This article has been written by Vandna Kumari Chouhan, pursuing a Diploma in Corporate Law & Practice: Transactions, Governance and Disputes from LawSikho and edited by Shashwat Kaushik.

It has been published by Rachit Garg.

Introduction

In a technology driven world, it is crucial to have legislation that checks and balances the efficient functioning of online financial transactions. Financial service providers are one of the top money makers in India. When we talk about the financial market, we can see an accelerated hike in institutional and retail investors in the country. As fintech companies grow, regulation has become the government’s foremost concern.

Download Now

One such concern is online bond trading platforms (OBPs), as there is a rapid increase in the number of investors, especially non- institutional investors, in bond trading platforms. Additionally, these platforms are not registered with any regulator; hence, they do not fall under SEBI’s regulatory purview. In a tech-savvy world, a number of OBPs have shot up in the last 2-3 years post pandemic, which sell debt securities and the process of buying is similar to the functioning of the stock exchange market.

To deal with this scenario and the problems that have arisen or may arise in the future, the Securities and Exchange Board of India (SEBI) proposed a regulatory framework that was needed for the working of bond trading platforms and the protection of investors who may fall prey to online fraud.

Background

The bond trading platform in India is governed by SEBI. SEBI received its legislative powers in 1992 from the Securities and Exchange Board of India Act, 1992.

The board meeting held on June 29, 2021, led to major changes in the regulation of the Indian bond market. SEBI unified the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 and the SEBI (Non-Convertible Redeemable Preference Shares) Regulations, 2013 into a single regulation, the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021.

The SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021, were the beginning of the regulatory framework, and a set of new rules were introduced in terms of the bond market. There was also the introduction of many more rules through the Consultation Paper on Online Bond Trading Platforms on July 21, 2022, by the Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities) Regulations, 2021 [Amendment on November 2022].

In this article, we are going to discuss this regulatory framework, the conditions that led to these new regulations and their impact in the short and long term.

What is a bond

In layman’s language, a ‘bond’ is the proof of the debt taken and issued by organisations to the buyer or investor of the bond. The bond in India is usually issued by institutions, i.e., governments or corporations.

Bonds are recognised as securities under Section 2 (i) of the Securities Contract (Regulation) Act, 1956. Bonds have a definite maturity date, which is usually a longer period. A bond is a type of debt securities that involves relatively lower risk and is a long term investment as compared to stocks. In most cases, bond providers are the same as stock providers. This is because both stocks and bonds are issued by corporations. The face value is paid back to the lender by the issuer. 

Types of bonds

There are different kinds of bonds that are traded in the Indian market. There are separate categories of foreign bonds. But in this article, we are concerned with the bonds that are primarily categorised into four types. These are as follows:

  1. Corporate Bonds : These categories of bonds are issued by companies to investors.  They are relatively riskier than government bonds but give higher yield depending on growth of company and the terms and conditions of bond.
  2. Government Bonds: These are securities issued by the central,state, local or municipal governments at various points in time. They possess taxes imposed by the government, which can be increased based on circumstances. These bonds are safe as the government repays the face value of the bond at maturity and in lump sums.
  3. Agency Bonds: As the name suggests, the issuer of bond in this case is an agency (enterprise) acting on behalf of the government. These are some of the safest investments and are often compared with Treasury bonds.
  4. Municipal Bonds: These are bonds issued by municipalities or states to fulfil  responsibilities on a day to day basis. Generally, these are free from federal tax. These are issued for infrastructure and other kinds of projects that the government is planning to start.

What is online bond platform provider

Regulation 51A of SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (NCS Regulations), inter-alia, defines “online bond platform provider” as ‘any person operating or providing an online bond platform’ and “online bond platform” as ‘any electronic system, other than a recognised stock exchange or an electronic book provider platform, on which the debt securities which are listed or proposed to be listed are offered and transacted.’

  • Just like in stock, there are providers like Grow, Zerodha and other fintech companies that offer the platform to buy and sell shares to investors. A bond trading platform provider also gives investors and institutions a platform to buy and sell bonds. As we have discussed above, bonds are debt securities issued by the government or corporations. An OBP must also be a SEBI registered institution.
  • OBPPs are operators, providing investors with opportunity to engage in bond trading and offering a number of options to invest in. Additionally, they create awareness about the kinds of bonds available to invest, provide information about the risks and profits involved in investing and explain the consequences of the actions taken by investors on these platforms.
  • Today, investors have access to a wide selection of bonds and can browse through their details, credit ratings, interest rates, maturities, and offer documents. They can evaluate the risk-return profiles of various bonds and compare them, enabling them to make wise investment decisions.
  • Usually, bond trading platforms are either backed by stock brokers or are the same. SEBI, in its consultation paper issued in July 2022, discussed that in the previous few years there has been a rapid increase in online bond trading platform providers and a lot of money has been transacted through them, which is not regulated by any government authority or enactment.
  • In short, online bond platform providers operate electronic systems for “offering or transacting” listed or proposed-to-be-listed debt instruments.

