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Fixed Income Securities Markets: An Overview

Dr HK PradhanXLRI Jamshedpur

What are Fixed Income Securities• Debt securities are often called “fixed” income

securities, wherein borrowings being made in return for a predetermined stream of cash flows, paid on a fixed schedule.

• Fixed income securities broadly are classified under the general definition of debt securities or interest rate sensitive securities

• The concept of fixed income is often nebulous when instruments such as floating rate instruments or other instruments that have future cash flows uncertainties

Defining Features

– The defining feature is that there are well-defined rules governing when there will be a payout to the holder of the security

– Holders of debt securities are creditors, and the issuer is the borrower (Government, or corporate)

– Cash flows promised to the holders of securities represent contractual obligations of the respective issuers

Role of Debt Markets in the Economy • Facilitates government financing and its roll over• Low-cost financing opportunities for the government• Governments use special purpose securities for raising

resources for specific purposes (Relief bonds, Oil bonds..)• Meets long term investments needs for infrastructure• Meets long-term investments needs for infrastructure• Banks and financial institutions invest in debt instruments to

meet their statutory requirements• Eases over-concentration of credit risk and funding

mismatch in the banking system• Provident funds, pension funds, insurance companies

require long term instruments, invest in debt markets

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Role of Debt Markets• Debt markets provide an assured rate of return for buy-hold

investors• Household prefer bank deposits, savings schemes, and to an

extent debt instruments• Sub sovereign entities (state local and state sponsored SPVs)• Sub-sovereign entities (state, local and state sponsored SPVs)

extensively use debt markets for financing & investments• Corporate raise money thro debt markets (CPs, debentures,

bonds)• Mutual funds, ULIPs invest in debt related instruments• FIIs too allowed to invest in debt markets, though to a

limited extent

Government Securities serve important purposes• Yields on government securities serve important purposes

– G Sec yields represent indicators of risk free rates– Government securities yields serve as benchmark yields for

rest of the sectorrest of the sector – Used for derivative pricing

• Government securities can be used to meet liquidity needs of an institution

• Government securities can be used as collateral to borrow funds in the repo/CBLO market

Benchmarks

• Government Securities issued keeping in view the yield curve development, liquidity positions, minimizing roll over risk, benchmark & YC i li tiimplications

• Benchmarks is a product of market as well as RBI operations

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10-year GOI bond yield

• Issuers• Investors• Instruments • Intermediaries

Key Components of Debt Markets

• Infrastructure • Market regulations• Benchmark reference rates • Primary & secondary markets• Coordination & monetary policy issues

Classification of Debt SecuritiesBy Issuers

– Central Government, State Governments, Municipal Corporations, PSUs, PFIs, Corporate

By Instruments – T Bills, Government Securities, SDLs, Municipal Bonds, Corporate bonds,

FRBs, Inflation Indexed, Convertibles, ABSsBy Interest rates

– Fixed rate issues, Floating rate issues, Zero coupons, inflation indexed bondsg pBy Maturity

– money market instruments (T Bills, CPs), Bonds with 2 or more years tenor, By Optionality, Structured Obligations

– Calls, Puts & Convertibles, ABS, CDSBy Tax features

– Taxable, non-taxable bondsSectoral/Special bonds

– PUSs, Bank bonds, Infra, oil, special purpose bondsBy Derivatives

– FRAs, IRFs, OIS, IRFs, Options, Caps and Floors

Market Participants

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Treasury Bills• Instruments of short-term borrowings of Govt. • Maturity –91, 182 and 364 days• Issued at a discount through auction by RBI and

redeemed at par• Serves as a bench mark for short-term securities• All issuance of T-Bills (including under MSS & LAF)

run online on PDO-NDS system• Multiple Price based Auction• Demand for T-Bills inversely related to call rates• Repo transactions permitted in all T-Bills•

State Government Securities• Until 1998-99 the states issued securities at pre-announced coupon

rates and prices and were issued by the Reserve Bank through common tranches.

