Corporate Bond
Summer Internship Report Exploring opportunities in Resource
Mobilization from
Domestic Markets by the means of Convertible Bonds for
PFCLSubmitted by:
Preeti gupta(200709 Batch)POWER FINANCE CORPORATION LTD.,
URJANIDHI, 1, Barakhamba Lane, Cannaught Place, NEW DELHI
110001
Under the guidance of
Mr. Milind M. Dafade
Manager (Finance)
Power Finance Corporation Ltd.
Jagan Institute Of Management StudiesNew Delhi
Table of ContentsSummer Project
Certificate......4Acknowledgement..5Executive Summary...61) Indian
Power Sector: ....7
1.1 Introduction..7
1.2 Privatization...13
1.3 Highlights of Performance....14
1.4 Demand side Management: Recommendations..16
1.5 Supply side Management: Recommendations172) Power Finance
Corporation: Overview.183) Resource Mobilization Unit29
3.1 Rupee Resources (Domestic).29
3.2 Foreign Currency Resources (International)..30
3.3 The 3 Main Decisions Taken by RMU.....31
3.4 Instruments Used By PFC to Raise Funds in Domestic
Market...........344) Indian Debt Market.37
5.1 Overview.37
5.2 Market Micro Structure....41
5) Capital Market: Fixed Income Market.............46
4.1 Introduction....46
4.2 Classification of Bond Market......47
4.3 Bonds Market Instruments...49
4.4 Factors Influencing Bond Market....51
6) Corporate Bond.......52
6.1 Convertibles and Exchangeables..52
6.2 Adjustment Events.....56
6.3 Why Invest in Convertible Bonds: Investors perspective.607)
Some General Underlying Legal Issues in Convertible...61
7.1 SEBI Guidelines.....62
7.2 Guidelines for Preferential
Issues.................................67
7.3 Guidelines for the OCTEI Issues..69
7.4 Guideline for Bonus Issues70
7.5 Some SEBI Circulars for Amendment of Guidelines.727.6
Private Placement of Securities79
7.7 The Indian Stamp Act...828) General Procedure Followed While
Issuing Convertible Debenture.....849) Methodology.88
9.1 Essentials in case PFC goes for convertible debentures
issue....88
9.2 Assumptions.......89
9.3 Analysis...909.4 Recommendations .9210)
References...93Summer Project CertificateAcknowledgementThis
project would have been difficult to complete without the
invaluable contributions from some important persons. Let us take
this opportunity to thank them.
First of all, we would like to thank Power Finance Corporation
Ltd for giving us such challenging projects to work upon. We hope
this challenge has brought the best out of us.
We are indebted to our project guide Mr. Milind M. Dafade, Sr.
Manager (Finance), Resource Mobilization Unit, for the direction
and purpose he gave to this project through his invaluable
insights, which constantly inspired us to think beyond the obvious.
His encouragement and co-operation helped us instill a great degree
of self-confidence to deliver a good work. We are also thankful to
Mrs. Parminder Chopra (DGM) and Ms. Tabassum for taking
constructive interest in our project and providing us valuable
support at many points of time.
We are also thankful to all the employees of Power Finance
Corporation who provided us with an environment conducive for
learning during the last two months.
We hope we can build upon the experience and knowledge that we
have gained here and make a valuable contribution towards this
industry in the coming future.Preeti GuptaExecutive SummaryAs
Indian economy has been growing at a rapid and impressive pace
averaging over 8.5% and Electricity is one of the most vital
infrastructure inputs for economic development of a country; the
country needs a commensurate growth in the Power Sector also. So,
even Power Finance Corporation (PFC) has to live up to its
impeccable image of being a leading Power Sector Financial
Institution in the country. PFC is committed to act as a catalyst
for reforming Indias Power Sector to mobilize various types of
resources at competitive rates and further lend the funds to enable
availability of required quality power at minimum cost to
consumers. Herein lays the justification of the project
undertaken.
Our project attempts at analyzing various present and
prospective sources of finance that can be used by PFC to maximize
rate of return through efficient borrowing & lending and
introduction of innovative financial instruments for the power
sector. With the blurring of geographical boundaries after
globalization, taking advantage of the global markets for
mobilizing resources at a cheaper rate has become a necessity to
sustain and grow. Hence, exploring the possibilities of mobilizing
resources through innovative routes becomes a natural extension for
any Power Financing Corporation.
The following project aims at working out the possibility of
issuing Convertible Bonds and MIBOR-linked Bonds in the Domestic
market as a means of resource mobilization. As PFC is a Public
Sector Undertaking, issuing Convertible Bonds will although lead to
dilution of Governments stake in the undertaking but it can turn
out to be a good a source of finance bringing in hordes of funds,
the benefits of both Debt & Equity and at the same time can
help in containing the Debt-Equity Ratio of the corporation within
the financial covenants specified by the corporations lenders. At
the same time, resorting to another option of issuing MIBOR-linked
Bonds can further expand the horizon of sources of finance for the
corporation. It can help the corporation in enjoying the advantage
of market-linked interest rates and avoiding a fixed rate of
interest which has to be paid irrespective of the market conditions
prevailing in the economy.
Our project has thrown open two new ways of mobilizing funds in
the Domestic market which if implemented can definitely reduce the
cost of borrowings for the corporation and can facilitate in
achievement of the Corporations long term goal of catapulting the
sustainable development of Indian Power Sector.
Indian Power Sector
Introduction to the Power Sector in India
Electricity is one of the most vital infrastructure inputs for
economic development of a country. The demand of electricity in
India is enormous and is growing steadily. The vast Indian
electricity market, today offers one of the highest growth
opportunities for private developers.
Since independence, the Indian electricity sector has grown many
folds in size and capacity. The generating capacity has increased
from a meager 1362 MW in 1947 to more than 91000 MW by 2003, a gain
of more than 60 times in capacity addition. India's per capita
energy consumption is projected to grow from 6.2 million Btu in
1980 to 18.2 million Btu in 2010 -- a rise of almost 300 percent.
Although, India's energy consumption per unit of output is still
rising, but it is expected to level off and to decline in the
future. India consumes two-thirds more energy per dollar of gross
domestic product (GDP) as the world average. India consumes only
about 18 percent of the energy per person as the world average.
Nearly 64.4 per cent of India's electricity is produced in thermal
facilities using coal or petroleum products. 25 per cent
electricity is generated by hydroelectric facilities.In its quest
for increasing availability of electricity, the country has adopted
a blend of thermal, hydro and nuclear sources. Out of these, coal
based thermal power plants and in some regions, hydro power plants
have been the mainstay of electricity generation. Of late, emphasis
is also being laid on non-conventional energy sources i.e. solar,
wind and tidal.
India is one of the main manufacturers and users of energy.
Globally, India is presently positioned as the eleventh largest
manufacturer of energy, representing roughly 2.4% of the overall
energy output per annum. It is also the worlds sixth largest energy
user, comprising about 3.3% of the overall global energy
expenditure per year. In spite of its extensive yearly energy
output, Indian Power Sector is a regular importer of energy,
because of the huge disparity between oil production and
utilization.
Indias power market is growing faster than most of the other
countries. With an installed generation capacity of 141.5 GW,
generation of more than 600 billion kWh, and a transmission &
distribution network of more than 6.3 million circuit Kms, India
has today emerged as the fifth largest power market in the world
compared to its previous position of eighth in the last decade.
Usually energy, especially electricity, has a major contribution
in speeding up the economic development of the country. The
existing production of per capita electricity in India is around
600 kWh per annum. Ever since 1990s, Indias gross domestic product
(GDP) has been increasing very rapidly and it is estimated that it
will maintain the pace in the next couple of decades. The rise in
GDP should be followed by an increase in the expenditure of key
energy other than electricity.The gross electricity production
capability of Indian Power Sector is placed at around 141.5 GW. A
key portion of this generated electricity i.e. 64.4 per cent is
thermal energy. Though, this is still not sufficient.
Installed Generation Capacities
Total installed capacity is 141,500 MW
Electricity generation mix is heavily dependent on thermal at
around 64.4% with hydro contributing to 25%
The following graph shows a near doubling of per capita
consumption of electricity from about 350 units in 1998 to over 600
units in 2005.
Structural and regulatory reform conducive to PSPIn the past,
the power sector growth has not kept pace with the economic
expansion and this has resulted in India experiencing a 13 per cent
shortage in peak capacity and 8 per cent in energy terms, on an
overall basis. Driven by the requirement to enhance the budgetary
allocations to social sectors to meet the emerging requirements of
sustainable growth, the Government has envisaged a manifold
increase in the role of the private sector in the financing and
operations of the power sector. Significant structural and
regulatory reforms have paved the way for increased private sector
participation in all aspects of the sector. Many of the legal and
regulatory requirements to enable this are in place, while the
operational provisions are in different stages of implementation in
different states.Opportunities of growth in the Indian power
sector
The Government of Indias blueprint for the power sector
envisages a capacity addition of 100,000 MW between 2002 &
2012, and a required associated investment for the transmission and
distribution network. A similar substantial capital investment is
required to develop the national grid, for renovation and
modernization of inefficient and ageing generation plants and
network, for electrification of rural areas, and to improve
adequacy, reliability and the quality of power supply.