SEBI’s regulatory framework for bond trading platform

Absence of legislation for regulation

Before 2021, the bond trading platform was governed by the SEBI (Non-Convertible Redeemable Preference Shares) Regulations, 2013, which were also for the governance of stock and other debt securities exchanges. Hence, new legislation was needed that mandated the registration of these bond platforms. As a result, the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021, were introduced and consequently amended in November 2022.

Standard requirements on Know Your Customer (KYC) provisions

KYC in the financial industry is the common procedure that a financial institute has to go through before issuing debt securities. The motto behind the process is to prevent crimes like money laundering, fraud, etc., which are there. Verification is very much needed; hence, SEBI introduced the regulation that before bond trading, the OBPs must go through the procedure and establish the relationship between broker, borrower and provider. The KYC process ensures that there is no fraud and the government can even opt for the history of money transacted by the customer, hence monitoring the trading platforms.

Uncertainty in redressing investor grievances

When carrying out online bond transactions, there is a need to deal with the problems that are faced by investors in an effective manner. This was missing in the previous framework so SEBI introduced the investor grievances redressal mechanism’. Now the Bond platforms should mandatorily provide for solutions and must take steps to deal with the issues within one month’s time frame. An online bond platform provider must receive SCORES accreditation and set up a clear procedure for handling any complaints that may or are likely to emerge while operating an online bond platform, as determined by SEBI.

No supervision on product offerings and information

As there was no compulsory registration of online bond trading platforms, there was a lot of confusion and different kinds of information regarding bonds, like the kinds of bonds and whether they were listed or unlisted. The sellers were taking advantage of the scenario by providing the listed and unlisted debt securities both on the same platform and in the same section of the website. This gave tremendous powers to the brokers, which would lead to fraud or other kinds of financial crimes due to less obligation on the provider’s part. This was one of the major concerns of the SEBI and steps had to be taken in this framework to protect the buyer.

Possible mis-selling by issuer

We know the Latin phrase ‘Caveat emptor,’ which means “let the buyer beware.” Its significance  is that an individual buys at their own risk. This is one of the fundamentals of the bond trading market but this does not relax any obligation on the seller’s part. When there is no legislation governing a transaction or market, there are a number of problems that may lead to Mis-selling. Here, online bond traders were free to sell any bond according to their will without any specific provisions; hence, they were prone to exercising misleading practises.

Concerns regarding deemed public issuances

According to SEBI’s board, issuing securities to more than 49 but no more than 200 people in a fiscal year would be considered a deemed public offering, and companies/promoters would be required to offer investors an exit option at a price that is 15% higher than the subscription amount in order to avoid penalties. Many bond trading platforms keep listed and non-listed bonds on the same page, and there are no restrictions on the trading of bonds or their extent. There is a high possibility that companies may sell their bonds through private placement and since there is no regulation on limits, it might lead to deemed public issuance.

Monitoring of  bond trading platforms

Even though OBPs give investors, especially non-institutional investors, a way to enter the bond market, their operations are not subject to SEBI’s supervision.  There is a need to set up balances and checks because the bond market has a great deal of room for growth, especially in the non-institutional space. These checks and balances should take the form of operational transparency, disclosures to investors dealing with these OBPs, actions to reduce payment and settlement risk, the availability of redress mechanisms in the event of complaints, and more. The use of names that are similar to those of the Online Bond Platform Provider for unregulated activities is prohibited, and limitations must be included for goods that are subject to laws.

In order to guarantee the long-term expansion and success of India’s bond market, SEBI implemented a regulatory framework in November 2022 that included OBPPs. This action was intended to safeguard investor interests and build systemic trust, laying the groundwork for the market’s growth.

Major changes introduced by SEBI for OBPPs

Mandatory registration

The bond trading platforms should register themselves as stock brokers (debt segment) with  SEBI under the SEBI (Stock Broker) Regulations, 1992. This would lead to in-built trust in OBPs by non-institutional investors, as now they will be regulated by SEBI. Among other advantages, it mandates that these bond platforms be registered as stock brokers, causing the transactions to be routed through the trading platforms of the exchanges. OBPs must be incorporated under the Companies Act, 2013.

