move to allow trading in ‘defaulted debt securities’ is welcome

SEBI has permitted trading in defaulted debt securities. This order could well be an important step forward for growth of the secondary debt market in India. The move is also an important definitive step towards trading in junk bonds — an asset class suitable for investors with high risk appetite. In the absence of specialised domestic investor community for such assets as yet, FIIs and other overseas investors, as may be permitted by SEBI, will initially be active in this market segment.

As observed in recent years in the equity segment, strong domestic investor class adds to market stability and can resist any unidirectional mass exit by overseas institutional investors. The beneficial impact of the said SEBI order is likely to be visible over the medium to long term, and will be determined by policy initiatives adopted to facilitate entry and growth in number of market participants, creation of a domestic investor class, inflow of adequate market liquidity, and enabling steps to encourage introduction/supply of such securities in the market, by institutions, banks, ARCs, etc.

The need for development of a vibrant long term debt market as also a secondary debt market for corporate papers, has been discussed intently over the years. The interest in the subject emerged from the important supplementary role, vis-a-vis banks, that a vibrant long term debt market can play in meeting the large needs of industrial financing in an aspiring and growing economy.

The discussion gained prominence, when the first set of PPP projects were proposed in the infrastructure sector. The need to put up physical facilities in the road, port, telecom and power sectors, where India first attempted infrastructure privatisation, was assessed to be too large for the banking sector alone to finance. A vibrant long term debt market was thought of as an important supplementary source.

Infrastructure financing

As the initial thoughts on the development of debt market emerged out of the need to meet the financing needs of the infrastructure sector, all such discussion were concentrated only on the long-term market. Discussion centred around the policy measures and enablers required to create a set of long term investors/liquidity providers to facilitate emergence of a long term debt market for financing long dated infrastructure projects.

The shorter end of the market was also not active, but there was then no felt need for a market segment across maturities, as the need of the short/medium maturity segment was then being met by banks. Considering the high level of NPAs (non-performing assets) and difficulties in raising capital, financing by banks on a sustainable basis may be difficult.

The Covid crisis with its accompanying lockdown is likely to push up NPAs in the Indian banking sector significantly (S&P has projected it at 14 per cent as on March 2021), and make availability of bank finance difficult. A vibrant debt market across maturities is, therefore, likely to become increasingly important in the days to come.

Notwithstanding the above, the long term debt market as well as the secondary debt market did not develop in proportion to the needs of the economy. There have been multiple reasons for the same, which have been examined and widely discussed/commented upon. The government and the RBI have been always responsive and adopted necessary measures to create the said market segments. The market with the required vibrancy, however, continued to elude the Indian economy.

In recent years, with the permission accorded to FIIs to invest in Indian corporate securities, emergence of specialised debt funds and increasing institutional appetite for debt investment, the situation has somewhat improved. The medium to long term debt market, as well as secondary debt market have also been facilitated by important policy measures, including permitting repo in corporate bonds.

Well organised

Indian financial markets are well organised. Reliable institutional mechanism to facilitate ease of delivery/transferability, clearing and settlement have already developed. Trading in any market is, however, essentially a function of the underlying demand and supply. A well performing deep market requires large number of participants, availability of adequate liquidity, ability to trade in any time horizon (overnight, short, medium, long), across risk matrices and at various price points. The bond/corporate debt market is no exception.

The measures/steps, mentioned above, have brought in new participants with additional liquidity and thereby infused new liquidity in the system. This has improved the demand side of the market. For vibrancy in trading, and to meet the varied risk appetite of participants, the market requires supply of debt papers/securities in a mix across asset quality and price points.

The market till now, had not permitted junk bonds (low quality papers) for trading, and thereby impeded inflow of liquidity with high risk appetite in the market. The recent SEBI permission for trading in defaulted debt securities, introduces a new asset class, which could add to the range and thereby facilitate trading across all asset class and time horizons in the market.

The writer is former Deputy Managing Director of EXIM Bank and former MD & CEO of IDBI Asset Management Company

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