Development of corporate bond market abroad

The Reserve Bank of India (RBI) has announced several measures to develop and deepen the corporate bond market, ending a decade-long wait for a big-ticket regulatory push that will encourage large companies to borrow more through the market.

The central bank is looking to permit brokers in corporate bond repos (or repurchases), authorize them to act as market makers and also allow foreign investors to directly trade in corporate bonds. More importantly, RBI said that it is also considering accepting corporate bonds as collateral at its liquidity adjustment facility (LAF) operations.

A corporate bond repo is where a company or a bank pledges corporate bonds with another company or bank to raise money. The pledger agrees to repurchase the bonds at a specified price. Currently, only bilateral repurchases of corporate bonds are allowed by RBI, limiting the interest in such bonds (and essentially making them illiquid). In contrast, it allows repurchases of government bonds, and consequently, such instruments are liquid.

Registered brokers, who will be authorized as market makers, will also be allowed to access the repo market through corporate bonds in addition to banks, primary dealers, insurance companies that are currently allowed.

This move will make corporate bonds fungible and thus boost turnover in the secondary market.

“Repo is the backbone of the guidelines. Large borrowers will be pushed to corporate bonds. The measures will give a boost to both demand and supply,” said Ajay Manglunia, head of fixed income at Edelweiss Financial Services Ltd.

Many of the recommendations were made by the H.R. Khan-led panel of officials from the central bank and the Securities and Exchange Board of India. They are expected to increase participation in the bond and currency markets and also increase market liquidity.

“To promote development of the corporate bond market, following emerging international practice, RBI is actively considering corporate bonds as eligible collateral for liquidity operations. The process to make necessary amendments to the RBI Act has commenced,” the central bank said in a circular on Thursday.

Currently, banks can use only government bonds to access funds under the LAF window, essentially a short-term mechanism for lenders to raise money quickly. By the end of this year, the central bank aims to put in place a design for an electronic trading platform for corporate bond repos that will enhance transparency and liquidity of the current opaque over-the-counter market.

In 2011, RBI had allowed repos in corporate bonds bilaterally, hoping that this would boost the secondary market turnover in the bonds. But the repos didn’t take off and the average daily turnover of the secondary market is still around Rs.4,000 crore.

Foreign portfolio investors will get access to the bond market more with direct access to market-infrastructure to ease the process of investment in debt securities.

RBI and in market regulator Securities & Exchange Board of India are also in the same page in allowing FPIs to trade directly in corporate bonds, with greater leeway is being proposed for residents to maintain open positions.

The permissible limits for hedging in the over-the-counter as well as exchange traded markets are also being rationalised.

RBI allowed resident and non-resident exposed to exchange rate risk to undertake hedge transactions with simplified procedures, up to a limit of $30 million at any given time. Over and above this, banks may allow an open position limit of up to $5 million, providing depth in the foreign exchange market.

In an effort to align bank exposure norms to global standards and reduce business concentration risks, RBI has proposed to cap banks’ large exposure limit to 20% and 25% of tier 1 capital in respect of each counterparty and group of connected counterparties, as against the current limits of 15% and 40% of capital funds respectively.

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