Proposed regulations may negatively impact India’s bond market

On July 21, the Securities and Exchange Board of India (SEBI) proposed new regulations for private debt platforms in the country in a new consultation paper. The envisaged changes could bring India’s growing number of online bond-trading platforms within SEBI’s orbit for the first time.

The consultation paper also tackles a range of other issues, including standardising debt market know-your-customer (KYC) requirements and heightening investor protections. Above all, however, SEBI’s proposals seek to reaffirm the distinction between private debt placements and public issuances in the country’s burgeoning corporate bond market.

Corporate debt issuance in India is dominated by financial institutions, with about 53% of total deals in 2021 stemming from non-bank financial companies and housing finance companies, according to CareEdge, an Indian ratings and advisory firm.

Much of this activity, however, is in the form of private placements, meaning the market as a whole is based around large institutional issuers and buyers conducting tailored, over-the-counter transactions. Under Indian law, such deals are subject to lighter regulatory requirements, and only 200 or fewer pre-identified investors are permitted to take part. 

In financial year 2021–2022, for instance, 1405 private placements were accompanied by just 28 public debt deals, which are open to all investors, according to SEBI. The reasons behind the dominance of private debt placements are complex. Higher regulatory requirements remain a significant obstacle to further public deals, as corporate entities are obliged to meet Company Act rules and SEBI directives concerning the listing of debt securities for public offer on a designated exchange.

Skirting the rules

In recent times, however, these rules have been circumvented by the growth of online trading platforms. These entities, which are typically owned by fintechs, brokers or banks, have opened new investment opportunities for retail buyers across India to tap into the country’s bond market through easy-to-use digital portals. But these online platforms are increasingly being used by debt issuers transacting private placements, meaning that retail investors are gaining exposure to, and investing in, bonds that should be limited to qualified institutional buyers. 

“If a platform is being used by an issuer to offer securities to investors in general, [it] effectively puts the securities up for subscription by unidentified investors, or identified investors [numbering more than 200]. As a result, it is breaching the essential rule about public offers,” says Aanchal Kaur Nagpal, assistant manager at financial consultancy Vinod Kothari. 

The implications of this trend are twofold. First, it has had a beneficial impact on the development of India’s corporate bond market by increasing its depth and liquidity. Online bond-trading platforms have brought a wider audience of investors to the table, helping to push the purchase and sale of corporate debt securities to new levels. On the other hand, it has placed these retail investors at increased risk, since they may be acquiring bonds that formed part of a private placement and that come with fewer protections.

“Such platforms have been able to bring the much-needed liquidity to the debt market by enabling trading in bonds for retail investors as well. The fact that these bonds are [accessible] by retail investors [means] they may pose several risks to the investors and India’s capital markets,” says Mr Nagpal.

Risks in regulation

For the Indian government, herein lies the challenge. Prime Minister Narendra Modi harbours ambitions to double the size of the country’s economy by 2025 relative to its 2018 levels. But reaching this objective will require India’s debt and equity markets, as well as its banking sector, to be firing on all cylinders. And while the country’s banking system, in particular, has strengthened considerably in recent years, its bond market has been plagued by illiquidity. The popularity of online bond-trading platforms altered this situation for the better.

The problem with SEBI’s proposed framework, according to some market analysts, is that it fails to find the right balance between generating investor protections and promoting increased liquidity. “While the intention of SEBI’s consultation paper is quite positive, the framework may limit or completely wipe off transactions in unlisted debt securities. For the debt market to grow, trading in unlisted debt securities must continue. These platforms should be regulated, but not in a way that limits the market,” says Mr Nagpal. 

Market players had until August 12 to submit their feedback on the proposals to SEBI, after which a decision will be made on how the regulatory framework will be deployed.