Sensible intervention

Unlisted bonds have been very popular with issuers and investors alike, and their popularity is amply reflected in the size of the private placement market, which some estimates put at around 80 per cent of the total corporate bond market.

The Reserve Bank's new norms for banks, enforcing new limits on banks' investment in unlisted bonds, together with the Securities and Exchange Board of India's new rule that full disclosures have to be made even when debt securities are privately placed, have therefore been a shock to the market.

Issuers liked the private placement system because access to funds was quick and hassle-free, while bankers liked them because they didn't have to do the long-winded due diligence necessary for advancing loans. There is an argument, therefore, that so long as both issuer and investor agree, the regulator should not put fetters on such a market.

Companies argue that the unlisted market was the result of a felt market need and it met the requirements of both borrowers and lenders.

A related argument has been that these deals do not involve the so-called 'small investor' who might get taken for a ride, and they have been struck between brokers and institutional investors who are professionals and fully aware of the risks they are entering into. There is much merit in this argument.

Nevertheless, anybody who has had practical experience of the private placement market knows that the lack of transparency was in many instances misused. When there are no market benchmarks, the scope for abuse is enormous.

What is to prevent a deal being done at an inflated rate, with kickbacks, when there is no market quotation to benchmark the deal against? More significantly, there are reports of banks using deals in unlisted bonds to book fictitious profits in March, with the deals then being reversed in April.

It can be argued that corruption is an internal matter of the bank. However, it is also true that when very large sums of money are involved, and this is certainly true for the private placement market, there may be a question of systemic risk.

This is especially true when bankers in their search for yield overstep the limits of prudence "" bond dealers have pointed out that trading in the unlisted market was sometimes in the letter of offer rather than on the basis of an underlying security. In these circumstances, the regulators have a clear duty to get involved, which they have done.

The Reserve Bank of India's intention in enforcing the new norms for investment in unlisted securities has been to ensure that such securities adopt a reasonable standard in terms of transparency and disclosure.

Unfortunately, banks feared being stuck with the unlisted debt on their books and panicked. There was also a lack of clarity in the RBI rules on whether security receipts issued in the course of securitisation or by asset reconstruction companies would also be affected.

Another grey area was whether banks could continue to invest in mutual funds that invested in unlisted securities. These initial glitches have now been ironed out and banks given time to adjust their portfolios.