17 August 2010 Emerging Markets Asia Woon Khien Chia Emerging Markets Strategy +65 6518 5169 [email protected]Teck Wee Yeo Emerging Markets Strategy +65 6518 6160 [email protected]www.rbsm.com/strategy Top View | India A primer on India’s fixed income market The Indian fixed income market has developed rapidly since the structural changes made in the 1990s. These changes included technological and regulatory changes such as the electronic screen-based trading, the establishment of Clearing Corporation of India Ltd. (CCIL) and new instruments and initiatives to broaden the investor base. This primer provides a full spectrum of India’s fixed income market, describing the different market instruments and the roles, objectives and choice of instruments of the central bank, banks, non- banks and foreign investors. A brief listing of settlement, pricing and taxation issues is also contained in this primer. Monetary Policy Framework - Policy decision making, policy targets, policy tools. Pages 2-5 Markets and instruments - Money market instruments, long-term instruments, derivatives. Pages 5-10 Supply - Issuers, issuance patterns. Pages 10-12 Demand - Primary dealers, banks, insurance companies, pension funds, FII, retail investors. Pages 12-14 Settlement, pricing and taxation. Pages 15-16 Conclusion. Page 16 List of tables - Table 1: Cash instruments’ basic features. Page 9 - Table 2: Derivative instruments’ basic features. Page 10 - Table 3: Cash instruments’ supply and demand. Page 14 - Table 4: Settlement and FII regulation and taxation. Page 16 Glossary. Pages 17-19 Appendix - Lists of credit rating agencies, primary dealers, custodians and countries with double taxation avoidance agreement (DTAA). Pages 20-22
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GSecs are held in security accounts maintained by interbank counterparties with
the RBI. All the deals are settled through CCIL using the DvP (Delivery vs.
Payment) mechanism. This mechanism ensures that on settlement date, transfer
of securities by the seller occurs simultaneously with transfer of funds from the
buyer. In the secondary market, CCIL guarantees settlement of trades on the
settlement date by becoming a central counter-party to every trade. All outright
secondary market transactions in GSecs are settled on T+1 basis. However, in
case of repo transactions in GSecs, market participants have the choice of
settling the first leg on T+0 basis or T+1 basis while the second leg has to be
settled on a T+1 basis.
Corporate securities
As decided by SEBI in 2009, all trades in corporate bonds between mutual
funds, foreign institutional investors or their sub-accounts, venture capital funds,
foreign venture capital investors, portfolio managers and RBI-regulated entities
are cleared and settled through the NSSCL (National Securities Clearing
Corporation Limited) or the Indian Clearing Corporation Limited (ICCL). This is
applicable to all corporate bonds traded after 1 December 2009 on OTC or on
the debt segment of the stock exchange. This arrangement facilitates the
settlement of secondary market trades on corporate bonds on a DvP basis.
Pricing Sources
Negotiated Dealing system (NDS)
The price and other information of a trade are stored under NDS on the RBI
website or on the CCIL website through NDS Order matching (NDS-OM).Since
NDS-OM is a live and anonymous platform where the trades are disseminated as
they are struck and where counterparties to the trades are not revealed, NDSOM
is the safest and most transparent pricing source.
Transactions undertaken between market participants in the OTC market or
through the telephone are expected to be reported on the NDS platform within
15 minutes after the deals are put through. All OTC trades are required to be
reported on the secondary market module of the NDS for settlement.
Fixed Income Money Market and Derivatives Association of India (FIMMDA)
FIMMDA is also a source of price information, especially for securities that are
not traded frequently. FIMMDA releases rates of various GSec issues that are
used by market participants for valuation purposes.
For benchmark, liquid securities, the prices are polled from various active market
participants between 3pm and 4pm every working day. The collected data gets
automatically transferred to Bloomberg’s valuation system for generating the
prices of all outstanding securities.
