How Sebi’s liquidity window may help investors sell bonds

The Securities and Exchange Board of India (Sebi) has introduced a three-day liquidity window facility to encourage retail participation in the corporate bond market.

In a 16 October circular, the market regulator said it would allow bond issuers to give investors voluntary put options to sell bonds back at specific intervals before maturity.

A put option will give investors the right but not the obligation to sell the bond back to the issuer during the liquidity window.

According to Sebi, India’s corporate bond market is perceived to be illiquid due to low levels of secondary market transactions, as large institutional investors hold them to maturity.

The liquidity window, it said, would help change that perception.

How will it work?

Let’s say there’s a bond with a 10-year tenure and a 9.5% coupon rate. Considering fixed deposits currently offer a return of 6% per annum, investing in the bond is certainly far more tempting.

But there are no free lunches in the financial markets. The trade-off is that the company might default, and the investor may not get back their money. This is also known as default risk in the bond market. The other prominent risk is that the investor might not be able to sell the bond before 10 years because of a lack of interest in the bond.

Sebi’s liquidity window aims to reduce the second risk.

The issuer can now offer to buy back a specific number of bonds at certain intervals before the maturity.

The issuer must offer to buy back at least 10% of the total issue size, but they can do so only after 12 months of the issuance.

The issuer can further specify how much they will buy back during each liquidity window if they have offered more than one liquidity window.

To be sure, it’s up to the issuer whether to provide investors with the option of a liquidity window.

The price at which the company will buy back the bonds will depend on the value of the bond just before the liquidity window opens. So, if a company offers to buy back some of the bonds in year 2 and keeps the liquidity window between 1st and 3rd April, then the value of the bonds as of 31 March (T-1) will be taken. The valuation will be done according to Sebi calculation per Chapter 9: Valuation of Master circular for mutual funds dated 27 June 2024.

Also, the issuer cannot buy back the bonds at a discount of more than 1%. So, if a bond is valued at ₹98, the issuer has to pay the seller at least ₹97.2.

The issuer has the choice of how much they want to commit to buying back through the liquidity window and at what intervals. It may be offered quarterly or monthly.

If more people seek to sell their bonds than the set limit, the issuer will accept bonds on a proportionate basis. Further, the amount would be paid one day after the liquidity window closes.

“The true effects of this policy will only be seen in a year’s time, but what it does is provide more confidence to retail investors, which in turn will create more confidence in new/growth stage issuers,” said Vishal Goenka, co-founder of IndiaBonds, a Sebi-registered online bond platform.

What will the issuer do with the bought-back bonds?

The issuer can do these things with the bonds within 45 days of the closure of the liquidity window:

1. Sell such debt securities on exchanges’ debt segment

2. Sell such debt securities directly on an RFQ platform if the issuer is eligible to access the RFQ platform

3. Sell such debt securities through an online bond platform

4. Extinguish such debt securities

Investors have to wait and watch how this mechanism will work when it becomes operational. For now, this is Sebi’s one step further in deepening the country’s corporate bond market.