SEBI wakes up early to the wild west of bond market

A clutch of online bond platforms floated by fintechs are showing the way of how to turn boring and safe fixed income investments into one that promises high returns. But financial engineering taken too far oftentimes begets trouble and the capital markets regulator has decided to act fast. The Securities Exchange Board of India (SEBI) has floated a consultation paper that seeks to bring online bond platforms under its purview.

The paper has flagged concerns that bond platforms are functioning in a regulatory vacuum, have no standardised know-your-customer processes, and clubbing listed and unlisted bonds together which may muddle the risk perception of investors. “There is a concern that such high yield securities may be relatively lower rated securities and investors may fall prey to mis-selling of such offerings, due to lack of appropriate product disclosures, which may not be commensurate with the investor’s risk appetite,” the paper said.

SEBI’s fears are not unfounded and a lot depends now on how quickly the suggestions of the paper become rules. SEBI has given market participants three weeks to give comments and suggestions. “There are some fintechs that are selling risky and low-rated bonds to retail investors who do not understand the underlying risks. This is a good move to weed out non-serious players in the retail bond market,” said Ajay Manglunia, MD & Head Investment Grade Group, JM Financial Products Ltd. The brokerage firm also has its own bond platform called Bondskart. “Our platform gives only safe and high-rated bonds to retail investors,” he said, adding that the trading volume on the platform has increased in a measured way and not aggressively.

Big boys' market

The corporate bond market is largely institutional even today and most of the deals are struck through private placements. Last year, roughly Rs 6 lakh crore worth of bonds were privately placed through bilateral deals between issuers and potential investors. With the introduction of the electronic bidding platform, issuers now invite bids from investors although the process is still akin to private placement. Public issuance of bonds is considered a costlier affair and less than one percent of the total issuance is through this route.

Retail participation in the bond market is limited in India with even sovereign bonds finding few takers on the newly minted retail platform of the Reserve Bank of India (RBI). Retail holding of debt is largely through mutual funds and direct purchase of bonds is minimal. Lack of awareness and cumbersome processes have rendered bonds unsavoury for retail investors. Fintechs are changing this through their online platforms where choosing and investing have become easy. That said, understanding the instrument and awareness still remains rather thin. “In India, fixed income is synonymous with bank deposits or debt funds. Even HNIs do not understand a bond nor they track the market as actively as the stock market is tracked,” said a dealer at a large bond house requesting anonymity.

The minimum investment lot size is Rs 10 lakh in private placement of bonds while the retail investor’s appetite may not be more than a few thousand rupees. This is where fintech companies have stepped in. Platforms that offer bonds to investors can do so in two ways. One is to host issuers and allow investors to purchase bonds as per their risk appetite and return expectations. Another way is to purchase bonds through private placement on their books and then chop these into small lot sizes to down sell to retail investors. It is this process that has come under scrutiny from the SEBI. The regulator has proposed that bonds once bought need to be held at least six months before selling them down on the platforms.

The disruptors

Over the past two years, several online bond platforms have mushroomed, offering retail investors a slice of an otherwise predominantly institutional corporate bond market. Low fixed deposit rates and a lack of safe investments that offer reasonable returns have meant that retail investors have begun participating on these bond platforms.

SEBI’s paper highlights seven bond platforms, out of which the regulator got data on transactions conducted from two of the platforms. Findings show that in FY22, the volume of transactions has tripled on these platforms. The number of registered users who have transacted on the platforms more than doubled during the said period. This is an accurate snapshot of a fast-growing online fixed income trading and investing market that needs regulatory oversight.

Moreover, unlikely public bond issues and those on electronic biding platform of exchanges, these online bond platforms do not route their transactions through the exchanges. SEBI believes that since these platforms act as brokers by bringing issuer and investor together, they need to be registered and adhere to regulations that govern a broker.

To be sure, the trading value isn’t large, especially compared with a mammoth institutional market. That said, the main worry is mis-selling as bonds have not been a popular investment among individuals for decades now. According to bond book managers, fintechs are offering low-rated corporate paper and in some cases structured deals to retail investors without adequate disclosures. A promise of high returns without full disclosure of risks associated will lead to losses. What is more worrying is that there is no established redressal mechanism for investors.

A long-drawn negative real interest rates cycle, volatile stock markets and high inflation have lured individuals into corporate bonds. The ease of investment offered by the online platforms has made adoption easy. Regulators need to ensure that retail investors are not misled or duped into burning their fingers.