This article explains SEBI’s proposal to regulate online bond trading platforms and the concerns it raises.
Retail investor interest in the Indian equity markets is at an all-time high. During the pandemic, as Nifty and Sensex rallied to reach new peaks, retail investors poured money into everything from blue-chip to penny stocks. But another segment of the capital markets – corporate bonds – has also witnessed phenomenal growth during this period.
Historically, India’s corporate bond market has been relatively underdeveloped. A company can publicly issue bonds through stock exchanges or privately issue them through the Electronic Book Provider Platform. Around 98% bond issuances in India happen through private placement and to institutional investors. Till recently, retail investor participation in the primary and secondary bond market was negligible. However, with the advent of online bond trading platforms, the tide is turning. Since 2020, the number of users has increased 24 times and the value of retail trades has increased 6 times for these platforms. SEBI has been cautiously monitoring this trend and it’s decided to step in before the genie escapes the bottle.
SEBI’s latest consultation paper on regulation of online bond trading platforms proposes four key measures. First, these platforms must register as stockbrokers in the debt segment. Second, trading of bonds must be routed through stock exchanges. Third, bonds of unlisted companies must not be offered to the public. Fourth, a lock-in period of 6 months must be observed from the date of allotment in case of privately placed listed bonds. Because if these bonds are re-sold to more than 200 investors within a short period, it may amount to a deemed public issue.
Industry stakeholders have appreciated SEBI’s attempt to promote orderly growth of the bond market. However, some of the proposals have raised concerns. First, the prohibition on offering unlisted bonds and the 6-month lock-in period for privately placed listed bonds means that only a miniscule portion of bonds will be available to retail investors. Second, the prohibition on offering unlisted bonds may create another grey market for trading of ineligible bonds. A better alternative can be allowing unlisted bonds to be offered through regulated channels with adequate risk disclosures. Third, many bond trading platforms work with clearing corporations and depositories to enable trades. The money paid by investors is deposited in the clearing corporation’s bank account and the bonds are sent to the investors’ demat accounts. In this model where the platform doesn’t handle investor funds, the payment and settlement mechanism may not require tweaking. Fourth, current SEBI regulations prescribe a large lot size of Rs.10 lakh for privately placed bonds. But it’s unclear whether this requirement extends to unlisted bonds. And some platforms let retail investors purchase unlisted bonds in smaller lots. Unfortunately, the consultation paper doesn’t provide clarity about this issue.
Bonds offer a middle path for retail investors who want higher returns than fixed deposits but lower risk than stocks. As the world battles stagflation, they may be the goldilocks solution for investors looking to park their money. And SEBI will have to perform a fine balancing act to ensure both investor protection and a liquid bond market.
(This post has been authored by the fintech team at Ikigai Law.)