The Development of India’s Corporate

Debt Market

February 2008

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Executive Summary

The Development of India’s Corporate

Debt Market

February 2008

ICMA CentreUniversity of Reading

Reading RG6 6BA

Tel: 0118 378 8239Fax: 0118 931 4741

www.icmacentre.ac.uk

Executive Summary

The Development of India’s Corporate Debt Market is published by the City of London. The authors of this report are the ICMA Centre, at the University of Reading. This report is intended as a basis for discussion only. Whilst every effort has been made to ensure the accuracy and completeness of the material in this report, the authors, the ICMA Centre at the University of Reading, and the City of London, give no warranty in that regard and accept no liability for any loss or damage incurred through the use of, or reliance upon, this report or the information contained herein. February 2008 © City of London PO Box 270, Guildhall London EC2P 2EJ http://www.cityoflondon.gov.uk/economicresearch

Table of Contents Foreword Executive Summary ………………………………………………….......................................... 3 1 Introduction …………………………………………………………..................................... 5 2 Project design ................................................................................................................ 7 2.1 Desk research ……………………………………………………................................... 7 2.2 Interviews ………………………………………………………...................................... 8 3 Corporate bond markets …………………………………………..................................... 11 3.1 Features of corporate debt markets ………………………...................................... 11 3.2 Why do countries need corporate bond markets? ……...................................... 12 3.2.1 Risk of over-reliance on a weak banking sector …….................................... 12 3.3 India’s need for a corporate bond market ………………..................................... 14 4 Indian capital markets ……………………………………………..................................... 16 4.1 Equity markets …………………………………………………...................................... 16 4.2 Derivative markets ……………………………………………...................................... 17 4.3 Government securities model ………………………………..................................... 19 4.4 Recent developments in the government bond market ..................................... 19 4.4.1 Government funding and debt issuance ……………..................................... 19 4.4.2 Auction pricing ……………………………………………..................................... 23 4.4.3 Auction timetable ………………………………………….................................... 23 4.4.4 Fragmented issues ………………………………………....................................... 24 4.4.5 Repo and financing ……………………………………….................................... 25 4.4.6 Short selling ………………………………………………….................................... 25 4.4.7 The result of reform ………………………………………...................................... 25 4.5 The Indian corporate bond market ………………………….................................... 26 4.5.1 Issues are not bonds ………………………………………...................................... 29 4.5.2 Many are not issued by corporates ……………………...................................... 30 4.5.3 Lack of liquidity ……………………………………………....................................... 32 4.6 Euro issues ………………………………………………………..................................... 33 4.7 Securitisation and structured finance ……………………….................................... 34 4.7.1 Assets securitised …………………………………………….................................. 35 4.7.2 Investors in securitised bonds …………………………….................................... 35 4.7.3 Risk structures ………………………………………………..................................... 35 4.7.4 Originators …………………………………………………...................................... 36 4.7.5 Infrastructure finance by securitisation ………………...................................... 36 4.7.6 Regulatory background …………………………………..................................... 37 5 The Patil Report …………………………………………………….................................... 39 5.1 The report’s recommendations ………………………………................................... 39 5.2 Progress since the report …………………………………....................................... 41 5.3 Implementation of the report ………………………………...................................... 41 5.4 Parallels with equity market development ………………...................................... 42 6 Micro-barriers – the effect of institutional rigidity ……………..................................... 43 6.1 High and complex taxation …………………………………..................................... 43 6.1.1 Stamp Duty ………………………………………………….................................... 43 6.1.2 Tax deducted at source (TDS) …………………………..................................... 44 6.2 Lack of risk management products ……………………………................................... 44 6.2.1 Interest rate futures ………………………………………..................................... 44 6.2.2 Interest rate futures ………………………………………...................................... 44

6.2.3 Repos ………………………………………………………....................................... 45 6.2.4 OTC derivatives and swaps ……………………………...................................... 45 6.3 Cumbersome public issuance process …………………….................................... 46 6.3.1 Public issues are difficult …………………………………..................................... 46 6.3.2 Private placements are easier …………………………..................................... 47 6.4 Lack of regulatory clarity ……………………………………...................................... 47 6.5 Secondary market and pricing issues ……………………...................................... 48 6.5.1 Limited transparency ……………………………………...................................... 48 6.5.2 No market makers ………………………………………….................................... 48 6.5.3 Non DvP settlement ………………………………………..................................... 49 6.5.4 No database of issues …………………………………….................................... 49 6.5.5 No universal conventions ………………………………...................................... 49 6.5.6 Long shut period …………………………………………...................................... 49 6.6 Restriction on short selling gilts ……………………………….................................... 50 6.7 Barriers to securitisation ………………………………………..................................... 50 6.7.1 Stamp Duty ………………………………………………….................................... 50 6.7.2 PTCs not securities ………………………………………….................................... 51 6.7.3 Lack of clear regulatory structure ……………………....................................... 51 6.7.4 Tax …………………………………………………………….................................... 51 6.7.5 Registration ………………………………………………….................................... 51 7 Macro-barriers – low levels of supply and demand ………….................................... 52 7.1 Government borrowing crowding out ……………………...................................... 52 7.2 Limited demand for bond finance …………………………..................................... 53 7.3 Limited investor base …………………………………………..................................... 55 7.3.1 Mutual funds ………………………………………………...................................... 56 7.3.2 Life insurance companies ………………………………..................................... 57 7.3.3 Pension funds ……………………………………………….................................... 59 7.3.4 Retail participation ………………………………………...................................... 59 7.4 Exchange control ……………………………………………….................................... 60 8 Summary and recommendations ………………………………..................................... 62 8.1 Summary ………………………………………………………….................................... 62 8.1.1 Current status ……………………………………………….................................... 62 8.1.2 Micro-barriers – institutional issues ……………………....................................... 62 8.1.3 Macro-barriers – demand and supply ………………....................................... 63 8.1.4 Securitisation – a special case? ………………………....................................... 64 8.2 Recommendations ……………………………………………..................................... 64 8.2.1 Macro-economic factors ………………………………...................................... 65 8.2.1 Practicable recommendations ………………………….................................... 65 Annex 1 Implications and opportunities for the City of London ................................ 67 Appendix A Key references ………………………………………...................................... 69

Foreword

Michael Snyder

Chairman, Policy and Resources Committee

City of London

The resilience of emerging markets to US growth slowdown is a striking development and the associated strong and positive global growth trends of the emerging ‘BRIC’ markets, led by China and India, represents a significant offsetting influence on global growth. The rapid growth of India in particular and its substantial progress towards becoming a major global trading economy and financial services centre presents a particular opportunity and a challenge for the City of London. The opportunity is to play a pivotal role in providing expertise in global financial services to an economy that is rapidly growing its share of world trade, while building on the advantages of the historically strong links of the UK to India. The Report of the High Powered Expert Committee on Making Mumbai an International Financial Centre identifies three ‘missing markets’ that handicap Indian international financial services development: a corporate and sovereign bond market, a spot currency trading market, and derivatives markets. These reinforce the comments of the R.H. Patil Committee Report on domestic debt markets. This latest report reviewing the corporate debt market in India and prepared for the City of London by the ICMA Centre at the University of Reading is therefore timely. It shows a number of areas in which the City and India could help repair these omissions and benefit from collaborating. These include advice and issuance expertise, the provision of structured finance and credit management, and the provision of education and training in the management and operation of corporate debt markets. In view of the uncertainty created by the collapse of the sub prime sector in the USA, it is especially important that at this time we emphasise the considerable advantages offered by the free-trade model. Among the array of evidence that can be assembled to support this position we can point to the particular experience of India. Politically stable, increasingly open to markets (though the pace of change remains a cause of concern in the financial services sector), and keen to facilitate the free movement of capital and people, India has reaped the rewards of such policies in its recent development. India presents a huge potential market for corporate financial services paralleling its corporate sector’s growing contribution to the global economy as an increasingly effective provider of both primary and higher value added products and services. In this role India provides a complementary role to China which is becoming the manufacturing and assembly workshop for the

world. India, with its well-educated workforce, has made a particular impact by its focus in providing high technology products and business services. In Mumbai we have an international financial centre that the recently published Global Financial Centres Index report indicates has considerable potential. In making the transition to being a more important financial centre, India needs to see Mumbai’s increased integration into the network of international financial centres. The connectivity between financial centres and specialisation in particular services are important supports to the efficient use of capital. Efficient capital markets ensure resources are well directed to sustainable development. The report shows that corporate bond markets in India remain modest in scale in comparison with corporate bond markets in the most developed countries. India has had a bank-dominated financial system with the corporate sector served relatively poorly by the domestic capital market, more effectively by borrowings from domestic banks and financial institutions but with a sharply rising share of loans raised from abroad. ICMA identify a range of factors that have kept the sector immature in India. These include the factors that we know inhibit any capital market and to which all regulatory authorities and markets need to respond – the complexities of taxation, and in particular, the way stamp duty is applied; the provision of effective futures and derivative markets; improved issuance processes; and proportionate regulation. The authors identify the inhibitory effects of state-domination of the banking system and exchange controls. The report's authors stress that the most pressing need is to reduce the barriers to institutional investors, who in other markets are the prime investors in corporate debt. As they note - without these key participants, the market cannot succeed, however attractive the trading environment may be.

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Executive Summary This project arose from discussion at the City of London Advisory Council for India, a high level group of Indian business representatives. The Advisory Council steers the work of the City Office in Mumbai and provides guidance on the City of London’s engagement with India. Their deliberations revealed an interest in the potential for development of the market for corporate debt in India, and the conditions that might promote this. The corporate debt market is anomalous among Indian financial markets in that it has not developed as rapidly, or to the same extent, as other parts of the Indian financial system, or comparable markets elsewhere. It is important to understand the likely benefits to be derived from the creation of a corporate debt market:

● Access to new sources of capital for existing, large firms. Many larger Indian firms already raise capital without undue difficulty through the Indian banking sector and international debt issues, however a corporate debt market would provide an additional source of finance.

● Access to capital markets for smaller firms, although these are likely to be low rated.

● The development of a competitor source of alternative funding to the (dominant) banking sector. In the absence of such a market, banks face limited competition, which reduces the pressure for innovation and the provision of new methods of finance for India’s growing corporate needs.

Indeed, a functioning corporate debt market is generally recognised to be a necessary component of a 21st Century economy, and is particularly important in the context of Mumbai’s development as a global financial hub. Arguably the current market is not, in fact, a true market for corporate debt, in that:

● Relatively few real corporates make debt issues. Most issues are either by public-sector entities or by financial institutions raising money to lend onwards.

● Almost all issues are private placements to a small group of investors, often just a single bank – thus they are closer to syndicated loans than bond issues.

● There is very little secondary market liquidity – partly because of the fragmentation of issuance and the small investor base.

Our analysis, consistent with a number of previous reports, suggests that there are two groups of factors which have hindered Indian corporate debt market development:

● Micro-effects – these are market-specific issues which could be addressed relatively easily. These include: complexities of taxation, (in particular, stamp duty); the absence of parallel debt-oriented risk

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management tools (in particular, the lack of bond futures, corporate bond repos and credit derivative markets); regulatory conflict; and the issuance process itself when compared with the speed and flexibility of private placements.

● Macro-effects – these are economy-wide factors which hinder the development of the corporate debt market, but are unlikely to be addressed simply to free this market. These factors include: the continued crowding-out effects of government capital requirements; the limited demand for bond finance; the state-dominated nature of much of the banking system (although the number of active private-sector banks is now increasing rapidly); limitations on international investment; and the remaining effects of exchange control.

At present, many companies’ financial decisions are motivated by the desire to avoid regulatory restrictions, tax burdens and the like. This produces distortions, with the result that genuine corporate debt issues are often the least-favoured option. Over the last three years, considerable efforts have been made to establish free and open debt markets. In particular, the regulators have sought to address a number of legal, institutional and infrastructure barriers, notably simplifying the issuance process and reviewing Stamp Duty. At present, however, many of these changes remain proposals, with no dates yet set for their implementation. What is striking, however, is that relatively little has so far been done to reduce barriers to institutional investors, who in other markets are the prime investors in corporate debt. The nature of the Indian savings market means that individuals already have very attractive, government guaranteed, savings vehicles available, while many institutional investors are prevented from broadening their portfolios. Structured finance has been growing in India and securitisation is seen as important in the financing of the enormous infrastructure needs of the country. Structured finance remains confined to certain parts of the market, however, and structures are often driven by arbitrage rather than commercial needs. As with corporate bonds, the market, while active, is hindered by the same sort of barriers that more generally affect corporate bonds. The following practicable recommendations are made, which we believe can be implemented reasonably swiftly: • Rapid implementation of the reform of stamp duty • Relaxation of exchange controls on corporate bonds. • Reform of regulations on the disclosure for public offers. • Controlled and phased relaxation of the investment mandates of

institutional investors. • Reform of regulations which currently exclude banks from derivative

trading.

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1 Introduction The City of London Corporation commissioned the ICMA Centre, University of Reading to produce a research report on the development of the Indian corporate debt market. The request originated with the City of London India Advisory Council, which proposed the research as likely to address a key area in the further development of Indian capital markets. Whilst the Indian capital market has developed rapidly over the last two decades, the corporate debt market remains small, restricted and illiquid. These are undesirable features which persist, despite considerable attention. The focus of this report is to identify which of the many problems identified in previous work are responsible for this lack of progress. We believe that there has been a tendency to focus on factors that might facilitate the development of an already existing market, but which are unlikely to provide the initial stimulus for a new market. International experience suggests, for example, that trading systems are unlikely to have much impact on the overall supply and demand for corporate bonds. Similarly the focus on the fact that the corporate bond market is largely a private placement market (that is, that many “bonds” issued in India are really renegotiable, syndicated loans), has distracted attention from the larger picture. Thus, the theme of this report is that, as far as corporate bond markets are concerned, there are significant structural problems – many of which are really larger issues to do with India’s macro-economic development and transition from a more centralised economy. Whatever their cause, these structural problems lead directly to:

● Limited supply from issuers. This results in part from the relatively easy access to bank credit which corporates can obtain.

● Limited demand for corporate bonds as investments. In particular we

note the dominance of the public sector in pensions and life assurance provision and the restrictive investment mandates which are imposed on life assurance and pension providers (both public and private sector).

Experience in other countries suggests that the market will not develop until there is a real demand for a corporate bond market – it cannot be created by government or regulatory action. Equally, where there is genuine demand, many of the barriers which are described below and on which much of the existing policy focuses, may appear less significant. We should note at this point that we are not aware of any significant opinion that there is a single factor, the removal of which would immediately unblock the corporate debt market. The objective of this project is more realistic, namely to examine some of the many factors that have already been

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identified and thereby to indicate which are likely to affect the establishment and growth of the market, and which are likely to have the more modest effect of facilitating trading and reducing costs once the market is established. The structure of the report is as follows:

● Chapter 2 describes the purpose of the research, its incremental content and the methodology adopted.

● Chapter 3 explains the value of corporate bonds for developing countries and follows this with a brief comparison of India to the position of other economies that have established corporate bond markets.

● Chapter 4 examines the current status of the Indian markets for equity, derivatives, and government and corporate bonds market. The section also reviews structured finance and the securitisation market in India.

● Chapter 5 summarises the Report of the High Level Expert Committee on Corporate Bonds and Securitisation, the Patil report, which is widely regarded as the benchmark in the analysis of the Indian corporate bond market, and examines progress in implementing its recommendations.

● Chapter 6 presents fuller discussion of the principal “micro-barriers” to development. These barriers are those that affect market infrastructure for trading, clearing and regulation.

● Chapter 7 focuses on “macro-barriers” to development, and contains a fuller discussion of the supply of corporate debt and the demand for bonds by financial institutions.

● Finally, Chapter 8 documents the conclusions of the report and suggests a limited number of key recommendations

Whilst the main body of the report focuses on conditions in India, we also include an annex to the report, which offers some suggestions as to the possible impact on, and opportunities for, the City of London from further development of the corporate debt market.

We wish to express our gratitude to Dr Ajay Shah and Dr Susan Thomas of the Indira Gandhi Institute for Developmental Research, Mumbai for their insights into the Indian market and for their assistance with some parts of the field work.

