Unlike the snoozy and, these days, buzzing market for stocks, trading corporate bonds in Sri Lanka isn’t for the faint hearted. Since the Central Bank has got a steer on interest rates, before which issuing bonds was virtually impossible, it’s now time to shine a searchlight into the murky world of corporate bonds.
So far, disclosure requirements for equity have been far more stringent than those for corporate bonds. Indeed bond markets are usually far less transparent than stock markets because big institutional investors, who dominate them, don’t need the same hand holding type protection that equity investors do.
Besides the government however, the rest of debt issued here is by unlisted companies with little or no disclosure. There are twin challenges here. Firstly the lack of transparency increases cost to the issuer because investors will demand higher interest to compensate. Secondly investors find it tougher to gauge the actual risk they take because disclosure about the company’s ability to repay is sketchy at best.
Here is possibly where the capital market regulator the Securities and Exchange Commission (SEC) can step in to develop the primary market for corporate bonds. What exists in Sri Lanka today is a grey market where; issuers, who may not have the right credit profile, hide behind sketchy disclosure to raise money through private placement. These transactions lack visibility and transparency, two key ingredients for price discovery in debt markets which are thin margin but volume driven.
Maninda Wickramasinghe of Fitch Ratings Sri Lanka in a report titled “Developing a Corporate Bond Market in Sri Lanka: Medium to Long Term Roadmap” argues for greater regulatory intervention to list all debt issued in the market, forcing issuers into greater disclosure. Listing reduces some risk by providing greater liquidity. He says credit rating agencies can also assist investors understand risks. Listed issues also reduce secondary market risk like settlement failure.
At present, transactions are over the counter (OTC). In the case of large trades transacted via cheque and where default occurs, legal title could already have been transferred. In other words, delivery of the security and payment of cash may not occur at the same time; a systemic risk. That risk can be eliminated using existing infrastructure. Ideally debt securities should be lodged in a central depository system (CDS) argues Wickramasinghe of Fitch, and once connected to the banking system there is a mechanism for price discovery and full visibility of the market.
Price of issuance is typically based on the risk free return and the risk premium of the bond issue. For this to happen, the secondary market must be visible. Secondary markets are viewed as an exit mechanism, and when there is liquidity it leads to a drop in risk premiums. Maintaining a corporate bond market in the grey makes it costlier for issuers as the investor carries the risk of uncertainty.
Wickramasinghe also says a repo market is vital to creating that liquidity and an important prerequisite to developing a secondary corporate bond market. The success of the government bond market is a good example of a repo market that’s created liquidity for those securities. However such units are outside the corporate bond system and need to be brought in.
Sri Lanka introduced primary dealers in the market before India. However Sri Lanka’s early start had little effect on the corporate bond market which has stagnated over the last 10 to 15 years while the bond markets in neighbouring India, for instance, flourished. This is primarily because of inadequate reforms in the market which open the door for secondary market players.
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