An issue which has always been debated is getting more retail investors to invest in the corporate debt market. Retail interest is high in the equity segment either directly or indirectly through mutual funds. When it comes to corporate bonds, however, the interest is more through the mutual fund route. Few individuals invest directly in corporate debt. One of the factors that has kept back retail investors is the difficulty in selling the security before maturity. In case of equity or mutual funds, there is a window open at any time for a sale transaction. For a listed debt security it is theoretically possible to be sold, but there may not be buyers as few securities are liquid. The absence of liquidity is the biggest challenge where the secondary market is not active for most securities. Unlike equity which is unique to a firm, a company would have multiple bonds listed at any point of time depending on the number of public issuances. Further, most buyers are institutions who would hold the securities to maturity to match their liability tenures.
It is against this background that the Securities and Exchange Board of India’s (SEBI) recent move to allow companies to announce a voluntary “put” option should be seen. In simple terms, an issuer of debt has the choice to give the investor a choice to redeem the security before maturity at specific points of time post-issuance subject to a minimum holding of one year. There are requisite approvals to be secured from the board for this purpose. The valuation norms for this “put” option have been specified as also the minimum amount of the issue size under this umbrella. The regulation is comprehensive.
On the face of it, having a “put” option on such issuances is a very good idea. It is not mandatory as of now, but it may be considered depending on how things work out. The new regulation fills the lacuna in the system, which has kept retail investors away, and hence is progressive. This becomes analogous to a fixed deposit with a bank that can be withdrawn
any time after it is opened subject to the minimum period and a penalty clause. The penalty clause here for a debt security would be similar as the value would not be the issue price but something different based on market conditions. Intuitively in a scenario of rising interest rates, the value could be lower. Therefore, from an investor point of view, this should read well as it mimics to a large extent the preferred bank deposit.
What could be the incentive for a company to have a “put” option? The first is that it would have access to a wider investor base. SEBI has made the concept optional to the issuer and also given the prerogative to choose the category of investors who qualify. It could be specified for only retail or all investors. Second, the “put” issuances would go with a different International Securities Identification Number (ISIN) and not clubbed with the existing mandatory limit placed by the regulator on the number of ISINs that can be issued in a year. It would thus enable the company to eschew the necessity of re-issuing a security if it has hit the limit of maximum permissible ISINs.
Third, the issuer may like to take advantage of the changing interest rate regime, and buy back their earlier security and issue a new one. This helps in treasury management. Fourth, depending on the market conditions, the issuer may price it better as it gives the option of early redemption to the investor. The coupon rate offered could be slightly lower with this option being provided. Fifth, for a lower rated company, such issuances with a “put” option would work better as investors can redeem before maturity depending on the prevalent conditions.
For all categories of investors the “put” option would work as it is not necessary to redeem but is an alternative. Individuals, in fact, already invest in some non-redeemable securities like the government floating bond. A better return for the investor on the corporate bond with the “put” option would be a better alternative, especially if the rating is high.
Therefore, SEBI’s move is very good and a big step in the direction of adding depth to the corporate bond market. It also opens the doors for retail investors to enter this segment. However, some awareness programmes should be carried out so that investors know how the bond market works. Unlike a bank deposit which has a fixed principal and interest, a bond which is redeemed in advance will have a variable value depending on the market conditions. Hence while the coupon rate is fixed, the capital redeemed before maturity will not be so. This is an issue also with investing directly in government securities, which is possible through the trading window offered by the Reserve Bank of India. The nuances need to be understood before investing.
A pertinent conundrum for the issuer is that once there is a “put” option, provisions have to be made periodically for possible redemption. This will mean having an active treasury which ensures funds are available. While this holds even for instruments that are redeemed on the due date, the exercise becomes periodic for such bonds. This could mean borrowing in the market or taking a loan from financial institutions to repay such debt in case normal business operations do not generate the requisite funds.
Developing the corporate bond market to include more retail players is a necessity. To do this, one has to mimic what happens in the conventional banking sector where deposits are offered with certain flexibility. The “put” option largely addresses a major concern for any household. Intuitively it can be seen that this idea will resonate well where the company is rated AAA or AA. The risk factor for a lower rated paper will always be overwhelming because a possible default will be a consideration. A way out would be to consider providing “bond insurance” much like deposit insurance where issuers would have to pay the insurer to provide cover of up to Rs 5 lakh as is the case with bank deposits. This could be an issue which can be further deliberated.
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