India’s corporate debt market has been lagging behind its global peers in terms of size, depth and liquidity. The COVID-19 pandemic has further exposed the vulnerabilities of the corporate bond market, as many firms faced difficulties in raising funds and refinancing their debt. To address these challenges, the Securities and Exchange Board of India (SEBI) has introduced the Corporate Debt Market Development Fund (CDMDF), a backstop facility for specified debt funds during market dislocations. This article will explain the features, benefits and challenges of the CDMDF, and compare it with similar funds in other countries.

What is the CDMDF?

The CDMDF is a fund set up by SEBI in the form of an Alternative Investment Fund (AIF) with an initial corpus of Rs 3,000 crore (about $400 million). The fund will be managed by a professional fund manager appointed by SEBI, and will invest in investment-grade corporate debt securities with a residual maturity of up to one year. The fund will act as a buyer of last resort for these securities in times of stress, when there is a lack of liquidity or demand in the secondary market. The fund will also provide liquidity support to specified debt funds, which are mutual funds that invest at least 65% of their assets in corporate bonds. The fund will charge a fee for its services, and will aim to earn a positive return over its benchmark.

The CDMDF is envisaged as a temporary measure to prevent financial crisis and instill confidence among the participants in the corporate debt market. It is not intended to bail out defaulting issuers or investors, or to distort market prices or incentives. The fund will operate within a well-defined framework of eligibility criteria, investment limits, valuation norms, exit options and governance structure.

Why is the CDMDF needed?

The CDMDF is needed to address some of the structural and cyclical issues that hamper the development and functioning of India’s corporate debt market. Some of these issues are:

• Low participation: India’s corporate debt market is dominated by banks, insurance companies and provident funds, which have a preference for long-term and highly rated bonds. Other institutional investors, such as mutual funds, pension funds and foreign portfolio investors, have a relatively low share in the market. Retail investors are almost absent from the market, due to lack of awareness, access and incentives.
• Low issuance: India’s corporate bond issuance is concentrated among a few large and well-established firms, mostly from the public sector or the financial sector. Small and medium enterprises (SMEs) face difficulties in accessing the bond market, due to high costs, stringent regulations and low credit ratings. The bond market also lacks diversity in terms of sectors, maturities and instruments.
• Low liquidity: India’s corporate bond market suffers from low trading volumes, wide bid-ask spreads and high transaction costs. The secondary market is largely driven by buy-and-hold investors, who have little incentive to trade frequently or offer liquidity to others. The market also lacks adequate infrastructure, such as trading platforms, clearing and settlement systems, reporting mechanisms and credit enhancement facilities.

The COVID-19 pandemic has exacerbated these issues, as many firms faced liquidity crunches, rating downgrades and defaults amid the economic slowdown. The mutual fund industry also witnessed large-scale redemptions, especially from credit risk funds that invest in lower-rated bonds. This created a vicious cycle of falling prices, rising yields and lower demand for corporate bonds.

The CDMDF aims to break this cycle by providing liquidity support to the market participants during times of stress. By acting as a buyer of last resort for investment-grade bonds with short-term maturity, the fund can help stabilize prices, reduce yields and improve demand for corporate bonds. By providing liquidity support to specified debt funds, the fund can help prevent fire sales, contagion effects and systemic risks in the mutual fund industry.

What are the benefits of the CDMDF?

The CDMDF can have several benefits for India’s economy and financial system. Some of these benefits are:

• Enhancing financial stability: The CDMDF can help mitigate the risks of financial crisis and contagion arising from liquidity shocks in the corporate debt market. By providing a safety net for investors and issuers during times of stress, the fund can reduce panic selling, default cascades and systemic spillovers.
• Supporting economic recovery: The CDMDF can help support the economic recovery from the COVID-19 pandemic by facilitating the flow of credit to productive sectors. By lowering borrowing costs and improving access to finance for firms, especially SMEs, the fund can stimulate investment, employment and growth.
• Developing corporate debt market: The CDMDF can help develop India’s corporate debt market by increasing its size, depth and liquidity. By creating more demand for corporate bonds, especially from lower-rated and shorter-term issuers, the fund can encourage more issuance and diversification in the market. By enhancing market confidence and transparency, the fund can attract more participation from institutional and retail investors, both domestic and foreign.

