A V Rajwade: The corporate bond market

WORLD MONEY

Let there be freedom for the participants to set up the trading platform they find convenient.

Given the fiscal constraints and need to comply with the Fiscal Responsibility and Budget Management Act, there are obvious limitations on the amount of fiscal resources that would be available to meet the financing requirements of the infrastructure sector (some time ago, the prime minister estimated these at $150 billion "" or Rs 6,90,000 crore). Clearly, much of the investment will need to come from the private sector or public-private partnerships in one form or another. And, a significant part may need to be raised in the corporate bond market. There is a paramount need for a liquid and efficient bond market at both primary and secondary stages. The Patil Committee Report has addressed and pinpointed the reforms needed.

In his Budget speech, while the finance minister stated that the government had accepted the committee's recommendations, he also stated that "we shall now take steps to create a single, unified exchange-traded market for corporate bonds." An internal committee of the Securities and Exchange Board of India (Sebi) seems to have taken its cue from the quoted statement and come out with a recommendation for confining trading in corporate bonds to the Bombay Stock Exchange. One is not quite sure whether this was the sort of thing which the finance minister had in mind while referring to "a single, unified exchange-traded market". One does not think so. For one thing, as the Patil Committee Report argues, most of the bond trading internationally is conducted in over-the-counter (OTC) markets, that is, not on the exchanges. To be sure, most of the actual trades take place on electronic platforms. Second, the committee has made clear its preference for a variety of trading mechanisms and structures, in the expectation that the most efficient will win out over the long term. To quote from the Report:

"62. Globally, there are a number of successful and efficient structures where market participants join together to provide trading platforms. Generally, such trading platforms are owned by banks and institutions as the markets are basically institutional in nature. These institutions possibly have found it less costly to trade in OTC markets among themselves but require an efficient price discovery mechanism. These trading platforms have operated on mutual arrangements often with no-profit-no-loss model.

"63. There are well defined clearing and settlement mechanisms in place in global markets which can form role models for Indian corporate bond market as it has almost the same institutional structure. A trading-cum-clearing corporation set up by leading market participants or for-profit model may be suitable for clearing and settlement purposes. The global market set ups in corporate bonds do provide a path which Indian corporate bond market may like to tread. If corporate bond market needs to be developed efficiently, it would be desirable to adopt a flexible approach that allows ... banks and institutions ... freedom to set up their own trading-cum-clearing and settlement system that would facilitate their OTC deals."

In short, let there be competition and freedom to the market participants to set up and use the trading platform and settlement systems which they find convenient, efficient and cheap. No monopolies please!

Hedge accounting
When I wrote the article on the above topic ("Hedge accounting", June 12), I had not seen the Reserve Bank's circular dated June 8 on the subject. Now that I have gone through it, it seems to me that it is not as clear and definitive as one would have liked it to be. For instance, it still does not specifically define what a hedged item is, and seems to accept that the swaps in question were "to hedge the interest rate risk in respect of capital instruments", in this case fixed interest bonds issued by banks. Again, it seems to have objected only to "conversion of fixed rate rupee liabilities in respect of Innovative Tier I/Tier II bonds into floating rate foreign currency liabilities". Read together, this gives an impression that the supervisor is objecting only to swaps that involved foreign currency liabilities. By implication, is the supervisor accepting that, if the swap were to be "receive fix, pay floating" in rupees, this is an acceptable hedge and therefore eligible for hedge accounting? If so, one would certainly like to question the logic. First, fixed rate bonds are not marked-to-market in the issuer's book, nor is there any uncertainty about the cost from changing interest rates. Therefore, such bonds cannot be a hedged item, nor can a swap converting the liability into floating rate rupee, be considered a hedge, even if no foreign currency liability is involved.

Again, in the circular, the regulator has carefully avoided using the word "mark-to-market". It merely says that "gains/losses need to be accounted for" in the manner prescribed. This could as well mean that the prescription relates to gains/losses from accrual accounting, and not necessarily fair value (that is, mark-to-market) accounting.

There is an obvious need for laying down clear and unambiguous guidelines on the subject, in conformity with accepted international standards.

Email: avrco@vsnl.com