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Removing barriers to a vibrant bond market

Asjadul Kibria | November 08, 2019 00:00:00

A working committee formed by the government few months back prepared a report titled 'Comprehensive framework on the development of bond market in Bangladesh.' Three dozens of recommendations were placed in the report to develop both the government and corporate bond markets.

Despite being an essential part of capital market, bond or debt market is almost invisible in the country while equity market, popularly known as stock or share market, is also weak. Interestingly, almost all the components of a debt market exist in the country. Over the years, a number of measures have also been taken to crate enabling environment for a vibrant bond market. But most of the measures were focused on government bonds, also termed as fixed income securities.

GOVERNMENT BONDS: The main problems identified by the working committee regarding the government bonds are: lack of proper cash forecasting, failure to maintain auction calendar, higher yield rates of national savings certificates, lack of adequate instrument balance, large number of outstanding securities in the market, lack of benchmark securities and absence of secondary yield curve.

To resolve the problems, the working committee report recommended a series of steps and also mentioned the name of implementation agencies to do the works. It strongly suggested that the Finance Division of the ministry of Finance 'should establish a central IT-based cash management cell, where all the stakeholders (different line ministries) could input their expenditure and revenue plans periodically.' It also suggested introduction of half-yearly basis or medium-term auction calendar for treasury bills and treasury bonds.

Two critical steps have also been recommended to deal with market distortion originating from national savings certificates. These are: limiting sales of savings certificates to a targeted group like senior citizens and low income people; and setting the yield rates of savings certificates in line with treasury bills and bonds. Currently, yield rate of 5-year t-bond is 8.0 per cent where the yield rates of 3-year and 5-year savings certificates are 11.04 per cent and 11.28 per cent respectively.

The recommendation in the report to reduce the number of outstanding government securities, currently 274, is worth considering. By raising the upper limit of each International Securities Identification Number (ISIN) and introducing buyback programme, it may be possible to reduce the number.

Introducing or identifying benchmark securities and developing yield curve are two essential things for any vibrant bond market. Generally, securities traded more frequently are considered benchmark bonds. By definition: 'A benchmark bond is a bond that provides a standard against which the performance of other bonds can be measured.' In most financial markets, government bonds are generally used as benchmark bonds for corporate bonds. Again, a number government bonds may also be used as benchmark securities for all the government bonds. In India there is a benchmark bond which is issued by the central government with a residual maturity of 10 years.

The next issue dealt with in the report is yield curve or secondary market yield curve. Currently, Bangladesh Bank constructs primary yield curve which is used by different market players. But due to low secondary trading of government securities, the secondary yield curve is still at an experimental stage. Secondary transaction of government securities stood at Tk 183.09 billion in the past fiscal year (FY19) which was Tk 153.34 billion in FY18.

The working committee, however, suggested publishing both the yield curves regularly and also 'check whether the already developed secondary market yield curve fulfils the international standards.'

CORPORATE BONDS: Corporate bonds mean debt securities issued by corporate entities to secure capital from the financial market. The working committee report mentioned that during 1988-2019, only three corporate bonds and 14 debentures were issued by public offerings and listed with the stock exchange. Those debentures not only failed to attract the investors and also failed to repay the principal amounts. Some of these bonds and debentures were partially convertible to common stocks.

The report identified a series of barriers to develop corporate bond market. Main barriers include: prolonged approval period, one-shot issuance, absence of secondary yield curve, lack of Special Purpose Vehicle (SPV), tax disincentives to the issuers and investors and high cost related to issuance and secondary trading.

Currently, consent from Bangladesh Securities and Exchange Commission (BSEC) is mandatory for the issuance of any kind of corporate bond. For banks and financial institutions, additional requirement is 'no ojection' from Bangladesh Bank. For private placement, seven working days is the maximum time limit to get approval from BSEC subject to application in compliance. The report did not mention the time limit for approval of bond for public issuance. Thus it is not clear how prolonged approval period effects issuance of tradable corporate bond.

As in government bonds, there is no yield curve for corporate bonds and the central bank needs to take care. There is also shortage of SPV, also called a special purpose entity (SPE), which is 'a subsidiary created by a parent company to isolate financial risk.' Though a legal framework is there to run an SPV, the working committee thought that regulations need to be clarified whether bonds, issued by a pass-through SPV under the Trust Act, would be subject to nominal stamp duty only and the SPV would be a non-taxable entity.

Tax disincentive to issuers and investors is a big barrier to the expansion of corporate bond. There are: 0.10 per cent tax on transaction, 10.0 per cent tax at source on coupon, 10.0 per cent tax on capital gain. There is also stamp duty of two percentage points on the notional value of bonds. Again only zero-coupon bonds are tax-exempted applicable for retail and corporate investors, not for institutional investors. The working committee rightly suggested removing stamp duty and reducing other taxes and fees. Exempting tax on capital gain from equity or stock trading and 10.0 per cent tax on capital gain from bond are highly discriminatory.

There are other barriers including absence of a separate trading platform for fixed-income securities; non-existence of legal framework for local and international guarantors; limited confidence among the investors in relation to the credit rating agencies; and absence of debt instruments issued by different government bodies.

PATH AHEAD: Without a sound debt and equity market, it is not possible to develop a strong and resilient financial market. Bond market helps to deal with risk-managements in a better way. It provides both short and long-term financing at lower cost to the investors and also reduces reliance on banks. In Bangladesh, it will help those who want to park money into low-risk securities. As the economy is growing at a faster rate, increasing number of people and institutions need better and diversified options to invest their surplus income. Active bond market will also help to check capital flight. Finally it makes the financial market more competitive by generating market-based interest rates.

The measures recommended in the report are not entirely new. Policymakers need to review the recommendations and devise a strategy towards bringing vibrancy and diversification in the bond market.

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