Growth Blue-print of Ministry of Power:
An investment requirement of US$ 90 billion in generation of
which US$ 19 billion is expected from the private sector
An investment requirement of US$ 90 billion in transmission and
distribution of which nearly US$ 15 billion is needed for the
National Grid
An investment of US$ 6 billion for the National Grid is expected
to come from the private sector, the rest from the Central
sector
The rest of the investment in transmission and distribution will
be financed through a mix of the state and the private sector
Implies at least US$ 25 billion of investments from the private
sector. The large capital and knowledge requirements cannot be met
by the Government alone. Further, given the magnitude of actual and
opportunity loss, these investments and efforts must be brought in
at the earliest. A partnership and private & foreign investment
is necessary to meet the rapidly growing demand and to achieve
global standards in operating efficiency and quality of supply.
In Generation, the development of the power market and
deregulation of supply to large consumers, presents options for the
sale of power to distribution utilities and to contestable
consumers.
In Transmission, competitive bidding guidelines are being
finalised, and the Central Transmission Utility has identified
specific elements of interstate transmission systems. The JV or BOT
model may be adopted in the intra-state transmission segment as
well.
In Distribution, privatisation continues to remain on the agenda
of states (e.g. Uttar Pradesh), though the actual timing of
initiation of any privatisation process remains uncertain. The Act
envisages the possibility of more than one distribution licensee in
an area. Some applications for such licenses have been made to the
relevant SERCs, and the guidelines for issue of such licenses
(including minimum service obligations) are expected to evolve.
Power trading has been recognized as a separate activity, and a
number of private firms have obtained trading licenses. The trading
volumes have increased manifold over the last few years, and are
expected to increase further as the national grid is strengthened
and inter-regional flows increase. The trading business offers
opportunities as a stand-alone business, as well as a strategic
adjunct to investments in other segments.
The investment required is not restricted to financial capital.
The electricity sector incurs a commercial loss of about Rs 20,000
crores (nearly US$ 4 billion) per annum; a significant part of
which is attributed to inefficient operation. To plug this, the
power sector, and specifically, the distribution companies must
re-engineer their business processes, invest in modern IT systems
for billing, MIS, tracking, energy audit etc., train their
operating staff to improve their management, commercial and
technical skills, and undertake other such performance improvement
measures. All of this provides significant business opportunities
to various service providers.
Ultra Mega Power Projects by Government of India
Reorganizing the fact that economies of scale leading to cheaper
power could be secured through large size power projects and for
introducing the efficient super critical technology in a big way, a
unique initiative has been launched for development of Ultra Mega
Power Projects (UMPPs) under tariff based international competitive
bidding route. 9 sites for development of 4000 MW project each have
been identified so far.
Government of India (GoI) has launched Ultra Mega Power Projects
initiatives to step up power generation capacity at rapid speed
Seven projects of capacity 4000 MW each identified to be
allocated to the developers on tariff based competitive bidding
Each Project to cost around USD 3 bn
Tariff determined in this manner to be accepted by the regulator
under the Electricity Act
GoI to acquire land, secure environment clearance, arrange water
linkage and secure Captive Coal Mine (for pit head plants) before
handing over the projects
Payment Security Mechanism in terms of Letter of Credit, Escrow
Arrangement and Third Party Sale
Transmission: Policy Initiatives Guidelines for encouraging
competition in development of transmission projects
Policy was issued on 13th April, 2006.
Promote competitive procurement of transmission services.
Encourage private investment in transmission lines.
Facilitate transparency and fairness in procurement
processes.
Facilitate reduction of information asymmetries for various
bidders.
Protect consumer interests by facilitating competitive
conditions in procurement of transmission services of
electricity.
Enhance standardization and reduce ambiguity and hence time for
materialization of projects.
Ensure compliance with standards, norms and codes for
transmission lines while allowing flexibility in operation to the
transmission service providers.
High Voltage Transmission Capacity:CapacityMVACircuit KM
765/800 KV1,500439
400 KV6,1707,390
220 KV7,8634,927
HVDC3,0005,872
Distribution In principle approval accorded for 90 projects with
an outlay for Rs.1588 crore to strengthen the distribution system
in urban areas
More than Rs.2030 crore utilized under APDRP for strengthening
& up gradation of electricity distribution network.
Incentive for cash loss reduction has been disbursed to Kerala,
Punjab and West Bengal.
Andhra Pradesh, Goa, Himachal Pradesh, Punjab, Gujarat,
Meghalaya, Chattisgarh and West Bengal have reported profits during
2005-06. Jharkhand, Madhya Pradesh, Haryana, Rajasthan,
Uttaranchal, Karnataka, Kerala and Assam have reported reduction in
losses during 2005-06.
Andhra Pradesh, Goa and Tamil Nadu have AT&C losses below
20% during 2005-06. Punjab and 2 DISCOMs of Gujarat (Madhya &
Uttar) have AT&C losses below 25% during 2005-06.
Action plan prepared for franchising in urban areas to reduce
AT&C losses and improve efficiency in distribution.
Maharashtra, Rajasthan and Madhya Pradesh have invited tenders for
franchisee in urban areas. The first urban franchisee has been
awarded by Maharashtra in Bhiwandi town.
5304 engineers of State distribution utilities were trained
under Distribution Reforms capacity building programme.
Started the Advanced Certificate Programme in Distribution
Management in collaboration with IGNOU, about 1212 have registered
so far.
Privatization
Many countries facing high electricity demand growth favor
privatizing their electric power sectors and opening their markets
to foreign firms. This approach can free up large amounts of public
capital, which can be used instead for social programs. In
addition, private ownership allows managerial accountability,
market efficiency, and better customer service while reducing
government deficits and international debt. The reasons for
electric utility privatization are numerous and vary from country
to country.
Some of the more evident reasons include the following:
Raising revenues for the state through asset sales
Acquiring investment capital
Improving managerial performance
Moving toward market-determined prices
Technology transfer
Reducing the frequency of power shortages
Reducing the cost of electricity to consumers through efficiency
gain
Taking advantage of creating national and regional power grids,
and
Re-thinking whether electric power generation in today's economy
constitutes a natural monopoly.
Privatization of formerly state-owned electric power assets in
developing countries has opened up enormous investment
opportunities. For foreign investors, investment in overseas
electricity assets offers opportunities to achieve potentially
higher returns and, in many cases, helps to realize greater growth
opportunities than are available at home.
In 1991, the Government began to encourage private sector
participation in the power industry. Since this date, a total
capacity of approximately 7,400 MW from 37 private power plants has
been commissioned. As of March 31, 2006 an additional capacity of
around 4,500 MW from 12 projects is reported to be under
construction. Orissa was the first state in the country to
privatize the state's electricity distribution. This was followed
by the privatization of Delhi Vidyut Board. Various other states
including Uttar Pradesh, Haryana, Karnataka, Andhra Pradesh, Madhya
Pradesh, Delhi and Rajasthan have restructured their boards into
separate entities for generation, transmission and distribution.
Some states are also attempting to corporatize the former SEB
entities.
Reliance Energy Limited and Tata Power Limited dominate the
private sector.
Tata Power, with a generation capacity of 2278 MW. Tata Power
recently bagged 4000 MW UMPP contract.
Reliance Energy has a 933 MW of generation capacity.
GMR Infrastructure Limited with a combined generation capacity
of 420 MW and an additional 389 MW plant to be commissioned in the
near future is another serious private sector participant.
Private investment in Power sector
Post Electricity Act 2003, private sector interest has
revived.
100% FDI allowed in generation, transmission & distribution,
100% FDI also allowed in power trading (License given to British
Gas).
Inter Institutional Group (IIG) and Green Channel constituted to
facilitate financial closure of Independent Power Projects
(IPPs).
11 IPPs of more than 4000 MW capacity have achieved financial
closure.
Another 3 IPPs have been agreed in principle by FIs for
financial closure.
Another 8 IPPs of about 9500 MW capacity are under active
consideration.
Highlights of performance of Power sector in 2007
(i) Capacity Addition:
9050 MW (5093 MW)
(ii) Placement of Award (generation projects):9354MW (9701
MW)
(iii) Growth in Power Generation:
6.9% (7.2%)
(iv) Plant Load Factor:
76.7% (75.77%)
(v) Villages Electrified:
39,383 villages
(vi) Ultra Mega Power Projects:
LOI issued in case
of Sasan and Mundra
(vii) Important policies notified:
- Tariff Policy
- Rural Electrification Policy
- Policy for development of Merchant Plants
- Guidelines for encouraging competition in development of
Transmission projects.
