Debt Market

Developing the corporate debt market.

An accountant cum tax consultant and an economist speaking at different fora where this reporter was also present spoke about the country’s private sector or corporate bond market.
Dr. Koshy Mathai, IMF’s Resident Representative in Sri Lanka  addressing a recent seminar organized by the Federation of Chambers of Commerce & Industry of Sri Lanka said that Sri Lanka’s listed debt market is Rs. 30 billion and unlisted also of the same value, cumulatively taking up the local debt market to 1% of GDP.
In contrast Malaysia’s corporate bond market is valued at between 40-50% of its GDP.
Mathai further said that borrowing from the corporate debt market is cheaper than borrowing from the traditional banking system.
He however stopped short of giving any suggestions, concrete or otherwise, as to what sort of steps the island should take to develop its corporate or company debt market.
“Causes and effects or effects and causes” as to what ails the country’s corporate debt market and how it may be developed were however not brought to the table by Mathai. But N.R. Gajendran, Senior Partner, Gajma & Company, addressing a seminar on taxation recently insinuated that the 10% upfront withholding tax (WHT)  charge on interest payable on company debt debentures was a constraint in attracting investors and the development of the island’s corporate debt market as a result (see last week’s The Sunday Leader Economy page).
The long and the short for the need  of the requirement of this upfront payment of WHT is because the Government is broke. It cannot wait for maturity of such bonds to collect this payment. It’s the same story in regard to Treasury (T) Bills and T Bonds, where the investor has to pay upfront the WHT.
As a result no WHT is payable in secondary market trading of both Government securities as well as private bonds.
At face value, paying WHT on interest even before such interest is remitted to the holders of such debt instruments or has matured appears to be bad in law; eroding the issuer’s debt capital even before it could be ploughed back to use in its totality, thereby seemingly negating the very purpose of raising capital by such an issue.
If the issue is Rs. one billion at 10% interest, then 10% WHT on interest works out to Rs. 10 million or 1% of the issue. That may be how the authorities are looking at this subject and therefore feel that the issuer can bear this upfront payment.
However paying Rs. 10 million upfront and paying Rs. 10 million on a staggered basis or at full maturity are two different things. For one thing if it’s staggered, the issuer has at least part of that money that may be made used by him to work for him, instead of having to make payment upfront in its totality, though however small that upfront payment may look like.
Paying such charges upfront may mean that the issuer of such debentures may also have to factor in such costs prior to the issuance of corporate debt, thereby inflating his expenses. However if the WHT was remitted at maturity, probably by then the issuer would have had been able to make his debt work for him, thereby being able to recover his WHT cost at the time of making remittance.
Granted, that the person ultimately liable by such payments is the holder of such debt who sees his interest income being depreciated by 10%; but then, if such payments have to be made upfront, prior to the maturity of such debt, the immediate hit may have to be borne by the issuer and not the holder of such debt.
In general, debenture interest payments are staggered. As such if the WHT payments were also allowed to follow suit, then such payments will also have to be made on a staggered basis, thereby causing a lesser of a  financial burden on the issuer than if he were to make that payment upfront.
Modify the WHT laws on corporate debt interest payments to be more democratic, ie payment at the point of maturity, similar to interest payments; whether that will help or not help the development of the corporate debt market is a different matter, but doing that which is right, because it is right, may prove to be a dividend to the Government in the long term.

Stability

Another article carried in last week’s “Economy” page of this newspaper, referred to 10 of the 28 stock broking houses in the island, or a third of such brokering houses, not meeting the regulator’s new criterion to qualify to be a dispenser of broker credit, by failing to be holders of net liquid assets, which in turn could be offered as such credit.
This then poses the question as to how stable the bourse is to meet its market obligations if 10 of the island’s 28 stock broking houses, leave alone not meeting the criterion to be eligible to provide broker credit, but in another dimension, what sort of systemic risk they pose to the stock market itself by being holders of such dubious baggage?
Such illiquid broking houses may be having bank credit lines to provide them with sustenance to meet their market obligations and other, but are those alone sufficient to ensure market stability?
That may be an issue that will need the regulator’s urgent attention. A possible way out may be to introduce capital adequacy ratios (CARs) to such market players based on the “buy” transactions they execute on behalf of their investors to ensure a degree of stability in the market. Banks have to maintain minimum CARs on their lending, why not also broking houses on the “buy” transactions they execute? It may be for the greater good of the industry if the Securities and Exchange Commission gives thought to such matters.