Regulator wants corporates to raise more funds via bonds. Here’s what it means for you

Recently, SEBI has come out with a consultation paper titled “Designing a Framework for Enhanced Market Borrowings by large Corporates”. It is a nudge to corporates to access the bond market rather than rely only on bank funding. It says companies with more than Rs 100 crore in long-term borrowing should raise 25 percent or more of their funds through bond issuance. The objective is, the companies will have a wider funding base, there will be scrutiny by more entities than just lending banks and with more instruments on offer, it will deepen the bond market.

Advantages from a broad perspective

A delay of even a single day in honouring interest servicing means default tag on the bond and downgrade in credit rating. After a downgrade of credit rating, due to any delay in coupon payment, while it is theoretically possible to come back to the earlier credit rating, it is not easy, and it is time consuming as the default tag stays forever. Things are relatively easier in case of bank loans as norms are not so strict. With stricter scrutiny, it will make corporates more alert and disciplined about debt servicing. The other benefit is, with a wider investor base, a bank can fund a corporate by purchasing bonds, which are saleable in the secondary market, than granting a loan which is one-to-one. Banks can even participate in the secondary corporate bond market as it becomes deeper.

Advantages for you- the retail investor

We have discussed in earlier articles, the advantages of investing in bonds. To recap, while mutual funds are the preferred route due to the multiple advantages offered, through investments in bonds you can do a ‘laddering’ of your portfolio. That is, you can buy bonds of multiple maturities to suit your cash flow requirements – the bond matures and you automatically get the proceeds. Since the bond market is wholesale in nature, initial public offers are good for you to participate, for any amount you may like to invest. With more corporates coming to the market, it is likely that there would be more public offerings of bonds and you will have more investment options. To be noted, bonds are raised mostly through private placements and not public issues.

Credit Rating

The draft paper states that the credit rating should be AA and above, for compulsory issuance of bonds for 25 percent of long-term funding requirements. The implication for you is that you should stick to highly rated papers i.e. credit rating of AA and above. While nothing stops a lower rated company from hitting the market, the push is being given to higher rated papers and to that extent you will get good quality investment options, to the extent they come out with public issues as against private placements. It mentions that subsequently SEBI may take a view on lowering the threshold rating to A from AA, but for you portfolio construct purposes, a rating of AA and above is advisable.

What more needs to be done

The consultation paper is a step in the right direction as it gives the right nudge, to widen the funding base and deepen the market. However, the other side needs to be addressed as well: to make it an attractive deal for the investors and attract more investors. Credit default swap (CDS) is a kind of ‘insurance’ on bond default which you can purchase to do away with the credit risk. CDS guidelines have been in place for years now, but the market has not taken off. The regulators have to give a similar ‘nudge’ for the development of the CDS market so that market participants offer it and investors purchase it. Similarly, credit enhancement imparts a better credit rating to the bond issue, through better structuring of the deal. For relatively lower rated issues, SEBI can come out with guidelines for credit enhancement, which would lead to a higher credit rating and better overall quality of the bond market. Net-net, it is not only about pushing companies to the bond market but also attracting more investors that will really deepen the market. Interest rates are a function of market forces, but the regulators can work towards better liquidity and better credit risk management.

Conclusion

At this stage, it is a proposal and implementation date is April 1, 2019. Nonetheless, given that more than 95 percent of bond issuances take place through private placement, we have seen quite a few public issues of late. Moreover, the public issues of recent past are of decent credit rating and came with attractive interest rates. With a compulsion to hit the bond market, it may be expected that more corporates would like to have a wider investor base and come out with public issues. That will impart more investment options to you.

source: moneycontrol