• Since 1999, an option has been given to the states to raise their borrowings by way of competitive auctions

• RBI manages state borrowing programmesRBI manages state borrowing programmes• Sub-sovereign issuances, carries implicit guarantees • The outstanding SDLs increased from 5.9 per cent of GDP (at CMP)

in 2006-07 to 6.6 per cent of GDP in 2008-09.• Number of Securities outstanding as on March 3, 2009 at 1233 (vis a

vis 97 securities of the GoI) • Security-wise outstanding amount ranges from Rs1.5 Crore (7.02%

Tripura SDL 2015) to Rs.4000 crore (7.83% Maharashtra SDL 2019)

State Sponsored Institutions

• State sponsored institutions include state level financial institutions, state sponsored special purpose vehicles (SPVs), and statutory boards p p ( ), ysuch as Water Supply and Sewerage Boards.

• The instruments are usually known in India as “structured obligations(SO)”

Municipal bonds(ULBs)

• Trends towards decentralization and urbanization have necessitated borrowings by municipal corporations

• Municipal bonds have a number of interesting features• Municipal bonds have a number of interesting features. There are two basic types:– General Obligation Bonds: The government’s

taxation authority backs the bond.– Revenue bonds – revenue from a specific project is

used to pay the bonds down– Tax-free bonds

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Municipal issues are in the nature of revenue bonds, with fixed interest rate, with government guarantee, maturity 7-15 years, are in the form of Structured Obligations(SO)

Municipal Bonds

M unic ipa l C o rpo ra t io ns (A mo u nt in C ro re s o f R upe e s )M unic ipalC o rpo ratio n

Iss ueD ate

M aturity(Ye ars)

C o upo n(% )

R ating A ge nc y A m o unt G uar ante e

B ang alo re 1 997 7 1 3 A -(SO ) C R ISIL 1 00 Ye sA hme dabad 1 998 7 1 4 A A -(SO ) C R ISIL 1 00 N oN as hik 1 999 7 1 4.75 A A -(SO ) C R ISIL 1 00 N oL udhaina 1 999 1 0 1 3.5 -14 L A A (SO ) IC R A 1 0 N oN ag pur 2 001 7 1 3.43 L A A -(SO ) IC R A 5 0 N oM adurai 2 001 1 5 1 2.25 L A + (SO ) IC R A 3 0 N oIndo re 2 001 7 1 1.50 - - 1 0 Ye sH yde rabad 2 002 8 .5 7 A A +(SO ) C R ISIL 8 2.5 N o

Municipal Bonds With AMC as an Intermediary

Principal Municipal Interest Bonds

Investors

AMC Guarantee byDFIs/MDBs

Bonds

Principal + Interest

Project Cash Flows

ULBsLoan/Bonds

Escrow Debt Reserve Fund

Corporate SecuritiesCommercial papers, Bonds/NCDs/ABSSecured or unsecured debtEmbedded Options: calls, puts Spread as per ratingsSpread as per ratingsRatings and rating migration Securities other than AAA are classified as non-SLR securitiesCorporate trustee represents bondholdersMay have guarantees(third party’s guarantees)May have debt service reserve fund/Sinking FundCan be asset backed, structured securities

Debt Market: Selected Indicators

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Trading Size Major Players• Issuers (typically Governments, Corporations, Municipalities,

Banks and FIs)• Investors or the buy side institutions

– (banks, financial institutions, Pension Funds, Mutual Funds,Debt Funds, Reserve Bank of India, Insurance Companies,etc )etc. )

• Foreign Institutional Investors• Primary Dealers• Inter-dealer Brokers• Rating Agencies• Reserve Bank of India

G Sec Operations• G-SECs issued by the Order of the President of India

thro the Ministry of Finance(Department of Economic Affairs: Budget Division)

• RBI manages the entire government debt operations at its IDM its IDM

• Both the initial sale of securities and subsequent transfers are handled by the RBI

• Settlement thro a computerized book-entry system called the SGL and constituents SGL Accounts

• Settlement System is Delivery versus payment (DvP)/RTGS with T+0, T+1 as the conditions of deals

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Institutional Arrangements• Regulator

– Government of India (through the Public Debt Act of 1944, replaced with GS Act, 2006) empowers RBI to regulate primary issuance of debt securities, issuance and redemption; Lien/Pledge /Hypothecation, STRIPS

– SEBI regulates primary issuance of debt securities other than government securitiesgovernment securities

• Trading– Direct, Broker driven (OTC markets generally predominate)– Anonymous Order Driven

• Platforms– NDS-OM/NDS-Call/CBLO/CROMS– NDS-OTC

• Clearing & Settlement – CCIL

Organization • Negotiated Dealing System (NDS)

– NDS of RBI provides an electronic platform for negotiating trades in government securities.

