Debt Markets by StephenDonald

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									CHARTERED FINANCIAL ANALYST. December 2000
                                                                                                      FINANCIAL MARKETS
                                                                  Debt Markets



                                              The Tiger Could Wake Up
                                              Since we are moving away from the administered interest rate structure to a market
                                              determined structure, we observe that the longer maturity bonds carry greater price
                                                         risk and smaller coupon bonds also have greater price risk.



                                             D
                                                    ebt is a contractual obligation, which   this risk is a barrier for retail investors. Agencies
        Prof. R Vaidyanathan                        requires to be met irrespective of the   like trustees to the corporate bonds are not
       Professor of Finance Indian                  performance of                           active on behalf of the investors and it is
        Institute of Management,         the entity or borrower who is using the funds.      required that trustees to the corporate bonds are
                 Bangalore               This being an internationally accepted crucial      activated to be watch dogs of the investor's
                                         characteristic of debt, the issue of speedy         interest for which they collect fees at the time of
                                         enforcement of contracts becomes critical in the    issuance of these instruments. On the other
                                         context of the development of the debt market.      side, we find that the. Government security
                                         The important aspect for activating the debt        market is mainly consisting of Government or
                                         market is related to contract enforcement in our    Government controlled institutions both as
                                         context. The legal delays are well documented       issuers and also as subscribers. In the nineties
                                         and it could take anywhere between 10 to 12         the share of holdings of households, HUF's, etc.
                                         years for cases to be concluded. For instance       in the Government securities market was around
                                         the case of Nick Leeson which started much          5 to 9 percent whereas in the early sixties it was
                                         after that of Harshed Mehta has not only been       of the order of 30 percent. Somewhere along the
                                         completed, he has also completed the prison         line this market has moved away from individual
                                         term. In our country even now the case is           investors to commercial banks and other
                                         continuing at the special court level leave alone   government Fl's.
                                         any judgement / punishment even after nearly             Since we are moving away from the
                                         nine years. This is taken as an example to          administered interest rate structure to a market
                                         highlight the nature of lengthy processes in        determined structure, we observe that the longer
                                         contract enforcement. This is a major reason for    maturity bonds carry greater price risk and
                                         the lack of small investors' participation in the   smaller coupon bonds also have greater price
                                         corporate bond market.                              risk. It is possible for large institutional investors
                                             One of the main focuses of the second           to adopt mechanisms like duration / convexity to
                                         generation reforms could be in the area of          immunize between price risk and investment
                                         contract enforcement, since the premium for         risk, but individual investors may not be
                                                                                             adequately informed to do so. But compared to
                                                                                             the early nineties, we find lesser number of
                                                                                             issues of government bonds of very long
                                                                                             maturity like 25 - 30 years and we also find that
                                                                                             the coupon rates are more in line with market
                                                                                             determined rates. This brings us to the
                                                                                             interesting area of major changes, which are on
                                                                                             the anvil in the debt markets in the next two to
                                                                                             three years.
                                                                                                  The first pertains to securitisation which has
                                                                                             not taken-off in the last decade due to various
                                                                                             constraints. For instance the
                                                                             CHARTERED FINANCIAL ANALYST. December 2000
DEBT MARKETS



                             transfer of property act is not in consonance         market holding and activities. This is
     After the success       with the process of securitisation since the          particularly true of the" late or maturing money"
   pertaining to Demat       act does not recognize transfer of future benefits    portion of the funds since" early money" could
    of share instruments     and according to some experts it also does not        be invested in the stock markets due to the
     the Pepositories are    recognize. part transfer of debt ownership.           maturity requirements. The increased activities
        taking concerted     There are also issues relating to taxation and        of the income funds among mutual funds and
   interest and efforts to   treatment of the special purpose vechile, which       insurance and pension funds would provide the
                             is an important element in securitisation. But,       much-needed fillip to the debt market.
      enlarge the Demat      the situation could change for the better.                The net trading activity also would
      segment in debt        Reserve Bank of India as well as SEBI has             significantly alter the contours of the debt
    securities. This will    taken coordinated efforts to bring about changes      market since this would reduce transaction cost
  reduce the transaction     in various legal issues in order to activate the      and also revolutionize the churning of the funds
       cost and impart       securitisation process particularly that of           in terms of speed and promptness. The arrival
    liquidity to the debt    secondary markets. Already some state                 of net based trading also will enhance
                             governments like Maharashtra and Tamil Nadu
           papers .                                                                settlement procedures and electronic payment
                             have brought down the stamp duty substantially        of interest obligations. This would also facilitate
                             for instruments related to Housing transfers. If      the participation of small investors in the debt
                             the desired changes are brought about, then           market. The activating of the settlement and
                             this could provide a big boost to the debt            Clearance Corporation for the debt segment
                             markets since house mortgage loan and auto            would further strengthen the process of Demat
                             loan are two major markets in our country. The        and give big thrust to the secondary markets.
                             process could extend to trade credit market
                                                                                        It looks that the day of debt market has
                             also. Rating of these instruments will also
                                                                                   arrived      particularly  for   the   million
                             enhance the credit worthiness and market
                                                                                   "Abhimanyu's" in the share bazaar, who knew
                             activity.
                                                                                   how to get into the "share viyuha" but do not
                                   The second reform pertains to Demat of
                                                                                   know how to come out of it. In other words the
                             debt securities. After the success pertaining to
                                                                                   identification of "investment cult" with "equity
                             Demat of share instruments the Depositories
                                                                                   cult" may change and bond investments could
                             are. taking concerted interest and efforts to
                                                                                   become an important secondary market
                             enlarge the Demat segment in debt securities.
                                                                                   activity.
                             This will reduce the
                                                                                        But there is one important caveat. It .
                             transaction cost and impart liquidity to the.
                                                                                   pertains to the changing face of our corporate
                             debt papers. This is significant for the MF's
                                                                                   sector particularly those, which are the current
                             since the accounting valuation norms adopted
                                                                                   engines of growth namely IT sector. Good
                             by the SEBI require them to do a mark to market
                                                                                   number of companies in this sector do not rely
                             for their debt portfolios and apply a discount for
                                                                                   on debt funds since they feel they already have
                             illiquid securities. Also, different stamp duty
                                                                                   significant levels of
                             regulations covering companies located in
                                                                                    business risk and hence no need to add on
                             different states have
                                                                                    financial risk in terms of leverage. For instance
                             affected the trading in debt markets. It is to bEt
                             noted that nearly Rs. 3000 crore worth of debt        the flagship Company Infosys does not have
                             instruments comprising over 200 instruments held      any debt in it's capital structure and the same is
                             by over 1000 clients have already been                true in different degrees for many of the IT
                             dematerialized by NSDL and if the legal and           firms. But the process of securitisation, Demat
                             procedural issues are sorted out then the market      and Insurance and Pension funds may offset
                             would by very large.                                  the absence of active bond market due to this
                                   The arrival of new insurance and pension        segment. We can expect and hope the next
                             funds augur well for this market since substantial    two to three years will be the years of debt
                             portion of the investment will be made in these       markets.
                             instruments by these funds due to prudency and
                             regulation. Globally, we find that insurance and
                             pension funds constitute significant portion of the
                             bond

                                                                                   Reprint # 120001220
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