Note: Figures in brackets pertain to year 2006Highlights of the
XIth Five Year Plan
Capacity Addition Projections (as on 28 Feb. 2008)
Figures in MW
Total Installed Capacity:Sector MW%age
State Sector 74,453.7652.5
Central Sector 47,520.9934.0
Private Sector 19,525.0913.5
Total 1,41,499.84
Fuel MW%age
Total Thermal 91,145.84 64.6
Coal75,252.3853.3
Gas14,691.7110.5
Oil1,201.750.9
Hydro (Renewable) 35,378.7624.7
Nuclear 4,120.002.9
RES** (MNRE) 10,855.247.7
Total 1,41,499.84
Power Situation: (April 2007-February 2008)
(Provisional)DemandMetSurplus/ Deficit
Energy671,915 MU608,053 MU-9.5 %
Demand side ManagementRecommendations
Encourage Non-conventional energy usage, Raising energy
efficiency awareness Turning the Computer Monitors off when not in
useThere is a need to boost: Energy audits reports by energy
managers consumption of >1MVA Commercial buildings to use only
energy efficient lighting and equipment. Energy efficient equipment
manufacturing incentives. TOD tariff Buildings with natural
ventilation and lighting Passive Houses Penalty for power factor
Evaluate the major facilities for interruptible load
opportunities.Supply side Management
RecommendationsThere is a need to boost:
Upgrading existing Supply Load Aggregation On-Site Generation
Use of Captive Power Plants Peak Power development through Hydro
Encourage capacity addition through various fuels Distributed
Generation Setting up Big size High efficiency plants Setting up
Merchant Power Plants-
Power Finance CorporationBackground
PFC was established in July 1986 as a Development Public
Financial Institution (PFI) under Section 4A of the Companies Act,
1956. It is dedicated to the Power Sector. It is a wholly owned by
Government of India. A Nav-Ratna public Sector Undertaking. It has
highest safety ratings from domestic and international credit
rating agencies and also ISO 9001-2000 Certification for the
Project Appraisal System.
PFC provides financial assistance to all types of power projects
like Generation, R&M, Transmission, Distribution, system
improvement, etc. PFC encourages optimal growth and balance
development of all segments of power sector through assigning
priorities for financing different categories of projects. The
state sector utilities are the main beneficiary of PFCs financial
assistance. PFC has also been funding private sector projects for
last 5-6 years.
Mission
PFC's mission is to excel as a pivotal developmental financial
institution in the power sector committed to the integrated
development of the power and associated sectors by channeling the
resources and providing financial, technological and managerial
services for ensuring the development of economic, reliable and
efficient systems and institutions.
Received awards from Hon'ble President, Hon'ble Vice President
& Hon'ble Prime Minister for being in the top ten Public Sector
Undertakings of Government of India
Credit Ratings
Placed at Sovereign Rating by International Rating Agencies -
Moodysand Standard & Poorsfor long term foreign currency
debt.
Placed at thehighest safety ratings by accredited rating
agencies in India - CRISILand ICRA
Domestic borrowings include term loans and bonds; External
borrowings take the form of Syndicated Loans, Fixed & Floating
Notes.
Consistently rated Excellent by the Government of India (GOI)
for overall performance against the targets set inMemorandum of
Understanding (MoU) between GOI and PFC.
Performance Highlights*Consistently rated Excellent for its
overall performance against the targets set in Memorandum of
Understanding (MoU) by the Government of India (GoI) since
1993-94.
*Nav-Ratna Public Sector Undertaking.*Ranked among the top 10
PSUs for the last four years.
*Employee profit stands at Rs.3.9 crores per head.
A Development Financial Institution - has consistently
maintained profitability in its operations provides finances for
projects/ schemes, has expertise in reform linked
studies/consultancy.
PFC has an authorized capital of Rs.20000 Million and paid-up
capital of Rs.11477.70 Million (presently the entire equity is in
owned by Government of India). PFC in its present role has the
following main objectives: -
To rise the resources from international and domestic sources at
the competitive rates and terms and conditions and on-ward lend
these funds on optimum basis to the power projects in India.
To act as catalyst to bring institutional, managerial,
operational and financial improvement in the functioning of the
state power utilities
To assist state power sector in carrying out reforms and to
support the state power sector during transitional period of
reforms
Range of Services
Fund Based
Rupee Term Loan
Foreign Currency Term Loan
Buyers Line of Credit
Working Capital Loan
Loan to Equipment manufacturers
Debt Restructuring/ Refinancing
Take out Financing
Bridge Loan
Bill Discounting
Lease Financing
Non-Fund Based Guarantees
Exchange Risk Management
Consultancy Services
Clients of PFC:
State Electricity Boards
State Power Utilities
State Electricity/Power Departments
Other State Departments (like irrigation Department) engaged in
the development of power projects
Central Power Utilities
Joint Sector Power Utilities
Co-operative Societies
Municipal Bodies
Private Sector Power Utilities
Institutional Development
Institutional Development of Power UtilitiesFormulation and
Implementation of Operational and Financial Action Plan (OFAP) for
its borrowers - to achieve qualitative improvement in the
functioning of the State Power
Utilities in managerial, technical and financial areas through:
- Participative approach in formulation of OFAPs - prepared in
consultation and agreement with the Utility and State Government
concerned.
Organizing seminars, workshops and training for Power Sector
personnel - in India and abroad.
Studies and Consultancy Services
Reforms & Restructuring InitiativesPFC has been actively
persuading State Govts. to initiate reform and restructuring of
their power sector in order to make them commercially viable. In
this regard following initiatives have been taken:-
PFC is providing financial assistance to reform-minded States
under relaxed lending criteria/exposure limit norms
PFC has decided to provide technical/financial assistance to
State Govts. / Power Utilities for structural reforms of the State
Power Sector.
Reform Group constituted in PFC to advice and assists the State
Govt. /Power Utilities to formulate suitable restructuring
programmes.
Major Projects Funded by PFC:
Name of the Project Capacity (MW)Cost (Crs)Amount Funded by PFC
(Crs)
Malwa TPS2x500 40542730
Yamuna Nagar TPS2x300 24001920
Tenughat Extn. Stage II3x210 23661892
Khaperkheda TPS Extn.1x50021911753
Kameng HEP4x15024851740
Birsinghpur TPS1x5001950
Mejia Extn. Unit 2x2502801456
Sagardighi TPS PH12x30027541925
Chandrapura Extn. Unit 7&82x25020531435
Panipat TPS Stage V2x25017851428
Parichha TPS Units 3&42x21017551404
Revival of PP& LNG work of Dhabol Power Co.
2150100381400
Tehri Dam HEP Stage14x25080002560
Nathpa Jhakri HEP6x25083281438
Financial Position
Financial Highlights for the year 2007-08(Audited) Profit After
Tax Rs. 1,206.76 Crores
Sanctions Rs. 69,498 Crores
Disbursements Rs. 16,211 Crores
Net Interest Margin 3.75 %
Resource Mobilization Rs. 52,421 Crores
Net Worth Rs. 8824 Crores
Realization 99%
Resources as on 31 March, 2008
Recent Initiatives:
Exploring possibilities of faster capacity addition through
Special Purpose Vehicles.
Made a foray into renewable energy sector.
Extended tenor of loans up to 20 years for Hydro and 15 years
for other schemes.
Policy for short term financial assistance for import of coal
introduced
Expense limit increased for reforming GENCOS.
Short-term loan extended to TRANSCOS against receivable from
DISCOMS.
Aims to capture a share of 20-25% of the total investment to be
made in the Power Sector during the Xth and XIth Plan period.
Accomplishments:
First Developmental Financial Institution to introduce
Operational and Financial Action Plans to improve efficiency in the
State Power Sector.
Long term financial resources to the power sector from
multilateral agencies channeled through PFC.
Tapped international financial markets to raise ECBs, setting
benchmark rates for Indian corporates.
Complementing the efforts of Govt. of India, for its sponsored
programmes Accelerated Generation & Supply Programme and
Accelerated Power Development & Reform Programme.
Introduced new tailor-made products and services like debt
re-financing, interest restructuring, funding to equipment
manufacturers, short term loans, buyers' line of credit and loans
for asset acquisition.
Future Plans:
Aims to capture a share of 20-25% of the total investment to be
made in the Power Sector during the 10th and 11th Plan period.
To consolidate and expand present business.
To introduce new financial initiatives such as Universal Banking
Services, Insurance, Equity Participation and Merchant Banking.
To spread into allied sectors.
To make a foray into global markets.
Diversification in terms of forward or backward integration in
the power sector (financing for fuel tie ups and laying down of gas
pipelines).
SWOT Analysis:
Strengths
Govt. of India undertaking.
Good quality management
Well established, Long standing relations in the power
industry
Implementing agency for Mops schemes including AG &SP and
APDRP
Highest credit rating (due to government ownership)
Weaknesses
Poor asset quality with most of the lending to SEBs, whose loan
repayment capabilities in the long run is doubtful.
Concentration risk attributed to lending in single sector.
Opportunities
Power sector presents significant investment opportunities.
Sector expertise for consultancy and providing investment
gateways for domestic and external financial agencies.
New business opportunities to cover the entire range of
activities in the Power sector.