For the illiquid securities, the various market participants are polled for different
illiquidity premiums on different maturity buckets. These illiquidity premiums are
then added to the liquid yield curve and an illiquid yield curve is established by
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The Royal Bank of Scotland
the FIMMDA. There is no mathematical way of deriving the illiquidity premium – it
is generally estimated by market makers who would base it on maturity, coupon
rate, issue size and distribution of the illiquid bonds.
Taxation
Currently the interest income tax on FIIs is 20% subject to double taxation
agreement (DTA) whereas the capital gains tax is 30% and 10% for short-term
and long-term respectively. The capital gains tax is also subject to double tax
agreement. India has entered into a Double Taxation Avoidance Agreement
(DTAA) with numerous countries (see Appendix). If the capital asset is held for
more than 36 months prior to its transfer, the gains are long term gains. However,
the qualifying period of holding is 12 months in the case of GSecs and listed
corporate bonds. The government is the midst of streamlining the tax rates for all
holding periods of bonds by FIIs.
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Table 4: Settlement and FII Regulation and Taxation
Settlement primary market
Settlement secondary market
Restrictions for FII Interest Income Tax Capital gains tax
Treasury Bills T+2 T+2 Subject to USD5bn limit on GSec 20% subject to DTA 30% subject to DTA
Cash Management Bills
T+1 or T+2 T+1 Subject to USD5bn limit on GSec 20% subject to DTA 30% subject to DTA
T+1 T+1 Subject to USD5bn limit on GSec 20% subject to DTA 10% for long-term,30% for short-term subject to
DTA
GSecs
State Development Loans
T+1 or T+2 T+1 Subject to USD5bn limit on GSec 20% subject to DTA 10% for long-term,30% for short-term subject to
DTA
T+0 or T+2 T+1 Subject to USD15bn limit on corporate bonds
- 30% for short-term subject to DTA
Commercial Paper
Certificates of Deposit
T+0 or T+2 T+1 Not permitted - 30% for short-term subject to DTA
T+0 or T+2 T+0 to T+2 Subject to USD15bn limit on corporate bonds
20% subject to DTA 10% for long-term,30% for short-term subject to
DTA
Corporate Bonds
Public Sector Undertaking (PSU)
T+0 or T+1 T+2 Subject to USD15bn limit on corporate bonds
20% subject to DTA 10% for long-term,30% for short-term subject to
DTA
Source: RBI, CCIL, SEBI, RBS
Conclusion
While the Indian fixed income is characterised by a well-defined set of rules and
regulations and a deep matured GSec market, the slow growth of the corporate
bond market as well as retail investors’ participation are areas for future
development. Although credit rating and issuer knowledge are generally quite
well developed relative to other emerging markets, an active secondary market
and credit curve have not fully evolved. Addressing these deficiencies are
acknowledged priorities of the SEBI.
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Glossary Broad Based Funds – This refers to a fund established or incorporated outside
India having at least twenty investors with no single investor holding more than
10% of the shares or units of the fund. The exceptions to the requirements
arise when the fund has institutional investors, then it is not required to have
twenty investors. In the case that the institutional investor is holding more than
10 % of the shares, the institutional investor itself must be a broad based fund.
BSE – Bombay Stock Exchange
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CCIL – Clearing Corporation of India Limited (CCIL) is the clearing agency for
government securities. It acts as a central counterparty for all transactions of
the government securities. CCIL guarantees the settlement of all the trades of
all trades in the government securities.
CMB – Cash management bills were introduced in August 2009 to allow the
government to meet temporary cash flow mismatches. Their tenors can be no
more than 91 days. The government issued two such bills in H1 2010 which
had since matured.
CSGL – Constituent’s Subsidiary General Ledger Account also known as SGL
II account is an account in which a bank or primary dealer acting as a
custodian of gilt accounts can hold its constituents.
Depositories – Investors can hold government securities in dematerialized
account with a depository. The most prominent depositories are NSDL and
CDSL.
