Trust, confidence severely impacted by IL&FS default, says Sebi chairman

Episode has highlighted issues arising out of complex corporate subsidiary structures

The default by Infrastructure Leasing & Financial Services (IL&FS) has "severely” impacted the trust and confidence of investors, said Ajay Tyagi, chairman, Securities and Exchange Board of India (Sebi).

Speaking at the conference organised by rating agency Crisil, he said “Let me briefly touch upon the issue of ‘trust’ and how this “trust" and consequently investors’ confidence has been severely impacted due to developments in the recent months, particularly as a result of default by a large entity.”

“One of the issues that this episode has brought out is the interconnectedness arising as a result of complex corporate subsidiary structures and how the maze of subsidiaries facilitate masking the end use of funds,” Tyagi said, emphasising the need for proper monitoring of end use of funds.

Tyagi said recent developments have impacted mobilisation through the corporate bond market, however, bond markets remain the most viable option for financing in the long run.

“There is an opportunity for development of bond markets in the present NPA crisis of banks. Of course, the volatility in bond yields in the last few months has roiled the markets, thereby impacting the raising of bonds. However, in medium to long term, there seems to be no other option but to shift from bank financing of projects to bond funding.”

The development of a corporate bond market is often seen as the proverbial ‘chicken & egg’ story, he said, highlighting both demand and supply side issues plaguing the bond market.

The concentration of a few issuers, lack of appetite for low-rated bonds and a dearth of long-tenure bonds remain key supply-side constraints, he said.

At present, corporate, non-banking finance companies (NBFCs) and housing finance companies account for 86 per cent of the outstanding corporate bonds. Also, 90 per cent of the bonds issued are rated AA and above. “The market has a very narrow bandwidth to absorb issues below AA rating,” said Tyagi. Further, a majority of corporate bond issuances are between 2 to 5 years and there is not much to cater to long-term investors unlike in case of insurance and retirement funds.

Tyagi said Sebi, the Reserve Bank of India and the government in the recent past have taken steps to address some of these issues.

Lack of participation of individual investors and “many nuances” of corporate bonds are among key demand-side issues, Tyagi said.

“In addition to credit rating, there are several other factors which influence the risk-return matrix in corporate bonds which include whether a particular bond is secured or unsecured, liquid or illiquid, issued by a one-time issuer or perpetual issuer, backed by sovereign or sub-sovereign support or not, extent of tax benefits,” he said.

Due to these complexities, institutional investors remain the predominant investors in the corporate bond market, he added.

Tyagi said there is spoke to improve the participation of pension funds, provident funds and insurance companies. They “can generate far higher demand for longer-dated corporate issuances.”

The Sebi chief said the participation of high net-worth individuals (HNIs) and small corporates can also increase if they are allowed to raise funds by pledging their bond holdings.

“While getting a loan against shares is par for the course, a loan against corporate bonds is hard to access. Allowing HNIs and small corporates to access the corporate bond repo to borrow and lend could accelerate their interest in this asset class,” he said.

Tyagi said the issue of “Information asymmetry” also needs to be addressed.

India still has a long way to go as far as the development of a corporate bond market is concerned.

“The outstanding corporate bonds-to-GDP ratio in US and China is approximately 96% and 54%, respectively. In comparison, for India, this ratio stood at only around 18%,” he said.