Improving The Money Flow By A Liquidity Window
Author: LawSphereX
Category: General Law
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IMPROVING THE MONEY FLOW BY A LIQUIDITY
WINDOW Mr. Shreyanshu Gupta, BA LLB, ILS Law College, Pune Introduction The Securities and Exchange Board of India (SEBI) has unveiled the Liquidity Window Facility1. This innovative facility operates through the stock exchange mechanism and is designed for the betterment of liquidity in debt securities. By doing so, it aims to foster greater investor participation and enhance transparency in the market. This will allow participants to access funds more efficiently, thereby promoting a vibrant trading environment for debt instruments. Keywords: Bond market, Liquidity window facility, Debt Instruments Understanding Bonds as Debt Instruments Bonds are essential debt instruments that provide investors with a fixed interest rate over a specified period, with the principal amount being repaid at a future maturity date and it typically ranges from 5 to 20 years.
Unlike shares, where shareholders own a portion of the company, Debt instrument, bondholders are creditors of the company. This distinction is significant as dividends on shares are distributed at the discretion of the board only in profit fiscal years, while interest payments on bonds are obligatory as they function like a loan for the issuer which increases a sense of security for an investor and could provide a steady stream of revenue especially for retail investors. Need for this Mechanism India’s bond market, valued at approximately $2. 5 trillion2 plays a pivotal role in financing enterprise growth and contributing to overall economic development. Despite its significance,
1 SEBI, Circular No.
SEBI/HO/DDHS/DDHS-PoD-1/P/CIR/2024/141, (16 October 2024)
2https://www. indiabonds. com/bonduni/blogs/size-of-the-indian-bond-market-is-us-2-59-trillion/Shantanu Kurup, Size of the Indian Bond Market is US$ 2. 59 trillion! , (14 June 2024), IndiaBonds the market faces challenges, including a limited investor base and issues with transparency. To unlock the bond market's full potential, it is vital to broaden participation among various investor categories, including retail investors. As one of the key reasons that causes lower retail investor turnout in the bond market is the lack of availability of liquidity and another key factor contributing is the large holdings of institutional investors over such bonds till maturity, all of this has made the market being perceived as illiquid. Thus, there was a need felt to introduce Liquidity Facility for these debt instruments.
Liquidity Window Facility Under this, a framework has been provided to facilitate liquidity window to an investor under which an issuer through use of put options provide liquidity window facility with an aim of investment enhancement of debt securities. In this regard a reference is made to SEBI (Issue and Listing of Non-Convertible Securities) Regulations, which allows an issuer a right to recall or redeem the issued securities before the date of maturity. This right allows redemption of debt securities prior to the date of maturity but such right is subjected to the terms of the issue and there has to be a detailed disclosure about such right in the offer document itself and this also includes specific disclosure on date from which this right is exercisable, the period of time available (which should be atleast three working day) and the amount which can be redeemed.
But such right can only be exercised after expiry of one year from the date of issue. 3 Here, providing of such facility is the choice of the issuer and not mandatorily imposed on them. This facility can only be provided for new issue of debt instruments, meaning it doesn’t affect already issued debt instruments. Key Features • Authorization – Before providing such facility, it is necessary for an issuer to get accessed 29 October 202
3 SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (NCS Regulations), R.15.
approval of the board of directors. • Monitoring committee – the issuer entity has to establish a body which shall overlook and monitor the implementation of this facility, in case of entities with listed specified securities a Stakeholders Relationship Committee (SRC) shall be the monitoring body and in case of only debt listed entities, for whom it is not mandatory to constitute a SRC, its implementation and outcome should be monitored by its Board or such board level committee that the Board may determine. • Eligibility – an Issuer can provide this facility only after expiry of one year from the date of issuance of the securities.