Threats
PFC has significant exposures entities which are loss making,
financially weak and are defaulting to most of their creditors.
Delinquencies by these entities to PFC could impair the currently
sound Balance Sheet of PFC.
Under the Tenth Five-year Plan, REC has been allowed to disburse
funds through AG & SP. Since this scheme gave a price advantage
to PFC, its competitive edge is diluted.
With increasing exposure to SEBs, their weak balance sheet may
affect PFCs creditworthiness.
Currently, borrowers of PFC are unable to attract other sources
of funding. If the reform programme is successful, and these
entities become creditworthy, PFCs ability to lend against quality
assets would be weakened.
Resource Mobilization UnitResource Mobilization Unit (RMU) is
responsible for raising fund resources both in domestic for further
disbursement as financial assistance to its customers. RMU also
undertakes various activities like appointment for various agencies
like RTA, Trustees, IPA, Collecting and Paying Banker for
coordinating the resource mobilizing process. It is also
responsible for listing for various debt instruments on NSE.
The main objective of the RM department is to mobilize
resources/raise funds at the minimum cost and the easiest terms and
conditions keeping in mind the requirements, objectives and the
financial position of the company.
The fund requirement for carrying out disbursement varies from
year to year. In 2000-2001, the disbursement was amounting to Rs.
3230 crores. In the year 2005-2006 PFC achieved a disbursement
level of as high as 9870crores, a three-fold increase. Thus, in
order to keep pace with the increasing level of disbursement needs,
the RMU has to keep itself occupied and vigilant to tap the markets
for smooth operations of the company.
The company segments the market into two:
Domestic (under the RM dept.)
International
Rupee resources (Domestic)
In terms of domestic resources, a significant proportion of our
Rupee funds are raised through privately placed bond issues in the
domestic market and term loans. We have a diverse investor base of
banks, financial institutions, mutual funds, insurance companies,
provident fund trusts, gratuity fund trusts and superannuation
trusts. The bonds we issue are unsecured, redeemable,
non-convertible, non-cumulative and taxable and are listed on the
wholesale debt market segment of the NSE. Our bonds are rated LAAA
by ICRA and AAA by CRISIL, the highest safety domestic ratings. In
fiscal 1988, the Ministry of Finance authorized public sector
issuers that were infrastructure oriented to issue tax-exempt
bonds. We were historically given a large share of this annual
allocation and a large portion of our funds were raised through tax
exempt bonds. From fiscal 2001 onwards, it became part of the
governments overall policy to reduce funding support to companies
that had become financially independent and that could raise
resources at competitive rates on their own. After this time, our
direct support from the GoI for raising debt reduced.
The following table gives details of our Rupee funds as on March
31 in FY 2007-08:
Foreign currency resources (International)
Multilateral, Bilateral and Export Credit Agencies
We began accessing foreign currency loans from multilateral,
bilateral and export credit agencies in fiscal 1991 when we
obtained funds from the French government, which were guaranteed by
the GoI. Subsequently, we obtained a complementary financing loan
from the Asian Development Bank in fiscal 1991, which was
denominated in US Dollars and Japanese Yen. Traditionally, our
major foreign currency borrowings have been from multilateral
institutions such as the World Bank and the ADB. These funds were
routed through GoI, where the foreign exchange risk was borne by
GoI. These sources enabled us to raise long term funds at
competitive costs, which supplemented the funds available from
commercial sources. Presently, we are borrowing directly from these
agencies, and the foreign exchange risk is borne by us. We have a
US$ 50 million line of credit facility with the ADB that has 20
year tenure. This line of credit facility is guaranteed by the GoI.
We also have foreign currency loans from two other external credit
agencies namely KfW and Export Development Canada (EDC).
Commercial borrowings in foreign currency
We first accessed commercial foreign currency borrowings that
were not guaranteed by the GoI in January 1997 with the
establishment of a syndicated loan facility. Since then, we have
borrowed funds in the international commercial markets in the form
of syndicated loans as well as fixed and floating rate note/bonds
issues. This has enabled us to diversify our investor base.
The 3 main decisions taken by Resource Mobilization department
are:
1. When to raise Funds and for what tenure.
2. Instruments to be used for raising these funds.
3. Pricing of the debt raised.
1. When to raise funds
The RM Unit has to decide when it will be most conducive to
raise funds for the company so as to ensure there is:
a. Timely availability of funds.
b. Lowest Cost at which funds can be raised.
c. Least pressure for obligations.
The amount of funds to be raised is normally decided by the
Treasury Management Unit. The RM Unit prepares a Liquidity
Statement to find out the time for raising funds when there is
least pressure for obligations for the company. Liquidity Statement
shows the funds inflows and outflows of the company. The following
factors are taken into consideration while preparing it:
Amount of Disbursement that has to be made.
Interest Payments.
Repayment of loan taken by the company.
Taxes, Dividends, etc.
Funding Sources:
PFC generally fund their assets, comprising loans to the power
sector, with borrowings of various maturities in the international
and domestic markets. Their market borrowings include bonds, short
term loans, medium term loans, long term loans, and commercial
papers.
2. Instruments to be used for raising funds:
Debt instruments are obligations undertaken by the issuer of the
instrument as regards certain future cash flows representing
interest and principal, which the issuer would pay to the legal
owner of the instrument. Debt instruments are of various types.
They are:
a. Money Market Instruments: The term money market refers to the
market for short-term requirements and deployment of funds. Money
market instruments are those instruments, which have a maturity
period of less than one year. The most active part of the money
market is the market for overnight and term money between banks and
institution (called call money) and the market for repo
transactions. The main traded instruments are commercial papers
(CPs), certificate of deposits (CDs) and treasury bills (T-Bills).
All of these are discounted instruments i.e. they are issued at a
discount to their maturity value and the difference between the
issuing price and the maturity/face value is the implicit interest.
These are also completely unsecured instruments. One of the most
important features of money market instruments is their high
liquidity and tradability. A key reason for this is that these
instruments are transferred by endorsement and delivery and there
is no stamp duty or any other fee levied when the instrument
changes hands. Also there is no tax deducted at source from the
interest component.
b. Long term Debt Instruments: These are the instruments having
a maturity exceeding one year. The main instruments are Government
of India securities (GOISEC), State Government securities (state
loans), Public Sector bonds (PSU bonds), corporate debentures,
etc.
Most of these are coupon bearing instruments i.e. interest
payments (called coupon) are payable at pre specified dates called
coupon dates. At any given point of time, any such instrument has a
certain amount of accrued with it i.e. interest which has accrued
(but is not yet due) calculated at the coupon rate from the date of
the last coupon payment. E.g. if 30 days have elapsed from the last
coupon payment of a 14% coupon debenture with a face value of
Rs.100, the accrued interest will be
100*0.14*30/365 =1.15
Whenever coupon-bearing securities are traded, by convention,
they are traded at a base price with the accrued interest separate.
In other words, the total price would be equal to the summation of
the base price and the accrued interest.
3. Pricing of the Issue: The unit has to keep a number of
factors into consideration to decide upon the price of the
instruments and loan facilities it wish to avail.
The factors considered by the company normally are:
Liquidity Position of the company
Present Benchmark Rates
Primary / Secondary Market Conditions
Timing of issue or raising
Quantum of funds to be raised
Liquidity in the debt market
Other Economic and market considerationsTypes of Instruments
used for raising funds by PFC in the Domestic Market
I. Bonds - Bonds are a form of indebtedness that is sold in set
increments. In return for loaning the debtor the money, the lender
gets a piece of paper that stipulates how much was lent, the
agreed-upon interest rate, how often interest will be paid, and the
term of the loan.Features of bonds
1. Nominal, principal or face amount: The amount over which the
issuer pays interest, and which has to be repaid at the end.
2. Issue price: The price at which investors buy the bonds when
they are first issued, typically Rs.1 million (specifically for
PFC). The net proceeds that the issuer receives are calculated as
the issue price, less issuance fees, times the nominal amount.
3. Maturity date: The date on which the issuer has to repay the
nominal amount. As long as all payments have been made, the issuer
has no more obligations to the bond holders after the maturity
date. The length of time until the maturity date is often referred
to as the term or maturity of a bond.
i. short term (bills): maturities up to one year;
ii. medium term (notes): maturities between one and ten
years;
iii. Long term (bonds): maturities greater than ten years.
4. Coupon: The interest rate that the issuer pays to the bond
holders. Usually this rate is fixed throughout the life of the
bond. It can also vary with a money market index, such as MIBOR or
LIBOR, or it can be even more exotic.
5. Optionality: A bond may contain an embedded option; that is,
it grants option like features to the buyer or issuer:
i. Callability: Some bonds give the issuer the right to repay
the bond before the maturity date on the call dates. These bonds
are referred to as callable bonds.
ii. Puttability: Some bonds give the bond holder the right to
force the issuer to repay the bond before the maturity date on the
put dates.
6. Liquidity: A bond is a highly liquid instrument which is
freely tradable in the market. A large number of investor
categories such as bank treasuries, mutual funds, insurance
companies and funds like pension fund and provident funds prefer
this instrument because of its assured returns and suitable
maturities for each investor category.
