Corporate bond market development
The Securities and Exchange Commission (SEC) set up a Corporate Bond
Development Task Force (CBDTF), consisting of a cross section of market
participants, to identify impediments, formulate strategies and an
action plan to develop a vibrant corporate bond market as an initiative
of the Capital Market Development Master Plan. This article presents a
summary of key findings by the CBDTF.
A well developed corporate bond market has a significantly positive
impact on the countryís economic growth and the financial system
stability. It helps firms raise long-term capital at relatively lower
costs and provides investors with long-term investment instruments.
It plays a vital role in risk diversification of the financial
system, through providing a cushion to reduce vulnerability of the
macro-economy to both external and internal shocks.
The corporate bond market in Sri Lanka is relatively underdeveloped
with a total outstanding of Rs. 19 billion listed corporate bonds as at
end 2007, which is about 1.4 per cent and 2.2 per cent of the total
Government bills/bonds (GSs) outstanding and the equity market
capitalisation respectively or 0.5 per cent of the GDP as at the end of
2007. Compared with other Asian countries, the size of the corporate
bond market in Sri Lanka is significantly smaller as shown below.
The issuer and investor bases are very narrow. The secondary market
hardly has any liquidity. There are no active bond traders and market
There is also a sizable unlisted corporate bond market where the
primary market is loosely regulated, whilst the secondary market is not
regulated at all. The lack of a reliable benchmark yield curve, anomaly
in the interest rate structure, coupled with the lack of transparency in
the GSs market are some of the causes for inappropriate pricing of
corporate bonds, resulting in bond financing being relatively more
expensive than bank borrowings.
The lack of general awareness on the corporate bond market, the
limited number of qualified issuers and the current high interest rate
environment also contribute to the lack of supply of corporate bonds.
The limited number of intermediaries engaging in the corporate bond
business, their narrow distribution channels and the underdeveloped unit
trust industry has made it difficult for investors to access the
corporate bond market. Institutional investors such as pension funds and
insurance companies which play a vital role in the development of the
market in other countries do not actively participate in the corporate
bond market. The current high volatility in interest rates, together
with the absence of risk management tools has discouraged investors to
actively trade corporate bonds.
The distorted tax treatment on corporate bonds and the lack of market
transparency have further limited the activities in the secondary
The unregulated, unlisted corporate bond market and the limited role
and responsibility of bond trustees could lead to loss of investor
confidence in the market. The current settlement system has a potential
systemic risk exposure due to the utilising of a single settlement bank.
The widening and broadening of the issuer and investor based are the
first steps for the development of the corporate bond market, which
includes encouraging potential issuers such as SOEs and Public Private
Partnership (PPP) projects to issue bonds, creating a secondary mortgage
market, establishing a reliable benchmark yield, correcting anomaly in
interest rate structure, improving awareness on risk-reward structure,
greater participation of institutional investors and relaxing the
restriction on foreign investor participation.
The market access needs to be improved through enhancing and creating
distribution channels to reach investors, developing the unit trust
industry and improving skills and expertise of intermediaries on
Improving market liquidity and the price discovery mechanism is a key
to developing secondary market activity. This will include enhancing the
market transparency and information availability of GSs and corporate
bonds, developing tools to facilitate the liquidity creation such as
repo and borrowing/lending of corporate bonds, interest rate derivative
instruments and removing the distorted tax treatment of corporate bonds.
Laws and regulations need to be expanded and strengthened to enhance
bond holder protection and create an effective regulatory framework for
the corporate bond market, including expansion of the SECís regulatory
framework to the unlisted securities market and unregulated key
intermediaries in the bond market and a streamlining of the present
regulatory arrangements in the corporate bond market.
Creating a robust depository and settlement system will reduce the
systemic risk, including the mandatory lodging of securities in the CDS,
strengthening the fund settlement mechanism, thereby creating an
efficient depository and settlement system for unlisted bonds as well.
These initiatives have to be supported by a series of awareness
building and education programmes related to fixed income products
targeting issuers, investors, intermediaries, regulators and financial
journalists to improve their financial literacy on debt market products
and develop their technical capacity.