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2 Project design The study of corporate debt market development is by now quite well established, with large numbers of studies conducted by local and international bodies in respect of many countries worldwide. This means that many of the issues relating to development are known, and that the challenge facing researchers is the ordering of issues facing each jurisdiction rather than the establishment of new topics. Our explicit research plan was to build on existing reports for India and other markets so as to avoid re-covering old ground. As a result, the research was divided into two parts:

2.1 Desk Research This part of the research was designed to provide points of comparison with related work in related markets, to collate the key issues identified by previous research, and to examine, where possible, progress that has been made towards implementing the recommendations made in those reports. Much of this research was focused on the principal previous reports relating to the Indian corporate debt market. In this context, the 2001 ADB report on India (in which we were involved) was used to provide an independent point of reference for the position of the Indian corporate debt market, on which we could build in this report. The Patil report, which is discussed below, provided a more detailed view of the market and showed the developments that had been made in the corporate debt market since 2001. The RBI reports provided an update on the government securities market, which has developed much faster than the corporate market since 2001. We also examined material relating to developments in comparable debt markets, including those of China and Thailand. These reports enabled us to bring an alternative international perspective to the Indian markets and they highlight areas where solutions being strongly pressed by some in India had not succeeded elsewhere, and the importance of relaxing exchange control. A listing of the more significant references in each of these areas is contained in sections 1 and 2 of Appendix A. Other relevant material is contained in reports which form part of the ongoing European debate on bond markets and their transparency; these reports are listed in Appendix A.3. This material is particularly useful in highlighting the importance of the distinction between retail and wholesale markets, and their differing regulatory and institutional needs. Finally, we made use of material relating to securitisation, which has largely been produced independently of the bond market discussions, and which is listed in Appendix A.4. The outcome of this research is the conclusion that there is a significant difference between policies designed to enhance an already existing and active market and those required to induce the market to become active in the first place. Thus, European markets are generally in the first category

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(already active) and policy discussion is focussed on improvements to market infrastructure, including, for example, trading systems and transparency. Markets such as those in India and China are in the second category, however, and the changes required for those markets are more related to reform of laws, regulation and market custom than to infrastructure.

2.2 Interviews To complement the desk research, a series of semi-structured interviews were also conducted. The principal purposes of the interviews were: ● To discover whether new issues or factors not identified in the desk

research have arisen; ● To discover participants’ views on the relative importance of the issues; ● To discuss participants’ views on progress being made towards

addressing these objectives. An informal set of questions and areas to be discussed was developed in advance of the interviews. These questions included general topics to elicit interviewees’ views on general corporate debt market development, as well as specific questions on the individual items identified as potential barriers to development from the desk research. It was agreed that all questions should be addressed to all interviewees, accepting that each would wish to focus on one or other set of concerns. Where possible, we stayed away from matters peripheral to the specific project brief, and so we did not discuss the general economic development of India, its broader infrastructure needs and its emergence as a truly global power. While these are interesting topics, they lie outside the scope of the present project. Interviews were conducted confidentially to ensure that the views expressed were as open as possible. In keeping with this, we did not record the discussions and did not take a verbatim record, although handwritten notes were taken. Interviewees understood that their views would not be reported directly, but would be used to inform the researchers’ own arguments. To this end, we do not attribute views in the report, nor do we make use of direct quotes, which could lead to the identification of the interviewee concerned. The interviewees were selected in two stages: ● The City of London Corporation in liaison with the India Advisory Council

developed a list of interviewees. These interviewees were chosen on the basis of the advice of the India Advisory Council’s representatives and were chosen so as to provide a good cross-section of opinion within the appropriate industry sector on the chosen topic. All of the representatives were senior within their organisation and all had sufficient experience and authority both to represent the views of their organisation and to offer views that were based on their own experience with the debt market. Of the initial list, seven institutions were initially available to meet the researchers and of these we met five in Mumbai and

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exchanged email correspondence with the others. No members of the India Advisory Council themselves were on the list of participants.

● The India Advisory Committee list was entirely drawn from the banking

and regulatory sectors. As noted, while the participants were all senior and eminent, the industry-spread was felt to be too narrow to give the market wide perspective required for this project. In addition, our earlier work and the desk research undertaken for this project showed that the banking sector was the main supplier of corporate funds and might, therefore, be less concerned about the development of the corporate debt market than were other market participants. As a result, additional interviewees were sought from the researchers’ existing contacts to ensure a broader coverage of market participants. We were particularly keen to interview infrastructure providers who have already provided much innovation in the Indian equity, derivatives, and to a lesser extent, government debt markets. The researchers added a further eight institutions to the list of interviewees, consisting of non-bank practitioners, infrastructure providers and independent analysts. Once again, these representatives were all senior and had experience of corporate debt markets and the issues surrounding them in India. Where appropriate, individuals also had experience of regulatory standard setting in this area and were able to comment on the practicability of reform.

In total, 26 individuals participated in the discussions. All interviewees were senior representatives of their organisations, and all had specific views on corporate bond markets. The interviews were between 45 and 90 minutes long and took place in the interviewees’ offices. A common set of ‘discussion topics’ was developed. This included: ● General

○ An invitation to comment on the state of India’s capital markets ○ Specific introduction of the condition of the corporate bond market ○ Whether the interviewee regarded this market as important for the

development of India’s financial markets and economy ● Market Infrastructure

○ Trading platforms ○ Settlement arrangements ○ Pricing and the existence of a reliable yield curve ○ Bond issues versus private placement ○ Stamp Duty and taxation on issuance

● Market participation

○ Supply of debt by firms ○ Levels of institutional demand ○ Degree of retail involvement ○ Crowding out ○ International Participation

● Securitisation

○ The desirability of securitisation in Indian markets

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○ Constraints on firms ability to securitise ○ The impact of Stamp Duty on asset transfers

● The Environment

○ What prevents faster reform ○ Regulatory arbitrage ○ Regulatory conflict

While we report a consensus view of the interviewees and do not attribute opinion to any individual, we can report that all interviewees agreed that the market was under-developed and that none of the items of those that we discuss below was regarded as completely irrelevant by anyone. The differences of opinion emerged in the rankings of the issues. Broadly, regulators were more interested in infrastructure and retail participation, while participants and traders regarded these as of lesser importance.

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3 Corporate bond markets This section outlines what corporate bond markets are and then moves on to the issue of why growing economies are often encouraged to develop them.

3.1 Features of corporate debt markets Although this report is concerned with the establishment of a successful corporate debt market in India, it is appropriate to note some of the key findings from analyses of international corporate bond markets. We summarise these here and return to them in the context of Indian markets below.

● Few bond markets are substantially used by any but the most highly rated or large corporates. Functioning corporate bond markets for high yield issuers are rare. For small and medium enterprises (SMEs), banks have an obvious informational advantage in that they see and control the cash flows so that the cost of monitoring is lower than it would be for a bond-holder. Where smaller, higher risk, companies do access bond markets, they do so through private placements (a topic of special relevance to India). Private placements are taken up by a small number of investors who, in many cases, take an active involvement in the company – they are legally bonds but in economic terms they are syndicated loans.

● There are very few liquid secondary bond markets. Even the largest

issues in the largest markets trade for a brief period after issue and rarely thereafter. Coupon payments or credit events may spark some trading, but otherwise the bonds are usually seen as buy-and-hold investments. Government stocks may be traded more actively, though trading is usually highly concentrated in a few runners with the rest of the government stocks being inactive.

● There are very few bond markets in which retail interest is substantial.

This contrasts with equity markets, where retail interest is frequently a significant proportion of the market. Individuals will invest in equities where they perceive there are prospects of large profits and similarly in derivatives. The percentage returns from bond investment are generally small, however, and few retail investors choose to participate. Investors, especially in developing markets, rationally invest in simple deposits and mutual funds (including bond funds).

● Finally, whilst almost all developed markets have corporate bond

markets, relatively few are regarded as large or active. It is noticeable that the active markets are often those that developed in response to a failure of the local banking sector to adequately fund corporate expansion, while countries with historically strong banks have often managed with only limited use of corporate bonds. Thus, the US has a

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large and active corporate bond market, while that in the UK is smaller. This suggests, in turn, that what matters for economic growth is the availability of capital for firms, rather than the necessity of one particular form of debt finance.

3.2 Why do countries need corporate bond markets? Many international agencies strongly recommend the development of corporate bond markets as a key part of countries’ capital market development. In large part this recommendation was prompted by the events of the Asian financial crisis in 1997, during which many countries suffered as a result of an over-reliance on weak banking sectors for the finance of corporates. India largely escaped the worst effects of that crisis – mainly because at that time it was not part of the global financial system. While this may have been seen as beneficial from a crisis-management point of view, India’s relative detachment from the global economy has since been seen by the authorities as a barrier to national development. As a consequence of the accelerating liberalisation that began in the early 1990s, India is now very much a part of the global economy and the global financial structure. It is therefore more open to profiting from involvement in global finance but is, at the same time, no longer immune from problems caused by residual weaknesses in its financial structure. Developed markets, outside the USA, tend to rely heavily on the banking sector for debt finance and tend to have active, but not dominant corporate debt markets. This suggests that it is not necessarily a reliance on bank finance that hinders economic growth or causes instability, rather it is a reliance on a banking sector which is intrinsically weak that creates the systemic risk in a credit crisis.

3.2.1 Risk of over-reliance on a weak banking sector In markets with weak banking sectors, it is important to develop other avenues of corporate finance, and in particular the corporate bond market. Bonds provide an alternative to bank deposits for investors. Often in developing markets there is an absolute shortage of assets for long-term investors to acquire (often not helped by legal investment mandates which prevent them investing in equities). Corporate bonds are particularly important for the development of long-term institutional investors such as pension and life insurance funds. As we discuss below, there is often a view that retail investors may be attracted into bonds as an alternative to deposit investments, but this, as noted, is rarely achieved. Banking sectors in developing markets have tended to suffer from structural weaknesses that have made them vulnerable to crises. The following sub-sections outline some of the principal reasons for this.

3.2.1.1 Government ownership In many markets the government is, or has been, the owner of many of the banks. Often those that are not owned by the government are owned by

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other entities such as the military or local authorities. In some countries, such as Indonesia, many banks were owned by industrial conglomerates that used the bank subsidiary as a source of working capital for the conglomerate. This ownership structure led to a number of failings:

● The banks were fundamentally inefficient, being overstaffed and slow to adopt new technologies.

● Often their lending decisions were influenced by non-commercial factors.

● They were slow to adopt new techniques such as risk management and credit scoring.

● Some banks, the so called policy banks, were given explicit mandates to lend to sectors that could not attract commercial lending.

3.2.1.2 Implicit or explicit guarantees Banks which were either state-owned, or were considered to have some form of government guarantee, often engaged in lending without adequate evaluation of the risks, and often without adequate data relating to the borrowers. Credit skills were often poor, information was rarely complete and the bank staff had few incentives to turn away business. In addition, balance sheet size is still generally seen as a mark of stability for developing country banks. As a consequence, such banks often have a significant proportion of non-performing loans (NPLs) on their books. There is little chance of these loans being repaid, but at the same time they remain as a drag on the balance sheet. Most of the countries affected by the Asian crisis have adopted restructuring strategies, essentially bail-outs, to rescue the banks. Additionally banks may have policy loans/bonds on their books. These are a hangover from directed lending policies of the past, when banks were instructed to lend to fund infrastructure. Again these bonds are unlikely to be repaid, but cannot be marked to market without disrupting the banks’ capital adequacy margins.

3.2.1.3 Dominance of retail deposit market The perception that the banks had government guarantees, together with their nationwide network and the relatively low incomes of the population has meant that banks are the dominant, indeed often the only, repository for individual savings. Lack of competition has deterred them from innovating or improving their efficiency. More recently, the growing wealth of the population together with a growing awareness of investment opportunities has attracted investment into other vehicles, but banks still dominate the market for savings in terms both of money value and the number of customers.

3.2.1.4 Weak banking regulation Banks are usually under the control of the central bank which is responsible for monitoring compliance with capital adequacy/solvency requirements. In developing markets, the skills for regulation are usually in short supply although the central bank often has the best of those available. The regulatory weaknesses have been particularly pronounced in respect of:

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● Gathering adequate information from the banks, especially when they were state-owned and did not conform to normal banking or accounting practices.

● Enforcing suitably robust treatment of defective assets, in particular marking to market – in the face of political issues or a desire not to destroy the capital base of the banks.

3.3 India’s need for a corporate bond market As is true of many Asian countries, India is a bank-dominated market, with Moodys/ICRA reporting that banks hold around 90% of the assets of the financial sector. Credit demand is growing rapidly but remains low by Asian standards. While banks have been the main source of corporate credit, they have often competed aggressively for corporate business and this suggests that there is at least a measure of competition to supply funds. The structure of managed interest rates is gradually being dismantled and most wholesale rates are now market-determined. A number of key retail rates remain controlled, however, such as the post office savings and provident fund rates, which are both fixed at attractive levels and for which there are significant political barriers to change. While the Indian banking sector has shown significant progress, especially with regard to the transformation of the development banks, it is still in a transition stage. The key structural features are:

● The development banks have been transformed from agencies for directed lending in support of infrastructure development. They have moved into the private sector and in many cases become something close to investment banks (ICICI is probably the best known example of this). Their focus is on corporate finance and raising money in wholesale markets.

● The commercial banks remain closer to the state sector. RBI figures

show that in 2006/07, state-owned banks retained a 72% share of the financial assets of the banking system. These banks remain:

○ Dependent upon the state for business. The state remains a

significant borrower both through state-owned enterprises and through the government deficit. This latter is partly funded by the banks through the Statutory Liability Reserve, which requires them to keep 25% of their deposits in government bonds.

○ Poorly capitalised with significant holdings of bad and doubtful

debts. The non-performing loan (NPL) situation of the banks has improved substantially in recent years, to around 3% of assets, (Reserve Bank of India, RBI, figures for 2005/06 give an average of 3.3% across all banks – state-owned banks have a larger proportion at 3.7%), but they still carry many legacy loans/bonds. Many of the bonds are not marked to market, being in the non-trading (that is, held to maturity) portfolio, and are unlikely to be repaid. The implementation of Basel 2 (which among other things requires loans

14

to be marked to market as well as bonds) begins in 2008, but it is not clear how these remaining NPLs will be dealt with.

○ Somewhat inefficient, but at the same time under increasing

commercial pressure because of the large number of banks competing for limited (albeit rapidly growing) consumer and corporate business.

● The risk culture in India is not well developed. A legacy of explicit and

implicit government guarantees remains present in the market. Despite the growth of the private sector, and policy statements to the contrary, the experiences of repeated government interventions (for example, to rescue the Unit Trust of India), convinces many investors that the banking sector and the state-controlled part of the investment sector will be supported in any eventuality. This is common in transition economies such as China, which has an even less well-developed corporate bond market. All so-called “corporate bonds” in China are required to have a bank guarantee, which is in turn taken as an implicit government guarantee.

Rapid economic growth, which is expected to continue, is expected to put pressure on conventional (largely bank-based) sources of finance in the future:

● Future infrastructure demands are enormous – estimated to exceed $300bn over the period 2007-11 (GDP in 2006/07 was approximately $1,000bn).

● Bank credit is currently expanding at the very rapid rate of 30% per

year, while the deposit base is only expanding at 20%, putting pressure on the liquidity of banks. The rapid growth of the economy is driving up consumer and corporate demands for credit. The implementation of Basel 2, starting in 2008, will put further pressure on bank balance sheets.

Finally, the development of a corporate debt market can also be seen as a way of mobilizing savings, either by encouraging direct retail participation in bond markets or, more likely in our view, by encouraging the development of indirect investment vehicles. Thus, a successful corporate bond market might also increase the supply of investment capital to firms.

15

4 Indian capital markets This section of the report presents some background to Indian capital markets. We begin with equity and derivative markets. Although these may be seen as peripheral to the corporate debt market, equity is one of the fundamental sources of capital and therefore provides one of the major alternatives to debt issues for firms. The revolution in Indian equity markets over the last ten years has been immensely successful, and this has emphasised the weakness of the corporate debt market. We then move on to the market for Indian government debt, which has been significantly reformed as part of India’s liberalisation policy. A well-functioning government debt market is a prerequisite for a corporate debt market, and we spend some time discussing the remaining rigidities in this market and their ongoing reform. In the final part of the section, we discuss the international debt market, before moving on to the market for securitised finance.

4.1 Equity markets The Indian equity market has grown rapidly since the reforms to the equity trading infrastructures and the setting up of the National Stock Exchange of India, NSE, in 1992. (Although India has many stock exchanges, the Bombay Stock Exchange, BSE, and the NSE now account for almost all the business conducted). Chart 1 shows the growth in the market value of equities listed on the Bombay Stock Exchange (most major stocks are listed on both exchanges so the market values of the two exchanges are very close). Market value has expanded at a cumulative rate of about 60% a year over the period covered by the chart.