• NDS– Order Matching (NDS-OM)– NDS-OM is an electronic, screen based, anonymous, order driven

trading system introduced by RBI as part of the existing NDS system totrading system, introduced by RBI as part of the existing NDS system to facilitate electronic dealing in government securities

• WDM Segment of NSE Trading System– BSE and NSE to have in place for bond trading– NSE’s Wholesale Debt Market (WDM) segment offers a fully automated

screen based trading platform through the NEAT (National Exchange for Automated Trading) system

Trading, Clearing & Settlement System of CCIL

Trading

Pre-Trade

Trade

OrdersManagement

Execution

Settlement

Clearing

Settlement

Pre-Settlement

Clearing

Post-Trade

Post-Settlement

Deal Management

Netting/Exercise/Assignment

Risk Management/Novation

DVP III

AccountManagement

Debt market serves as important conduits for monetary policy • Key route for monetary policy applications• Management of liquidity in the financial markets

– Statutory liquidity requirements for banks and financialinstitutions are met using government securities marketsg g

• Debt markets signal long run prospects of the economy• Signals inflationary expectations, in term structure of interest

rates• Links money markets and foreign exchange markets

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RBI operates both as the monetary authority and the debt manager to the GOI• Debt manager (debt management functions are undertaken at the

IDM cell of the RBI)– Issuer & custodian of government bills and securities– Manages servicing and redemptions

Raises funds on behalf of the state governments– Raises funds on behalf of the state governments• Monetary Authority (monetary policies for price stability and

liquidity management)– Open-market operations (OMO)– Bank rate policy– Repo/Liquidity Adjustment facility (LAF)– Market Stabilization Schemes (MSS de-sequestering recently)

Demand and Supply of G Secs• Long Term Securities

– Budget financing– Redemption

• Short Term SecuritiesShort Term Securities– Treasury Bills, Cash Management bills

• Moderating variables– OMOs, Repos, MSS, LAFs

• Cash management (pattern of taxes/Government expenditures – expenditures are front loaded, whereas tax collections gather

towards year-end

Net Supply of Issuances – 2009-10

(Rs.crore)

Item 2007-08 2008-09 2009-10

Gross Market Borrowings 97,000 106,000 299,000

GOI Borrowings : 1st Half of the FY 2009-10

(Dated securities)

Less : Repayments 30,554 44,028 33 089

Net Market Borrowings 66,446 61,972 265,911

Less : OMO Purchases 0 0 80,000

Less : MSS Unwinding * 0 0 42,000

Add : MSS Issuances (net)* 69,077 5,263 0

Net Supply of Fresh Securities 135,523 67,235 143,911

* Includes dated securities and Treasury Bills

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SEBI regulates corporate debt instruments listed on the stock exchanges.

• All government securities are ‘deemed’ listed as and when they are issued.

• SEBI issues guidelines for corporate debt issuance and also for their listing on stock exchangesalso for their listing on stock exchanges.

• Secondary market trading of corporate bonds are conducted as per the rules set by SEBI

• Privately placed debt paper of banks, institutions and corporates requires an investment grade credit rating to be eligible for listing

www.fimmda.org

• Self regulatory organization• Market follows FIMMDA practices• Valuation methods prescribed for the markets• FIMMDA/PDA/Bloomberg yield curve used by

markets• FIMMDA-CRISIL Spread matrix for corporate bond

pricing• FIMMDA corporate bond valuer

Government Debt Issuance• Half-yearly issuance calendars• Rationalization of Issuance (auction formats, frequency, size of

issuances, allocation among specific instruments, acceptance criteria, etc)

• Development of yield curve, efforts to issue longer maturities 30up to 30 years

• Passive Consolidation ( reissuances/ reopening) Restructuring • Buyback of illiquid securities & reissue of liquid securities

– (reverse auction, switch/swap, secondary market purchase)• Primary Issuance (underwriting commitments from PDs,

liquidity support..)

