Historically, the market for corporate debt instruments remained small and under developed due to the following reasons:
(a) The bulk of long term debt required by the corporates was provided by the financial institutions in the form of term loans. (b) There were severe restrictions on the design of debt instruments as well as the interest rates payable on them. (c) The principle buyers of debentures issued by companies were the investment institutions. Typically, debentures were privately placed at a discount with them. The investment institutions bought these debentures with a view to keeping them till maturity.
The market for corporate debentures has been enlivened since mid-1990s. The following factors, which have gradually fallen in place, suggest that it is poised for a healthy growth in the years to come: (a) Financial institutions are currently providing lesser support to industrial projects by way of debt. (b) Corporates now enjoy complete freedom in designing debt instruments. (c) A certain amount of provident fund money can be invested in approved corporate debentures. (d) Foreign institutional investors now have fewer restrictions in investing in debt securities. (e) The sharp fall in equity returns in mid 1990s has enhanced the attractiveness of debentures in the eyes of investors. (f) Major investments are expected in the infrastructure sector which naturally relies more on debt finance. (g) The National Stock Exchange has set up a ‘Wholesale Debt Market’ segment for gilt-edge securities and has listed a number of corporate debentures on its ‘Capital Market’ segment.
The issuance of corporate debt securities is regulated by SEBI. Debentures are offered to the public or issued on a rights basis or privately placed. The mechanics for a public issue of debentures are much the same as that of a public issue of equity. However, there are some differences:
* Pure debt securities are typically offered through the 100 percent retail route because the book building route is not appropriate for them.
* Debt securities are generally secured against the assets of the issuing company and that security should be created within six months of the close of the issue of debentures.
* A debt issue cannot be made unless credit rating from a credit rating agency is obtained and disclosed in the offer document.
* It is mandatory to create a debenture redemption reserve for every issue of debenture.
* It is necessary for a company to appoint one or more debentures trustees before a debenture issue.
Presently, corporate debentures in India are mostly placed privately. The private placement of a debenture issue is managed by a lead arranger, who is also the advisor and the investment banker for the issue. Book building mechanism is commonly employed. There is also a virtual book building portal called debtonnet, a joint venture of NSE and ILFS, through which investors can bid for issues. While other investors can hold debentures in paper or electronic form, RBI requires that banks, financial institutions, primary dealers, and secondary dealers must hold debentures, privately placed or otherwise, only in demat form.
From 1995 onwards private placement of debentures thrived, thanks to minimal regulation. Corporates, financial institutions, infrastructure companies, and others depended considerably on privately placed debentures which were subscribed to mainly by mutual funds, banks, insurance organizations, and provident funds. Information and disclosures to be included in the private placement memoranda were not defined, credit rating was not mandatory, listing was not compulsory, and banks and financial institutions could subscribe to these issues without too many constraints.
The regulatory framework changed significantly in late 2003 when SEBI and RBI tightened their regulations over the issuance of privately placed debentures and the subscription of the same by banks and financial institutions. The key features of the new regulatory dispensation are:
The disclosure requirements for privately placed debentures are similar to those of publicly offered debentures.
Debt securities shall carry a credit rating of not less than investment grade from a credit rating agency registered with SEBI.
Debt securities shall be issued and traded in demat form.
Debt securities shall be compulsory listed.
The trading in privately placed debt shall take place between QIBs (Qualified Institutional Buyers) and HNIs (High Networth Individuals) in standard denomination of Rs.10 lakh.
Banks should not invest in unrated non-SLR securities.