Chart 1 - Equity Values on Indian Exchanges

Market value of equity listed on main Indian exchanges

0100200300400500600700800900

2002 2003 2004 2005 2006

$bn

BombaySE

NationalStockExchangeIndia

Source: World Federation of Exchanges (WFE)

16

Turnover has similarly expanded, as shown in Chart 2, aided by advanced IT infrastructures supporting the trading and settlement of trades. NSE, the first exchange in India to adopt electronic trading, has seen more rapid turnover growth than the BSE which has only relatively recently adopted electronic trading and moved to a demutualised structure.

Chart 2 - Turnover on Indian Exchanges

Equity turnover on main Indian exchanges

050

100150200250300350400450

2002 2003 2004 2005 2006

$bn

BombaySE

NationalStockExchangeIndia

Source: WFE

In regional terms the market value of the Indian equity market is similar in size to that of Korea, slightly smaller than China and Australia. In terms of turnover it is similar to Australia and Hong Kong, about half the size of Korea and China.

4.2 Derivative markets The National Stock Exchange of India has been very successful in developing equity derivative markets. Chart 3 shows the growth over the last five years. The NSE has been particularly successful in developing single stock futures, the trading volumes of which significantly exceed that in other countries.

17

Chart 3 – Equity Derivatives Trading

Source: WFE

ternational comparisons of underlying value of trading in equity derivatives

Chart 4 – Asian Derivatives Exchanges

Source: WFE

he NSE also offers interest rate futures – short (3 month) and long (10 year),

Inshow the NSE as of comparable size to the other major derivative exchanges in Asia (except for Korea which dwarfs all other Asian, and most global, equity derivative markets).

Equity derivative trading - India

-

50

100

150

200

250

2002 2003 2004 2005 2006

Con

trct

s tra

ded

(m)

-2004006008001,0001,2001,4001,6001,800

Und

erly

ing

Val

ue $

bn

Contracts(LHS)

Underlyingvalue $bn(RHS)

Equity derivatives - Underlying Value 2006

0

1,000

2,000

3,000

Australia HongKong

Korea Singapore Tokyo NSE

U/L

Val

ue $

bn $45 tr

Tbut these have not been successful in attracting activity, for reasons that we discuss in the following sections.

18

4.3 Government securities market The government securities market provides the underpinning for a successful corporate debt market, by providing the benchmark yield curve and a low default-risk tool for portfolio management. It is important that the government market functions freely and offers adequate liquidity for this benchmarking to be effective. This efficiency has not always been present in India, and the report by the Asian Development Bank in 2001 noted that:

● The heavy demands of the government funding requirement were risking crowding out other borrowers, and the exigencies of the funding requirement were making the Reserve Bank of India, RBI, over-cautious in its approach to market reform. Banks are required to maintain a Statutory Liquidity Requirement, SLR, of 25%.

● The auction prices were distorted by repeated interventions in which the RBI subscribed to the auction to ensure that it produced the correct price.

● The lack of a clear auction timetable meant that the market could not plan for government issues.

● The fragmentation of the gilt issuance with a large number of outstanding issues (116 in 2001), many very small, was a barrier to increased liquidity.

● The restricted and insecure repo market was hampering the role of primary dealers as providers of liquidity.

● The prohibition on short selling was hampering liquidity and imposing an impossible task on primary dealers who were required to quote firm, two-way prices, but could not sell stock they did not own.

It should be noted that a process of reform had started before this, with the introduction of auctions supported by primary dealers to replace the previous system of allocation. In 2002, the RBI also introduced the Negotiated Dealing System, NDS, which was largely a reporting and settlement platform. More recently, the RBI has introduced the NDS-OM system, which offers trading functionality. NDS-OM has gained significant market share and is widely regarded as very successful.

4.4 Recent developments in the government bond market This section describes the major developments, through reform actions or other influences, in the government securities market.

4.4.1 Government funding and debt issuance Borrowing by the Indian government in the late 1990s and early 2000s was large and growing rapidly. Government deficits in this period were large and the revenue deficit exceeded 5% of GDP in the fiscal year 2001-02. The deficit was driven by:

● Rapidly growing expenditure, especially in grants from central to state government and the heavy involvement of the government in the economy through subsidies and direct ownership.

● Poor tax collection results, partly as a result of an underdeveloped structure, and partly because of collection difficulties.

19

Chart 5 and Chart 6 show the revenue and expenditure trends. The figures show the budget estimates, the revised budget estimates and the actual out-turn (figures follow the Indian practice of measuring in crore and use Indian financial years which run from 1 April to 31 March).

Chart 5 – Government revenue

Central govt. current revenue

0

100,000

200,000

300,000

400,000

500,000

600,000

95-9

696

-97

97-9

898

-99

99-0

000

-01

01-0

202

-03

03-0

404

-05

05-0

606

-07

07-0

8

Rs C

rore Budget

RevisionActual

Source: Ministry of Finance Note: amounts in crores of Rupees, 1 crore = 10,000,000 Rupees Chart 6 – Government Expenditure

Central govt. current expenditure

0100,000200,000300,000400,000500,000600,000700,000

95-9

696

-97

97-9

898

-99

99-0

000

-01

01-0

202

-03

03-0

404

-05

05-0

606

-07

07-0

8

Rs

Cro

re

BudgetRevisionActual

Source: Ministry of Finance Note: One crore = 10,000,000

The revenue and expenditure data illustrate how the Indian government overestimated revenues in the early part of the decade, and how expenditures were rising more rapidly than revenues at that time. The result was a rapidly rising deficit, as shown in Chart 7 and Chart 8.

20

Chart 7 – Indian Government Deficit

Central govt. current deficit

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

95-9

696

-97

97-9

898

-99

99-0

000

-01

01-0

202

-03

03-0

404

-05

05-0

606

-07

07-0

8

Rs C

rore Budget

RevisionActual

Source: Ministry of Finance

Note: One crore = 10,000,000 Chart 8 – Deficit as % of GDP

Current govt. deficit as % of GDP

0.0

1.0

2.0

3.0

4.0

5.0

6.0

94-9

5

95-9

6

96-9

7

97-9

8

98-9

9

99-0

0

00-0

1

01-0

2

02-0

3

03-0

4

04-0

5

05-0

6

06-0

7

07-0

8

% o

f GDP

Source: Ministry of Finance

The situation was serious in the early part of the decade, and was recognised as such by the Indian government. The enactment of the Fiscal Responsibility and Budget Management Act (FRBM) in 2003 was the culmination of a lengthy process of attempting to devise a control strategy for public finances. The act requires the government to follow a strategy to reduce the current fiscal deficit to less than 3% of GDP by 2009. Additionally the government is

21

required to produce a Medium Term Fiscal Policy Statement (MTFPS) as part of the annual budget, in which it explains the sustainability of current policies, how they are consistent with the FRBM, and makes projections for the current and following two years. The discipline which this has imposed has led to improvements in tax collection and some rationalisation of central government funding of state governments. In turn, this led to the possibility of stabilising the absolute deficit – although it has shown considerable volatility over the past few years. More importantly, the sharp acceleration in GDP growth has led to major decline in the deficit as a proportion of GDP. From its peak in 2001-02, the percentage has declined substantially and is now below the FRBM target for 2009. Table 1 below shows the projections made in the MTFPS since the enactment of the FRBM. For each year it shows the projection for the current year, the out-turn for the previous year and the projections for the next two years. For example, the Medium Term Fiscal Policy Statement in fiscal year 2005-06 (left column) showed the previous year out-turn as 2.7% of GDP, slightly above the 2.5% target set in 04-05. For 2005-06, the MTFPS set a target of 2.7% and in the next two years it made projections of 2% and 1.1%. Generally, the current year projections are close to the out-turns, which suggests that the target of eliminating the current deficit by 2009 is on course. As noted, however, there must still be some caution, as the sharp rise in the absolute deficit in 2005/06 and the upward revision of budget estimates for 2006/07 raise doubts about the budgeted reduction for 2007/08.

Table 1 – Fiscal Policy

Medium term fiscal policy statements Year Budget

year 03-04 04-05 05-06 06-07 07-08 08-09 09-10 04-05 3.6 2.5 1.8 1.8 05-06 2.7 2.7 2.0 1.1 06-07 2.6 2.1 1.1 0.0 07-08 2.0 1.5 0.0 0.0 Key: Actual for previous year Current target Target for next two years

Source: Ministry of Finance

Whatever the future movement of the deficit, it is currently more manageable than before. As a consequence, central government borrowing to fund the deficit may have stabilised albeit at a high level and, given the rapid growth of GDP, at a falling proportion of GDP, as Chart 9 shows.

22

Chart 9 – Government Borrowing

Market borrowing to fund deficit

0

20,000

40,000

60,000

80,000

100,000

120,000

94-9

595

-96

96-9

797

-98

98-9

999

-00

00-0

101

-02

02-0

303

-04

04-0

505

-06

06-0

707

-08

(bud

get)

Mar

ket b

orro

win

g R

s C

rore

00.511.522.533.544.55

% o

f GDP Market

borrowing(LHS)

Marketborrowingas % ofGDP

Source: RBI Note: One crore = 10,000,000

4.4.2 Auction pricing The RBI no longer intervenes in the auction. There is discussion concerning transferring the RBI’s role in the entire auction process to an independent Debt Management Office, DMO, similar to that in other countries, including the UK. The objective of this would be to ensure a price-taking rather than a price-making role in the auction for the RBI. Usually law or the constitution of a DMO requires it not to intervene, except in extreme circumstances. An argument for an independent DMO in India is that it would take some time for the non-interventionist credibility of the RBI to be built up, and transferring the role might expedite this change in perception. Whether or not a DMO is established, the removal of RBI intervention will reduce the cost of funding and encourage the primary dealers to bid more actively, so assisting the development of the market.

4.4.3 Auction timetable In 2001 there was a published timetable for Treasury Bills but not for longer dated securities (so-called “dated securities”). In part this was a consequence of weak control of the budget deficit, which meant that there were frequent revisions in the funding requirement during the course of the year. We understand that the RBI now publishes annual timetables for T-Bills and for dated securities.

23

4.4.4 Fragmented issues India has many legacy issues of debt – many of which are very small. This limits liquidity in the market, and the pattern in other markets has been to try to focus the market into a small number of highly liquid benchmark issues. The government bond market now comprises 105 issues with a total face value of Rs 12 trillion. The RBI has adopted a policy of passive consolidation, meaning that it re-opens existing lines of stock for further issues rather than starting an entirely new line for each issue. It has not, however, actively consolidated by calling in existing stocks. In consequence the issuance remains very fragmented. Chart 10 shows the number and nominal value of stocks maturing in each future year. Each bar represents the total value of the government stock outstanding which matures in that year. The splits in each bar represent the value of each individual stock maturing in that year. Thus in 2009-10, eight of the stocks currently in issue are due to mature. It is clear that in most years there are several issues none of which are very large (or therefore very liquid).

Chart 10 – Indian Debt by maturity

Indian government debt - stocks by maturity

-

5

10

15

20

25

30

35

2007

-08

2009

-10

2011

-12

2013

-14

2015

-16

2017

-18

2019

-20

2021

-22

2023

-24

2025

-26

2027

-28

2031

-32

2034

-35

Indian Fiscal Year

USD

bn

(Nom

inal

)

Source: Reserve Bank of India By way of contrast, Chart 11 shows the same chart for Australian government debt. Australia has made a point of aggressively consolidating issues into a few, highly liquid benchmarks. It should be noted that such consolidation can be expensive if done by tendering for existing stocks and then re-issuing. The Australian government has followed a market-driven approach whereby market participants are invited to submit proposals for consolidating bonds. To illustrate, while India has eight stocks maturing in 2009-10, Australia has concentrated all the liquidity into a single stock.

24

Chart 11 – Australian Debt by Maturity

Australian government debt - stocks by maturity

01

234

56

78

2007

-08

2009

-10

2011

-12

2013

-14

2015

-16

2017

-18

2019

-20

2021

-22

2023

-24

2025

-26

2027

-28

2031

-32

2034

-35

Indian Fiscal Year

USD

bn

(Nom

inal

)

Source: Reserve Bank of Australia

4.4.5 Repo and financing The RBI has freed the call money market, which is open to banks and primary dealers. The call-market now operates freely in a corridor of rates between the RBI’s repo and reverse-repo rates. In addition the RBI has been supportive of the development of collateralised lending and borrowing obligations, CLBOs, which have become a more secure and flexible alternative to repo finance. Both repos and CLBOs are discussed in more detail later in this report.

4.4.6 Short selling Short selling of gilts was prohibited until March 2006, when the RBI permitted a limited amount of intra-day short-selling by primary dealers and banks (other investors are not permitted to sell short). This restriction has now been eased and banks and primary dealers may run short positions, of no more than 0.25% of an issue, for up to five days. Other investors are still not permitted to sell short. Thus, while restrictions remain, the direction of policy is clear and the barrier caused by short selling restrictions is becoming progressively less important.

4.4.7 The result of reform Chart 12 illustrates the effect of the reforms discussed above. Turnover steadily increased up to 2003 as the market was reformed and liberalised, and since mid-2003, repo trading has outstripped outright trading.

25

Chart 12 – Gilt Market

Monthly gilt turnover - outright and repo

0

100,000

200,000

300,000

400,000

500,000

Jan-

95

Jan-

97

Jan-

99

Jan-

01

Jan-

03

Jan-

05

Jan-

07

Rs

cror

e OutrightRepoCombined

Source: Reserve Bank of India (RBI)

As Chart 12 and the discussion show, the reforms have had a beneficial effect on liquidity in the government bond market. As all concerned with the market acknowledge, however, there is still work to be done before the market can be regarded as fully liberalised.

4.5 The Indian corporate bond market While the rest of India’s capital market has forged ahead and now offers a world class market, its corporate debt market has not flourished. India has successfully developed some of the critical infrastructure requirements, such as a risk-free yield curve and credit rating agencies (linked to global agencies), but the market remains underdeveloped. Table 2 shows the relative size of bond markets in a range of developed and developing countries.

26

Table 2 – Outstanding Bonds

Private bonds

outstanding / GDP%

Public bonds

outstanding / GDP%

USA 111.8% 46.3% UK 15.9% 31.1% Germany 34.1% 41.0% France 41.4% 53.8% Spain 42.0% 38.9% Korea 54.0% 21.1% Japan 42.4% 150.2% Thailand 20.2% 21.1% India 1.0% 32.9% China 10.4% 15.2% Hong Kong 17.8% 9.1% Singapore 18.8% 39.2% Australia 39.3% 12.6% Indonesia 2.4% 16.6% Brazil 12.0% 44.6%

Source: World Bank

The data indicates that while India has a government (public) bond issuance which is not much out of line with the rest of the world, its corporate bond issuance is very much lower than the norm. It is below even that of Indonesia, which suffered severely in the Asian crisis, and where the market has been marked by catastrophic failures - most recently when its bond mutual funds collapsed after a sharp rise in interest rates. Chart 13 shows the movements in the relative importance of different asset classes in India over the longer term. There has been a gradual, but consistent, reduction in the relative importance of bank deposits from 44% in 1990 at the start of the reform program to 28% in the latest figures. It should be noted that in May 1992 the ceiling on rates payable on corporate debentures was removed. Equity has generally expanded, but with a halt in the early 2000s when world equity markets were falling and the Indian government’s debt was rising strongly. Over the whole period, government bonds have declined from 31% to 22% of domestic financial assets. Corporate bonds briefly became visible on the graph in the mid to late 90s but have now almost disappeared.

27

Chart 13 – India Domestic Financial Assets

India Domestic Financial Assets

0%

20%

40%

60%

80%

100%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Govt bondsCorporate bondsEquityBank deposits

Source: World Bank

To provide an international comparison, Chart 14 shows the pattern of financing in Asian and some developed markets.

Chart 14 – International Sources of Finance

Sources of corporate finance 2005

0%

20%

40%

60%

80%

100%

Chi

na

Hon

gkon

g

Indi

a

Indo

nesi

a

Japa

n

Kor

ea

Mal

aysi

a

Sin

gapo

re

Thai

land

Ger

man

y

UK

US

A

Corporate bondsEquityBank deposits

Source: World Bank

28

What is clear is that relatively few countries have a truly substantial corporate

● China is experiencing massive growth but has a far higher reliance on

● y from its lack of a corporate bond

● ith a much

lthough this suggests that India’s economic growth need not be hindered

● Many issues are not true bonds; rporate issuers;

ach of these is discussed below.