DvP – Delivery versus Payment is the mode of settlement wherein the transfer
of securities and funds happens simultaneously. There are three types of DvP
settlements: DvP I, where the securities and the funds legs of the transactions
are settled on a gross basis; DvP II, where the securities are settled on a gross
basis whereas the funds are settled on a net basis; and DvP III, where both
securities and funds legs are settled on a net basis.
ECB – External commercial borrowing limit is set by the RBI on local
corporates’ to restrict their overseas borrowing. To promote the country’s
infrastructure development plans, rules governing prior approvals and spreads
over USD Libor have been relaxed for infrastructure firms in 2008.
FII – Foreign institutional investor refers to a non-resident investor which has
been licensed by the Securities Exchange Board of India (SEBI) to trade and
invest in the Indian equity and debt markets.
FIMMDA – Fixed income money market and derivatives association of India
Gilt Account – Since registration of SGL accounts with RBI is restricted,
investors have the option of opening a Gilt Account with a bank of primary
dealer which has a CSGL account.
LAF – Liquidity adjustment facility is the repo/ reverse repo window provided
by the RBI for overnight borrowing or lending by the banks with the central
bank.
MIBOR – Mumbai inter-bank offered rate
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MIFOR – Mumbai inter-bank forward offered rate
MSS – Market stabilization scheme was introduced in 2004 for the RBI to issue
GSecs to sterilize its USD buying intervention in the FX market where the
proceeds of these GSec issuance would be kept in a MSS account set up at
the RBI, withheld from the government so that the proceeds cannot be used
for fiscal funding.
NDS – The negotiated dealing system was introduced in 2002 for electronic
dealing and reporting of the transactions of government securities. NDS
members can send in bids for primary issuance of GSecs. Membership is
restricted to members holding SGL or Current accounts with RBI. NDS also
facilitates settlement of transactions for GSecs in the secondary market.
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NDS-OM – An order driven electronic system was introduced where the
participants can trade anonymously by matching their orders with other market
participants. Direct access to NDS-OM is available to selected commercial
banks, primary dealers, insurance companies and mutual funds while others
can only access this system through their custodians.
NDTL – Net demand and time liabilities are the base used by scheduled
commercial banks to compute their required cash reserves to be placed with
the RBI.
NSE – National stock exchange
Participatory Notes (PN) – These are notes issued to foreign funds with no FII
licence by FII-registered institutions to trade in the domestic markets on their
behalf.
PSU – Public sector undertaking
SEBI – Securities exchange board of India
SGF – CCIL guarantees settlement of all the trades in the government
securities and provides funds/securities by its own means in case the
participant fails. To hedge this risk, the CCIL collects margins from all
participants and this maintained margin is called the settlement guarantee
fund (SGF). It can be in the form of cash or securities (minimum 10% cash).
Eligible securities for SGF are specific issues of central government securities
and treasury bills listed by the CCIL through notification where the list is
reviewed periodically.
SGL – Subsidiary General Ledger Account (SGL) facility is provided by RBI to
select entities who can maintain their securities in SGL accounts with the
Public Debt Office of RBI
Shut Period – Shut period is the period for which securities can not be
delivered or settled. This shut period serves the purpose of facilitating the
servicing of the security e.g. payment of coupon and redemption proceeds
and to avoid any change in ownership during this process. Example if the
coupon payments dates are 26th August and 26th February then the shut
period will fall on 25th August and 25th February and trading in this security for
settlement on these two days is not allowed. Currently the shut period for
securities held in SGL accounts is one day.
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Sub accounts (FII) – Sub accounts refer to foreign corporates, foreign
individuals and institutions, funds or portfolios established or incorporated
outside India on whose behalf a registered FII can make investments.
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Appendix
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List of Credit Rating Agencies, Primary Dealers and Custodians
Credit Rating Agencies
CRISIL limited
Fitch Ratings India Private Ltd.