Procedure followed by PFC for issue of bonds:1. Board
approval.
2. Borrowing limit of the corporation as laid down as u/s 293
(1) (d) of the Companies Act, 1956.
3. Determining nature of bonds to be issued.
4. Credit rating.
5. Appointment of registrar and transfer agent.
6. Appointment of trustees.
7. Debt/Equity ratio.
8. AL&RM position of the corporation.
9. Collection banker.
10. Interest rate determination.
11. Shelf Information memorandum.
12. Merchant banker.
13. One to one deal with banks, institutions, body corporates
etc.
14. Receipt of application money and application forms.
15. Allotment of bonds.
16. Conversion of application money into bonds.
17. Issuance of letter of allotment/ bonds in Dematerialized
form.
18. Remittance of interest on application money along with
excess application money if any.
19. Issuance of letter of allotment in physical form.
20. Payment of stamp duty.
21. Listing with NSE.
22. Execution of documents with the trustees.
23. Appointment of printers.
24. Appointment of payee bankers.
II. Commercial Paper
Commercial paper is a money market security issued by large
banks and corporations. It is generally not used to finance
long-term investments but rather to manage working capital. It is
commonly bought by money funds (the issuing amounts are often too
high for individual investors), and is generally regarded as a very
safe investment. As a relatively low risk option, commercial paper
returns are not large.
The stamp duty on Commercial paper is between 5 to 7 basis
points which is very less in comparison to bonds. It is a short
term instrument, highly liquid resulting in free tradability among
the market participants. It is mainly preferred by mutual funds and
it proves to be an efficient instrument in raising money in
emergency situation. III. Loans
A bank loan to a company, with a fixed maturity and often
featuring amortization of principal. If this loan is in the form of
a line of credit, the funds are drawn down shortly after the
agreement is signed. Otherwise, the borrower usually uses the funds
from the loan soon after they become available.
A fixed-rate term loan offers an unchanging interest rate for
the life of the loan, making it easy to budget, with the same
predictable payments over the life of the loan.Secure, fixed
interest for the life of the loan borrowed what you need with a
predictable monthly payment. Fixed-rate loans offer an unchanging
interest rate for the life the loan, making it easy to budget with
the same, predictable payments over the entire term.
i. Simplify budgeting with predictable payments
ii. Lock in interest rates with fixed interest over the life of
the loan
iii. Stabilize your business finances
Short-term
Short-term loans can have maturations of as little as 90-120
days or as long as one to three years, depending on the purpose of
the loan. In general, banks require very specific repayment plans
for their short-term loans. For instance, if you took out a loan to
even out your cash flow until your customers paid you, the lender
would expect you to repay the loan as soon as you receive your
money. In the case of short-term loans for inventory purposes, you
would pay off your debt when you sell your inventory. Before a
lender will grant a short-term loan, it will review your cash-flow
history and payment track record. Most short-term loans are
unsecured, meaning they do not require collateral. Rather, the bank
relies on your personal credit history and credit score for
approval.
Medium-term
Medium term loans have maturity of less than three years; these
loans are generally repaid in monthly installments (sometimes with
balloon payments) from a business's cash flow. There repayment is
often tied directly to the useful life of the asset being
financed.
Long Term
Long term loans are commonly set for more than three years. Most
are between three and 10 years, and some run for as long as 20
years. Long-term loans are collateralized by a business's assets
and typically require quarterly or monthly payments derived from
profits or cash flow. These loans usually carry wording that limits
the amount of additional financial commitments the business may
take on (including other debts but also dividends or principals'
salaries), and they sometimes require that a certain amount of
profit be set-aside to repay the loan. The Indian Debt Market
The Debt Markets play a very critical role in any modern
economy. And more so in the case of developing countries like India
which need to employ a large amount of capital and resources for
achieving the desired degree of industrial and financial growth.
The Indian Debt Markets are today one of the largest in Asia and
includes securities issued by the Government (Central & State
Governments), public sector undertakings, other government bodies,
financial institutions, banks and Corporates.There is no single
location or exchange where debt market participants interact for
common business. Participants talk to each other, conclude deals,
send confirmations, etc on the telephone, with clerical staff doing
the running around for settling trades. In that sense the wholesale
debt market is a virtual market. The daily transaction volume of
all the traded instruments would be about Rs.5 bn per day excluding
call money and repos.
The debt market is much more popular than the equity markets in
most parts of the world. In India the reverse has been true. This
has been due to the dominance of the government securities in the
debt market and that too, a market where government was borrowing
at pre-announced coupon rates from basically a captive group of
investors, such as banks. Thus there existed a passive internal
debt management policy. This, coupled with automatic monetization
of fiscal deficit prevented a deep and vibrant government
securities market.
The debt market in India comprises broadly two segments, viz.,
Government Securities Market and Corporate Debt Market. The latter
is further classified as Market for PSU Bonds and Private Sector
Bonds.
The market for government securities is the oldest and has the
most outstanding securities, trading volume and number of
participants. Over the years, there have been new products
introduced by the RBI like zero coupon bonds, floating rate bonds,
inflation indexed bonds, etc. The trading platforms for government
securities are the Negotiated Dealing System and the Wholesale Debt
Market (WDM) segment of National Stock Exchange (NSE) and Bombay
Stock Exchange (BSE).
The PSU bonds were generally treated as surrogates of sovereign
paper, sometimes due to explicit guarantee of government, and often
due to the comfort of government ownership. The perception and
reality are two different aspects. The listed PSU bonds are traded
on the Wholesale Debt Market of NSE.
The corporate bond market, in the sense of private corporate
sector raising debt through public issuance in capital market, is
only an insignificant part of the Indian Debt Market. A large part
of the issuance in the non-Government debt market is currently on
private placement basis. Tables 1, 2 and 3 provide details of
amount raised by financial institutions and non-financial
institutions by way of public issue and private placement. Private
placement accounts for little over one third of the debt issuance.
Unofficial estimates indicate that about 90 per cent of the private
corporate sector debt has been raised through private placement in
the recent past. The amount raised through private placement has
been continuously rising for the past five years which increased by
more than 300 per cent over the five year period. The growth rate
in the public issue processes is only about 80 per cent over the
period, increasing from Rs. 20896 crore to Rs. 36466 crore. The
listed corporate bonds also trade on the Wholesale Debt Segment of
NSE. But the percentage of the bonds trading on the exchange is
small. The secondary market for corporate bonds till now has been
over the counter market. With the recent guidelines issued by SEBI
the scenario is expected to change.
The development of a corporate bond market in India has lagged
behind in comparison with other financial market segments owing to
many structural factors. While primary issuances have been
significant, most of these were accounted for by public sector
financial institutions and were issued on a private placement basis
to institutional investors. The secondary market, therefore, has
not developed commensurately and market liquidity has been an
issue. The Government had constituted a High Level Committee on
Corporate Bonds and Securitization (Patil Committee) to identify
the factors inhibiting the development of an active corporate debt
market in India and recommend necessary policy actions. The
Committee made a number of recommendations relating to
rationalizing the primary issuance procedure, facilitating exchange
trading, increasing the disclosure and transparency standards and
strengthening the clearing and settlement mechanism in secondary
market. The recommendations have been accepted in principle by the
Government, the Reserve Bank and SEBI and are under various stages
of implementation. The two stock exchanges, namely, the Bombay
Stock Exchange (BSE) and the National Stock Exchange (NSE), as well
as the industry body FIMMDA have since operationalized respective
trade reporting platforms. While all the exchange trades in
corporate bonds get captured by concerned exchanges reporting
platform, OTC transactions can be reported on any of these
platforms. The aggregated trade information across the platforms is
being disseminated by FIMMDA on its website. BSE and NSE have also
started order driven trading platforms in July 2007. In practice,
however, trading still continues to be largely OTC. SEBI has also
implemented measures to streamline the activity in corporate bond
markets by reducing the shut period in line with that of G-sec,
reducing the size of standard lots to Rs. one lakh and
standardizing the day count convention. Further, to streamline the
process of interest and redemption payments, Electronic Clearing
Services (ECS), Real Time Gross Settlements (RTGS) or National
Electronic Funds Transfer (NEFT) are required to be used by the
issuers. Further progress is anticipated in regard to rationalizing
the primary issuance procedures, which is a critical step for
moving away from the pre-dominance of private placements. To reduce
the settlement risk and enhance efficiency, the Patil Committee has
also proposed setting up of a robust clearing mechanism. The
settlement was proposed to be initially on delivery versus payment
(DvP) I basis (i.e., trade by trade basis) to address the
counterparty settlement risk and gradually migrate to DvP III (net
settlement of funds as well as securities) to impart enhanced
settlement efficiency. (The DvP modules can be broadly classified
into three broad categories, viz., DvP I, DvP II and DvP III. Under
DvP I, the funds leg as well as the securities leg is settled
simultaneously on a contract-by-contract basis. Under DvP II, while
the securities leg is settled on a contract-by-contract basis, the
funds leg is settled for the net amount. Under DvP III, both the
funds and the securities legs are settled for the net amounts.)