4.5.1 Issues are not bonds ssues in India, that is, where they are offered to a

hese features of private placements lower the issuance costs but public

● Issues by small or poorly rated corporates – where the small investor

● c

● l offerings linked to a particular project. he oddity in India is not that there are private placements, even by large

hart 15 shows the growth in number and value of private placements in the last ten fiscal years.

bond market. Only in the USA and Korea does it exceed 20% of the total, and there seems to be no direct link between economic success and the structure of corporate finance, for example:

bank debt than any other country. Hong Kong has not suffered notablmarket and has a corporate finance structure similar to that of India, albeit with a much smaller and entirely different economy. Korea, with a large corporate bond market, and Taiwan, wsmaller one, have both experienced considerable economic success.

Aby its low level of corporate debt, Table 2 actually overstates the size of India’s corporate bond market because:

● It is not a significant market for co● There is only a limited secondary market.

E

There are almost no public iwide range of investors and conform to the regulatory standards required of public issues of bonds. Almost all corporate bond issues are made as private placements. Private placements are characterised by being only offered to no more than 50 “Qualified Institutional Buyers” (that is, professional investors), by having limited disclosure requirements, and by having lower regulatory hurdles (similar to Rule 144A issues in the US). Tissues are, in other markets, viewed by investors as more attractive, because of the wider spread of investors, better liquidity and better disclosure. This leads to lower cost of capital, which offsets the higher issuance costs. In other markets, therefore, private placements tend to be used in specialised areas such as:

base means that the investors can have more involvement in the company and can better monitor cash flows and the like. Smaller issues, which would not justify the distribution costs of a publioffer. Specia

Tcorporates, but that there are so few true public offerings. C

29

Chart 15 – Private Placements

Private placement - number and value

0

200

400

600

800

1000

1200

1400

1600

1800

97-9

8

98-9

9

99-0

0

00-0

1

01-0

2

02-0

3

03-0

4

04-0

5

05-0

6

06-0

7

Num

ber

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

Valu

e Rs

cro

re

Number Value Rs crore

Source: RBI

Private placements are a growing, although still small, source of capital for

dian corporates. At the same time, only two companies have made public

nly quite small, with an average size of Rs850m pproximately $20m). In fact, corporates wanting to raise a larger amount

are actually yndicated loans – an impression confirmed by the fact that the largest

Chart 16 and Chart 17 show how the 2006-07 issuance of Rs145, 571 crores different categories of issuer. They

Inissues in recent years. The issues are also mai(amay well make a number of separate placements, sometimes on the same day. Since the number of investors is limited, the separate issues will all go to practically the same investors and will usually have similar terms. The conclusion is that many of the “bonds” that are issued sinvestors are banks.

4.5.2 Many are not issued by corporates

($35bn) in 1,678 issues was split between show that public sector entities accounted for 42% of value of issues and 8% of the number of issues. These issues were relatively large, with an average of Rs4, 400 crores ($107m). Private financial companies, largely banks raising money to lend on to clients, represented 35% of the value and 39% of the number. Private, non-financial corporate issuers represented only 23% of

30

value, but 53% of the number indicating an average value of Rs37 crores ($10m).

Chart 16 - Value of Private Placements by Issuer Type – 2006/07

Chart 17 – Number of Private Placements by Issuer Type – 2006/07

Source: RBI

Source: RBI

Value of private placements by issuer type

Private financial35%

Private non-financial

23%

Public financial34%

Public non-financial8%

Number of private placements by issuer type

Private financial39%

Private non-financial53%

Public non-financial2%Public financial

6%

31

This shows that the issuers who are the main participants in other corporate bond markets (that is, private sector, non-financial), represent only a small proportion of the corporate debt issues in the Indian market.

4.5.3 Lack of liquidity As noted, corporate debt markets worldwide typically have low liquidity. Until 2007, information on Indian turnover was incomplete and largely anecdotal. SEBI has, in 2007, however, launched initiatives to ensure more comprehensive reporting of the OTC bond market, where the bulk of the trading occurs. Chart 18 shows the monthly turnover figures, as published by SEBI.

Chart 18 – Corporate Bond Turnover

Source: SEBI Note: One crore = 10,000,000

Current volumes are running at around 150 transactions per day, with a daily value of Rs350 - 400 crores (approximately $100m). In contrast, gilt turnover (outright plus repos) is running at between Rs12,000 and Rs15,000 crores per day. Commentators suggested that there is relatively little liquidity in the corporate bond market because:

● The total issuance is highly fragmented because of the dominance of private placements.

● The number of participants in the market is relatively small, there is little diversity of view, and hence little incentive to trade.

● Most buyers intend to buy and hold.

Corporate bonds - monthly turnover 2007

1,500

3,500

4,000

4,500

4,000

12,000

14,000

16,000

Va

ore

Trades(LHS)

2,000

2,500

Trad

es

6,000

8,000

10,000

lue

Rs

Cr

3,000

Value

1,000

-

500

Jan-

07Fe

b-07

Mar

-07

Apr

-07

May

-07

Jun-

07

Jul-0

7A

ug-0

7

Sep

-07

Oct

-07

-

2,000

Rscrore(RHS)

32

4.6 Euro issues As Indian conglomerates have come on to the global stage, they have been increasingly able to access Euro markets. The Exchange Control Board (ECB) regulations were relaxed in 2004 to allow Indian companies to issue in foreign currency to finance foreign acquisitions. This is an area where major Indian companies have come to the fore in recent years, particularly in IT, but also in steel, food (tea) and a range of other industries. Chart 19 shows the issuance of Eurobonds by Indian issuers over the last ten years, and shows the sharp increase in the use of Euro markets since the ECB relaxation.

Chart 19 – Euro issues

The BISfinaissu c

Table 3 – International Debt Outstanding

Euro isssues by Indian issuers

40

100120140160180

Rs

bn

20

30

40

50

60

Num

ber

Value Rsbn (LHS)

Source: RBI

figures shown in Table 3 confirm the increasing interest in this form of nce. Euro issuance remains small, however, representing only 12% of the

2006/7. an e in the private placement market in

International debt securities by Indian issuers: amount outstanding ($bn) Dec

2005 Dec 2006

Mar 2007

Jun 2007

Financial institutions 4.0 7.2 11.9 14.2 Corporates 6.7 12.7 14.8 16.4 Total 10.7 20.0 26.7 30.7

ource: Bank for International Settlements (BIS) S

oreig bonds (FCCBs) have become a popular vehicle r Indian corporates to access foreign capital markets; major corporates,

such as Tata and Reliance, have used this vehicle to raise capital. A number are listed on the London Stock Exchange. These bonds have been issued with

Ffo

n currency convertible

020

97-9

8

98-9

9

99-0

0

00-0

1

01-0

2

02-0

3

03-0

4

04-0

5

05-0

6

06-0

7

0

10

60Va

80

lue

Number(RHS)

33

a wi on, namely n of a ri over the las lling

The i es RBI approv ries (ma but ot s.

4.7 Indi ng

with 2000,

reachi

Structured Finance

has ,

de range of structures and coupons, but with a common motivati to borrow at a reduced yield on the basis of investors’ expectatio

se in the share price of the issuer. That rise has happened, especiallyt couple of years, and so the coupon discount that investors are wi

to allow on convertible bonds has declined and the issuance has slowed

ssuance of FCCBs is subject to substantial regulation and requiral. Approval can be automatic, in the case of some indust

nufacturing industry and infrastructure) meeting specific conditions,herwise requires explicit approval, which is given on a case-by-case basi

Securitisation and structured finance a began securitisation early among Asian markets with transactions goi

back to the early 1990s. Initially these started out as loan sales usuallyrecourse or other originator support. Growth accelerated from

ng a total of Rs370 bn in 2006/07, as shown in Chart 20.

Chart 20 –

Structured finance issuance

0

01/

02/

03/

04/

05/

06/0

7

Rs b

n

250Asset backedsecurities

50

100

150

200Mortgage backed

itiessecurCDO/CLO

Partial Gu earante

Others

02 03 04 05 06

Source: ICRA

The figure also shows the different patterns of growth, with asset-backed securities (predominantly backed by auto loans), being the main type of securitisation. Other assets have fluctuated, with mortgage backed securities, MBS, showing steady growth to 2005 but since declining. There

lso been an upsurge of collateralised debt and loan obligation, CDO/CLOaand securitisations, including a significant volume of single loan securitisations in 2006/07.

34

4.7.1 Assets securitised Securitisations have been backed predominantly with auto loans and mortgages. Mortgage backed securities have been restricted by the difficulty of reconciling investors’ preference for fixed rates with the typically

ariable rates used on residential mortgages. Mortgage securitisations have mainly mmercial.

Credit card securitisations have not featured, partly because of stamp duty difficulties (as we discuss), but also because the credit card market in India, while growing fast, is still relatively small. There has also been a limited amount of future flow securitisations, such as toll receipts, and some infrastructure financing. The demands for infrastructure financing in India are now recognised and it is expected that securitisations of receivables from those projects should expand rapidly. As the nature of the securitised assets suggests, the originators have mainly been banks and non-bank financial institutions. These include housing finance companies, and former development banks that have been privatised and which have become major players in the consumer lending market. There has also been some securitisation of corporate loans, again with substantial credit enhancement. These even have included single loan securitisations, whose economic benefit is hard to see. These transactions,

hich (or no) diversity in the assets and higher granularity, tend to e les and so are mainly attractive to banks as investors. India, erhaps fortunately, has not developed asset-backed commercial paper

re very substantial levels of credit enhancement. Methods of enhancement have included:

● straight recourse to the originator (often structured as put options); ● originator or third party guarantees; ● over collateralisation; ● cash collateral;

4.7.3 Risk structures One attraction of securitisation is the ability to split the bonds issued by the SPV into a number of tranches, each bearing a different level of risk. Some tranches would be very secure and gain a high rating, others would be subordinated, and so more risky, and therefore be lower rated. Until recently subordinate tranches were not offered in India, and they are still a rarity because there is little investor demand for such subordinated and hence lower-rated paper, and because there was no capital penalty for the originator retaining the first loss tranche. The latter reason has been affected

v been residential rather than co

w involve less s highly ratedb

pconduits in any of the variants that have evolved in other markets.

4.7.2 Investors in securitised bonds The investors in the securitised paper are predominantly banks and insurance companies. Insurers are subject to restrictive investment mandates (discussed below), and so the securitised assets are structured to achieve a very high rating and, often, to minimise prepayment risk. To gain these ratings, successful issues requi

35

by the RBI guidelines described below, and the market is now seeing some hes.

although these have proved be useful elsewhere, when tax or other considerations make transfer of

y in some cases, and the desire to rystallise a profit by selling assets that have increased in value. In other

ian banks are not especially eager to divest themselves of what they see as the better assets on their balance sheet, and the amount

fferent risks have not been available in India.

his may be difficult in India, given the

gn investment in Indian debt.

re bonds. These would probably have to be guaranteed (explicitly or implicitly) by the government, so that these

ilar standing to government bonds, and be subject to

use of subordinated tranc India does not currently have credit insurance or an active market for credit derivatives. This means that these risk management tools are not available for use in structuring deals. It also means that the use of credit swaps to create synthetic securitisations is impracticable in India, toassets to Special Purpose Vehicles, SPVs, difficult or costly.

4.7.4 Originators The number of originators remains small; ICRA estimates that the top five issuers account for about 80% of issuance. Motives for securitising vary. The main motivations seem to be liquiditcmarkets, banks have securitised to get loans off their books or to profit from the reconstruction of assets to create a more highly-rated asset. These do not appear to be major drivers in India because:

● Ind

issued so far would not be material for most banks anyway. NBFCs and some of the more highly leveraged banks may have incentives to reduce their balance sheet size, but this does not appear to be a significant motivation.

● The unwillingness of investors to buy lower rated tranches means that

profits generated by structuring assets into packages with di

4.7.5 Infrastructure finance by securitisation India recognises that very large investment in infrastructure is required over the next decade. There are several methods of financing infrastructure spending:

● Issuing straight government debt. Tthe substantial amount of government debt currently issued and restrictions placed by the RBI on forei

● Issuing infrastructu

would have simthe same objections.

● Private-public partnerships. The private sector takes a large stake,

usually involving private sector operation of the infrastructure facility. Where this approach has been used, it is less for the financing side, and more because it removes the responsibility for management control and labour relations from the government. Our interviews did not

36

suggest that this is an option that is of substantial current interest in India.

● Securitisation of future flow receipts has been used in a number of

countries, including India, as a way of attracting external finance, while retaining government control. Infrastructure financing differs from conventional securitisation because there is no asset (mortgage or other debt instrument) to sell to the SPV. Instead, a right to the future cash flows is transferred to the SPV (so-called future flow securitisation is used), rather than the asset itself, which remains in government ownership. As the future flows are not linked to a

payment schedule, such as a mortgage, and as the

might be noted that offshore securitisations have allowed some governments, such as Brazil, to

4.7.6 dia, being a common law country, has been able to develop structured

finastructumain le curitisation are:

ct (SCRA), which is the main

rcement of Security Interest (SARFAESI) Act, which was intended to clarify the status of securitisation but which experts consider has had

SPVs in is imilar to English trust law, and the preference for trusts reflects the fact that

conot (afor a sdistinc

Reg aamendstraighhas anmarkeStandard Assets”, before which there had been little regulation and banks

prescribed operation of the asset may retain in the government’s control, the future flow is more risky than in conventional securitizations and so the structure needs to reflect this with substantial credit enhancements. The bonds issued are still domestic bonds and so would be subject to the sovereign rating ceiling (that is, they would have a yield higher than domestic government bonds). It

pierce this so-called sovereign ceiling. This is only possible when the cash flows are offshore, however, so they can be insulated from any transfer and convertibility risk, and where the operation of the asset is largely outside the control of the government.

Regulatory background In

nce and securitisation without the need for a special law to define res such as SPVs, as would be required in statute law jurisdictions. The gislative instruments relevant to se

● the Securities Contracts Regulation Acapital market law; and

● the Securitisation and Reconstruction of Financial Assets & Enfo

little effect.

India are usually set up as single purpose trusts. India’s trust laws

rporate SPVs would be subject to corporate income tax, whereas trusts are lthough the tax position is not entirely clear, see below). Trusts are used ingle transaction (that is, they are not master trusts that run a number of t SPVs).

ul tory responsibility is not clear in that the SCRA is currently being

ed to make SEBI the regulator for securitisations. As was the case with t bonds, however, the involvement of banks means that the RBI also interest, and its regulations will have an important impact on the

t. In February 2006, the RBI issued “Guidelines on Securitisation of

37

were require le retaining the first-loss portion or some similarly risky credit

nhancement. Basel 2 addresses this point by imposing higher (potentially mu the nerequireare, in The fopool oretaini Table 4

guidelines guidelines

able to move assets off balance sheet. This reduces their capital ment, whi

ech higher) capital requirements on such first-loss tranches, but the RBI felt

ed to act more quickly. The effect was to sharply increase the capital ments associated with securitisations and to impose requirements that

some circumstances, more strict than those of Basel 2.

llowing example illustrates this effect. It assumes a bank securitising a f 1,000 in personal loans and providing credit enhancement by

ng 100 on its balance sheet, 50 as first loss and 50 as second loss:

– Capital Requirements Example

Before RBI Post RBI Basel 2

1. Caasset

pital relief on s moved off B/S

9%*1000=90 9%*1000=90 9%*(125%*1000) = 112.5

2. Carequienha

pital rement for credit ncement

9%*100=9 100%*100=100 (100%*50) +(9%*50) = 54.5

Net c = 1.

apital saving minus 2.

81

–10

58

Source: Vinod Kothari website

tes increase in capital requirement

, whereas as 2

Thetha eprobathe market also responded by developing structures that circumvented some

f the the guidelines. For example, the guidelines state that

Note: Negative number indica

The increase in capital required after the RBI guidelines reflects the higher risk that the bank has taken on through credit enhancement. The greater severity of the RBI requirement as compared to Basel 2 arises mainly because

e RBI imposes a 100% risk weighting on all credit enhancementthB el only imposes the 100% on the first loss component.

issuing of the guidelines has caused a slowdown in the market, especially t r lating to personal loans, although opinion is that capital saving was

bly not a major motivation for securitisation in India. Not unexpectedly,

requirements ofothey only apply to securitisations, which the RBI defines as a structure involving an SPV. This has caused a growth of “direct assignments” (that is, bilateral transactions of assets and cash flows), which are unregulated and do not involve any capital market issues of securities. It is expected that the RBI will act on this, and, in any case, Basel 2 will treat direct assignments in the same way as securitisations, so this is a likely to be a short-term phenomenon.

38

5 The Patil Report In December 2005, the Report of the High Level Expert Committee on Corporate Bonds and Securitisation, under the chairmanship of Dr R.H. Patil, was published. The report made a number of recommendations to address

ilings in the corporate bond market. The key recommendations are

t have roduced the buoyant market expected at the time.

