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Bond issuers set to become Market Maker to enhance liquidity

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Issuer to provide Liquidity Window facility to eligible investors effective from Nov 1, 2024

Vinita Nair & Palak Jaiswani | corplaw@vinodkothari.com

August 18, 2024 (Updated October 22, 2024)

While SEBI took numerous measures to deepen the bond market and increase transparency and participation viz., Electronic Book Building Platform (‘EBP) for issue above Rs. 50 cr., Request for Quote (‘RFQ’) platform, reduction in face value of privately placed bonds, online bond platform (‘OBP’), corporate bond repo system etc, illiquidity in bond market continued to remain one of the major concerns for SEBI. To address the issue of liquidity mainly for retail investors, SEBI vide its consultation paper dated August 16, 2024, had proposed the introduction of Liquidity Window facility, a unique concept in bond market. SEBI notified this facility vide circular dated October 16, 2024 effective from November 01, 2024.

What is the proposed Liquidity Window Facility (‘LWF’):

LWF, at the issuer’s discretion, allows eligible investors to exercise a put option on NCDs on predetermined dates. This enables investors to sell their securities back to the issuer, removing the need to find prospective buyers in the market. In this setup, the issuer assumes the role of market maker, a concept that has not yet been fully implemented in the bond market.

Key Features of LWF:

  • Issuer’s discretion: It is optional for the issuer to provide LWF.
  • Nature of issuance: Issuers can provide this facility for prospective bond issuances through public issues as well as on a private placement (proposed to be listed) at the ISIN level.
  • Quantum of LWF: Minimum 10%[1] of final issue size. Aggregate limits and sub-limits (in no. of securities) for put option that can be exercised in each window to be disclosed in the offer document.
  • Timing: LWF to commence after the expiry of 1 year from date of issuance. Facility may be operated on a monthly or quarterly basis at issuer’s discretion, as indicated in the offer document upfront.
  • Eligible Investors: The issuer will determine which investors are eligible, with a particular focus on retail investors. Investors need to hold securities in demat form to avail this benefit. If put options exercised during the period exceed sub-limits, acceptance will be on a proportionate basis.
  • Pricing of bonds under LWF:
    • Date of valuation: ‘T-1’day where T is the first day of the LWF[2].
    • Issuers can provide a maximum discount of 1% on the valuation arrived. Price plus accrued interest payable.
    • Display valuation on the website of the issuer and SE during the liquidity window period.
  • Option with the issuer for bonds purchased under LWF: Within 45 days of closure of LWF or before the end of quarter, whichever is earlier:
    • sell on debt segment of SE; or
    • sell on RFQ platform, if eligible to access; or
    • sell through an online bond platform provider; or
    • extinguish the NCDs. 
    • In case of sale, amount realized will be added back to the aggregate limit and will replenish any past usage of the limit.
  • Restriction on re-issuance[3]: Re-issuance is not allowed under ISINs in which LWF is offered
  • Exemption in ISIN capping[4]: ISI.Ns in which LWF is offered are exempted from computation of ISIN limits as per Chapter VIII of NCS Master Circular.
  • Operational Guidelines: Stock exchange, in consultation with clearing corporations and depositories, will issue detailed guidelines on how to use the LWF, including the process for exercising the put option.

Other Conditions:

  1. Authorisation and Implementation
    1. Prior approval of BOD.
    2. Monitoring of implementation & outcome SRC or BOD (in case there is no SRC).
    3. Transparent, non-discretionary and non-discriminatory within the class of investors.
    4. Does not compromise market integrity or risk management.
  2. Liquidity Window Period:
    1. Duration: Open for 3 working days.
    2. Intimation of proposed schedule: To be provided 5 working days before the start of the financial year in which facility it is to be given via SMS/WhatsApp.
  3. Mode and manner of availing:
    1. Put options can be exercised by blocking the securities in demat a/c during trading hours and using the specified mechanism to intimate issuer w.r.t. the exercise of put option.
    2. Investors may modify or withdraw bids during the window period[5].
    3. Submissions received during window period (during trading hours) will only be considered valid
    4. Further guidelines to be provided by SE
  4. Settlement[6]: T+4 days
  5. Reporting and disclosure requirements:
    1. Submit report to SE – within 3 WD from closure of window; and
    2. Inform the depositories and DT regarding NCDs to be extinguished – within 3 WD from end of 45 days from the closure of window (timeline to sell/ extinguish purchased securities)[7]
  6. Website disclosure:
    1. By: SE, depositories, DT, and Issuers
    2. When: Disclose on website upon issuance of each ISIN in which facility is provided. Details to be maintained and updated at all times.
    3. Details: List of ISINs for option is available, o/s amount, credit rating, coupon rate, maturity date, valuation details and other relevant information (as per para 6.11 of circular)
    4. Issuer to submit above details to SE, depositories and DT to disclose on their website
    5. In case of change: Issuer to intimate SE, depositories and DT within 24 hrs of change. SE, DT and depositories to update their website within 1WD of such intimation.

[1] Minimum 15% was proposed in the CP.

[2] CP proposed the date of valuation as the day of closure of liquidity window.

[3] Not proposed in the CP earlier.

[4] Not proposed in the CP earlier.

[5] Not proposed in the CP earlier.

[6] Not proposed in the CP earlier.

[7] CP proposed the timeline  of 3 working days from the date of window closure

Other resources related to the topic:

  1. SEBI rationalises offer document contents and certain timelines for NCD public issuance
  2. LODR norms of equity extended to debt listed entities
  3. SEBI further caps limit for ISINs to reduce fragmentation and boost liquidity

Bond market needs a friend, not parent

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Policies seem to be working at cross-purposes

Vinita Nair, Senior Partner | corplaw@vinodkothari.com

The need to promote bond markets is almost cliched, and does not require elaboration. However, when one observes the regulatory and fiscal developments concerning bond markets in recent times, one wonders whether there is a clear and unified sense of direction. The role of policymaker may be supporting, reformative, protective, promotional, etc. Sometimes, protective regulation may also be intended to play a promotional role – for example, if investors’ interest is better protected, it may promote investor confidence and hence, appetite. However, it is hard to see a clear theme in the spate of changes concerning bond markets in the recent past.

Fiscal measures:

As regards fiscal measures, there are several changes in the Budget 2023 that may be directly or indirectly affecting the bond markets. The Budget saw market-linked debentures[1], a bit controversial development, as a case of fiscal arbitrage, and killed the same, resulting in the death of the instrument. The exemption from  withholding tax exemption in case of listed bonds was taken away – which will be difficult to understand as the theoretical justification for withholding tax is the possibility of tax leakage in case of destination-based tax. The case for the leakage is difficult to make, as listed bonds are issued in demat format, and hence, all transactions take place through regular banking channels. If the intent of policymakers was to promote retail investment in bonds, this is certainly antithetical to that objective.

Another fiscal change, which may have a long-term negative impact, is the denial of long-term capital gain treatment to investment in debt mutual funds[2]. Debt mutual funds were also responsible for the demand-side of corporate bonds. Mutual fund’s share in the outstanding corporate bonds as at the end of FY 2022 stood at 15.85%[3]

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Workshop on Large Corporate Borrowers

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Click here to register for the workshop- https://forms.gle/mmRSswBTjX79SR8c7
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