Debt Markets For All

Debt Markets For All

How to create transparency and accountability via a new set of reforms.

There have been many reforms in debt markets over the past few years, but it's important to hasten the pace utilising digitisation to create market transparency, higher liquidity and appropriate safety vaults.

The debt markets will thrive and be accepted by every section of the market if regulators and market participants are able to deliver an improved and more transparent customer journey. This has been demonstrated in the government bonds markets via the market framework developed by the RBI. This transparent framework needs to flow through to all credit markets. The latest dislocation in the credit markets, especially in NBFCs, has eroded investor confidence.

The root cause of this dislocation lies on the issuer's side, mainly excessive reliance on short-term funding to save costs and the resultant asset liability gaps. Poor disclosure of information on balance sheets and regarding unlisted and unrated investments is another factor. There was a clash of interest for rating agencies as well: they are paid fees by issuers to rate their liabilities.

There are also concerns on the investor side, which includes mutual funds, insurance companies, provident funds and others (excluding banks). While all these are professional investors, proper due diligence and portfolio management principals have not been applied, which puts a question mark on the mechanism used to check the health of existing books.

Banks have been blamed for bad loan portfolios and non-performing assets; the state of our professional investors is similar. End investors suffer, while fund managers go scot-free with very little accountability.

The moot point is how to create transparency and accountability via a new set of reforms, so that the market is more liquid and liquidity/savings are channelised to the right enterprises.

One way to do this is to introduce a compulsory screen-based secondary market trading platform; to begin with, for standalone AAA and AA+ papers, certificate of deposit (CD), and commercial papers (CP) rated A1+. Introduce a screen-based corporate bond repo trading platform. A haircut-based approach on ratings will also improve liquidity.

Disallow unrated and unlisted papers as only non-transparent issuers resort to this route. Allow direct retail participation with tax incentives because it's imperative to develop a new investor class. Credit enhanced structures via well capitalised entities should be allowed as this will in turn develop the credit default swap (CDS) market and enhance the instrument's liquidity. One could start with exchange-cleared CDS contracts in 15-20 top issuers and expand the list later. This will allow disbursal of credit risks into different pockets of risk takers, and also bring in a new class of sophisticated credit risk underwriters. Exchange-cleared CDS can be adequately margined and that will help develop a transparent credit curve.

Apart from 15-20 regular issuers in the PSU and private space, rest of the investments by MFs are mostly illiquid, much like banks' hold-to-maturity portfolios. Therefore, no inter-scheme transfers should be allowed, at least in these illiquid bonds. Currently, there are no buffers in place for MF investments. At the least, MF management fees should be made zero in cases of negligence.

Reforms are required in the sovereign markets too. Banks' held-to-maturity portfolio, currently 19.5 per cent of the G-sec portfolio, is dormant. This protects banks from mark to market fluctuations but also encourages lazy treasury risk management, which affects market liquidity. Held-to-maturity for mandatory portfolios should be removed. Primary dealer exclusivity should be made mandatory, like the primary dealer framework in the US. We also need stable Foreign Portfolio Investment (FPI) regulations and a digitised framework to encourage transparency in dealing without being tied to a custodian.

These reforms and more are required to deliver a deep, liquid and transparent debt market to all sets of market participants, and deliver capital market solutions to businesses.

(Views expressed are personal.)

The writer is MD & Head-Trading and MM, Treasury and Markets, DBS Bank India