The report’s recommTable 5 summarises the issues and recomme ntained in the Patil r vided i thre as S Se s are used id y of these recom t

y of Patil Report Recommendations TOPIC RECOMMENDATION

fasummarised in the next section; section 5.2 outlines the progress made since then towards implementation of the report’s recommendations. Finally, section 5.3 addresses some of the reasons why implementation may nop

5.1 endations ndations co

eport. These are diecondary Market and

nto the samecuritisation) a

e broad aren the Pati

(Primary Market, l report. We

iscuss man

Table 5 – Summar

mendations la er in this report.

PRIMARY MARKET

Stamp m for an issue duty Standardise nationally; set maximu

Tax Deducted at Source Apply the same rules (that is, exemption) as for government bonds

Enhancement of the issuer base

Reduce time and cost of public issuance Simplify disclosure and listing for private placements Substantially reduce disclosures required for already listed issuers

Enhancement of the investor base

Reform provident/pension funds’ investment guidelines towards risk(ratings) rather than specific types of assets Encourage retail investors to access market through mutual funds and exchanges if preferred Steady increase in total investment allowance in corporate bonds by foreign institutional investors

Consolidate fragmented private placement bonds

Use stamp duty cap to encourage re-opening of existing bonds Guidelines on number of separate issues in a quarter

Bond database Stock exchanges should compile and publish list of available bonds and update for credit events

39

TOPIC RECOMMENDATION

SECONDARY MARKET

Trade reporting system Increase transparency by ensuring all trades are reported

Interest rate derivatives Increase transparency for OTC trading Introduce exchange traded interest rate derivatives

Market makers Develop framework of incentives to encourage large intermediaries to act as market makers

Clearing and settlement Upgrade procedures to conform to international f Delivery versus Payment, DvP standards o

Trading platform Develop order-matching platform to support market

Market conventions Fixed Income and Money Market Dealers Association, FIMMDA, should lead adoption of standards for day count and actual/actual accrued interest calculation

Repos RBI to permit repos in corporate bonds

Market lot size Reduce to Rs100,000

SECURITISATION

Stamp duty Work towards consensus on appropriate rates nationwide

Taxation plicit the tax treatment of pass Clarify and make exthrough payments No withholding tax as most investors are Qualified Institutional Buyers, QIBs, and tax exempt

Listing sted

Define bonds issued by SPVs legally as securities so they can be li

Widen investor base Allow larger NBFC and non-NBFC corporates tinvest in securitised paper

o

Source: Patil Report

These recommendations are nt of the corporate bond market. We note here:

● The proposal to increa ate placements. Our rese n is

.

● More substantively, we re concerned about the enthusiasm for direct retail involvement in th

as comparab n rates, we note that fe wide

all appropriate to the developme

se the documentation requirements on privarch suggests that the level of documentatio

now appropriate

ais market. While it is tempting to see all financial

markets le and to take lessons from equity participatiow, if any, corporate bond markets world

40

have significant retail involvement. The point is also discussed further later on in this report.

accepted by the Union government in February 2006. rities E nal ed in

to examine the SEBI committee’s report which reported in July 2006. SEBI has e

, the governm r of the primary and secondary corp ) to

co-ord nks regulated by the RBI were the SEBI. The

ed as the regon corporate debt. Regulation of corporate debt derivatives and unlisted

ld be dec may appear to resolve the issue, and it is likely that ambiguity in

effort has been spent systems for ds, with the res ng systems (NSE, BSE

are now licensed b ational, through which rate debt can be reported. Both the NSE and the BSE also

g functionality, a that on trading is now e has

been a significant increase in market transparency.

Other significant progress has following areas:

● SEBI is in the proce ts, although there is no uction of change.

● The government is pr ments to the Companies Act llow shelf

is ex tamp Duty on corporate bonds.

● I mandated changes to the shut period, day count conventions and lot size.

Giv recom

ot ‘ta re the reasons why this may not have occurred, it is se l

into

●

theory, they are reasonably simple to address. In practice, however,

The Patil report wasFollowing this, the Secucommittee which report

xchange Board of India, SEBI, set up an inter March 2006. The RBI then set up a committee

also published several updat s to its report.

5.2 Progress since the report In January 2007 ent clarified SEBI’s position as the regulato

orate debt markets (exchange and OTCaddress the lack of ination between two regulators when ba

main users of a market regulated by RBI was confirm ulator of the market for repo and reverse repos

debt securities wou ided as required. As we discuss, whilst thiskey points of dispute are, as yet, unaddressed terms of regulatory responsibility may remain.

Much on developing appropriate tradingcorporate bonand FIMMDA)

ult that three trading/reportiy SEBI and are oper

trades in corpooffer tradininformation

lthough this is little used. The result is available where it was not before, so ther

been made in the

ss of simplifying the disclosure requiremen published timetable for the introd

ogressing amendrequired to a

● The governmentregistration. amining the proposal to simplify and reduce

SIn April 2007, SEB

5.3 Implementation of the report en the progress made towards implementing the Patil report’s

mendations, it is perhaps surprising that the corporate debt market has ken off’. To explon

u fu to note that, in most markets, the barriers to market development fall two classes:

Micro-barriers – relatively minor impediments such as tax, legal barriers or lack of market venue. They are minor in the sense that, at least in

41

even seemingly minor changes in the law can take a very long time in most countries.

● Macro-barriers – more significant barriers, in the sense that they require

development of other parts of the market before they can be removed. Examples include: lack of demand for capital market finance because alternatives are easily available, lack of demand for investments, and governance problems.

lopments in response to the Patil report fall

products which it had aditionally been offered, and which was prepared to accept more risk in

came from orporates keen to improve their balance sheets as economic reforms, the

openinlong-tecomm iplines. As we this underlying supply and demand are rfrom s limited. The implications of this are also x

We note that most of the deveunder the first of these. As such, they are unlikely to be sufficient in themselves to initiate the corporate debt market. Equally, it is true that the macro-barriers may be impossible to address in the short-term, whilst the micro barriers can be. In the following chapters, we discuss these two categories in more detail.

5.4 Parallels with equity market development Whilst we believe that there are significant similarities between the needs of all financial markets, we also believe that there is a danger in simply applying methods that worked for one market to another. In particular, India has successfully developed its equity and equity derivatives markets by improving their infrastructure. There may be a view that doing the same for the corporate debt market would achieve a similar result. It is critical to note, however, that the demand for and supply of equity was always present, but the market was seen as inefficient, opaque, and possibly unfair. There was significant demand from a retail market, which wanted to diversify away from the guaranteed investment trexchange for the possibility of large gains. Supply largely c

g of the economy, and improved growth, significantly improved their rm prospects, while at the same time making them more subject to

ercial disc

go on to discuss, it is not clear that p esent for corporate bonds and, as a result, the likelihood of success

imple infrastructure reform may be e plored.

42

6 In this reportcorpoimport ificant issues first. While this

rdering is ours, we note that it corresponds broadly with that of our

We have treated securitisation and barriers to its rapid development as a Patil report, and the fact

es were related to those in

e rate of duty is variable depending upon both

The level and complexity of stamp duty encourages an arbitrage-based approach to corporate finance, so that decisions may be tax-driven rather than strategy-driven. There is a stated intention to reform stamp duty, probably by introducing a standard national rate with a maximum cap, as recommended in the Patil report. This would be a significant enhancement to the market, and the timescale suggested to us, six months to one year, is encouraging. The problem has been known for a long time, however, and, since it would require changes to the Indian Stamp Act of 1899, progress may be slower than the market would like.

Micro-barriers – the effect of institutional rigidity section we discuss the institutional reasons, advanced both in the Patil and in our interviews, for the lack of development of the Indian rate debt market. The sub-sections discuss these in decreasing order of ance, and so we discuss the more sign

ointerviewees, although the regulators tended to see the points related to secondary market and investor protection related to issuance procedure as being more significant than did the others. Within each area, specific issues are also presented in descending order of importance.

separate discussion, following the approach of thethat the practitioners we spoke to seemed to see it as somewhat separate from the mainstream discussion of bond markets. The securitisation market also does present some new issues which do not affect conventional bonds.

dditionally, it seemed that while some of the issuAthe wider bond market, they appeared in a different form (such as the impact of stamp duty being upon the transfer assets rather than the creation of instruments).

6.1 High and complex taxation Two significant tax issues have a special impact on corporate bonds:

6.1.1 Stamp Duty Stamp duty is high, typically 0.375% for debentures (that is, on creation of corporate bonds) and, as it is strictly ad-valorem, there is no volume discount. The existence of Stamp Duty may encourage the borrower to go for a loan instead. In addition, thlocation (various states have set their own rates) and the nature of the issuer. It may also vary with the nature of the investor to whom the bond is initially sold (for example, promissory notes bought by commercial and some other banks are subject to only 0.1% duty, compared to 0.5% if issued to other investors).

43

6.1.2 Tax deducted at source (TDS) Bond interest and tax on bond interest is calculated on an accrual basis, but

herefore a y The previous

res were introduced for trading on the NSE. The RBI restricted gulated banks to only using interest rate futures for hedging purposes,

however. Derivative markets, and arguably all financial markets, need a mix rate adequate liquidity. So, whatever the

ic eant that the market was limited to rivatives

so far been relatively unsuccessful. There is currently a high-level t interest rate derivatives. Much of the committee’s

o market is open to primary dealers and banks, who are required maintain a Statutory Liquidity Ratio of 25% (although most actually hold

nt bonds, however. The limiting factor to date has been one of regulatory co-ordination. The corporate bond market is under the general regulatory view of SEBI, but the RBI considers

is paid at the end of the tax year by the holder on that date. Tbu er may have to collect the tax from the previous holder. holder remits the tax owed by him for his holding period plus tax claimed from the previous owner in respect of the current tax year and so on. An additional complication arises because some entities, mainly mutual funds and insurance companies, are tax exempt. Exempt investors are sometimes reluctant to buy stock from non-exempt investors, as they become responsible for the tax payment, despite being themselves exempt. Although government securities have been exempted from TDS, it remains in place for corporate bonds.

6.2 Lack of risk management products Liquidity in bond markets is often not about trading the cash bond, itself but in changing the risk profile of the portfolio using risk management tools – derivatives, stock lending and borrowing (SLB), repos and swaps. Whilst India has world class markets in equity derivatives, it has had mixed success in developing risk management tools for debt markets.

6.2.1 Interest rate futures Interest rate future

of hedgers and speculators to genejustif ation for this restriction, it mmatching hedging transactions. As a result, the NSE’s interest rate dehavecommittee looking afocus is on technical issues, however, (for example, the precise definition of the underlying asset), but, in contrast, practitioners suggest that the problem is not technical but simply lack of players. This means that the market is limited, and suggests that, unless bank participation is allowed on a freer basis, it is unlikely that interest rate futures will succeed. This will in turn have a negative effect on the corporate bond market itself.

6.2.2 Repos The gilt reptomore than 25%), and they are free to repo their non-SLR holdings. Gilt repos are almost exclusively between the market and the RBI and there are few third-party repos. The RBI also uses repo and reverse-repo to conduct money market operations. Daily rates are announced, and set a corridor between the repo and reverse-repo rates where the call money market operates. As Chart 12 previously demonstrated, the volume of repos has grown sharply in recent years. Repos are only permitted in governme

44

corporate bond repos to be money market instruments, since they would

ed OTC futures. The growth and opacity of badla led SEBI to finally ban the practice and force the unwinding of positions.

gations are an Indian initiative

nd primary dealers the borrowers 6/07). Pledged collateral is held in the depository,

owed to bid for loans up to a value determined by

risk, however, and this is absent in T t derivative products or credit insurance in India, (see

gh the RBI is currently consulting on this.

global monoline insurers – MBIA and Ambac are the industry aders. These firms have not yet expanded their operations into India. It is

affect bank liquidity, and therefore also to fall within its regulatory scope. There is reported to be active consideration of corporate bond repos, but no implementation timetable has yet been published. Conventional stock borrowing is theoretically available, but general market illiquidity makes it impracticable. India does have an efficient, automated stock borrowing and lending infrastructure for equities, which was introduced when badla was outlawed in the early 2000s, but not for corporate bonds. It is worth noting that badla was a feature of most markets in the sub-continent. Essentially it involved the carrying over of positions rather than settling them – in effect unmargin

Collateralised lending and borrowing obliintroduced by the Clearing Corporation of India (CCIL). Essentially they are a negotiable and tradable third-party repo. They offer secured (against government bonds) lending, and are open to a wide range of participants, including banks, primary dealers and mutual funds. Currently, mutual funds are the main lenders (62% in 2006/07), with banks amain (73% in 200and those pledging are allthe collateral. The pledging of stock provides a tradable instrument, the CLBO, and the market operates through an electronic auction, matching the bids and offers for CLBOs. As well as the advantage of security, because of the collateralisation, CLBOs offer greater flexibility than repos, because the tradability of the CLBO means that parties can close out positions by trading the CLBO, rather than waiting until the end of the term as is normal with repos. Volumes have grown rapidly since introduction and now exceed repo volumes. CLBOs are only permitted on government stocks, however.

6.2.3 OTC derivatives and swaps Forward rate agreements (FRAs) are regularly traded and there is a reasonably active OTC swap market in India. A strong OTC swap market tends to require a wholesale exchange traded interest rate derivative market where swap counterparties can lay off theirIndia. here are no credibelow), althou There is also an OTC swap market for Indian interest rates (and currency) in Singapore, and recently a gold contract priced in Rupees has been introduced in Dubai. This leads to the possibility of establishing a domestically based swap market.

6.2.4 Credit insurance Credit insurance is not available in India. Such insurance is provided elsewhere by lealso true that the basic data on bond issues and defaults does not exist in comprehensive form, which would add further costs to insurers entering the Indian market.

45

6.3 Cumbersome public issuance process The corporate bond market is, has been, and remains, largely a private placement market. Table 6 shows a comparison of the Indian market with a generic bond market to illustrate its unusual nature.

Table 6 – Breakdown of Indian Corporate Bond Market

ISSUER Large Medium Small Generic bond market High rating Public Public/PP N/A Medium rating Public/PP PP PP Sub investment grade PP PP PP Indian bond market High rating PP PP (possibly) N/A Medium rating PP (possibly) N/A N/A Sub investment grade N/A N/A N/A

Source: Asian Development Bank (ADB) Note: PP = Private Placement

Why, then, do highly rated, large Indian corporate issuers prefer to make private placements when in other markets they would be making public offers?

6.3.1 Public issues are difficult, slow, expensive, risky and inflexible A public issue requires a prospectus to be submitted to SEBI. Throughout the fieldwork we were told that the level of detail required is excessive (although it is not unusual for issuers and investment bankers to complain of excessive disclosure requirements). Although a detailed evaluation of SEBI’s disclosure

e of this report, some of the comments are

ocess. The prospectus examination is relatively quick, on it contains, but the amount of information e to get valuations from government offices, means

volves substantial risk for the issuer. There is neither a grey

requir ments is beyond the scopesuggestive:

● The size of the prospectus was reported to be of several hundred pages.

● The disclosure requirements for prospectuses are identical, irrespective of whether the company already has an equity listing or not. This is unusual, and is not normal international practice.

● There is no provision for shelf registration, whereby a programme of tranches can be covered by a single prospectus.

The issue process is reportedly slow, taking several months for an issue to go through the entire prgiven the amount of informatirequir d, and the needthat compiling the prospectus is slow. In other markets, the regulatory processes for issuing a bond take a matter of days, or less if issuers use shelf registration. Public bonds also have to remain open for subscription for a month at a fixed price, which in

46

market, in which underwriters can lay off this risk, nor any interest rate

safer and more flexible. In con te placement is mall, although the documentation requirements have been increased in

rece . Five years ago, m sheet to po buyers was little ge and many key pieces of information were omit cumen three or four pag wees re appropri h ances. Plac er ith k building a ricing usually completed The or o more th r d), makes it relat egotiate l an a change in int a coupon nt during the ssue. his makes priv te placements very flexible in com specific provisions in the prospectus for res practical to renegotiate terms with all the bond-holders. It also emphasises the similarity in India between corporate

es of issue are usually listed on a stock exchange, as RBI regulations restrict banks’ ability to invest in unlisted bonds, as do the investment

ctions of the RBI also have a significant impact, however. Whilst g

a r uongoinpreand cregtha

derivatives for hedging. Estimates vary, but cost estimates for a public issue average out at about 4%.