And it is the discretion of the issuer to whom such facility is available, it can either be available to all investors in the debt instruments or only to the retail investors but such eligible investors who are desirous of availing of the liquidity window has to hold the debt securities in demat form. • Aggregate limit – again, it is the discretion of the issuer to decide and specify the percentage of issue which shall be eligible for liquidity window facility, but it should not be less than 10% of the final issue size. • Sub-limit – Issuer shall specify the sub-limit of put options that can be exercised in each liquidity window during the period of this facility. In case the put options exercised by eligible investors exceeds the per window sub-limit, the acceptance of put options from eligible investors shall be on proportionate basis.
• Period of liquidity window – The liquidity window will remain open for three working days. The Issuer may operate the window on a monthly or quarterly basis at its discretion. The schedule for these windows will be disclosed upfront in the offer document. Notification regarding the availability of the liquidity window, including the put option, will be provided via SMS or WhatsApp within five working days from the start of each financial year. This notice will confirm whether the facility will follow a monthly or quarterly schedule for that year and will constitute compliance with Regulation 15(6) of the NCS Regulations. • Valuation – the debt securities shall be evaluated and their value shall be based on ‘T- 1’ day where T is the first day of the liquidity window.
Reporting and disclosure requirement – the issuer within in 3 working days after the closing of the liquidity window shall furnish a report to the stock exchange and also inform the depositories and debenture trustee regarding debt securities to be extinguished. Challenges ahead • Lower Valuation for debt securities – The bond market is viewed as illiquid since various large institutional investors hold bonds till maturity thus limiting secondary market transactions. This causes Low trading volumes and make these securities harder to buy or sell quickly, further increasing risk of price fluctuation, which can lead to lower valuations when these bonds are assessed for the liquidity facility. As a result, lower valuations may reduce investor returns, further diminishing the bond market’s appeal.
• Operational Complexities – Managing periodic liquidity windows, including monitoring eligibility, tendering, and reporting requirements, imposes administrative burdens on issuers. All of this can discourage the issuers in providing such facilities to their investors which can further make this market illiquid. • Disrupting Market Dynamics – Weak market sentiment has potential to trigger a large number of investors to exercise their put options, forcing the issuer to buy back significant amounts of issued bonds. If these bonds cannot be easily resold due to low demand, the resulting excess supply can drive bond prices down, further reducing trading activity. This decline may cause negative sentiment amongst various investors especially retail investors, viewing similar securities as risky, leading to broader market volatility and discouraging future investments in the bond market.
• Resentment amongst investors – Since it is the discretion of the issuer to decide upon the eligibility of investor for accessing this facility, and any excess demand must be managed through proportionate acceptance, investors may feel dissatisfied if they are unable to fully exercise their put options. This can fuel the frustration of the investors potentially eroding investor’s trust and confidence in the facility, further discouraging investment in the bond market.
Impact on issuer’s cash flow – Here Issuers would require to be prepared for potential outflows due to the exercise of put options. This could strain their liquidity management, especially if a significant volume of debt securities is tendered during a liquidity window. Situation is very critical in case of small issuer who has lower cash liquidity. Way Forward The Liquidity Window facility introduces a strategic solution toward the long-standing liquidity issue in the corporate debt market, with a focus benefitting retail investors. However, its success will critically depend on careful navigation over several challenges. The challenge for issuers is how to preserve market integrity but remain operationally flexible and able to handle liquidity demands while managing potential risks associated with asset liability and compliance.
A collaborative approach, including exchanges, depositories, and trustees, is crucial in addressing reporting obligations and maintaining the level of transparency. Periodic changes to the framework would also be inevitable as the market evolves, and these have to be done in ways that maintain investor confidence. Addressing these issues proactively may increase participation, change market sentiment, and provide for a healthy secondary market in debt securities. Conclusion Ultimately, the Liquidity Window Facility has a great potential to unlock significant value in India’s bond market, enhancing market depth and liquidity making it another viable investment option for retail investors, increasing their participation.
With proper implementation, it can create a more dynamic and robust environment for debt trading, benefiting both issuers and investors, and contributing to the overall development of India’s financial markets.