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Project Submitted to


Assistant Professor of Law


(A State University established by Act No. 9 of 2012)
NavalurKuttapattu, Srirangam (TK), Tiruchirappalli – 620009.

MARCH 2017









Within any country’s capital market, it is essential that there exist a well-developed bond market
with a sizeable corporate bond segment alongside the banking system, so that the market
mechanism ensures that funds flow in accordance with the productivity of individual investments
and the market exerts a competitive pressure on commercial banks’ lending to private business
and helps improve the efficiency of the entire capital market. Further, the debt market must
emerge as a stable source of finance to business when the equity markets are volatile. However,
most countries do not have corporate bond markets comparable in efficiency with their equity
markets, as the secondary market for corporate debt is mostly Over-the-Counter (and/or
telephonic), rather than exchange traded, and it is extensively dominated by a few institutional
investors and professional money managers. The market for non-sovereign debt (particularly, the
corporate debt segment) in India also has a number of shortcomings: a primary market structure
where private placements, sans mandatory credit ratings, dominate in an overwhelming manner,
lack of transparent market making, and a tendency on the part of institutional investors to hold
securities to maturity. The secondary market is thus prone to suffer from low liquidity and
fragmentation and the consequent pricing anomalies.


In this paper, an attempt to understand the nature and extent of imperfection of the Indian market
for corporate bonds using available data on market trading channeled through the major stock
exchanges. In some aspects of the market which include depth of the market in terms of
frequency of trading of outstanding bonds; composition of the market in terms of trading of debt
of various risk categories as indicated by their credit ratings; relationship between Yield-to-
Maturity (YTM) and volatility of return. The observed patterns of over time movement of
spreads also suggest that in a number of instances, private information/expectations work strong
enough so that investors tend to ignore the public information contained in the declared credit
rating of corporate bonds. Further, estimates indicate that the market fails to evolve a uniform
market price of risk across rating categories

 Whether the corporate bond market is properly regulated?

 Whether RBI is the regulator of Corporate bond market?


In the Indian corporate bond market, equity market has not yet become attractive to the majority
of private investors because of the inherent high risk involved in equity market investment. The
debt market has also not become popular yet as a destination of savings of individual savers
either. This has been so essentially because of the absence of an active secondary market for debt
instruments, which makes investors feel that the investment in debt is highly illiquid. Coming to
the corporate bond segment of the debt market, such a market has been in existence since
independence in 1947. Public limited companies have been raising capital by issuing term debt
securities since then mostly through private placement.

As things stand today, the participants in the Indian debt market are the central government, state
government, PSU, corporate and banks on the issuing side and the RBI , commercial banks,
insurance companies, mutual funds, other non-bank financial companies, corporate treasuries
and individual on the investment side.


Corporate Bonds are Bonds issued by private or public sector companies in order to borrow
funds from the market. The Indian Companies Act, 1956 has not made any distinction between
Corporate Bonds and Debentures. The term Debentures has been defined as follows1 "debenture
includes debenture stock, bonds and any other securities of a company, whether constituting a
charge on the assets of the company or not."Corporate Bonds can be issued by way of Public

Section 2(12) of Indian Companies Act, 1956
issue where the retail investors as well as institutions can participate in the issue or by way of
Private Placement where only a limited number of investors participate in the issue. Corporate
Bonds unlike equity shares don't guarantee an ownership in the Company but give regular
income in the form of Interest. Corporate Bonds are generally issued for a period of 1 year to 20
years and they can also be Listed.

Corporate Bonds are differentiated on the basis of Maturity i.e. Short Term, Long Term or
Medium Term; Coupon i.e. Fixed Rate, Floating Rate or Zero Coupon; Option i.e. Call Option or
Put Option and Redemption i.e. Single redemption or Amortizing Bonds.


Some of the advantages of Corporate Bonds are

 Corporate Bonds are useful for meeting the long term capital requirements of the
corporate sector especially in those scenarios when the equity market is not working well
or the Company doesn't wants to issue equity or preference shares.

 The principal amount is safe as compared to investment in Equity Shares also there is
regular income in the form of interest.

 Issue of Corporate Bonds is beneficial for Infrastructure Companies as they require

Capital for a long period as compared to other sectors.

 Corporate Bonds help in reducing the overall cost of borrowings as compared to cost of
borrowings from the Banks.

 Long Term Capital can be effectively raised through issue of Bonds.