.3.2 Private placements are easier, faster, cheaper,6trast with public issues, the documentation for a priva

snt years the ter sent out tential more than half a pa

d. Currently,ted or implie the do tation runs to aate for t

bout ircumstes, which intervie garded as

ickly, we c

ements can be issued v within a day.

y qu boo nd p

small number of invest s (n an 50 are peunderst

mitteively easy to ren terms. Typica

gotiationly we d that

erest rates will lead tocurrency of the i

rene T

of thea

on a placeme

parison - unless a public bond hadld be imetting the coupon, it wou

bonds and corporate loans. Both typ

mandates of most institutions.

6.4 Lack of regulatory clarity The corporate bond market is affected by a number of regulatory agencies. SEBI is the regulator charged with responsibility for the primary and secondary market. As the banks are major players in the corporate debt market, the regulatory are ulatory agencies are adamant that there is co-ordination between them,

ec rring theme of our discussions with practitioners was a perception of g friction between regulators. While the practitioners’ view is

dictable (and is often raised by practitioners in other markets), the strength onsistency of the view convinced us that there is a perception of poor tory co-ordination, or even conflict. A number ula of examples suggest

t this perception may not be entirely mistaken:

● The failure to develop a corporate bond repo market, for which the actions of the RBI have been blamed for creating obstacles.

● The delay in implementation of even some of the less contentious

recommendations of the Patil Report is widely blamed on failures of regulators to co-ordinate their activities, or on conflicts between agencies.

Indian regulators were also accused of “shooting from the hip”, meaning that they tended to be reactive and that the effects of their reactions on the

47

market are not always thought through. As an example of this, SEBI issued a regulation requiring trades in listed bonds to be transacted through an exchange trading system. The rule only applied to trades transacted through brokers, however, and did not cover so-called “spot-trades” between two

o

out the organisation of bond markets, and had ersistently tried to force the market into certain ways or down false trails. In

g, attempts by the regulator to force business on that platform are unlikely to be successful, and may lead to perverse

r Quotes, like the RBI’s own NDS and NDS-OM systems.

s is that the volume figures ublished by SEBI do now capture the bulk of the market.

There i while the

onsensus is that equity markets should be very transparent, the judgement on towardharde

.5.2 No market makers

invest rs. The result was an upsurge in spot trades, often assisted by brokers but without the broker issuing the contract note. The consequence was that trades that would previously have been transacted OTC, and reported to the exchange for publication, were no longer even being reported. Thus, the regulators action had inadvertently led to a reduction rather than an increase in transparency. Finally, there were comments that the regulators seemed to have some mistaken perceptions abpparticular, the regulator has consistently tried to force corporate bond trading on to a conventional order-driven platform. It is true that such trading platforms have been highly successful for equity trading, but the success of conventional order-exposure trading systems has been less clear in bond markets. For example, whilst the NSE offered an order-matching system (Wholesale Debt Market, WDM), it was little used for order matching, but well used for reporting and publication of trade data. As this system has not been successful in attracting tradintoeffects (one example of which is described above). Where electronic trading systems have made inroads into bond markets it is by offering broader functionality such as Request fo

6.5 Secondary market and pricing issues The secondary market for corporate bonds is highly illiquid. A number of issues, detailed below, have been raised both by the Patil committee and during the discussions that we had with practitioners.

6.5.1 Limited transparency Until relatively recently, there was very little transparency in the secondary market for corporate bonds, in contrast to that established in Indian equity markets. SEBI has tried to increase transparency by increasing the number of reporting venues, and its recent initiatives mean that the level of post-trade reporting is now substantially higher. The consensup

s a worldwide debate on the merits of transparency and, c

bond markets is less clear. Thus, whilst it is easy to have a predisposition s transparency, calibrating the precise amount to mandate is a much

r task.

6The market lacks formal market makers but a number of players are reported to act as informal market makers, and this function is widely recognised in the

48

market (a similar phenomenon is found in many other markets worldwide). The likelihood of persuading firms to act as formal market makers, (that is, to commit to making firm quotes at all times), seems low, given the low levels of liquidity and the absence of hedging tools.

6.5.3 Non DvP settlement Corporate bonds have been held in dematerialised form since SEBI mandated this in the early 2000s. DvP, is available for trades transacted on the stock exchanges’ dealing platforms (that is, by order matching) but not for OTC trades. DvP is, also, provided in the gilt market for OTC transactions

rough the NDS system.

while other regulators see the benefits of offering DvP to the OTC market.

new issues of bonds, but l outstanding.

is one of the basic

development.

th Corporate bond OTC transactions (most of the market) are settled bilaterally between the counterparties, however, (that is, there is no central counterparty to novate the process and so reduce settlement risk). Sellers instruct the Clearing Corporation of India, CCIL, to move stock before they have the funds from the buyer, so the system is not true DvP, and sellers are at risk during settlement. Yet, because the market is, in practice, limited to a small number of major players, the risk is manageable. If the market were to expand to encompass a wide range of investors, then it would require a better settlement infrastructure. Extending the existing arrangement to offer DvP for OTC transactions in corporate bonds would not seem to be a major task, but this has yet to be implemented. This might be because some in the regulatory agencies wish to encourage OTC business to move on to exchange platforms where DvP is available,

6.5.4 No database of issues There is no single database of issues of corporate bonds or of credit events affecting those bonds. PRIME runs a proprietary database, but this is not yet a complete record. SEBI and RBI produce statistics on not of credit events or the tota

6.5.5 No universal conventions Bond market conventions are largely absent, such as standardised day counts for calculation of accrued interest, which smooth trading in bond markets by reducing the need for negotiation. There is a bond market association, Fixed Income and Money Market Dealers Association (FIMMDA),

nd it is perhaps surprising that standard setting, which afunctions of a trade association, has yet to be completed. While the absence of standardised conventions may be surprising, given the ease of adjustment between conventions and the small number of participants in the market, it is hard to see that this represents a major constraint on

6.5.6 Long shut period The period between books close and payment of coupons is longer than for government bonds. This interval is long enough to necessitate cash payments

49

to settle the interest payment (on top of the cash payments to settle TDS). This adds a small amount of complexity to the management of bond portfolios.

6.6 Restriction on short selling gilts An im ortant part of pricep formation is the ability of intermediaries, such as

of their capital usage. This usually involves them

till, not permitted to sell short. Banks and

y small issues that still exist). The direction of policy is clear, however, h ort selling restrictions is becoming progressively

ecently, some states have responded to criticism of the effect of the duty by

Stamp Duty purposes.)

is thought to be part of the reason why credit card

primary dealers, to arbitrage anomalies. This ensures that asset prices stay in line and eliminates pricing anomalies. It tends to be the function of intermediaries rather than investors, since intermediaries have better access to the market and face lower transaction costs, enabling them to exploit smaller arbitrage channels. Intermediaries try to minimise their risk and

aximise the efficiency marbitraging through offsetting transactions in different assets. The usual pattern for corporate bond traders is to trade the corporate bonds one way and offset this with transactions in government bonds (that is, trading the risk spread). This often means buying the corporate and selling the sovereign. Their need to work their capital and minimise risk, however, means they will often not own the sovereign bond, and so will need to short sell. As noted, short selling of gilts was prohibited until March 2006, when the RBI permitted a limited amount of short-selling by primary dealers and banks.

ther investors were, and are sOprimary dealers were only allowed to sell short intra-day and could not short sell more than 0.25% of an issue. More recently, the prohibition on short selling across trading days has been relaxed, allowing banks and primary dealers to run short positions for up to five days. Market opinion is that the remaining restrictions still pose a significant barrier (for example, the limiting of short positions to a maximum of 0.25% of an issue can be restrictive in the case of the manand t e barrier caused by sh

mless i portant.

6.7 Barriers to securitisation

6.7.1 Stamp Duty Stamp Duty is a major barrier to the development of securitisation. Transfers of assets require written instruments, which are subject to stamp duty. Rates of duty on asset transfers are variable between states, but are generally high – most states charge between 3% and 16% on the value of the property being transferred. Roffering special rates of 0.1% for securitisation transactions and, as a result, securitisation structures tend to be based on assets in those states. Note that it is the location of the asset, rather than the location of the SPV, that determines the jurisdiction for

The barrier of Stamp Dutyreceivables have not been securitised in India, whereas in other markets they

50

are one of the first things to be securitised, and a major driver in developing those markets.

6.7.2 Pass Through Certificates not sec urities

ce, and

The SCRA does not define Pass Through Certificates (PTCs, the normal type of bond issued for securitisations), as securities. They cannot therefore be listed, and consequently, trading is limited. Even in other markets, securitisation paper is rarely a liquid instrument, partly because of the small sizes of issues imposed by tranching structures, but also because of the nature of the investors. An amendment to the SCRA to address this lack is in progress.

6.7.3 Lack of clear regulatory structure The amendment to the SCRA also makes SEBI the principal regulator, although, as with corporate bonds, the RBI will retain a significant role because banks are major users.

6.7.4 Tax here are no clear rulings on the taxation of SPVs. Market practiT

current opinion, is that taxation of interest paid on SPV bonds will be levied on the investors, rather than being paid by the SPV. This has not been tested, however, and there is an unquantifiable risk that the tax authorities may challenge this in the future and apply a change retrospectively.

6.7.5 Registration Transfers of immovable property, or mortgages on such property, require registration. This is a cost and, more importantly, a significant administrative burden when securitising a pool of mortgages.

51

7 Macro-barriers – low levels of supply and demand

ame established in the first place. To create a thriving corporate bond market

e hich limit investor demand for, and

The main feature of Indian debt markets is that there appears to be:

l investors are prohibited from participating in the market.

7.1 Government borrowing crowding out Crowding out can happen in two ways: 1. It can mean simply that the government takes all available liquidity, or

takes so much as to push the price beyond the willingness of the private sector to borrow. This does not seem to be the case in India, where interest rates have been falling and, at least until the recent growth in demand for credit, there was abundant liquidity in the banking system.

2. It can also affect investment decision making. In effect, government

bonds become the only debt investment option, either because of directed investment and/or low-risk investment mandates and/or because investors do not develop the skills necessary to evaluate risk.

We noted earlier that there has been significant progress on the government deficit. That said, the government’s demands on the market remain very large, with the total outstanding debt at over 90% of GDP. The government has historically financed the deficit by borrowing from banks and financial institutions. Banks are required to maintain 25% of their net current and deposit account balances in government securities as part of the Statutory Liquidity Requirement, SLR, (reduced from 31.5% in November 2001). In fact most hold more, with an average of 31%, although rapidly growing demand for credit has seen banks reduce their excess SLR holdings.

The micro-factors considered in the previous section have the common property of being found, one way or another, in most non-Indian financial markets. In most cases where unusual market structures exist, traders simply work within the structure available to conduct the business that they wish to transact. Addressing these factors leads to more efficient markets, and may increase market activity, but does not explain why the markets bec

requir s consideration of the factors wcorporate supply of, bond-based debt finance in India. These are considered in this chapter.

● little corporate supply of debt, because corporates have alternative

sources of capital; and

● little demand to hold debt, either because retail investors have more secure and attractive alternatives, or because institutiona

This chapter outlines some of the constraints on demand and supply of corporate debt.

52

As well as the possibility of crowding out other borrowers, the dominance of

ernment include

ntinues to dominate corporate debt funding. As already

to lend g

able e Indian banking sector giving the number of d

the government in banking, (banks own over 50% of all govsecurities), has encouraged a number of regulatory restrictions. Thesedirected lending and restrictive investment mandates for financial institutions, as described below. In addition, it may have been instrumental in discouraging the development of a true credit culture, with the skills to assess, and respond appropriately to, levels of credit risks.

7.2 Limited demand for bond finance There is limited corporate demand for genuine bond finance (as opposed to loans disguised as bonds). Traditionally, Indian corporates have borrowed from banks to meet their financing needs. This continues to be the case, and

ank credit cobnoted, banks account overall for 90% of financial assets, and state-owned

anks represent 75%. Until recently, banks have been liquid and keenbto ood quality, corporate borrowers.

7 shows the structure of thTIn ian banks in each type together with some efficiency metrics.

Table 7 – Breakdown of Indian Banking Sector

Type Number Branches Total

Profit per employee

employees

(Rs lakh) State Bank of India and Assocs. 8 14,456 256,224 20 Nationalised banks 20 36,898 472,947 66 Other Scheduled CBs 25 7,104 138,144 113 Foreign banks 29 261 27,840 477 Total 82 58,719 895,155 73

Source: RBI Note 1 Lakh = 100,000

Chof BI and the

ationalised banks.

art 21 shows total deposits, investments, and advances for each category bank, and makes clear the continued dominance of S

n

53

Chart 21 – Deposits, Investments and Advances by Bank Type

Source: RBI Note 1 crore = 10,000,000

Th in source of finance f r m ks; c ly little corporate lending. The development banks have emerged from the state-o ed me but are a and domina corp lend hey fina th deposits, whi hey a era from ta , b t issues. The development banks are a the p placement market, borrowing wholesale to lend on to sm rporate We have noted the dominance of private placements in debt issuance, and the fact that usuall ven a single bank will subscribe to the issue. he de er to issue a bond or take a loan is determined by on-strategic factors such as:

s in private placements. Thus, a bank that wanted to offer a very tight rate to a highly rated corporate borrower would present the loan as a bond.

● Interest rate expectation may influence the choice. When rates are falling, as they have been for several years, borrowers will prefer a variable rate loan and lenders a fixed rate bond. But, as we have noted, the private placement bonds are regarded as renegotiable in the event of unanticipated interest rate changes.

Key measures for Indian banks by category - 2006-071,500,000

Deposits1,000,000

500,000

Rs

cror

e

-SBI Nationalised

banksOther

Comm.Fgn banks

Banks

InvestmentsAdvances

e ma or smalle companies is develop ent banommercial banks do relative

wn develop nt banks, nowggressively private te orate ing. T nceemselves not through ch t re gen lly barred kingut through deb ctive in

aller corivates.

y banks or ecision as to whethT

n

● At various times the RBI has prohibited banks from lending at rates below their Published Lending Rate, but the prohibition did not apply to investment

54

● process, usually by the board or a board committee. Private placement

again s.

● bject

● rked

ed to there

Similarly, . This

st Th is beyo top

y rati

AAA AA A BBB Non.inv. grade

Large bank loans are required to pass an internal approval

investments are not subject to the same scrutiny (or delay), giving banks an incentive to grant loans but present them as bond

It can be more tax efficient to issue a bond, since loans are not suto Stamp Duty, whereas bonds are.

Loans may be preferable for banks since they are not currently mato market (but will be under the Basel 2 rules). Bonds are markmarket, and, in the absence of reliable secondary market prices, is scope for manipulation and window dressing.

corporates tend to regard loans and bonds as interchangeableoccurs to some extent in most markets, but in India there seemed to be a

rong focus on managing the sort of micro-issues described above.

e full range of corporate finance options available to Indian corporates nd the scope of this project. It is clear, however, that all but the

corporates are excluded from the bond market. Table 8 shows the split bng of private placements:

Table 8 - Distribution of corporate bonds issued by rating

% of total No. Value No. Value No. Value No. Value No. Value

1999-00 35.0 83.0 25.9 9.4 25.0 6.1 7.7 0.8 6.4 0.6 2000-01 38.3 76.6 33.6 10.1 21.4 11.6 3.1 1.3 3.7 0.3 2001-02 31.7 61.6 33.5 27.8 24.0 9.3 7.8 1.1 3.0 0.2 2002-03 45.6 76.0 27.1 13.8 18.2 7.5 6.3 1.6 2.8 1.0 2003-04 50.4 77.5 24.8 14.9 17.3 6.1 6.5 1.1 1.0 0.4 2004-05 56.7 72.2 22.4 22.0 11.8 3.7 7.1 1.9 1.8 0.3 2005-06 54.6 75.1 30.8 16.7 9.4 7.8 4.4 0.3 0.8 0.0

Source: SEBI

he data shows that the numT

and tber of sub-investment grade issues is minimal,

hlargestexcludunusua

.3 Limited investor base The vinvestonaturaindiffe

considerations. A

e proportion below AA is small (8% by value in 2006-07). Only the corporates are likely to achieve an AAA rating. Others are therefore ed from the bond market and obliged to rely on bank finance – a not l phenomenon in other markets.

7 in estor base for corporate bonds is limited, with banks being the main

rs in corporate bonds. As banks are the main providers of loans, they lly see loans and bonds as alternatives, and appear to be largely rent between them at the strategic level. Decisions, as already noted, to be based on regulatory and tax arbitrage tend

55

sucthese a

7.3.1 he Indian mutual fund (unit trust) market has evolved through a number of

ph

● Phase 1 1963-1986 – the Unit Trust of India was established by the

● Phase 2 1987–1992 – various public sector entities, including banks and

ch UTI represented Rs 44,541 crores).

