Around the world, there are two primary channels for companies to raise capital and secure future financial support. These are debt capital markets and equity capital markets. Of these, equity capital markets or ECMs mostly hog business headlines globally because they are the platforms for high-value IPOs and high-profile investment banking.
But Debt Capital Markets or DCMs are no laggards. They are a combination of investment banking on a limited scale and sales or trading of bonds. This is an avenue which most companies use when they are desperately short on funds and need an immediate influx of liquidity.
Such companies trade debt securities, including government and corporate bonds, to raise capital. It must be noted that these business entities have to pay interest on these securities since they are essentially ‘borrowing’ capital from the market.
One great advantage that debt capital markets have over ECMs is that using the DCM route ensures that there is no decline in stockholdings or any decrease in ownership.
A debt capital market is one of 2 major economic avenues which are used by both governments and privately-held companies to raise funds via the trading of government and corporate bonds, debt securities, and other financial instruments with short-term maturities. Only syndicated investment-grade bonds are traded in such markets.
Worldwide, DCMs are perceived as “higher volume but lower margins” businesses. Hence, ECMs are much more in demand than DCMs.
However, when markets are down, most companies usually turn automatically to debt markets. In a bear economy, for example, DCMs will have considerably larger transactions than ECMs. That can be ascribed to the risk-averse nature of major players in ECMs; however, there is no lack of prospective investors in debt markets who will purchase bonds at lower prices and then resell them when economic conditions stabilise.
In the United States of America, all DCMs abide by regulations laid down by their SEC. In India, the debt market works as per rules set down by the RBI and the SEBI.
The following institutions are eligible to issue securities for varying periods –
The next segment is directly connected to this one as it provides investors and market watchers a chance to gauge our country’s economy.
Until about a year ago, there was a remarkable disinterest among investors and institutions vis-a-vis India’s DCM. However, with the downfall of major players like IL&FS and DHFL, and the consequent erosion of the value of their securities, debt markets are once again witnessing activity.
With India’s capital markets, its DCMs have fared poorly. It remains a largely skewed market with a handful of major players showing any interest in issuing bonds. One major problem with DCMs in India is bilaterally-priced trades which discourages retail and institutional investors.
According to figures made available by the Reserve Bank of India, India’s domestic corporate bond market constitutes a mere 16% of the country’s GDP. These figures are higher in developed nations- for example, in South Korea; it is more than 70%.
This is where leveraged debt capital markets come in. It is not very different from the standard debt capital market, except that it deals in sub-par or ‘risky’ bonds.
There are 3 globally accepted credit rating agencies – Moody’s Investor Service and its competitor, Standard and Poor’s S&P Global Ratings. The third is Fitch Ratings. These firms assess the viability of bonds and securities, chances of default and its future prospects.
In leveraged DCMs, most issuances traded are “below-investment-grade” or with credit ratings of Ba1 or BB+. While they are below-par when compared to bonds and securities traded in debt capital markets, they have one significant advantage – their resale value might increase quickly if some extraneous and unforeseen event occurs.
It is why leveraged bonds are also sometimes called ‘leveraged loans.’
In India, there are several assets which do not have top-notch credit ratings of AAA etc. While some PSUs do have high-rated assets, they also enjoy sovereign or Governmental backing.
Luckily, the state of debt capital markets may change for the better in the near future. Before the pandemic hit, economic indicators of all sorts had one thing in common – that India’s growth rate was slowing down.
The Government at the Centre and States has already announced massive packages to kickstart the economy. But for these stimuli to work on the ground, the country’s debt markets have to provide enough liquidity.
The RBI and SEBI have taken several steps in the right direction. The RBI’s IBC, a slew of bond market policies added by SEBI’s think-tanks to extant laws and the ‘large borrower framework’ will all play significant parts in reviving debt markets.
Several experts and economists have stated that RBI’s liquidity infusion has helped most NBFCs overcome their financial woes. These experts believe that within 2 to 4 years, DCMs will overtake ECMs.
The Bottomline
Debt capital markets worldwide are experiencing serious liquidity challenges. Already, many European countries have been forced to ask for a second round of shutdowns as the pandemic refuses to die down. The global market is waiting for a vaccine; until then, most fund-raising will happen via DCMs.
While there are risks involved in DCMs- including credit, interest and settlement risks- it is safe to assume that most countries will assume a bullish stance on their respective DCMs. India, for one, is certainly betting that its domestic DCM will fare a lot better by the 2nd quarter of FY 2020-’21.