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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