-Mahesh Jethani (finserv@vinodkothari.com)
Background
SEBI on the recommendations of Mutual Fund Advisory Committee (MFAC) on July 22, 2020 has issued a circular with an intent to accelerate the transactions in Corporate Bonds and Commercial Papers and to enhance the transparency and disclosure pertaining to debt schemes. This move from the capital market regulator makes it mandatory for the mutual funds to undertake at least 10% (in value) of their secondary market trades in corporate bonds through the Request for Quote (RFQ) platform of stock exchanges from October. In this write-up we intend to explore the nitty-gritties of Request for Quote (RFQ) platform, how does it operate, how is it different from EBP, what are the requirements and the potential impact of these new requirements.
Request for Quote (RFQ) Platform of stock exchanges
Request for Quote (RFQ) platform is meant for execution and settlement of trades. It is a renowned mechanism and is used across the globe in premier stock exchanges like London Stock Exchange (LSE) and New York Stock Exchange (NYSE). This platform was launched by BSE and NSE on 4th February 2020, as a part of continuous measures taken for development of an online order matching platform for corporate bonds by exchanges or jointly by regulated institutions.
What is RFQ platform?
Request for Quote’ (RFQ) is a web based online trade execution and settlement platform which allows interaction amongst the market participants who intend to negotiate transactions amongst themselves. It is a part of existing reporting and settlement platform of NSE’s (CBRICS) and BSE’s (NDS-RST) for corporate debt securities. RFQ is a trading mechanism where a quote by participants is provided in response to a request for quote by initiator. The quote will be executable only by requesting member and is based on mutual agreement on deal parameters. It is a participant to participant model which enables dealing and execution in various debt securities such as corporate bonds, securitized debt instruments, municipal debt securities, Government securities, State development loans, treasury bills, commercial papers and certificates of deposit etc.
All regulated entities, listed corporates, Institutional Investors as defined under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, All India Financial Institutions and any other entity as allowed by Exchange from time to time will be eligible to participate on the RFQ platform. The initiators and responders will include any of the aforesaid entities.
How does RFQ operate?
What is Electronic Bidding Platform (EBP) and how is it different from RFQ?
EBP is a mechanism for issuance of debt securities on private placement basis. It helps to reduce the time and cost of new issue of securities. The circular dated January 05, 2018 issued by SEBI has mandated that every new issue of debt securities and non-convertible redeemable preference shares (NCRPS) on private placement basis with an issue size of INR 200 crores and above, inclusive of green shoe option (if any) shall use this platform. Our detailed analysis on the EBP Platform along with various parameters can be read here.
Automated order matching trading platform
EBP varies from RFQ in the sense that, in RFQ the participant-to-participant model is followed wherein the deal parameters are based on mutual consent and is not an automated order matching trading platform. EBP on the other hand is a bidding process which has prescribed requirements that are to be met after that, the auction is carried out and the initial cut-off rate is determined by the system which is computed on the base issue size However, the participants on RFQ platform can deal as per their best interests and the control is with the initiator or respondent.
Secondary market trading and primary market issuance:
It is to be noted that, RFQ is a secondary market trading mechanism and EBP platform is for primary issuance that was launched long back in 2016 and was modified in order to streamline procedures for primary issuance of debt securities on private placement basis. Earlier the new issue size was capped at INR 500 crores and above, which is now reduced to INR 200 crores and above to widen the coverage. However, issue sizes less than INR 200 crores can also utilise this platform voluntarily. On RFQ platform the trades which are to be executed have a requirement which prescribes that is minimum RFQ size should be in multiples of face value with minimum size to be accepted as Rs. 5 lac or face value, whichever is higher.
Compliance requirements:
The requirement of venturing to EBP route is to be complied by entities who have their ‘specified securities’ listed on any recognised stock exchanges as prescribed in SEBI (Issue and Listing of Debt Securities) Regulations, 2008 and SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations 2013. Unlisted entities can follow the procedure specified under the Companies Act, 2013 and relevant rules made thereunder. In the HR Khan Committee Report on Development of Corporate Bonds, it was recommended to extend the applicability of EBP to all the primary market issues.
While RFQ platform is to be utilised by regulated entities, listed corporates, institutional investors as defined under SEBI ICDR Regulations, 2018, All India Financial Institutions, and any other entity as allowed by exchanges from time to time for trading in debt securities.
What are the new requirements?
