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WHITE PAPER DEVELOPMENT OF SECONDARY DEBT
MARKETS IN INDIA
I C A P ( I N D I A ) P V T . L T D .2 0 2 , D A L A M A L T O W E R S , N A R I M A N P O I N T
M U M B A I 4 0 0 0 2 1 I N D I A
TABLE OF CONTENTS
1. Need for Debt Markets 3 - 4
2. Debt Market in India 5 - 6
3. Regulators 7
4. Market Infrastructure : Trading 8 - 9
5. Intermediary : Broker 10 - 11
6. Summary of Fixed Income Markets in Other Countries 12 - 25
7. Electronic Trading Systems 26 27
8. Inter-Dealer Broker 28 - 29
N E E D F O R D E B T M A R K E T S
In any economy, the financial sector plays a major role in the mobilization and allocation of savings. Financial institution, instrument, and markets which constitute the financial sector act as a conduit for the transfer of financial resources from net savers to net borrowers. World over all the governments face deficits, in India the case is more acute thus the Central Government indulges in borrowing through issuances of sovereign securities by its merchant banker (RBI) every year as a part of funding programme as envisaged in the Annual Union Budget. In recent years government borrowing has increased making it the major borrower. Average annual budgeted borrowings of Central Government have been 140,000 crores. The underlying philosophy of government in raising the Funds from the Debt market is to finance the development activities of government. Furthermore; these markets also bring about transmission channel for use of indirect instrument of monetary control. Some other reasons that has resulted the emergence of debt market are:
Governments may borrow to meet temporary needs, as when estimated revenue
falls below or is exceeded by estimated expenditures. Short-term treasury notes, payable by increased taxes or by greater economizing,
may be issued. Borrowing to finance public works thereby reducing forex exposure from
cross-border financing. To finance emergencies such as war, famine, floods etc. Government borrowing interest rates are determined by the market participants
based on their assessment of the current economic situation. These interest rates serve as benchmarks for pricing of corporate paper and other saving instruments.
They also infuse greater transparency in the process of credit allocation in view of the information that is contained in market determined rates. It may be difficult for Government to intervene through debt market for directed subsidized lending as compared with the banking system. Hence, it is claimed that debt markets facilitate the reduction of bad loans.
D E B T M A R K E T I N I N D I A
The debt market in India comprises of two main segments viz., the Government Securities Market and the Corporate Securities Market, besides the emerging market for interest rate derivatives. The government securities market is a core constituent of the Indian financial system. Since 1991, a number of measures have been taken by the RBI for widening and deepening the market. With the switch in 1992 to borrowings by the government at market-related interest rates through an auction system, and the abolition of the system of automatic monetization, it became possible to progress towards greater market orientation in government securities. Depth, Liquidity and Transparency were added to the market by reforms such as;
Introducing new instruments across the maturity spectrum (zero coupon bonds, floating rate bonds, capital-indexed bonds, bonds with call and put options),
Establishing a system of delivery versus payment (DvP), the introduction of primary dealers with liquidity support and incentives for underwriting,
Authorizing foreign institutional investors to invest in dated securities and T-bills in both the primary and secondary markets,
Clearing Corporation of India Ltd (CCIL) commencing operations,
Introducing a Negotiated Dealing System (NDS), and
The dissemination of online market information.
Government Securities form the major part of the market in terms of outstanding
issues, market capitalization and trading value. The outstanding volume in marketable securities (of Central as well as State Government) is estimated at around Rs. 641, 2121 crore at the end of March 2003.
As the markets have grown with reforms so have the investor base, this has lead to greater market depth. But, clearly a lot still has to be done to make this market more vibrant as any other developed market and focus on development of intermediaries is of utmost important. The diagram below clearly depicts all the important aspects of Indian debt markets.
OVERVIEW OF INDIAN DEBT MARKET
Regulator SCRA MoF RBI SEBI NSE
Issuers GoI State Govts DFIs PSUs Banks Corporates
Market Infrastructure NSE BSE NDS (RBI) OTCEI CCIL NCCIL, CDSL
Counterparties Banks PDs FIs Insurance Co.s PFs, MFs Corporates FIIs
Instruments Gilts CDs, CPs Repos Bonds Debentures
R E G U L A T O R S
Financial markets and securities transactions are regulated by the Department of Economic Affairs (DEA) that comes directly under Ministry of Finance (MoF). The Indian Financial system is regulated and supervised by two government agencies under the Ministry of Finance (MoF) The Reserve Bank of India and The Securities Exchange Board of India. Securities Contract Regulation Act (SCRA) of 1956 provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges and aims to prevent undesirable transactions in securities. Most of the powers under the SCRA are exercisable by DEA while a few others by SEBI.
The Reserve Bank of India is the main regulator of the Debt Market and its main participants, the Banks. Apart form its role as a regulator; it has to simultaneously fulfil several other important objectives viz. managing borrowing program of Government of India, control inflation etc. It regulates Banks through its control on issuances of new banking licenses and their (banks) development of money markets through its policies on CRR, SLR.
Securities Exchange Board of India (SEBI) gets involved whenever there is any corporate entity raising money from Indian investors. SEBI through power bestowed on it by the act regulates various players in the markets such as intermediaries, mutual funds, FIIs, but not the counterparties in government securities.
Another regulator for the debt market is the SROs such as the Stock Exchanges like National Stock Exchange (NSE), Bombay Stock Exchange etc. Broker intermediaries that seek to trade on NSE have to be registered with SRO such as NSE and comply with its rules and byelaws.
Clearly, regulatory jurisdiction in the Indian market is allocated between RBI and SEBI with SROs playing their own part. Secondary debt market participants, thus face a situation where in their working is regulated by multiple entities often resulting in regulatory overlap which affects their working.
M A R K E T I N F R A S T R U C T U R E : T R A D I N G
Trading is nothing but buying and selling of securities by various counterparties. Trading in debt markets take place on NSE-WDM, OTCEI and the latest is on RBI-NDS which is the primary platform of the wholesale debt markets in India. In order to support financial stability, the trading of fixed income securities, both Government and corporate, must be conducted in markets that are:
Anonymous: counterparties trade through a broker who maintains anonymity till the trade is confirmed.
Efficient: prices balance underlying supply and demand; prices reflect fundamentals; informational efficiency holds; prices react rapidly when news breaks.
Liquid: transactions are executed rapidly without unduly moving prices.
Orderly: equivalent orders are executed at broadly equivalent prices.
Stable and resilient: the market continues to operate in an efficient, liquid and orderly manner during times of uncertainty and market stress.
At present most of the secondary market trades in government securities takes place through bilateral negotiations. In common parlance, this is a telephone market. Deals are negotiated through brokers or done directly by counter parties such as banks, financial institutions, and mutual funds between themselves on the NSE NEAT system (for corporate bonds only) or RBI NDS (for G-Secs only).
NSE WDM trading system called NEAT (National Exchange for Automated Trading) enables its registered trading members across the country to trade simultaneously. The trading system has both Negotiated Trading Screen for reporting of a predetermined transaction and Order Driven Screen for direct inputs. The Order Driven trading platform has, however failed to pick up as the market mostly prefers negotiated trading through brokers. To meet regulatory requirements brokers are required to report all deals on the NSE NEAT.
Negotiated Dealing System (NDS) an initiative by RBI, is a negotiated dealing platform (no order boo