Igniting the Dormant Corporate Debt Market (CDM)
The relatively young private bond segment in India presently
stands at US$100bn and is predicted to grow to US$ 575bn by 2016.
The primary market for corporate debt paper issuance is dominated
mainly by domestic non-banking finance companies (NBFCs). For other
corporate borrowers, bank finance has traditionally been the
favored funding source.
Significant developments in the CDM space since the 1990s
include abolition of controlling function by government and the
controller of capital issues (CCI) on the interest rates that
Corporates had to pay whenever they raised capital through
debentures. Reserve Bank of India (RBI) also gradually annulled all
the conditions in regard to the level of interest rates that the
banks could charge on their loans to corporate clients. Over time,
the role of the development financial institutions, which were the
major source for funding long term corporate projects, also
declined.
In 2004, SEBI mandated secondary market trading through an
automated order matching screen-based trading system. However,
this, did not find favor with the institutional participants, thus
leaving the OTC deals still the preferred way of dealing in
corporate bonds for operational and liquidity concerns. The
government has accepted the recommendations of the report submitted
by the High Level Committee on Corporate Bonds and Securitization
(RH Patil Committee) and have re-iterated that necessary steps
would be taken to create a single, unified, exchange-traded market
for corporate bonds. The leading exchanges, Bombay Stock Exchange
(BSE) and National Stock Exchange (NSE), as well as the industry
body Fixed Income, Money Market and Derivatives Association
(FIMMDA) have already commenced services of the trade reporting
platforms for deals done in the CDM segment.
On the whole though, the CDM hasn't picked up in India. One can
sense that this market was left on its own, hence it has become
more lethargic, inefficient and less vibrant. The reform process in
the CDM faces multiple challenges. Attracting the retail investors
is not going to be an easy task given the current state of CDM
microstructure. There is not a single trade reported in the Retail
Debt Market Segment (RDM) of the NSE in the second half of year
2007. There is a disincentive for a retail investor to invest/trade
in corporate bonds as the total cost of trade (including stamp
duty, brokerage, and cost of settlement) impacts the returns to the
investor. The same money can be deployed in debt schemes of mutual
funds without hassle and worry about costs. Efforts should be
directed towards educating the retail investors about the pricing
of bond and peculiar bond market concepts like yield to maturity
etc, in the same way as was done when derivatives were first
introduced in India. This will help them to better understand and
embrace the debt market.
From the issuer's point of view, reaching retail investors adds
to the cost of distribution, plus there is a continuous cost of
servicing the retail bond holders and the time to market is longer.
Hence Corporates prefer private placement as it is much cheaper and
quicker. Also, private placement of bonds bypasses the already
loosely tied regulations and gives Corporates one more reason not
to buy public bonds.
There is an urgent need to introduce market makers as this will
improve the liquidity and bring in more variety of investors with
different risk profiles. Another way forward could be to allow the
banks to distribute the debt products to the retail investors for a
fee-based income.
The way forward is to establish screen-based trading and a well
defined and structured clearing and settlement mechanism. The
procedure for issuance of bonds in the primary market needs to be
rationalized in order to widen the investor base and move away from
the dominance of private placement deals. There is also a need to
re-examine the stamp duty structure for consistent application
across the country.
Market Micro Structure
It is necessary to understand microstructure of any market to
identify processes, products and issues governing its structure and
development. In this section a schematic presentation is attempted
on the micro-structure of Indian corporate debt market so that the
issues are placed in a proper perspective. Figure 1 gives a birds
eye view of the Indian debt market structure.
The microstructure of the Indian Debt Market can be explained
under two broad sub sections:
a) Primary Corporate Debt Market
1) Market structure consists of issuers, instruments, processes,
investors, rating agencies and regulatory environment.
i) Issuers
Indian Debt Market has almost all possible variety of issuers as
is the case in many developed markets. It has large private sector
corporate, public sector undertakings (union as well as state),
financial institutions, banks and medium and small companies: Thus
the spectrum appears to be complete. Above figure delineates
details on various classes of issuers. Two main classes include
private sector corporates and banks.
ii) Instruments
Figure provides names of some of the more popular instruments
that have been issued. Till recently Indian debt market was
predominantly dominated by plain vanilla bonds. Over a period of
time, many other instruments have been issued. They include partly
convertible debentures (PCDs), fully convertible debentures (FCDs),
deep discount bonds (DDBs), zero coupon bonds (ZCBs), bonds with
warrants, floating rate notes (FRNs) / bonds and secured premium
notes (SPNs).
The coupon rates mostly depend on tenure and credit rating.
However, these may not be strictly correlated in all cases. The
maturities of bonds generally vary in between one year to ten
years. However, the median could be around four to five years. The
maturity period by and large depends on outlook on interest rates.
In expectation of falling interest rates environment, corporate, it
is observed, mostly go to shorter term instruments while the
opposite is true in case of possible hike in interest rates. For
the past few years interest rates have been falling and short end
issues are on the rise. This is one of the reasons that many
corporate are reluctant to go for public issue route and listing of
their securities.
iii) Processes
There are several processes that are in vogue in India as well
as in other markets. The more popular ones are public issue and
private placement routes. Both these have their own pros and cons.
In a mature and developed market where large number of
institutional investor /sophisticated investors is available and a
highly developed mutual fund industry is in operation, the private
placement route may be acceptable to issuers, investors and
regulators. In a less developed market / small market it is a catch
22 position. Private placement is not suitable because this market
do not have adequate number of informed investors and the public
issue route may create regulatory arbitrage, higher compliance
costs resulting sometimes in migration of markets. In India private
placement route is highly popular owing to various reasons.
iv) IntermediariesTwo classes of intermediaries required for the
proper development of debt market are broker and investment banker/
merchant banker. Most of the brokers as well as merchant bankers in
India are inadequately capitalized and their professional knowledge
also needs further improvement. In some markets, it is observed
that there are dedicated Debt Managers who facilitate subscription
or sometimes subscribe to the issue and later on even facilitate
trading in bonds. India needs a dedicated Bond Manager concept.
v) Investors
For the development of Corporate Debt Market / Fixed Income
Securities Market, it is necessary and sufficient to have a large
as well as diverse number of sophisticated / institutional
investors. Figure lists some of the classes of investors that have
been investing in the debt market. Institutional Investors in India
are few in number and the variety also is limited. We have only 37
mutual funds, hardly five insurance companies till recently and
there are no pension funds. Banks and financial institutions, by
and large, do not take active interest in Corporate Debt Market.
Investors with diverse expectations are a precondition for the
development of corporate debt market. Diversity could be in terms
of maturity needs as well as expectations on interest rates. The
most important structural weakness in India is lack of large and
diverse institutional investors.
India has large number of retail investors; however, their
expectations are quite contrary to market principles - risk and
return. Most investors think and perceive that investments in bonds
should provide them guarantee, repayment of principal and regular
payment of coupons. Any delay/default causes worries in their
minds. And sometimes these investors complain to regulators or to
the government for non receipt of coupons or non-repayment of
principal. This type of behavior implies lack of understanding of
the principles of the capital market on the part of the
investors.
vi) Rating agencies
India has a well developed Credit Rating Agency system and
rating agencies are well experienced and regarded. By and large,
their ratings do carry confidence in the market.
2) Some of the Structural Weaknesses identified in the Primary
Market are:
(i) Lack of large and diverse investors
(ii) Lack of dedicated intermediaries (Bond Manager)
(iii) Heavy tilt towards private placement
b) Secondary Corporate Debt Market
1) Appropriate micro-structure of secondary market is vital for
trading, clearing and settlement. The present infrastructure has
its own merits and demerits. Some of the micro structure features
are discussed below:
i) Trading PlatformCorporate debt instruments are traded either
as bilateral agreements between two counterparties or on a stock
exchange through brokers. Worldwide, the majority of transactions
in corporate bonds is conducted in the over-the-counter (OTC)
market by bilateral agreements. In India corporate bonds are
traded, mostly, on WDM segment of NSE.
The National Stock Exchange (NSE) introduced a transparent
screen- based trading system in the whole sale debt market,
including government securities in June 1994. The wholesale debt
market (WDM) segment of NSE has been providing a platform for
trading / reporting of a wide range of debt securities.
The WDM trading system, known as NEAT (National Exchange for
Automated Trading), is a fully automated screen based trading
system, which enables members across the country to trade
simultaneously with enormous ease and efficiency. The trading
system is an order driven system, which matches best buy and sell
orders on a price/time priority.
Trading system provides two market sub-types:
Continuous Automated Market:
In continuous market, the buyer and seller do not know each
other and they put their best buy/ sell orders, which are stored in
order book with price/time priority. If orders match, it results
into a trade. The trades in WDM segment are settled directly
between the participants, who take an exposure to the settlement
risk attached to any unknown counter-party. In the NEAT-WDM system,
all participants can set up their counter-party exposure limits
against all probable counter-parties. This enables the trading
member/participant to reduce/minimize the counter-party risk
associated with the counter-party to trade. A trade does not take
place if both the buy/sell participants do not invoke the
counter-party exposure limit in the trading system.