What are the challenges of the CDMDF?

The CDMDF is not without its challenges and limitations. Some of these challenges are:

• Operational risks: The CDMDF will face operational risks related to its fund management, investment decisions, valuation methods, exit strategies and governance structure. The fund will have to balance its objectives of providing liquidity support and earning a positive return, while avoiding moral hazard and market distortion. The fund will also have to ensure adequate risk management, compliance and reporting systems.
• Regulatory coordination: The CDMDF will require coordination and cooperation among various regulators, such as SEBI, RBI, IRDAI and PFRDA, as well as other stakeholders, such as issuers, investors, intermediaries and rating agencies. The fund will have to align its operations with the existing regulatory frameworks and market practices, while also addressing any gaps or inconsistencies that may arise.
• Market development: The CDMDF is not a substitute for structural reforms and policy measures that are needed to develop India’s corporate debt market. The fund is only a temporary and contingent facility that can address some of the cyclical issues in the market. To address the structural issues, such as low participation, low issuance and low liquidity, the government and regulators will have to implement various reforms, such as simplifying regulations, enhancing infrastructure, improving disclosure, promoting credit enhancement, incentivizing retail participation and fostering market culture.

How does the CDMDF compare with similar funds in other countries?

The CDMDF is not a unique or novel idea. Several countries have established or considered similar funds to support their corporate debt markets during times of stress. Some of these funds are:

• US Federal Reserve’s Secondary Market Corporate Credit Facility (SMCCF): This facility was launched in March 2020 as part of the Fed’s response to the COVID-19 pandemic. The facility was authorized to purchase up to $250 billion of corporate bonds and exchange-traded funds (ETFs) in the secondary market. The facility aimed to improve market functioning and availability of credit for large employers. The facility stopped purchasing assets in December 2020 and started unwinding its holdings in June 2021.
• European Central Bank’s Corporate Sector Purchase Programme (CSPP): This programme was launched in June 2016 as part of the ECB’s asset purchase programme (APP). The programme was authorized to purchase investment-grade corporate bonds issued by non-bank corporations in the euro area. The programme aimed to enhance the transmission of monetary policy, ease financing conditions and stimulate credit creation. The programme was expanded in March 2020 as part of the ECB’s pandemic emergency purchase programme (PEPP). As of November 2021, the programme had purchased about €300 billion of corporate bonds.
• UK Bank of England’s Corporate Bond Purchase Scheme (CBPS): This scheme was launched in August 2016 as part of the Bank’s quantitative easing programme. The scheme was authorized to purchase up to £10 billion of sterling-denominated corporate bonds issued by non-financial firms that make a material contribution to the UK economy. The scheme aimed to lower borrowing costs for firms and stimulate economic activity. The scheme was expanded in March 2020 as part of the Bank’s response to the COVID-19 pandemic. As of November 2021, the scheme had purchased about £20 billion of corporate bonds.
• Japan Bank of Japan’s Corporate Bond Purchase Programme (CBPP): This programme was launched in December 2008 as part of the Bank’s comprehensive monetary easing policy. The programme was authorized to purchase up to ¥3 trillion of corporate bonds with a residual maturity of up to three years issued by non-financial firms. The programme aimed to improve corporate financing conditions and support economic activity. The programme was expanded several times over the years, most recently in March 2020 as part of the Bank’s response to the COVID-19 pandemic. As of November 2021, the programme had purchased about ¥5 trillion of corporate bonds.

These funds differ from India’s CDMDF in terms of their size, scope, duration and objectives. However, they share some common features, such as being set up by central banks or securities regulators, investing in investment-grade corporate bonds or ETFs, acting as backstop facilities during times of stress, charging fees for their services and aiming to earn positive returns over their benchmarks.

To conclude, India’s CDMDF is a welcome step towards enhancing financial stability, supporting economic recovery and developing corporate debt market. The fund can provide liquidity support to the market participants during times of stress and improve market confidence and transparency. However, the fund also faces operational risks, regulatory coordination challenges and market development limitations. Therefore, the fund should be implemented carefully and complemented by structural reforms and policy measures that can address the underlying issues in India’s corporate debt market.