SEBI in its circular dated July 22, 2020 has introduced some requirements that are some small steps towards enhancing the bandwidth of the debt market. There are two new measures introduced by the capital market regulator with an intent to increase the liquidity on exchange platform- 10% trades by MFs in Corporate Bonds, and to enhance transparency and disclosure pertaining to debt schemes and investments by mutual funds in Corporate Bonds and Commercial Papers- disclosure of debt schemes on fortnightly basis. These are the rules which were introduced and shall come into force with effect from October 1, 2020:
1. Mutual Funds shall undertake at least 10% of their total secondary market trades by value in the Corporate Bonds by placing/seeking quotes through one-to-many mode on the Request for Quote (RFQ) platform of stock exchanges. This will not include Inter Scheme Transfer (IST) which is the process of a mutual fund scheme selling specific securities to another scheme within the fund house. It is an alternative to otherwise selling the assets outside. This would have prevented increase in volume of real transactions.
2. 10% shall be reckoned on the average of secondary trades by value in immediately preceding 3 months on rolling basis. Let us understand this an example-
For instance, in the month of October 2020 to comply with the new requirement, following calculation will have to be done:
In October 2020, Mutual Funds shall undertake 10% (by value) of their average secondary market trades (excluding IST) done in immediately preceding three months i.e. July 2020, August 2020 and September 2020 for Corporate Bonds by placing/ seeking quotes through RFQ platform of stock exchanges.
| Exposure required for the month of October 2020 (Amount in crores) |
| Month |
Secondary Market Trades |
IST |
Trades excluding IST |
Average of last 3 months |
Deals to be executed using RFQ platform
(10% of preceding 3 months) |
| July |
1314332.71 |
22452.72 |
1291879.99 |
1385871.687 |
138587.1687 |
| August |
1353072 |
21814.93 |
1331257.07 |
| September |
1547560 |
13082 |
1534478 |
3. It is required to be noted that any transaction entered by mutual fund in Corporate Bonds in one-to-many mode that gets executed with another mutual fund, shall also be counted for another mutual fund for the aforesaid 10% requirement. The intent here is to encourage the participation by mutual funds when the quote is initiated for Corporate Bonds, as it will ensure compliance to the 10% requirement.
4. Also, SEBI has partially modified the circular dated September 13, 2012 which now makes it essential for debt schemes that the disclosures shall be done on fortnightly basis within 5 days of every fortnight. In addition to the current portfolio disclosure, yield of the instrument shall also be disclosed. Earlier, the part of circular which is modified, required disclosures monthly and no specific requirement was there to disclose yield of instrument. This move will ensure enhanced transparency.
Potential impact of the new requirements
It is well recognised now, that sophisticated corporate bond market accelerates the growth of economy by complementing the banking system to provide an alternative source of finance for investment needs. This is among one of the many initiatives such as EBP, information repositories that provide consolidated data, tri-party repo trading on exchanges etc. are taken by regulators that are crucial in building a vibrant Corporate Bond market.
This will enhance the liquidity to a certain extent in Corporate Debt securities. A mere 10% of total value of secondary market trades is an optimistic number as earlier there was no mandatory requirement at all. The recent statistics on SEBI website show that the total fund deployment of all Mutual Funds towards Corporate Debt securities was roughly around 30.32% in March 2020 and has in June 2020 reduced to 24.15%.
The RFQ platform provides users a range of options to seek a quote and to respond to a quote, while keeping an audit trail of all the interactions i.e. quoted yield, mutually agreed price, deal terms etc. This will bring pre-trade transparency and disclosures for over the counter transactions in Corporate Debt securities. The requirement of disclosure of schemes at a fortnightly basis will enable the investors to react as quickly as possible. Disclosure of reliable, timely information is a factor that contributes to liquid and efficient markets by enabling investors to make investment decisions based on all the available information that would be material to their decisions.
Concluding Remarks
The overall market of the corporate debt market in India is yet to evolve in terms of enabling vibrancy and depth as almost 90% of the issuances are privately placed. The new requirements are just another addition to the measures which regulators are constantly coming up which vary from introduction of Electronic Book Mechanism, we have separately covered this in a detailed write-up that can be found here to introducing the framework by SEBI which mandated Large Corporates to raise 25 per cent of their funding need from the bond market in Budget 2018-19, detailed write-up can be found here. The combined effect of all the untiring efforts of SEBI will go a long way for developing a vibrant and liquid corporate bond market in India.
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