Monday, 1 August 2016

There’s a need to develop corporate debt market: H.R. Khan (Former Deputy Governor of RBI)

H.R. Khan, former deputy governor of RBI, speaks of the need to develop India's corporate bond market and verious steps in how to go about it

H. R. Khan
Let me start where the governor ended his previous monetary policy press interaction; he said that repo in corporate bonds will be allowed and Mr. Khan is going to be in-charge of a committee that will present the roadmap to it. Can you tell us how soon we will be having repo in corporate bond markets? 
 Let me give you a bit of a background about corporate debt market, which we have been talking since ages.
There are structural issues and in fact, not many countries also have very robust corporate debt market and many countries like India have a bank-dominated system but corporate debt market is assuming criticality because there is a risk diversification, it compliments and supplements (what) banks are doing and more particularly in Indian context, it has also assumed importance because given the bank’s position in terms of their non-performing loans (NPLs) and other constraints, there is a need to develop corporate debt market and particularly when we are also planning to see that corporates at an aggregate level, they should not get overexposed to the banking sector part of their financial requirement should go to the market and through the bond market.
So if that is the case, then we need to do what all need to be done to develop corporate debt market.

It was in that context that I thought it was very crucial that RBI is contemplating allowing corporate debt in the repo transactions?
The whole idea is that it would be a major change in terms of— we are only taking sovereign papers so far as the repo is concerned. However, if you see world over, there are central banks whether it is unconventional monetary policy or quantitative easing and all, they have gone for corporate debt paper and expanding their balance sheet.
In RBI, we have been conservative and rightly so because given the illiquidity of corporate bond market and credit risk that may come and probably it may have impact on the balance sheet but we have to move on in the sense that we want to develop the corporate market, we have to do something which will be a game changer.

Is that committee report, which you were leading, ready, submitted?
FSDC has been discussing about this corporate debt market for quite some time. Then about few months ago, the sub-committee of the FSDC decided that let us have a group of all regulators and government to give a list of implementable recommendations, not go for a big report because there have been many reports on this corporate bond market to call out what all can be done and what new things we can do for the corporate debt market. So, we had all the regulators and government we sat together and we have worked out—the job is almost done and it is being submitted. Broadly, we had tried to look at what are the factors, which can further enable development of corporate debt market, which I put it in a characteristic manner in terms of issuer, in terms of investor, in terms of infrastructure, in terms of intermediaries, in terms of instruments and incentive and innovation.

Therefore, from what you are saying, it looks like a repo of corporate bond in RBI’s liquidity adjustment facility (LAF) is only one part. You have many other recommendations?
Yes; many other parts, and all the parts have to play together and in fact, most of the regulators and particularly RBI and Sebi are mostly involved and we have good understanding and quite a few things, implementers and timelines are also being suggested. So, we will see a lot of action in the next couple of months in terms of actual implemention.

So, which other areas? The LAF is one. What are the other things possible?
If I can take you through very quickly for example, on the issuance side, we have not seen much reissuances. And volumes are not there so liquidity is not there. And on corporate side, there is a problem because bunching will be there. So, what we are trying to say that whether you can have same International Securities Identification Number (ISIN) number but different redemption date so you can do it so, National Securities Depository Ltd (NSDL) and the Central Depository Services India Ltd (CDSL) will probably work on that. And the other thing is that if you do reissuances, the stamp duty can be removed so that there is an incentive for reissuances.
Similarly, in the case of, for example, investor. We have not allowed foreign portfolio investors to invest. So, now as announced in the budget, now unlisted bonds and PTC they will be allowed to invest. And if you talk of intermediaries, the very critical point is market making. So, what we are looking at is whether some of the brokers can be market makers and if they become market makers, what sort of support they can get. So, they probably will get an access to repo and corporate bond market which is not allowed to them. So, if they get an access through repo to the market repo, probably they can make market. But then exchanges are working out a scheme and I think it is in advanced stage of being implemented.
And the other is in terms of banks, and primary dealers are already trading members. So, they could be also encouraged to become market makers. And if you see the infrastructure side, there are quite a few things. For example, one is electronic book for this private placement. And there is integrated trade repository where both primary and secondary market issuances one place, prices, volume, everything is available.
And one critical element of infrastructure is credit rating agencies who play very important role. So, they will be encouraged to become members of credit information bureaus. So, they can access information. They are eligible users, but many of them are not members. And also possibly, going forward, whether they can be given access to Central Repository of Information on Large Credits (CRILC) data, but that has to be used very carefully, because SMA-2, SMA-2 does not mean that it is full default. So, probably that is one area.
And other critical part is some of the instruments we have introduced, they have not really taken off. Take the example of credit default swap (CDS), repo in corporate bond. For example, in CDS we allowed few things, it does not work. In the corporate debt repo, we have reduced the haircut.

So you will allow more partial re-enhancement?
So, what we are trying to do is in terms of CDS, the main issue which has been a stumbling block as per the market is this netting issue involving public sector because of that capital charge increases. So, we were in dialogue with the government whether we have that amendment to the RBI act, netting and if that is not possible, pending that whether based on legal opinion we got second tracked whether the netting can be allowed. So, that will be a big boost.
And so far as repo is concerned, we would like to have a screen based platform. Some cases where the liquidity can be a central counter-parties (CCP) facility and some where it is not liquid it can be without CCP facility. So, that is one area where we can work for this instrument. And other is of course, tripartite repo but better collateral management. The other issue is very important
So, it can be increased, maybe 30-50%. And also, NBFCs were providing credit enhancement, for them there may not be any limit.

But what is the timetable for all this?
Another very critical point in terms of incentive as I have stated is that corporates’ exposure to the banking system as a whole should come down and part of that, they should go to market. So, that is a work in process and RBI will come out with their own recommendation. And of course, finally, as you mentioned is this LAF eligibility.
The whole idea is that once the market repo, tripartite repo gets some traction, there is some liquidity, probably we can open up this for LAF, but we have to see the legal aspect because RBI act is not very clear in terms of whether we can accept or not accept. That will be examined. My hunch is that pending RBI act amendment, possibly we can do. And very important thing which has happened is this bankruptcy code which is one of the main stumbling blocks. We have now the bankruptcy code in place, but the challenge lies in creating the infrastructure of ports and insolvency professionals.

The most attractive proposal or rather one of the more attractive proposals is allowing corporate bonds to be used in the LAF window. The legal opinion at that time was that the RBI would only take sovereign paper. Is this settled?
I would say it is not settled, but we will be in a position to interpret that it can be taken. Of course there has to be very sound risk management practices in terms of ratings, in terms of haircuts and all that. But if there are ambiguities, better to get the act amended. So that view has to be taken.

Now, I wanted to know the timetable. When can we expect some of these?
Many of the things should happen over the next two months.

So in the current governor’s tenure itself some of it may be implemented?
I suppose so. Some of the things will happen. For example, allowing FPIs to invest in unlisted debt and PTCs can happen anytime. And few things market making and all that SEBI is in advanced stage of doing it. And we are also in dialogue with Pension Fund Regulatory and Development Au t h o r i t y (PFRDA) and insurance companies, they will also slightly relax their norms for investment. And for example, even bonds of banks, so insurance companies and PF bonds, they will probably be investing. So, we are in dialogue with them. So, some of the major recommendations are likely to be implemented sooner than what was expected because the whole idea of this group is to give the recommendation and lay down some time frame.

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