● as it became progressively more difficult to meet its guaranteed commitments, and was split into two parts. One part took over the guarant liabilitie no long perates as a mutual fun e othe

TI Mutual Fund Ltd which operates as a conventional, regulated u fu e ati w a p e nd June 2 th w 2 fu agi l o0,8 o d 2

I st su e or h i u be , uf tor c s y pub c Th u ofa r r io v th min s -ow p r fthe market t iva cto The Ind l fund industry has a number of distinctive features that mark out as different to the industry in other countries – particularly the short

cessful corporate bond market needs to attract non-bank investors, but re relatively undeveloped and restricted in India.

Mutual funds T

ases since its beginnings in 1963:

government to operate as the sole mutual fund in India. UTI mainly offered guaranteed return funds. Assets under management by the end of this period were approximately Rs 6,700 crores.

the government-owned insurance companies, were allowed to offer mutual funds. Assets under management by end of this phase had risen to approximately Rs 47,004 crores.

● Phase 3 1993–2002 – private sector mutual funds, including joint

ventures with foreign funds, were permitted. SEBI issued regulations but these exempted UTI. Assets under management by end of 2003 were Rs 121,805 crores (of whi

Phase 4 2002 to date – UTI faced consistent problems

eed returnr becames and er o d. Th

Um tual nd. A phas of consolid on follo ed mong rivat sectorfu s. By 007, ere ere 3 nds, man ng a tota f Rs 40 42 cr res un er 77 schemes.

n contra to the life in ranc sect , whic s disc ssed low the m tual und sec is mu h les dominated b the lic se tor. e tro bles UTI, nd thei esolut n, ha e removed e do ant tate ned laye rom

so the marke is largely pr te se r.

ian mutuaitinvestment horizon of its investors. Table 9 shows assets under management, sales and redemptions for the 12 months to June 2007.

56

Table 9 - Mutual Fund Data H2 2006 - H1 2007

Net sales

mgt%

Sales + Redmptns

/ Assets under

/ Assets under

Fund style Managed

Assets Sales R mgt% edemptions Net sales Income 428,689 308,861 217,363 91,498 21.3 72.0 Growth 460,476 83,428 67,336 16,092 3.5 18.1 Balanced 36,986 4,512 2,866 1,646 4.5 12.2 Money mkt 361,586 1,907,418 1,929,382 -21,964 -6.1 527.5 Gilt 8,410 1,878 2,581 -703 -8.4 22.3 ELSS 38,522 4,831 318 4,513 11.7 12.5 Gold ETF 351 280 5 275 78.3 79.8 Other ETF 7,014 3,122 962 2,160 30.8 44.5 Total 1,342,034 2,314,330 2,220,813 93,517 7.0 172.4

FI)

The daChurn

ppar parent in come funds

inv aresearmanagmarkethis wafrom tainvesti

oney in gilt and equity funds.

ans through single-loan

liabilities. As Table 10 shows, the Indian life insurance market is growing rapidly but penetration remains relatively low:

Source: Association of Mutual Funds of India (AMNote all amounts in crores of Rupees (1 crore = 10,000,000)

ta indicate the short-term nature of mutual fund investment in India. rates are very high, with an overall churn rate of 172%. This is very ent in the turnover of money market funds, but is also apa

in . It is clear that investors use mutuals as short-term homes for est ble funds. What is not clear from the table, but was found from field

ch, is that the corporate sector uses the mutual funds as a way of ing their corporate treasury. Surplus funds are parked in money

t mutual funds, which are redeemed when the need arises. Historically s supported by a tax advantage as mutual fund profits were exempt x for corporates. This is no longer true, but the practice of corporates

ng in mutual funds has continued. Corporates naturally focus on market funds, but are also investorsm

Mutual funds have a strong preference for shorter duration issues, given the investment style of their customers. This limits their ability to participate in the corporate bond market. In addition, they are not permitted to invest in loans but have become indirect investors in losecuritizations, as described above.

7.3.2 Life insurance companies In other markets, insurance companies are major investors in corporate bonds – which allow them to match long term assets and

57

Table 10 - Insurance penetration 2005

Life premiums/GDP% North America 4.05 Europe 4.69 Asia 5.16 So ea 0.uth Kor 1 15 Thailand 3.61 Malaysia 3.6 Indi 2.5a 3 Chin C) 1.78a (PR

Source: W

Life Ins ment-owned, was the nly lif now been opened to

orld Bank

urance Corporation of India, LIC, which is governe company allowed to operate. The market haso

private sector companies, including foreign joint ventures. The market remains relatively undeveloped in terms of structure, however. While there is a growing involvement of private companies, including the foreign joint ventures, which tend to be more aggressive, the dominance of the Life Insurance Corporation of India continues. Table 11 shows the size and nature of investments of LIC and other participants

Table 11 - Investments of life companies

Central State Govt.

and other Infrastructure

Government

Bonds Approved Securities

and Social Bonds Other Total

LIC 197,419 43,685 48,182 100,162 389,448 Other 4,259 115 1,456 1,910 7,740 201,678 43,800 49,638 102,072 397,188

Source: Insurance Regulatory and DNote all amounts in crores of Rup

evelopment Authority (IRDA) ees (1 crore = 10,000,000)

fe business require that at least 65% of assets be held in various types of public sector bonds. Funds are permitted to invest in corporate bonds, but the category of “approved investments” only includes bonds rated AA or above. Bonds below AA (which are rare in India), can be held in unapproved assets, but total unapproved assets cannot exceed 15% of the portfolio and are subject to exposure norms limiting exposure to any company or sector. In practice Life Insurance companies hold less than 7% in unapproved assets.

In terms of investment, LIC represents 98% of the market. In terms of assets held, roughly 75% of the assets are in public sector bonds. Investment regulations governing li

58

7.3.3 dia has traditionally had two pension structures for the formal sector (the

informal sector is not included loyers offered provident funds, whose investment was largely gove ment managed; government employees were covere you-go scheme. The government scheme has (for employ g after 2004) n replaced by the New Pension Scheme (NPS), w is planned even to offer individual, self-managed pension funds. The scheme is currently in transition, and funds in the interim period are ma lly and earn a basic rate, currently 8%. Private sector employees are obliged to belong to a notionally funded scheme known as the Em e Provident Fund/Employee Pension Scheme. This collects contributions hem, bu rs a guaranteed rate of return o contributors, currently 8.5%. At retirement the scheme delivers a ump s f an annuity. Scheme members can withdraw funds

Pension funds In

). Private sector emprn

d by a pay-as-ees joinin beehich tually

naged centra

ploye and invests t t offe

tle

um for purchase oarly with no tax penalty and most do so; lump sums are small. The funds of

the EPF/EPS (historic contributions total some Rs2 trillion) are invested according to the law as follows:

Table 12 – EPF/EPS Investment Ratios

1 Central Government securities 25% 2 State Government and Government guaranteed 15%

securities 3 Bonds and securities of Public Financial Institutions 30% 4 Any of the above three categories 30%

Source: Iief.com

The trustees may invest u um of one third of funds from category 4 in Table se s have investment grade rating fro c ge t absolutely clear what would happen in of EPF sufficie ee

ee gove guara e oe, th ste in government bo t

e fund h at tain a o derefore sets. It is likely

that a would require dditional .

bonds are seen as buy-and-hold investments, and there is little gain to be made from the sort of regular trading that is a feature of retail-dominated equity markets. As a result, worldwide, bonds are rarely

p to a maxim12 i

m at least twon private ctor bonds/ ecurities which

redit rating a ncies. It is no if the vestments were in nt to m t the

guarant d rate, but a rnment ntee is wid ly assumed t exist. In practic e EPF is inve d largely nds and sta e bonds. Th as no oblig ion to main ctuarial s lvency and oes not, th , need to invest in corporate bonds or other risky as

y by EPF ny move towards a more active investment policskills correctly to assess these new asset classesa

7.3.4 Retail participation One feature of the debate about corporate bond markets is the extent to which retail participation in this market is either desirable or necessary. Indian experts believe that retail investors form a natural part of the market, and that retail trading could become a significant factor in corporate (and government) bond markets if the right environment were created. In part, this is supported by the high level of retail participation in the equity market in India. International opinion is that bond and equity markets are different, however. Essentially,

59

instruments for direct retail investment. Where they are, it usually follows either

ond investment requires substantial portfolios, and the percentage gains are

regulatory thrust over the years to create a ond market environment where retail investors could operate without

disadv en if the trading and disclosure nvironment were appropriate, retail customers simply have neither the

inte t

7.4 Exchange control Fore n ctive in th ian market lders of Indian equity. are require rised by SEBI to enter the Indian market, and exchange

ontro imit foreign investors to a cumulative total of $1.5bn

a tax break (such as in the US for the municipal bond market), or a tax advantage (as in the bearer status of Eurobonds). As a result, many in Europe argue that the natural avenue for debt investment for retail investors is through bond funds rather than the bonds themselves. Clearly, this raises potential risks and costs to investors, which are outside the scope of this report. It may be, however, that true retail demand for corporate bonds, in India as elsewhere, will remain small. Blikely to be small. Consequently, as most retail investors tend to have small portfolios, they prefer to invest in equity. This is especially the case in India, where the term ‘retail investor’ encompasses a wider spectrum of the population than is true in many other Asian markets. Indian retail investors also have access to attractive risk-free rates, so the possibility of higher yields in corporate bonds is not especially compelling. These arguments suggest that theb

antage may be misplaced in that, eve

res nor the funds to participate.

ig institutional investors (FIIs) have been increasingly a e Ind,d

and have become significant ho FIIs to be autho

l regulations lc(approximately Rs 60bn) in corporate debt securities and $2bn in government securities (approximately Rs 80bn). This represents a fraction of the annual issuance, so it is unlikely that foreign investors will become significant while the current exchange control structures are maintained. One effect of the limitations imposed on FIIs is to force Indian issuers who want to access foreign investors to issue in the Euromarkets rather than domestically, thus further fragmenting the limited liquidity. In addition, foreign investors have proved to be valuable participants in bond markets in other countries, frequently providing counterweights to one-way local opinion, as well as being significant catalysts for reform. India has gradually relaxed its exchange control structures, but there is a strong government/RBI perception that the remaining controls on capital account are required to protect the financial system against external shocks. Historically, the need to strengthen the banking system (particularly its capital base and NPL position), and the need to improve the fiscal position of the government have been seen as the preconditions for any further relaxation. As recently as 2006, the Tarapore Commission re-iterated these preconditions, which suggests that the authorities do not yet see them as being met. It is curious that foreign inflows into equity investment, (which are large), are relatively unrestricted, whereas foreign inflows into bond investment, where

60

foreign investment is unlikely to become especially large, are much more restricted. This inconsistency is not confined to India. Thailand, for example, has a one year 30% deposit requirement for inflows into bonds (and property. This does not apply to equity inflows, which have always been very much larger. The deposit scheme was applied to equities, but after a day of market collapse it was withdrawn. It is important to understand that, while exchange controls are inevitably a

arrier to development of the capital market, they have a more pernicious

to comply with the letter of e exchange control regulations.

ctions are restricted. Thailand has long been an attractive destination for investors, but is gradually losing its appeal.

lobal indices it is shrinking, partly because of the

beffect in distorting markets and increasing costs. At several points in this report, mention has been made of the arbitrage motivation for transactions – to minimise tax or circumvent regulations. This is also true of the exchange control regulations, which are extremely complex and add significantly to the costs of any transaction, especially since so much is judged on a case-by-case basis by the RBI. Frequent mention was made of transactions being structured in ways that were not optimal, in orderth Thailand has been mentioned above, and it is instructive to consider the effect of exchange controls there. The Bank of Thailand takes a similarly cautious line to the RBI and, aside from equity inflows which are relatively free, capital and current account transa

In terms of its share of ggrowth of the Indian and Chinese markets. Its market has underperformed for several years, with Thai P/E ratios now at about half those of its neighbours. Malaysia has similarly had to work hard to attract foreign investors back, after its experiment with controls on repatriation of foreign investments. The point is that exchange controls make a country less attractive as an investment destination. India needs foreign inflows and its size and current rapid growth mean that foreign investors are, for the time being, prepared to ‘manage’ the barriers. There is, of course, no guarantee that foreign investors would want to hold significantly more Indian corporate debt. The fact that the current limits have been reached suggests that there is unsatisfied demand, however. Clearly, foreign investors would be a useful source of capital to finance India’s huge infrastructure plans.

61

8 Summary and recommendations India rightly considers that it has been successful in developing world-class infrastructures to support its capital market. Regulatory agencies also

aintain that they are acting on a number of fronts to address some of the

ry of the results of this report, followed by set of policy recommendations arising from this work.

bonds, and the only question is which is most efficient from a tax

terms of regulation, exchange control and taxation. This y has led to distortions and to an undue focus on arbitrage

transactions designed to exploit anomalies in the system. Examples of this include, “direct assignment” rather than securitisation, to avoid RBI guidelines, “spot trades” to avoid SEBI rules, presenting loans as bonds to avoid approval processes, and presenting bonds as loans to avoid stamp duty, all of which have been mentioned in this report. While this sort of distortion occurs in every market, it remains a prominent feature of the Indian market.

8.1.2 Micro-barriers – institutional issues Much analysis has been devoted to micro-barriers to development of the bond market. The most significant of these are:

mbarriers that have been identified with regard to the development of a corporate bond market. We agree with both of these assessments. Indian regulators, particularly the RBI, are mindful of the need to preserve financial order, and consider that this has priority over the development of the corporate bond market. It may be, therefore, that reform in respect of the main barriers described above is not as rapid as many market participants may wish. This chapter provides a brief summaa

8.1 Summary

8.1.1 Current status The Indian corporate debt market remains small despite:

● The rapid development of other parts of the Indian capital market. ● The growing demand for credit to fund industrial investment and

infrastructure. The true corporate debt market is even smaller than it appears at first sight, because much of what is classed as corporate debt is either raised by the public sector or by financial institutions to lend on to the corporate sector. From a corporate strategic view, it makes little difference whether finance is

om loans orfror regulatory point of view. In effect, the market is currently limited to private placements by highly rated entities, there are almost no public offerings, and there are no more than a handful of private offerings below AA rating. In spite of India’s reform process, the environment for financial markets

mains complex, inrecomplexit

62

● The disclosure requirements for public issues are very great and do not make allowance for previous disclosures. The issuance process is

e. In extremely rare, and private

ond issuance. There are discussions and proposals to simplify and reduce the stamp duty burden, the most significant of

estors in corporate bonds); and other regulators, such as the insurance regulator (IRDA) and the

● Lack of risk management products (both derivatives and grey markets) icant barrier both to the primary and secondary markets. Indian market has been innovative in developing products

ency (such as CLBOs), or that aid the equity market (for been as successful

o

tive to

tor is dominated by a single state-owned entity, and both it and the private funds are governed by

perceived to be risky, inflexible, cumbersome and expensivconsequence, public bond issues areplacements dominate the market. SEBI is examining the prospects for changing the disclosure requirements.

● Stamp duty is complex and variable between locations, and adds a

significant cost to b

which is to place a maximum amount of tax payable on a single issue.

● Regulatory overlap exists, as corporate bonds tend to fall between several regulators: SEBI, as the capital markets regulator; the RBI, as the regulator of banks (who are the main inv

Department of Commerce.

is a signifWhile the that add efficiexample, exchange-traded derivatives), it has notin developing ways to manage interest rate risk. The main barrier tdeveloping interest rate derivatives has been a combination of lack of diverse views, and restrictions on the participation of banks imposed by the RBI.

8.1.3 Macro barriers – demand and supply The macro problems are more serious, and are less likely to be addressed directly or independently of larger issues relating to India’s economic development:

● Crowding out has been a persistent threat to Indian market. Legislation, (especially the Fiscal Responsibility Act), and a desire to control the deficit, mean that government demand is falling relarapidly growing GDP, however. Despite this, the level of issuance of government bonds remains high, and the level of debt to GDP is very high, at 90%.

● Corporate borrowers have traditionally had little need to diversify their

financing, as ample bank finance has always been available. This continues to be the case in India, where the range of options offered by banks to their corporate clients includes a mixture of loan and pseudo-loan finance (that is, private placement of bonds to a single or limited number of investors, mainly other banks).

● Although insurance and pension funds are still largely state-controlled,

there is a growing market for private savings/pension arrangements as wealth increases. The life insurance sec

63

highly restrictive, government imposed investment mandates, which limit their ability to invest in corporate debt. Mutual funds are often treated as short-term investments by investors, and this, together with their conservative investment policies, means that their fixed income investment tends to be in gilts or short term bills, rather than corporate debt.