Negotiated Market:
In the negotiated market, the trades are normally decided by the
seller and the buyer, and reported to the exchange through the
broker. Thus, deals negotiated or structured outside the exchange
are disclosed to the market through NEAT-WDM system. In negotiated
market, as buyers and sellers know each other and have agreed to
trade, no counter-party exposure limit needs to be invoked.ii)
Clearing and Settlement Mechanism:Primary responsibility of
settling trades concluded in the WDM segment rests directly with
the participants and the exchange monitors the settlement. Mostly
these trades are settled in Mumbai. Trades are settled gross, i.e.
on trade for trade basis directly between the constituents /
participants to the trade and not through any clearing house
mechanism. Thus, each transaction is settled individually and
netting of transactions is not allowed. Settlement is on a rolling
basis, i.e. there is no account period settlement. Each order has a
unique settlement date specified upfront at the time of order entry
and used as a matching parameter. It is mandatory for trades to be
settled on the predefined settlement date. The Exchange currently
allows settlement periods ranging from same day (T+0) settlement to
a maximum of two business days from the date of trade (T+2).
iii) Instruments traded on WDM:
The WDM provides trading facilities for a variety of debt
instruments including government securities, Treasury Bills and
bonds issued by Public Sector Undertakings (PSU)/ corporate/ banks
like Floating Rate Bonds, Zero Coupon Bonds, Commercial Paper,
Certificate of Deposit, corporate debentures, State Government
loans, SLR and Non-SLR bonds issued by financial institutions,
units of mutual Funds and securitized debt by banks, financial
institutions, corporate bodies, trusts and others.
From Table 4, a highly skewed pattern can be observed in trading
of debt instruments. In 1994-95 government securities used to
account for less than 50 per cent of the total trades reported, in
2002-03 the same went up to about 94 percent which is more than
double. All other segments account for a little over 6%.
iv) Investors in WDM:Large investors and a high average trade
value characterize this segment. Till recently, the market was
purely an informal market with most of the trades directly
negotiated and struck between various participants. The
commencement of this segment by NSE has brought about transparency
and efficiency to the debt market, along with effective monitoring
and surveillance to the market.
v) Regulatory Environment:
The listed corporate debt is under the regulations of SEBI. SEBI
is involved whenever there is any entity raising money from Indian
individual investors through public issues/ private placement. It
regulates the manner in which such moneys are raised and tries to
ensure a fair play for the retail investor. It forces the issuer to
make the retail investor aware of the risks inherent in the
investment. SEBI has in fact laid down guidelines known as
Disclosure and Investor Protection (DIP) Guidelines, 2000
guidelines to maintain transparency in the market and make it
efficient.
Some of the Structural Weaknesses identified in Secondary
Market
(i) Absence of Clearing Corporation and CCPS.
(ii) Dedicated trading platform.
(iii) Exclusive, well capitalized and professional
intermediaries.(iv) Lack of reliable and up to date
information.Capital Markets: Fixed Income MarketIntroductionCapital
Markets comprise of the Equities Market and the Debt Markets.
Worldwide equity market attracts a lot of attention. Debt is
considered boring. But it is surprising to know that in any country
in the world, the debt market is several times bigger than the
equity market. So much bigger, that most of the market is beyond
the reach of ordinary investors. Institutional investors are the
major players in the market. These institutions buy bonds worth
tens of millions and not thousands. Debt Markets are markets for
the issuance, trading and settlement in fixed income securities of
various types and features. Fixed income securities can be issued
by almost any legal entity like Central and State Governments,
Public Bodies, Statutory corporations, Banks and Institutions and
corporate bodies.
Fixed income securities
Fixed Income securities are one of the most innovative and
dynamic instruments evolved in the financial system ever since the
inception of money. Based as they are on the concept of interest
and time-value of money, Fixed Income securities personify the
essence of innovation and transformation, which have fueled the
explosive growth of the financial markets over the past few
centuries.
Fixed Income securities offer one of the most attractive
investment opportunities with regard to safety of investments,
adequate liquidity, and flexibility in structuring a portfolio,
easier monitoring, long term reliability and decent returns. They
are an essential component of any portfolio of financial and real
assets, whether in form of pure interest bearing bonds, innovative
and varied type of debt instruments or asset-backed mortgages and
securitised instruments.
Market SegmentIssuerInstruments
Government SecuritiesCentral GovernmentZero Coupon Bonds, Coupon
Bearing Bonds, Treasury Bills, STRIPS
State GovernmentsCoupon Bearing Bonds.
Public Sector BondsGovernment Agencies / Statutory BodiesGovt.
Guaranteed Bonds, Debentures
Public Sector UnitsPSU Bonds, Debentures, Commercial Paper
Private Sector BondsCorporatesDebentures, Bonds, Commercial
Paper, Floating Rate Bonds, Zero Coupon Bonds, Inter-Corporate
Deposits
BanksCertificates of Deposits, Debentures, Bonds
Financial InstitutionsCertificates of Deposits, Bonds
Fixed Income Markets The Fixed Income securities market was the
earliest of all the securities markets in the world and has been
the forerunner in the emergence of the financial markets as the
engine of economic growth across the globe. The Fixed Income
Securities Market, also known as the Debt Market or Bond Market, is
easily the largest of all the financial markets in the world today.
The Debt Markets have a very prominent role to play in the
efficient functioning of the world financial system and in
catalyzing the economic growth of nations across the globe.
Classification of Bond Markets
Bond markets can be categorized into different classes based on
the nature of the market, nature of the issuer, and nature of
issuance. They can be classified as primary bond market and
secondary bond markets based on the nature of the market;
government and corporate bond market based on the nature of the
issuer; and domestic, foreign, and Eurobond market based on the
nature of bond issuance.
Primary and Secondary Bond Markets
Bonds are first issued in a primary bond market. In this
marketplace, a borrower issues or sells bonds to the investor or
buyer. As the name suggests, it is a first-sale market, where the
issuer places his bonds with the investor for the first time. Until
1970s, only primary bond markets existed and bonds were issued in
the form of plain vanilla products. Investors used to purchase
bonds and hold them until maturity. The predictable nature of the
future cash flows associated with bonds made them more attractive.
Investors enjoyed the risk-free returns.
A secondary market for bonds came into existence in the late
1970s. Since then, investors started taking advantage of price
differences. Unlike primary market, secondary market is a re-sale
market, where the buying and selling of already existing bonds take
place. There is no fresh issue of bonds; instead, the already
existing bonds are exchanged among investors.
Bond dealers and banks are the major participants in a bond
market. They act as intermediaries, by buying bonds from issuers
and selling the same to investors in a primary bond market. Bond
dealers also maintain active secondary bond markets. Bond trading
is largely done over-the-counter, where bond dealers bid for bonds
that investors are willing to sell and offer them to investors
willing to buy. Secondary bond markets are equipped with highly
sophisticated networked counters.
Bond markets can be segregated into government bond markets and
corporate bond markets based on the issuers of bonds.Government
Bond Markets
According to many studies, governments are the largest issuer of
bonds worldwide. Government bonds, also known as 'sovereign debts',
play an important role in enhancing the liquidity of a bond market.
These are the backbones of healthy domestic debt markets.
From a macroeconomic perspective, government bonds enhance
stability in an economy by acting as one of the sources for funding
budget deficit. Market-oriented funding of budget deficit reduces
debt-service costs. A government bond market also facilitates the
implementation of monetary policy. Development of a deep and liquid
government bond market helps in ironing out the friction caused by
financial shocks. Such a market, coupled with sound debt
management, can help governments reduce exposure to currency,
interest rate and other financial risks
Corporate Bond Markets
Private and public corporations issue corporate bonds in order
to fund their business purposes, ranging from building facilities
to purchasing equipment for expansion. Investors generally go for
corporate bonds due to their advantages of attractive yields,
marketability, dependable income, safety and diversity. Moreover,
credit ratings of the corporate bonds enhance the safety factor
associated with them. Investors in this market include individuals,
and large financial institutions e.g., pension funds, endowments,
mutual funds, insurance companies and banks.
Corporate bonds serve as a readily available source of financing
for companies hunting for long-term funds. These reduce companies'
over dependence on banks for short-term borrowing and instead
facilitate long-term financial planning. In order to issue
corporate bonds, companies approach investment bankers with their
proposal to issue bonds, who in turn send recommendations to
exchanges after a due diligence analysis.
Domestic Bond Markets
Bonds in domestic/local markets are issued by a domestic
borrower usually in the local currency. There has been a rapid
growth in the local bond markets over the past few years. This
growth is the immediate upshot of the financial crises. The blows
dealt by the financial crises made countries realize the need for
an efficient domestic debt market that could act as a substitute
for external sources of funding. These markets could shield against
the on-and-off nature of international capital markets during the
crises period. It could also help in creating a wider list of
home-grown instruments to overcome inherent currency and maturity
mismatches. Countries are poised to develop a strong domestic bond
market to reduce dependence on international markets. To what
extent the domestic bond market can prove to be a substitute of
international sources of funding in crisis still remains a point to
ponder.