 The rating of Bonds helps the investor to take an informed decision.

 Rate of Interest is higher as compared to Bank Deposits.

 In case of Listed Bonds there is Liquidity of Investment and Capital appreciation.

Although, Corporate Bonds have their own advantages they have not been able to get much
popularity in the Indian markets. Some of the reasons for the slow growth of Corporate Bonds in
India are

 Investors have a feeling that investment in Banks or Government securities is safer as

compared to investment in Corporate Bonds.

 Issue of Bonds to Public at general involves procedural formalities and is time consuming
on the other hand is borrowings from banks or a private placement is less complicated.

 Banks are sometimes more interested in giving loans to Corporate rather then investing in
the Bonds issued by Corporate.

 Corporate Bonds issued by private sector Companies don not qualify for meeting the
Statutory Liquidity Requirement(SLR) of the Banks which refrains the Banks from
investing in Bonds issued by private Sector Companies.

 The secondary market for Corporate Bonds is also not much developed as Institutional
Investors like insurance Companies, Provident fund authorities and Banks hold the
Corporate Bonds till their maturity which reduces their supply in the secondary market.

With a view to develop Corporate Bonds Market in India some of the measures which have been
taken by the regulatory bodies are:

SEBI amended the SEBI (Disclosure and Investor Protection) Guidelines, 2000 in 20072. The
Text of the Circular read as follows

1. Requirement of Credit Rating: For public/ rights issues of debt instruments, SEBI
(Disclosure and Investor Protection) Guidelines, 2000 presently stipulate credit rating to
be obtained from not less than two credit rating agencies. With a view to reduce the cost
of issuance of debt instruments, it has now been decided that credit rating from one credit
rating agency would be sufficient.

2. Below Investment Grade debt instruments: SEBI (Disclosure and Investor Protection)
Guidelines, 2000 currently require that the debt instruments issued through a public/rights
Circular No. SEBI/CFD/DIL/DIP/29/2007/03/12 dated 3rd December, 2007
issue shall be of at least investment grade. In a disclosure based regime, it should be left
to the investor to decide whether or not to invest in a non-investment grade debt
instrument. Given this, and in order to develop market for debt instruments, it has been
decided to allow issuance of bonds which are below investment grade to the public to suit
the risk/return appetite of investors.

3. Removal of Structural Restrictions: Further, in order to afford issuers with desired

flexibility in structuring of instruments to suit their requirements, it has been decided that
structural restrictions currently placed on debt instruments such as those on maturity,
put/call option on conversion, etc shall be removed.

Also, in October 20093, SEBI issued a Circular vide which it was decided that trades in corporate
bonds between specified entities, namely, mutual funds, foreign institutional investors/ sub-
accounts, venture capital funds, foreign venture capital investors, portfolio mangers, and RBI
regulated entities as specified by RBI shall necessarily be cleared and settled through the
National Securities Clearing Corporation Limited (NSCCL) or the Indian Clearing Corporation
Limited (ICCL) with effect from 1st December, 2009.

Some of the measures taken by Reserve Bank of India to develop the corporate debt market are
as follows4 :

i. To promote transparency in corporate debt market, a reporting platform was developed

by FIMMDA and it was mandated that all RBI-regulated entities should report the OTC
trades in corporate bonds on this platform. Other regulators have also prescribed such
reporting requirement in respect of their regulated entities. This has resulted in building a
credible database of all the trades in corporate bond market providing useful information
for regulators and market participants.

ii. Clearing houses of the exchanges have been permitted to have a pooling fund account
with RBI to facilitate DvP-I based settlement of trades in corporate bonds.

iii. Repo in corporate bonds was permitted under a comprehensive regulatory framework.

Circular No. SEBI/IMD/DOF-1/BOND/Cir-4/2009 dated 16th October, 2009.
www.rbi.org.in - Corporate Debt Market: Developments, Issues & Challenges, dated 15th October, 2012
iv. Banks were permitted to classify their investments in non-SLR bonds issued by
companies engaged in infrastructure activities and having a minimum residual maturity
of seven years under the Held to Maturity (HTM) category;

v. The provisioning norms for banks for infrastructure loan accounts have been relaxed.

vi. The exposure norms for PDs have been relaxed to enable them to play a larger role in the
corporate bond market.

vii. Credit Default Swaps (CDS) have been introduced on corporate bonds since December
01, 2011 to facilitate hedging of credit risk associated with holding corporate bonds and
encourage investors participation in long term corporate bonds.

