The setting up of the Corporate Debt Market Development Fund (CDMDF) by the government along with the markets regulator, the Securities and Exchange Board of India (Sebi), is a major step forward in the path to developing the corporate debt market. Rather than leaving it to the market participants to take the lead through other policy measures already implemented, the government has gone ahead with the creation of this fund. This fund would be sponsored by the government and have subscriptions from AMCs and debt funds who can then fall back on this reservoir in case they are unable to sell the securities they hold at the time of redemption. This is a major buffer provided to the mutual funds in particular.
As mutual funds are major buyers as well as traders of corporate bonds, this arrangement will boost volumes in both the primary and secondary segments of the market. MFs should now be willing to take on more risk in the debt market and probably also deal with lower-rated but investment-grade securities. In the absence of this backstop facility, there was apprehension in their minds as there are concerns on liquidity of these securities when it comes to redemption pressure. Can this concept be extended to other parts of the market to cover issues which have impeded growth?
One of the major problems of corporate debt issuances is that there is no security to the investor in case of a default. When a bank loan goes bad, the problem is really for the bank to sort out and there are structures for the same. In fact, banks evaluate project proposals and charge higher interest rates for loans which have a lower credit rating. The deposit-holder is protected from such failures, and hence, even at the peak of the NPA problem in India in the middle part of the last decade, the problem was largely faced by the banks and not the deposit-holder. However, in the case of bonds that failed, especially those issued by NBFCs, there was no fallback. The only recourse is approaching the courts, which is time-consuming. Besides, as an individual bond-holder, it is even more difficult to figure out how to seek recourse.
The CDMDF can be used to address this issue by mirroring its concept. Suppose all debt issuers have to mandatorily contribute to a CDSF (Corporate Debt Security Fund) when they are issuing debt, then a corpus can be built which can be used in times of a crisis for paying investors in case of a default. Presently, the only possible way out for the debt market is issuing CDS, which provides insurance to the investor in case of a default. But, it is a market-oriented instrument and the interest in such instruments is missing, given the cost involved. Besides, when most of the issuances are in the AAA or AA categories, there is low probability of default. Hence, the market does not see any merit in writing CDS on these instruments. The suggestion here is to make it mandatory for all issuers of debt to contribute to this fund. This will bring in a larger corpus as even lower rated investment grade bonds will find a window opening. In the case of the CDMDF, 25 bps is what has to be paid by the fund as a subscription. In case of the CDSF, the rates can be varied across the ratings. The ratings of agencies like CARE, CRISIL, ICRA, etc, can be considered for this purpose.
In fact, a dual rating can be the criteria for all issuances, with the lower rating being used to determine the subscription fee. For AAA-rated companies, for instance, it can be kept at 10 bps, and can increase down the ladder of ratings.
Will this be an added cost for companies? Definitely. Hence, it would be necessary to ensure that the charge being enforced is lower than the MCLR charged by banks; or else, there can be migration away from this market. However, for lower-rated companies, paying even 50 bps more may find acceptance as they normally tend to borrow at 100-200 bps more than the MCLR. Besides, for the issuing company, this will be a one-time charge unlike an interest cost which has to be paid on an annual basis. Therefore, for a five-year bond, the cost of 25 bps will actually work out to 5 bps per year.
A call can be taken on whether there should be an annual fee also paid to the fund as this would make using the debt market more expensive. To begin with, this may not be levied but depending on how this fund progresses along with the growth in the bond market, a much lower rate could be considered—maybe 1 bps or even lower.
The government could contribute an initial amount through the Budget and the fund can be managed by professionals. Leverage should be allowed for the fund depending on how the balance sheet builds up. Typically, the CDSF should invest their funds in government paper so that there is zero risk carried on the books. Investing typically in short term instruments like treasury bills also works as the MTM risk is eschewed. Treasury activity can also be considered based on the expertise that is built into the fund. Ideally, the fund should be exempted from paying taxes so that the income earned could fully meet the operating expenses and add to the reserves.
There is definitely a need to develop the corporate bond market. There have been several committees constituted and virtually all recommendations have been implemented. The gap that exists is getting in more buyers and sellers. Sellers are limited to highly-rated companies and buyers are more of the ‘buy and hold’ variety. There needs to be active trading, which can be done by mutual funds. With the CDMDF a reality, the area of operations of the MFs should get widened further. The CDSF is a way out, and to make it work, it should be made mandatory for all issuers. The design should be such that the pricing should continue to be of advantage for issuers relative to banks. This surely can be worked out.
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