ICRA Limited
Credit Analysis & Research Ltd. (CARE)
Brickwork Ratings India Pvt ltd.
Bank Primary Dealers Standalone Primary Dealers
Royal Bank of Scotland N.V. Deutsche Securities (India) Pvt. Ltd.
Bank of America ICICI Securities Primary Dealership Limited
Bank of Baroda IDBI Gilts Ltd.
Canara Bank Morgan Stanley India Primary Dealer Pvt. Ltd.
Citibank N.A. Nomura Fixed Income Securities Pvt. Ltd.
Corporation Bank PNB Gilts Ltd.
HDFC Bank Ltd. SBI DFHI Ltd
Hongkong and Shanghai Banking Corpn. Ltd STCI Primary Dealer Limited
J.P Morgan Chase N.A., Mumbai Branch
Kotak Mahindra Bank Ltd.
Standard Chartered Bank
Registered Custodian of Securities Entities where in-principal approval has been granted
Royal Bank of Scotland N.V. India Infoline Ltd.
AXIS BANK DSP Merril Lynch Limited
BNP Paribas MF Global Sify Securities India Pvt. Ltd.
Citibank N.A. Globe Capital market Ltd.
DBS Bank Ltd. India Edelweiss Custodial Services Limited
Deutsche Bank AG
HDFC Bank Ltd.
Hongkong and Shanghai Banking Corpn. Ltd
ICICI Bank Ltd.
IL&FS Securities Services Ltd.
JPMorgan Chase Bank, N.A.
Kotak Mahindra Bank Limited
Orbis Financial Corporation Ltd.
SBI Custodial Services Pvt. Ltd.
Standard Chartered Bank
Source: See list below
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List of Countries with Double Taxation Avoidance Agreement (DTAA)
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0 Dividends Interest Country Royalties
15 Australia 15 15
Austria 20 20 30
21
15 10 10 Bangladesh
15 Belarus 10 15
Belgium 15 15 20
15 15 15 Brazil
15 15 20 Bulgaria
25 15 15 Canada
10 10 10 China
15 10 15 Cyprus
20 15 30 Czechoslovakia
10 10 10 Czech Republic
20 15 20 Denmark
20 20 30 Egypt
15 10 20 Finland
10 15 20 France
10 10 10 Germany
20 20 30 Greece
15 15 30 Hungary
15 10 15 Indonesia
10 10 10 Israel
20 15 20 Italy
15 15 20 Japan
10 10 20 Jordan
10 10 10 Kazakhstan
15 15 20 Kenya
20 15 15 Korea
10 10 15 Kyrgyzstan
20 20 30 Libya
20 20 30 Malaysia
15 10 15 Malta
15 20 15 Mauritius
15 15 15 Mongolia
10 10 10 Morocco
10 10 10 Namibia
15 15 15 Nepal
10 10 10 Netherlands
15 10 10 New Zealand
15 15 30 Norway
12.5 10 15 Oman
20 15 15 Philippines
15 15 22.5 Poland
15 10 10 Portugal
10 10 10 Qatar
20 15 22.5 Romania
10 10 10 Russian Federation
15 15 15 Singapore
10 10 10 South Africa
15 15 20 Spain
15 10 10 Sri Lanka
10 10 10 Sweden
15 15 20 Switzerland
0 7.5 10 Syria
15 12.5 20 Tanzania
The Royal Bank of Scotland
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20 20 15 Thailand
10 10 10 Trinidad and Tobago
15 15 15 Turkey
10 10 10 Turkmenistan
15 12.5 10 United Arab Emirates
15 15 15 United Kingdom
20 15 15 United States
15 15 15 Uzbekistan
10 10 10 Vietnam
15 10 10 Zambia
Source: MOF
Sources
www.rbi.org.in
www.sebi.gov.in
www.bseindia.com
www.fimmda.org
www.finmin.nic.in
www.commerce.nic.in
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