Digital Gray Area: Fixed Income, Online
By Sandeep Parek
The past few years have seen rapid digitalization and a significant increase in internet usage, which has prompted investors to become more tech-savvy. Coupled with long periods of modest returns on traditional investment methods, this has led to a substantial increase in the number of investors trading on online bond platforms. Currently, these platforms are not subject to any sector regulator. As a result, there is ambiguity about several aspects of their operation. In this regard, a consultation paper was launched by Sebi in July setting out the key features of these bond platforms and a proposed framework to regulate them. As evidenced by the empirical data provided in the paper, debt securities offered on online bond platforms have become very popular among non-institutional investors. Therefore, there is a need to regulate these platforms to ensure fair gaming and efficient operation.
The document proposes to limit these bond platforms to listed bonds only. In India, listed securities can be publicly issued or privately placed for a nominal value of Rs 10 lakh or more. Thus, retail investors have limited options as they can hardly access listed securities placed on exchanges. This leaves them with only two title options, viz. listed securities placed on the stock exchange and unlisted securities. From the data reflected in the document, it can be deduced that public issues represent around 2% of the debt market. Even in this framework, it is only the top quality companies that would opt for a public offering.
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Naturally, retail investors will not be able to access much of the segment, representing almost 98% of the debt market. In addition to the continuing problem of the narrowness of the scope of “eligible securities”, the high ticket size prescribed for privately placed bonds raises concerns that it could lead to market inaccessibility. To alleviate these problems, a plausible solution would be to broaden the definition of “eligible securities” to also include unlisted securities. In addition, the minimum ticket size prescribed for privately placed bonds should be removed or reduced to Rs 1,000, similar to public issues.
The proposed rules further suggest that bond platforms should register as securities dealers with Sebi and be governed by securities dealer regulations since they facilitate the purchase of debt securities. Sebi seeks to gain investor confidence by treating online bond trading platforms as registered intermediaries.
However, while some aspects of these platforms may be similar to stockbrokers, their operations are more akin to those of a stock exchange. Since brokerage regulations were never written with the intention of regulating online bond platforms, a more prudent solution would be to regulate these platforms in a separate framework detailing their permitted operations. Alternatively, if Sebi chooses to regulate these platforms as part of brokerage, the best way to do so would be to put in place relevant adjustments and exemptions that meet the characteristics of these platforms to ensure efficient trading.
The document also proposes a blocking period of six months from the date of allocation, in which a privately placed bond cannot be introduced on the platform.
The underlying intention behind this was to ensure that these platforms do not breach the standards of “deemed public issue” under the Companies Act 2013. However, the document further states that bond platforms are required to obtain a license as a securities dealer and to use the mechanism. of the stock exchange for their transactions. It is argued that this restriction does not apply to exchanges and therefore should not be extended to bond platforms. As regards the concern that the offer could be interpreted as a “deemed public issue”, it can be argued that once the securities are issued, they are freely transferable and only if the issuer itself even makes offers that it can be construed as a “deemed public issue broadcast”. Generally, the objective of the regulator is to provide a framework to regulate transactions via bond trading platforms; however, in doing so, regulation should not run the risk of being rigid. Thus, in order to facilitate unqualified trading on the bond platform, it is suggested that the six-month blocking period requirement be removed, or alternatively reduced to a one-month period to ensure that said requirement is just at the platforms.
The proposed rules, if implemented, would not only facilitate efficient trading, but also, at the same time, ensure that strong standards of investor protection are in place. Better investor protection can be achieved by putting in place a due diligence protection framework to verify that the right products are made available to retail investors. Defined measures such as a mandatory risk meter that provides a graphical representation of the risks carried by a bond, as well as insurance cover that provides some coverage in the event of a default on the platform can go a long way in significantly reducing the risks involved. .
Additionally, imposing disclosures, disclaimers and awareness programs on platforms will ensure that investors are informed of the risks and expected returns of investments.
Currently, there is no certainty or consistency in how these platforms handle investor grievances. In this regard, the consultation document aims to put in place a grievance framework that will meet the needs of investors by answering their questions, resolving complaints and providing the arbitration mechanism for the resolution of disputes. However, in doing so, Sebi must ensure that there are adequate mechanisms to also address grievances arising from unlisted securities. While these may or may not fall within Sebi’s purview, creating a framework of best practices would create a baseline for everyone’s expectations of minimum rules of conduct.
The proposed framework is becoming increasingly relevant at a time when the Indian securities market has seen an increase in the number of online bond platforms. Since these platforms are currently unregulated, the suggestions offered in the consultation document are welcome. That being said, regulations adopted in this regard should generally aim to facilitate transactions for platforms and investors. In a farsighted view, the market will function efficiently and prosper only if it is comfortably regulated, so that all parties can access it easily and fairly.
The author is Managing Partner, Finsec Law Advisors
(Co-authored with Navneeta Shankar and Lipika Vinjamuri, Partners, Finsec Law Advisors)