Advantages

Registration of OBPs as a separate class of Intermediary

Any entity wishing to run an OBP must submit an application to SEBI for the issuance of a certificate of registration. The aforementioned registration certificate will be eligible for renewal under certain terms and conditions outlined in the regulations after a three-year period of validity.

 An exit opportunity for investors

With the regulated bond trading opportunity, investors can easily sell their bonds and equity stakes and have a history of transactions with SEBI. Registration will lead to easy monitoring of bond trading through fintech companies in the market.

 A risk management and surveillance mechanism

With steps like risk management policies, disclosure requirements, provisions pertaining to mitigation of conflict of interest, data governance norms, a code of conduct, reporting and monitoring overall, there will be the establishment of a surveillance mechanism by SEBI and enhanced interest of the investors in the market.

Concerns

Differences in functions of OBPPs and stock brokers

Bond platforms strive to give investors a way to find, evaluate, and invest in debt securities as opposed to stock brokers, who operate as the investor’s agent and keep their funds as well as provide margin funding. Registration of stock brokers and bond trading platforms within the same legislation might create confusion and inconvenience on the part of platform providers.

Difference in Revenue model of OBPPs and Stock Brokers

While stock brokers make money through commissions on trades, margin funding, and other expenses, bond platforms often make money through fees from bond sellers, spreads on bonds, revenue shares, or commissions from bond sellers.

 Complexity in Compliance formalities

Stock brokers and OBPPs operate very differently. Since many of the SEBI’s (1992) regulations are irrelevant to how online bond platforms operate, they are not subject to the same compliance requirements as stock brokers. This would lead to a lot of complexity.

Trading eligible securities only

SEBI suggests that only listed debt will be eligible securities and would qualify for subscription using a bond platform. Currently, only 200 potential allottees can be selected for a private placement of bonds under the Companies Act. By exceeding this limit, the private placement becomes considered a public issuance (“DPI”), giving rise to further DPI-related requirements in the Companies Act and its rules. A DPI was automatically created when unlisted bonds issued through private placement were made available for investment on bond platforms, according to SEBI, since some bonds were sold to more than 200 investors, in violation of DPI rules. In order to reduce the risk of a DPI, particularly where bonds are involved.

Many suggested that there should be trading of unlisted debt securities too but SEBI said that permitting unlisted debt will enable companies to skip the registration formalities and mixing of listed and unlisted debt securities. Further, there will be a false notion that unlisted securities are also regulated by SEBI.

Lock-in period for the eligible securities

Listed debt securities issued on a private placement basis and offered for sale on bond platforms shall be locked-in for a period of six months from the date of allotment of such debt securities by the issuer.

SEBI suggested The listing of securities issued through a private placement would be accompanied by disclosures made by the issuing company in accordance with the ILNCS Regulations of 2021 and the LODR Regulations of 2015. This would prevent any circumvention of important public issue requirements. As a result, the Companies Act of 2013’s presumed public issue rules may not be broken by offering listed debt securities issued on a private placement basis on online bond platforms within six months of the date of their allocation.

Transactions through either exchange trading platform (ETP), the debt segment or Request for Quote Platform (RFQ)

The OBP transactions must go through either the RFQ platform of the stock exchanges or the trading platform of the debt portion of the exchanges, where they will be cleared and settled on a Delivery Versus Payment (DVP-1) basis. The RFQ platform was created as a “participant-only” approach that only institutional investors could use. 

Further, in order to engage in any activity or to offer products, securities, or services (including the offering of unlisted securities) that are not regulated by a financial sector regulator such as SEBI, RBI, IRDAI, or PFRDA, a holding company, subsidiary, or associate of an online bond platform provider, as well as any third party, are prohibited from doing so.

Investors grievance redress mechanism

An online bond platform provider must get SCORES accreditation and set up a clear procedure for handling any complaints that might come up or are likely to come up while operating the online bond platform, as the board may from time to time specify. Within one month of the date of the complaint’s receipt, the provider of the online bond platform is required to take appropriate action to address the investors’ complaints. Consequently, the OBPPs must receive the SCORES registration. This will open the door for complaints by investors in the event of a default by the government.

