SEBI’s New Push for a Smarter Bond Market

The Securities and Exchange Board of India (SEBI) plans to launch a pilot project for bond tokenisation while introducing measures to simplify Foreign Portfolio Investor (FPI) onboarding. The initiatives aim to improve efficiency, transparency, accessibility and investor protection in the debt market.

Bond Tokenisation: Concept and Significance

·       Bond tokenisation involves converting a conventional bond into digital tokens recorded on a blockchain or distributed ledger.

·       Each token can represent a fractional interest in the underlying bond, allowing investors to participate with smaller amounts while receiving proportional interest and principal repayments.

·       Unlike conventional bond transactions that involve multiple intermediaries for issuance, settlement and custody, tokenised bonds can enable digital issuance, trading and settlement through a shared ledger.

·       This could make corporate bonds more accessible to retail investors by reducing the high-ticket-size barrier traditionally associated with the corporate bond market.

Why Is SEBI Testing Tokenised Bonds?

SEBI intends to examine whether a shared ledger can facilitate the simultaneous transfer of securities and funds. The pilot is expected to assess:

• Faster and more efficient settlement
• Reduction in reconciliation and operational costs
• Greater transparency in ownership and transactions
• Automated coupon payments and other bond-servicing activities through smart contracts
• Possibilities for reducing dependence on multiple intermediaries

Corporate bonds currently follow a T+2 settlement cycle. Blockchain-based systems could potentially enable near real-time settlement, thereby reducing the period during which counterparty and settlement risks arise.

Potential Advantages for Investors and Markets

• Fractional ownership can lower the entry barrier for retail investors.
• Immutable transaction records can improve transparency and traceability.
• Faster settlement can release capital more quickly.
• Smart contracts can automate coupon payments and redemption-related processes.
• Reduced reconciliation requirements can improve operational efficiency.

Challenges Before Large-Scale Adoption

• Cryptographic vulnerability: Advances in quantum computing could eventually threaten the cryptographic systems used to secure blockchain-based records.
• Interoperability: Linking blockchain infrastructure with existing depositories and legacy systems remains a major technological challenge.
• Regulatory uncertainty: Clear rules are still required regarding ownership, investor rights, dispute resolution and protection in tokenised securities.
• Liquidity risk: A new tokenised bond market may initially have limited secondary-market depth, making it easier to buy than sell.

Other SEBI Measures to Strengthen the Debt Market

SEBI is simultaneously working on additional reforms to improve investor protection and expand corporate bond distribution.

Credit Risk-o-Meter

SEBI is consulting on a standardised, colour-coded Credit Risk-o-Meter for debt securities.

• It will be linked to existing credit-rating symbols.
• It will appear in offer documents and on platforms distributing the securities.
• It will be accompanied by the credit rating and the name of the credit-rating agency.
• The objective is to make credit risk easier for investors to understand.

Fixed Income Channel Partners

SEBI is also preparing a framework for fixed income channel partners, broadly similar to mutual fund distributors.

• Partners will help expand the distribution of corporate bonds.
• Certification will be provided through the National Institute of Securities Markets (NISM).
• They will not handle client funds or securities.
• They will not charge investors separately.
• The framework seeks to widen market access while maintaining investor safeguards.

Simplifying Foreign Investor Entry

·       SEBI has also eased the onboarding process for Foreign Portfolio Investors (FPIs) by permitting them to submit a digitally signed Power of Attorney to their custodians.

·       A Power of Attorney allows a custodian to act on behalf of an FPI in relation to its investments.

·       The new arrangement removes the requirement for notarisation, apostillisation or consularisation of the PoA. This is expected to reduce documentation and processing time for foreign investors.

·       The measure builds on earlier efforts such as the common application form for FPI registration, aimed at simplifying compliance requirements.

Significance for India’s Financial Market

SEBI’s measures represent a broader attempt to modernise India’s debt-market infrastructure through technology and regulatory simplification. Bond tokenisation could potentially improve settlement efficiency and widen access, while the Risk-o-Meter, channel-partner framework and simplified FPI onboarding seek to improve investor participation and protection.

Together, these reforms aim to create a corporate bond market that is more accessible, transparent, technology-enabled and efficient.