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Informist, Friday, Oct. 18, 2024

 

By Sachi Pandey 

 

MUMBAI – The new liquidity window framework announced by the Securities and Exchange Board of India seeks to deal with a key issue by addressing the longstanding liquidity concerns associated with corporate bonds, often perceived as a barrier to entry for individual investors. However, it will be a while before any practical benefits and utility of the facility play out, making this yet another market-deepening measure that succeeds in ideation but is lacking in execution, market experts said.

 

The liquidity window, which will be implemented from Nov 1, will allow issuers to offer investors a periodic put option on debt securities, offering an exit to those worried about the illiquid nature of corporate bonds. Although bonds with specific put options have been available in the market, what sets this new framework apart is the introduction of more frequent liquidity windows, and clarification on how issuers can implement this feature in a more structured way.

 

Under the Liquidity Window framework, issuers may opt to offer this facility during the issuance of new debt securities, pending approval from their board of directors. Issuers have to specify the percentage of the issue size eligible for redemption, which must be at least 10%.

 

Issuers will be allowed to repurchase the bonds at a discount of up to 100 basis points from the assessed value plus the accrued interest, providing investors with more frequent opportunities to exit — potentially quarterly or monthly. The market valuation-linked exit pricing makes the new mechanism more akin to a buyback than a put option, which usually allows for premature redemption at par value, market participants said.  

 

"If the investors are facing difficulty in offloading a bond due to lack of liquidity in the secondary market, this mechanism makes the issuer to buy back at least 10% of the total issue size from investors at a discount of up to 100 basis," explained Venkatakrishnan Srinivasan, founder and managing partner of Rockfort Fincap LLP. "Following the buyback, the issuer has the option to either re-sell the bonds again in the secondary market or extinguish the same. This liquidity window offers much-needed exit flexibility to investors."

 

Market experts believe this facility is suited mostly for lower-rated corporate bonds, which typically struggle with liquidity in the secondary market. "With this rule, investors are more likely to buy such bonds knowing they have a reliable exit strategy," a senior official at a mid-sized brokerage firm said. "This opens up liquidity in the secondary market, as now institutions or retail investors can sell their holdings more easily in the secondary market with this option."

 

However, despite the potential benefits, challenges persist in the adoption of the new mechanism by issuers. Since regulations do not mandate liquidity windows, uncertainty looms regarding how many issuers will adopt this provision, especially smaller issuers, who may find it challenging to manage compliance and buyback processes.

 

In terms of pricing and market dynamics, too, the liquidity window is not expected to have a significant impact on bond yields. "For lower-rated bonds, this change could improve investor confidence due to the added liquidity, but it is not expected to have a major impact on bond yields. And for higher-rated bonds, the spreads are already low, so the effect will likely be minimal. The circular is more focused on improving liquidity rather than compressing yields," said Soumyajit Niyogi, director – Core Analytical Group at India Ratings and Research.

 

Without the incentive of a significantly lower cost of borrowing, issuers may not see value in taking on the increased compliance burden and refinancing headache that would come with the new mechanism. While the framework introduces much-needed structure and clarity, the success of this initiative will hinge largely on incentivising its adoption by issuers, market participants said.  End

 

Edited by Avishek Dutta

 

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