Net-worth criteria requirement

In order to be eligible for registration under these regulations, an entity must have a net worth of at least Rs. 5 crore (five crore only), of which at least 25% must be kept in liquid marketable securities. This minimum net worth requirement must be maintained at all times.

Advertisement code

For online bond platforms, a provision for the advertisement of qualified securities has been made.

Issuance of deal sheet and order receipt

When an order is executed, the provider of an online bond platform must immediately send a deal sheet for all transactions to its users and investors. This deal sheet must include information like the date and time of the order, the date and time of the settlement, the quantity and amount transacted, etc. On receiving an order from a user or investor, an online bond platform provider is required to immediately send the user or investor an order receipt that includes information such as the date and time of the order, the number and amount that were transacted, etc.

Issues with the framework

Issues with the framework are:

  • As the proposals by SEBI are new, there are some issues that should be considered in order to establish the framework without any bugs. Several regulations that were in existence earlier, such as the SEBI (Merchant Banker) Regulations, 1992, SEBI (Investment Advisers) Regulations, 2013, and the SEBI (Research Analysts) Regulations, 2014 are not taken into account  in the recent laws. These are the enactments that also mandate compulsory registration in order to be a broker or merchant and bond trading platforms could have been brought under these acts.
  • Nevertheless, putting out such a proposal without also changing other existing rules that might apply to bond platforms could cause problems with how the legislation is interpreted and used.
  • Another issue is mixing stock broker registration with that of bond traders. Although it is agreed that most of the bond trading platforms are backed by stock brokers, both of them operating with the same registration might lead to confusion and result in frustration over the separate regulation. 
  • Although it is recognised that the regulator intends to increase confidence and control risks, the minimum transaction size limit may prevent ultra-retailers from participating in the market. There has to be more clarity on  how individual investors who invest less than Rs 2 lakh will participate in the market.
  • According to the new regulation, only eligible securities, i.e., listed debt securities, need to be traded. But listed securities already have a market; it is the unlisted securities that lack liquidity. The very purpose of the OBPs will be in danger with imposition of such restrictions. This may completely end the market for trading in unlisted debt securities.

In the end, SEBI is a really efficient body and several measures will be taken in order to address and provide solutions to these issues. One of the industries with the most regulations worldwide is the finance sector. As a result, as fintech companies grow, regulation has become the government’s top worry. Companies in the finance sector have increased financial inclusion and reduced operating expenses by utilising fintech. Fintech finance is expanding, but there are regulatory issues. In this scenario, this framework was much needed  and the steps taken by SEBI are really crucial to the effective functioning of the market.

Impact of the framework

Impact of the framework:

  1. As this framework is new, it is really early to give any judgement on its impact. However, there are really good changes made that would lead to the structuring of online bond platform providers and their regularisation by the government.
  2. This approach also expands investment exit options for listed debt securities, which is likely to enhance secondary market price discovery.
  3. A law will not only guarantee that bond platforms are developed and that retail investor engagement is encouraged, but it will also strike a balance between the protection of potential consumers and the expansion of the debt market at a rate comparable to that of the digital economy.
  4. Small and Non-institutional investors are highly impacted by this framework, that has imposed mandatory registration, minimum face value, incorporation of company, stock broker backed investors, etc.
  5. Additionally, there is no explanation as to unlisted debt securities and their trading, as it won’t be allowed on online bond trading platforms. SEBI has refused to take into account ‘unlisted debt securities’ under its purview.

Conclusion

The limitations on product offers, divestiture requirements, and authorizations for offering particular securities on online bond platforms are described in SEBI’s Regulatory Framework for Bond Trading Platform. At times, people will be required to abide by the registration requirements set forth by SEBI. The entity would be responsible for ensuring that the minimal disclosure standards were met. Additionally, it would be required to disclose on its platform any and all potential conflicts of interest resulting from its dealings or transactions with connected parties. The Framework emphasises that OBPPs must abide by the prohibitions on selling goods or providing services other than listed debt securities and debt securities that are being proposed for listing through a public offering. It places a strong emphasis on the need to post warnings for regulated products and the restriction against using names that sound like those of the Online Bond Platform Provider for illegal activities.

However, the framework has faced many oppositions and SEBI has dealt with many of those problems that were put forward by the public. There are a lot of unresolved issues, like ‘unlisted debt securities’, that need to be addressed by SEBI.

References

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.

LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join:

https://t.me/lawyerscommunity

Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.

RELATED ARTICLESMORE FROM AUTHOR

LEAVE A REPLY

Please enter your comment!
Please enter your name here