● Exchange control rules place an aggregate limit on the amount of

investment that foreigners can put into domestic bonds. As well as excluding a possibly significant group, which at least might offer a countervailing investment view, foreign investors are an important catalyst for change and innovation.

8.1.4 Securitplans, many

On potenand munlikelwherefundinthere a Of the rriers noted above, stamp duty is the main barrier to extension

e asse ct of stamp duty is so strong it o securitisation of credit card

r bond market since it applies to the transfer of assets to the PV as well as to the issue of bonds. The issue is therefore less likely to be

adpayabthe stdepredemo

.2 Recommendations Som others,speedicontawithou

onclu more from a lack s

Securitisation – a special case? isation offers significant potential for financing India’s infrastructure especially as no specific securitisation law is required, as it has been in other Asian jurisdictions.

ce again, a main issue is demand and supply, particularly supply. If

tial originators are not under pressure to reduce their balance sheets, ost Indian banks are not, then securitisation is a costly option which is

y to be taken. Arbitrage gains have been common in other markets, the addition of lower-rated first-loss tranches has reduced the overall g cost. These have yet to have an effect in India, possibly because re no takers for the higher-risk tranches.

micro-baof th t-backed market. Indeed, the effethat is claimed as the major barrier treceivables, a mainstay of asset backed finance development in other markets. The impact of stamp duty in the securitisation market is different to that in the wideS

dressed purely by the recommendation to cap the amount of duty le on a single bond issue, and will require specific changes tailored to ructure of securitisations. Recent guidelines from the RBI had a ssing effect on the asset-backed market, but were desirable to nstrate a clear intent to regulate the market.

8 e actions that are feasible to implement are unlikely to have much effect;

which would have a major impact, are unlikely to be implemented ly because of their effects elsewhere in the economy. This section

ins practical recommendations that can, we believe, be implemented t risk to other parts of the economy. They are founded on the principal sion above, that the corporate bond market suffersc

of upply and demand than from a defective market infrastructure.

64

8.2.1 It is firsof the They abecau xchange control is a significant plank in a government’s macro-economic

pocorpobondsthe lac

nuing weakness of parts of its n ivate sector banking entities have

ness and considers that it is operating policies at will lead to strengthening of the sector. To comment on those policies is

es to legislation, in particular tamp Duty, because they are so critical to corporate bond market

● Relax exchange controls on corporate bonds. The restriction on rporate debt is anomalous, in that it is more

priate for public issues into a largely professional market by entities that are already well-known to the investment community. The regulations

Macro-economic factors t worth commenting on two issues which, while important to the success corporate bond market, are also part of the macro economic picture. re thus unlikely to – and maybe should not – be addressed merely se they are a barrier to development of a particular market.

Elicy, and its abolition is unlikely to be hastened by the wish to develop the

rate bond market. The restrictions of exchange control on corporate do seem, however, to be particularly onerous, especially considering k of quantitative controls on other capital flows.

Another difficult issue for India is the contibanki g system. While vibrant prdeveloped, and take a major role in corporate lending, the dominance of the state sector and, more importantly, its culture persists. We are aware that the RBI is conscious of the weakthoutside the scope of this report.

8.2.2 Practicable recommendations Sometimes in discussions of development it is seen as wise to avoid recommendations that involve changes to primary legislation, as this is a slow process everywhere. With regard to India, we are forced to make some recommendations which would involve changSdevelopment. We believe that these proposals are of equal importance and feel, therefore, that it would be unwise to rank them in any particular order. The key changes that would, in our view and in the view of the majority of practitioners we met, are:

● Reform stamp duty. Stamp duty was the issue raised most frequently in the interview field work as the largest barrier to development of both the corporate bond and the securitisation markets. The Patil report recommended that there should be a standard rate, and that the maximum payable should be capped. We agree with this conclusion and urge a rapid implementation of the reform.

foreign holdings of coonerous than the corresponding restrictions on foreign investment in equities, on foreign direct investment, and on foreign investment in derivatives. The macro-economic risks from relaxing this aspect of the exchange control regime seem slight, especially compared to the potential benefit.

● Reform disclosure for public offers. We believe that current regulations

should be reformed, to allow for disclosures that are appro

65

should also be changed, to allow techniques such as shelf registration,

Indian life assurance and pension sectors institutions are subject to strict

guidelines and we support this proposal. Such guidelines can only be useful, however,

ted derivative markets are small and OTC. Discussions about re-introducing exchange-traded derivatives have

chnical aspects. The main problem,

ll require changes to primary legislation, specifically he d

to tinstitutthe sco As a re

e implemented reasonably swi te, will encourage the o

fore o

even if this would require changes to the Companies Act.

● Less rigid investment mandates. Institutional investors are the main support for corporate bond markets in most jurisdictions. The

investment mandates, which mean that they have a limited ability to invest in non-government debt instruments. To avoid the risks of too rapid a relaxation of investment mandates (the experience of UTI is relevant here), we propose a controlled and phased relaxation. The Patil Committee recommends using risk-based

when the relevant skill set within the institution is at an appropriate level, and the historic data on risk is available.

● Develop and enhance related derivatives markets. Relevant

derivatives include not only exchange traded interest rate derivatives, but also OTC products (futures and swaps), and these based on credit risk. Currently, bond-rela

tended to be focused on tehowever, is that the natural constituency for derivative trading, banks, are excluded by regulations that limit their participation to hedging. Derivative markets will not develop in such an environment, and the regulations should be changed to allow banks to take a more active role in them.

As noted, these recommendations are all practicable, in that they can be addressed without affecting the broader questions of India’s infrastructure development. In addition, only the proposals in respect of stamp duty and to

isclosure requirements widt In ian Stamp Act and the Companies Act respectively. The amendments

he exchange control regulations, the investment mandates of investment ions, and the introduction of risk-management products, all fall within pe of the relevant regulatory authorities to implement.

sult, we believe that the reforms proposed here are practicable, can ftly and, when compleb

c rporate debt market to join the other parts of India’s financial sector at the fr nt of the world’s financial markets.

66

Annex 1

IWhilst debt involvepresenshouldto stim

s not restricted by exchange on

intefrom pmain markemarke UK plaopporpresumareas

arke cialised functions; some of these are described below.

YSE Euro next has eleven Indian ompanies listed and Nasdaq has three.

Indian corporates have been offshore issuers to fund their increasingly diverse international operations, partly because exchange control regulations restrict their overseas borrowing to overseas investments. London is a natural home for any offshore business, since it is the global centre for international bond issuance and trading. In the case of India, the strengths are reinforced, partly because of the large non-resident Indian business population in the UK, but also because of its historic links and cultural ties.

mplications and opportunities for the City of London the primary focus of this report is the development of the corporate market within India, London has been at the forefront of global ment in the Indian market, and its global banks now have a significant ce in India in trading and corporate finance. This means that there be opportunities for London based institutions to participate in moves ulate the Indian corporate debt market.

ed previously, the Indian market is still relativelyAc trol regulations, which place a barrier between the domestic and

rnational capital markets. Direct opportunities for the City could come articipation in a well developed Indian corporate debt market. The

opportunities will come during the liberalisation phase of the Indian t, however, as it becomes increasingly integrated into the global t in which the City is a dominant participant.

yers are generally extremely aware of the direct investment and other tunities presented by the growth of the Indian market and it would be

ptuous to say more about these opportunities. There are, however, where there may be other opportunities, which either affect the whole t, or affect spem

Gains from market expansion Currently, foreign investors are restricted in their access to the Indian market, and must be SEBI-registered to get direct access to any part of the market. FIIs’ exposures are separately limited in debt and equity markets. If the market were to become more open to foreign investors, then London would have clear opportunities, as the home of a major part of global cross-border investment and already an established player in the Indian market.

Many Indian companies have looked to the London market as a place to list shares and raise capital. Currently 28 Indian companies have equity listed on the London Stock Exchange’s main market or AIM with a total market value of nearly £5bn. Four Indian companies have listed convertible debt securities n London. By way of comparison, Nic

67

Whilst development of the local bond market in India might divert some activity from the international ma lso likely to lead to a general expansion of interest in Indian greater trading and advisory opportunities for City-based firms. In addition, there is the likelihood of gains for increased corporate finance and related work, as the pool of activity in the lo

may be some drawing back the global market, consequent upon the sub-prime problems, securitisation

ructured products etween the domestic and global markets. In addition, the size of structured

Finally, the restrictive domestic regulations have provided opportunities by re. There is a fairly active offshore market in

as

pproach to markets and market gulation. In India, as in other fast-developing markets, there is interest in

rket, it is adebt, with

cal market becomes larger.

Structured finance The securitisation market in India is not well-developed, and deals are often structured to avoid tax or regulatory barriers, rather than purely for economic benefit. Structured finance deals are growing in India, but the market remains constrained by regulation. While thereinis expected to become a vital part of the infrastructure investment in India over the next five years, especially as tax and regulatory reforms reach fruition. The narrow focus of the current securitisation market in India suggests that there may be a concomitant expertise gap in India, with respect to the range of structured products and also the integration of stbfinance deals that will be required to finance infrastructure projects suggests that there will be a need for significant foreign, as well as domestic, involvement. Of itself, this growth of the market, currently very small, will offer opportunities for City firms.

pushing some business offshorupee swaps and similar derivatives, in which Indian corporates manage their currency and interest rate exposures, and in which UK firms are already prominent. In the period after a relaxation of restrictions, UK firms, (and other foreign firms), would have an advantage as the market grows. Experience in similar situations suggests, however, that domestic practitioners quickly catch up, and that any initial advantage may be short lived. Equally, once the

arket has stabilised, UK firms’ early involvement would establish them msignificant, and profitable, members of the market.

Education and training and consultancy The growth of the corporate debt market also offers opportunities in regulatory and financial training, especially if these were part of a co-ordinated attempt to promote a UK arealternative regulatory models. The UK securities market and regulatory structure has considerable respect in India and is widely admired because of its flexibility. There is a clear awareness of the UK model and of the quality of UK training, although there may be a lack of understanding regarding how these things fit together and how they might be accessed. It should also be noted that recent global and UK events may have impacted on perceived respect for the UK regulatory model.

68

Appendix A – Key references A.1 - India related reports Development of a Secondary Debt Market, Asian Development Bank (ADB),

01

2007, Clearing Corporation of India Limited, 2007

ng paper, October 2007

nd Regulations in Selected APEC

ureau of Economic Research working paper, 2004

September 20

A Decade of Reforms in Government Securities, Market in India and the Road Ahead, Rakesh Moha, Reserve Bank of India, 2004

The Report of the High Level Expert Committee on Corporate Bonds and Securitisation (the Patil Report), December 2005

Recent Trends in the Indian Debt Market and Current Initiatives, Rakesh Mohan, Reserve Bank of India, February 2006

Factbook

New Era for India’s Economy Spurs Need for More Varied Debt Markets, Moodys, January 2007

High Level Expert Committee on Mumbai as an International Financial Centre, Ministry of Finance, February 2007

Development of the Corporate Bond Market in India: Tasks Ahead, Dr T.C. Nair, SEBI, August 2007

India: CLBO Markets – a New Type of Funding for Securities Markets, Jim Turnbull, Asian Development Bank worki

Developments in the Corporate Bonds and Securitisation Markets – An Update, SEBI, November 2007

A.2 - Non-India focused reports The Case of the Missing Market: the Bond Market and why it Matters for

Financial Development, Herring and Chatusripitak, Asian Development Bank, 2000

Building Local Bond Markets - An Asian Perspective, Ed. Alison Harwood, IFC, 2000

Harmonization of Bond Market Rules aEconomies, (Asean), Ismail Dalla, Asian Development Bank, 2002

Asia's Debt Capital Markets Appraisal and Agenda for Policy Reform, Lejot, Arner, Qiao, Chan and Mays, Hong Kong Institute of Economics and Business Strategy, 2003

Study on Korea’s Corporate Bond Market and Its Implications on China’s Bond Market Development, World Bank, January 2004

The Structure and Characteristics of East Asian Bond Markets, Ghon Rhee (in ‘Developing Asian bond markets’, T. Ito and Park Y.C. (eds.), 2004,

Why Doesn’t Asia Have Bigger Bond Markets?, Eichengreen and Luengnaruemitcha, National B

69

Making Markets: Reforms to Strengthen Asia’s Debt Capital Markets, Lejot, te for Monetary Research, 2004

omote Activity and Lessen Financial Contagion, Lejot, Arner and Qia, Hong Kong University, 2004

Intern nt and Capital Standards,

n Bond Market, The Bond Market Association, April 2005

ondary bond markets, DP05/5, Financial

Tradi4, Financial Services Authority, 2006

, 2006

A.4 -

Asset

Arner and Qia, Hong Kong Institu

Asia’s Bond Markets: Reforms to Pr

Assistance for Developing Bond Markets, (Vietnam – Asean), Nomura Research Institute, June 2004

Asian Local Currency Bond Markets, Jiang and McCauley, BIS Quarterly Review, June 2004

Developing a Corporate Bond Market and Associated Derivatives Market in China – a Study of the Opportunities and Challenges, FOA-UKTI, 2005

East Asian Finance – the Road to Robust Financial Markets, World Bank 2006

ational Convergence of Capital MeasuremeBIS, June 2006

Supporting the Implementation of the Capital Market Development Master Plan, (Thailand), Asian Development Bank ADB TA 4826-THA, November, 2007

Asia bond Monitor/Asia Bonds Online, Asian Development Bank (various issues)

A.3 - EU Bond Market deliberations Transparency of Corporate Bond Markets, International Organization of

Securities Commissions (IOSCO), May 2004

European Bond Pricing Sources and Services: Implications for Price Transparency in the Europea

Trading transparency in the UK secServices Authority, 2005

ng Transparency in the UK Secondary Bond Markets - Feedback on DP05/5, DP06/

European Corporate Bond Markets: Transparency Liquidity, Efficiency, City of London

CESR’s Response to the Commission on Non-equities Transparency, Committee of European Securities Regulators, June 2007

Markets in Financial Instruments Directive (MiFID), Background Paper, European Commission, September 2007

ICMA’s Response to the Commission’s Call for Evidence on Bond Market Transparency, International Capital Market Association, September 2007

Securitisation Rating Securities Backed by Future Financial Cash Flows, Fitch, Sept 2000

Securitization in Asia, Ian H. Giddy, New York University, 2000

70

Securitization of Future Flow Receivables: A Useful Tool for Developing Countries, IMF, 2001

Basel Committee on Banking Supervision Consultative Document - Asset Securitisation, May 2001

Assessing Public Sector Borrowing Collateralized on Future Flow Receivables, IMF, 2003

Why are Securitisation Issues Tranched? Jenkins and Firla-Cuchra, Said Business School, March 2005

RBI’s

n

Secu and the Pacific: Implications for Liquidity and Credit Risks,

The Stion April 2007

he Subprime Mortgage Crisis: A Synopsis, Deutsche Bank, Oct 2007

Update on Indian Structured Finance Market, ICRA, July 2005

Guidelines on Securitisation: Comments, Vinod Kothari, February 2006

Securitization of Remittances, Nathaniel Jackson, Inter-AmericaDevelopment Bank, April 2006

ritisation in Asia BIS June 2006

tructured Bond Market in Thailand, Japan Bank for International Co-opera

Indian Securitisation- Regulatory and Market Scenarios, Vinod Kothari, August 2007

T

71

The City of London Corporation

The City of London is exceptional in many ways, not least in

that it has a dedicated local authority committed to

enhancing its status on the world stage. The smooth running

of the City’s business relies on the web of high quality

services that the City of London Corporation provides.

Older than Parliament itself, the City of London Corporation

has centuries of proven success in protecting the City’s

interests, whether it be policing and cleaning its streets or in

identifying international opportunities for economic growth.

It is also able to promote the City in a unique and powerful

way through the Lord Mayor of London, a respected

ambassador for financial services who takes the City’s

credentials to a remarkably wide and influential audience.

Alongside its promotion of the business community, the City

of London Corporation has a host of responsibilities which

extend far beyond the City boundaries. It runs the

internationally renowned Barbican Arts Centre; it is the port

health authority for the whole of the Thames estuary; it

manages a portfolio of property throughout the capital,

and it owns and protects 10,000 acres of open space in

and around it.

The City of London Corporation, however, never loses sight

of its primary role – the sustained and expert promotion of

the ‘City’, a byword for strength and stability, innovation

and flexibility – and it seeks to perpetuate the City’s

position as a global business leader into the new century.