viii. FII limit for investment in corporate bonds has been raised by additional US$ five billion
on November 18, 2011 taking the total limit to US$ 20 billion to attract foreign investors
into this market. In addition to the limit of US$ 20 billion, a separate limit of US$ 25
billion has been provided for investment by FIIs in corporate bonds issued by
infrastructure companies. Further, additional US$ one billion has been provided to the
Qualified Financial Institutions (QFI).

ix. The terms and conditions for the scheme for FII investment in infrastructure debt and the
scheme for non-resident investment in Infrastructure Development Funds (IDFs) have
been further rationalised in terms of lock-in period and residual maturity; and

x. Further, as a measure of relaxation, QFIs have been now allowed to invest in those MF
schemes that hold at least 25 per cent of their assets (either in debt or equity or both) in
the infrastructure sector under the current US$ three billion sub-limit for investment in
mutual funds related to infrastructure.

xi. Revised guidelines have been issued for securitisation of standard assets so as to promote
this market. The guidelines focus on twin objectives of development of bond market as
well as provide investors a safe financial product. The interest of the originator has been
aligned with the investor and suitable safeguards have been designed.
xii. Banks have been given flexibility to invest in unrated bonds of companies engaged in
infrastructure activities within the overall ceiling of 10 per cent;

xiii. Bank has issued detailed guidelines on setting up of IDFs by banks and NBFCs. It is
expected that IDFs will accelerate and enhance the flow of long-term debt for funding the
ambitious programme of infrastructure development in our country.

Further, Reserve Bank of India in January, 20135 permitted credit Default Swap, an insurance
against default, on unlisted but rated corporate bonds even for issues other than infrastructure


The nature and extent of imperfections of the Indian secondary market for corporate bonds by
examining the following aspects

1. Depth of the market

2. Composition of the market
3. Relationship between the yield to maturity and volatility of return
4. Nature of spread between yield of maturity of different risk category of bonds.
5. Relationship between market depth and price/YTM
6. Market pricing of risk

As regard the data source the available data on that fraction of trading in corporate bonds that are
routed through the Bombay stock exchange (BSE) and the capital market (CM) and WDM
segments of the National Stock exchange.

Reserve Bank of India Notification No. RBI/2012-13/366, IDMD.PCD.No.10 /14.03.04/2012-13 dated 7th
January, 2013.

The primary objective was to judge the extent of inefficiency of this market in view of the well
known fact that this market is quite thin and shallow. For this purpose, several aspects of the
market such as depth and composition of the market, relationship between the YTM and
volatility of return as implied by observed price movements nature of spread between YTM of
different categories of bond, relationship between market depth and price/YTM and finally,
market pricing of risk.

Like the government bond market, the secondary market for corporate bonds too is marked by
lack of depth and width. However as opposed to the former which has been expanding, the
secondary market for corporate bond has been characterized by shrinking depth and width in
recent years. Despite the problems of measurement of YTM and hence comparision of the same
between bonds, the picture obtained would cause concern about the state of corporate debt
market. The imperfections in the secondary market for corporate bonds are manifest in frequent
trading, high liquidity risk, high degree of dispersion of price/ YTm over time, and a lack of
strong and unidirectional relationship between a bond’s credit rating(risk) and its market price in
quite a number of instances. Given the current slack in overall investment activity in the Indian
economy, the primary and secondary markets for corporate debt, represented by the private
placements market and an OTC market, may seem to be sufficient. But once the investment
climate improves and demand for long term funds picks up the need for a vibrant secondary
market for corporate debt would be rather acutely.

While the infrastructure is being developed extensively in the corporate debt segment the RBI
concern as a supervisor remains the large number of private placement/ unlisted bonds for which
the disclosure and documentation standards are rather unsatisfactory. The need to have a
standard in this regard, irrespective of whether the debt is publicly issued or privately placed, has
been stressed in recent times. Such measures should be collectively effective in ameliorating
problems of information asymmetry, low liquidity and consequent distortions from the corporate
debt segment, and hence help it grow to maturity.

Webpage referred:

 http://www.sebi.gov.in/acts/uwamend.html
 http://www.sebi.gov.in/sebi_data/commondocs/pt1b4_h.html

Articles referred:

 Hakansson, N. (1999) “The role of corporate bond market in an economy”

 Suchismita Bose, Dipankor coondo “ A study of the Indian corporate bond market”