Domestic bond markets were full of lacunae, such as, restricted
demand for fixed income products, limited supply of quality bond
issuances, and last but not the least, inefficient market
infrastructure. These loopholes were overlooked till the Asian
crisis, but as an aftermath, many governments are making consistent
and determined efforts to plug them. Nevertheless, there have been
differences in the rate of growth and factors driving the growth in
different countries. Financing expansionary fiscal policies, the
need for re-capitalizing the banking system and a lack of bank
credit have been the major drivers to the growth of domestic bond
markets in the Asian region. Whereas, the increased participation
of domestic institutional investors and corporate sector's
refinancing needs have been the main drivers to bond market growth
in the Latin American region. In the EU region, the harmonization
of regulations for the accession to the EU, has been the primary
driver for growth.
Foreign Bond Markets
Foreign bonds are issued by a foreign borrower in a local market
in the local currency. Foreign bonds have interesting nomenclatures
indicating the local markets where they are issued. Bonds issued in
US dollar by a borrower located outside US are called Yankee bonds,
bonds issued in sterling by a borrower residing outside UK are
known as Bulldog bonds. Similarly, bonds issued in yen by a
borrower residing outside Japan are called Samurai bonds.
Ninety years ago, international bond markets were confined to
foreign bonds. Erstwhile international bond markets were not very
different from today's markets in terms of types of issuers and
subscribers, and underwriting and syndication practices. In the
post-World War I era the US economy witnessed a tremendous growth
and so did its currency. The US foreign bond market, also called
the Yankee bond market, continued dominating the world's capital
markets. It grew more rapidly after World War II. The Yankee bond
market remained the most dominant and largest foreign bond market
for many years. But of late, it is being overtaken by CHF (Swiss
franc) foreign bond markets. Table 1 gives the history of foreign
bond markets in major countries.
Eurobond Markets
Loans arranged through a syndicate of banks of international
repute and placed in the countries not corresponding to the
currency of issue are called Eurobonds. The history of Eurobonds
dates back to the early 1960s, when Eurodollar bonds (USD bonds
issued outside US) dominated the Eurobond market. The first
Eurobond was issued in 1957. Presently, Eurobonds are denominated
in almost all the major currencies. Today, the Eurobond markets are
well developed and more sophisticated than they were at their
inception.
Bond Market Instruments: A wide variety of bonds are available
in the marketplace. Issuers can issue bonds according to the
specifications of an investor, such bonds are not publicly traded
and are privately placed. The most popular instruments of bond
markets are:
Straight bonds: These are the fixed income bonds with specific
interest payments on specified dates over a specified period of
years. Straight bonds are also known as debentures. These are the
basic fixed income bonds, where the owner receives a predetermined
interest amount from the issuer at regular intervals, either
annually or semi-annually. The issuer doesn't have an option to
redeem the loan prior to maturity. The issuer has to redeem the
bond at its face value, also known as par value at a predetermined
date. Perpetual bonds: These bonds have no maturity date. A steady
stream of interest on these bonds is paid forever and these cannot
be redeemed.
Callable bonds: The issuer has an option to call back or buy
back all or a part of their bonds under specified conditions before
the maturity date. Corporations and municipal corporations issue
these bonds in order to capitalize on the fall in interest rates.
When the issuer calls back his bonds, then the owner is obligated
to sell them back to the issuer at a price specified when they were
issued, which usually exceeds the market price. The difference
between current market price and the call price is the call
premium.
Zero-coupon bonds: These are the straight bonds with no periodic
interest payments. These bonds are issued at less than par value
and redeemed at par value. They serve to eliminate investment risk
to the investor. The investor does not receive any interest
payments on these bonds. Hence the investor bears no reinvestment
risk till the maturity of the bond. Greater certainty of the
returns is the major attraction to the investors of these
bonds.
Strips: A Separately Registered Interest and Principal of
Securities is an innovation to zero-coupon bonds. This is issued by
the borrowers and deposited with a trustee, who in turn, divides
the bond into separate individual payment components that allow the
components to be registered and traded as separate securities. Then
the trustee directs the appropriate amount of interest or maturity
payments to investors.
Floating rate notes: These notes are issued by banks and
building societies. FRNs are similar in structure to the straight
bonds except for their interest calculations. Coupon rates of FRNs
are linked to the London Interbank Offered Rate (LIBOR). The coupon
rates are reset at regular specified intervals, normally 3 months,
6 months, or one year. Investors benefit from lower pricing of bank
loans and larger maturities of straight bonds.
Convertible bonds: Convertible bond, as the name suggests, can
be converted to or exchanged for another security at the
bondholder's option under specified conditions. Convertible bonds
are generally exchanged for an issuer's common shares. Issuers can
have an advantage of lower funding costs and possibility of
non-repayment of the principal amount.
Junk bonds: Junk bonds are high-yield bonds issued by companies
and are considered highly speculative because of high risk of
default. The credit rating for these bonds are either 'speculative'
grade or below 'investment' grade. Although these bonds have higher
default risks than others, the returns associated with these are
relatively higher than those of other bonds. Hence the risk of
default is more than compensated by high yields. Catastrophe bonds:
These are insurance linked debt instruments used to raise money in
case of a catastrophe. The catastrophe could be an earthquake or
hurricane of sufficient magnitude and within a particular region.
Usually, insurance or a reinsurance company is the issuer of a
catastrophe bond. The special condition linked with such a bond is
that, if the issuer suffers a loss from a catastrophe, then the
investor is obligated to either defer or completely forgo the
principal and/or interest payable by the issuer.
Factors Influencing Bond Markets
The fluctuations in bond markets are caused by several economic
factors, the most significant factor being a change in interest
rates. Interest rates have an inverse relation with the bond price:
as interest rates rise, the bond price falls and vice versa.
Changes in interest rates could be due to changes in demand and
supply of credit, fiscal and monetary policies, exchange rates,
market psychology and inflation expectations.
Inflation is considered to be yet another major factor affecting
bond markets. Bond investors always have an aversion towards
inflation. They fear inflation, as it lowers the value of bonds by
reducing the future purchasing power of fixed interest payments
they receive. Hence, any economic development that is likely to
result in inflation causes panic in the bond markets.
International bond markets are exposed to exchange-rate risk.
Cash flows associated with foreign bonds are dependent on the
exchange rate at the time the payments are received. Hence,
fluctuations in the exchange rates cause changes in the value of
bonds.
Policy actions can also impact bond markets significantly. A
conscious policy move or increase in the forex reserves makes the
bond markets more volatile. Liquidity created by such policy
actions drives investors to trade more frequently and actively. In
an uncertain interest rate scenario, created by conflicting signals
from different policy makers, bond investors tend to become
increasingly risk-averse.
Corporate Bond
A debt security issued by a corporation and sold to investors.
The backing for the bond is usually the payment ability of the
company, which is typically money to be earned from future
operations. In some cases, the company's physical assets may be
used as collateral for bonds.
Corporate bonds are issued by private and public corporations.
Companies issue corporate bonds to raise money for a variety of
purposes, such as building a new plant, purchasing equipment, or
growing the business. When one buys a corporate bond, one lends
money to the "issuer," the company that issued the bond. In
exchange, the company promises to return the money, also known as
"principal," on a specified maturity date. Until that date, the
company usually pays you a stated rate of interest, generally
semiannually. While a corporate bond gives an IOU from the company,
it does not have an ownership interest in the issuing company,
unlike when one purchases the company's equity stock.
Corporate bonds are considered higher risk than government
bonds. As a result, interest rates are almost always higher, even
for top-flight credit quality companies.
Corporate bonds are issued in blocks of $1,000 in par value, and
almost all have a standard coupon payment structure. Corporate
bonds may also have call provisions to allow for early prepayment
if prevailing rates change.
Corporate bonds, i.e. debt financing, are a major source of
capital for many businesses along with equity and bank loans/lines
of credit. Generally speaking, a company needs to have some
consistent earnings potential to be able to offer debt securities
to the public at a favorable coupon rate. The higher a company's
perceived credit quality, the easier it becomes to issue debt at
low rates and issue higher amounts of debt.Convertibles and
exchangeables
Convertible bonds are corporate bonds with an embedded equity
option and often with embedded (issuer) calls and/or (holder) puts.
Convertibles have characteristics of both bonds and equities (or
equity derivatives if held on a hedged basis), i.e. they are
hybrids.
A convertible bond is a bond which can be converted into shares
of the bond issuing company at the option of the bondholder. The
bonds can be converted into equity at a pre-specified ratio, the
conversion ratio; or alternatively, at a pre-specified price, the
conversion price, which is at a premium to the underlying equity
spot price at issuance.
An exchangeable bond differs only in that the bond is
exchangeable for shares in a company other than the issuing
company. Invariably the issuer is committed to pay