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Primary Dealers• Primary Dealers are those banks & securities firms that are

approved to transact directly with the Reserve Bank in auctions.• Advantage of primary dealer system is that the Reserve Bank

will be in a position to conduct its auctions efficiently with asmall number of well capitalized institutions.

• Primary dealers are expected toPrimary dealers are expected to– Participate in auctions– Underwrite Auction– Act as "Market Makers”– RBI provides liquidity support (LAF)– PDs have access to the RBI’s open market operations– PDs are permitted to borrow and lend in the money market

A Bank PDs1 Citibank N.A., 2 Standard Chartered Bank 3 Bank of America N.A. 4 J P Morgan Chase Bank, N.A.5 HSBC Bank6 Bank of Baroda 7 Canara Bank

Primary DealersB Stand alone PDs1 IDBI Gilts 2 ICICI Sec P D Ltd. 3 PNB Gilts Ltd. 4 SBI DFHI Ltd 5 STCI PD Ltd 6 ABN AMRO Securities (India) Pvt 7 Deutsche Securities (India) Pvt Ltd7 Canara Bank

8 Kotak Mahindra Bank Ltd. 9 Corporation Bank 10 HDFC Bank

8 DSP Merrill Lynch Securities Trading Ltd 9 Lehman Brothers Securities Pvt.Ltd.

New Issues & Re-issuances• Government maintains large benchmarks in bonds across

maturities, in order to promote market liquidity • Reopen/Reissue an issue in an auction to create

• Adequate availability of benchmark securities– Benchmark issuance focus more on supply of bonds across

maturities– Re-issuance/re-opening be tailored to market liquidity– Lengthening of the maturity helps develop the secondary debt

securities market

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Issuing benchmarks across the yield curveIn the absence of benchmark bonds, market prices may not, therefore,

truly reflect ideal pricesIssue benchmark bonds at the right data points of the yield curve

Secondary Markets• Banks typically hold a substantial portion for bonds,

effectively to maturity, to a smaller extent for short term trading purpose• Large portion of HTM portfolio as against the trading

portfolioportfolio• Contractual saving institutions mainly focus on long term

bonds, buy-hold investors in general• Captive nature of holdings create market distortions in

yield and illiquidity (Pension funds, mutual funds, insurance companies)

• Price discovery processes must be as efficient as possible such that true market prices that accurately reflect conditions in the economy

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Reference Rates

• FIMMDA/NSE MIBOR/MIBID• Call/Repo/CBLO• MIFOR/OIS/IRS• NSE/CCIL ZCYC• NSE/CCIL Bond Index• FIMMDA/CRISIL Spread Matrix• NSE Var

Market Benchmarks

• FIMMDA, PDAI & Bloomberg Prices of GOI Securities FIMMDA Corporate Bond Spread Matrix FIMMDA Corporate Bond Traded Data & Spreads FIMMDA Moneyline Telerate India Commercial Paper FIMMDA y pMoneyline Telerate India Treasury Bill FIMMDA State Loan Calculator FIMMDA NSE MIBID/MIBOR FIMMDA Reuters MIFOR, MIOCS, MIOIS and MITOR

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Corporate Bonds Spreads

Yield Curve

• NSE ZCYC based on NS• CCIL ZCYV based on NSS• FIMMDA/Bloomberg Bootstrappingg pp g

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Yield Curve Stability 2007-09Indian and global marketsDollar Index and Indian rupee

Dollar Index: EUR 57.6%, JPY 13.6%, GBP 11.9%, CAD 9.1%, SEK 4.2%, CHF 3.6%

10-year US treasury and 10-year Indian G-sec

Retail Investors in Debt Markets

• Good avenue for investment• Highest safety• Regular stream of income every six months• Assured yield to maturity if held till redemption)• Assured yield to maturity if held till redemption)• Diversification of risk• Liquidity through trading• Specific debt instruments are available for retail investors

Foreign Issuers in Local Market

• Recent efforts by ADB/WB to issue local currency bond issuance in India

• Such issuances have shown great interest by local investors

• FIIs are allowed to hold government securities

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Reforms• Repos, CLBO, Short sales permitted• When Issued introduced • STRIPs introduced

IRF i d d• IRF introduced• FRAs, Swaps, OIS exist

• Indian debt market is becoming vibrant

Let us see how much you learn by y yreading Indian debt markets