SEBI Releases New Norms for Muni Bonds

SEBI Releases New Norms for Muni Bonds

Good alternative investment opportunity for conservative investment experts and investors is just around the corner. In a boost to the government’s “Smart Cities” program, the Securities and Exchange Board of India/SEBI has on Tuesday, 30th December 2014 issued a new set of norms for listing as well as trading of municipal bonds on the stock exchanges.

SEBI Proposes New Norms

For helping the GoI Smart Cities Programme, SEBI has put forth a new set of norms for listing as well as trading municipal bonds on stock exchanges, apart from channelising household investments for development of urban infrastructure. Issuance of draft regulations for these type of municipal bonds has been carried out by the regulatory authority. SEBI has also stated that issuing authorities would contribute close to 20% of the total project cost for which funds need to be raised.

Municipal authorities also need to have excellent financial track records and a minimum sustained performance of at least 3 years. “Conservative Indian investor mainly invests in fixed deposits, small saving schemes or gold. Bonds issued by municipalities having good financial track record would be an good alternative investment opportunity for such conservative investors, as it provides reasonable return with less risk, which in turn may accelerate the capital markets,” SEBI has indicated in a statement.

All About the Money: Muni Bonds

Muni bonds are extremely popular for those who want their money to grow. Investors in developed nations including the US have made significant investments in this type of bond. This is the preferred avenue for household savings in many nations. If the prime objective is the preservation of capital through generation of a tax less income stream, municipal bonds are an excellent option. Muni bonds are debt obligations issued by governmental entities. While purchasing municipal bonds, money is loaned to the issuer in exchange for established interest payments over a preset period. At the end of this period, the bond reaches a maturity date and the complete investment originally made is returned to the investor.

Municipal bonds can be obtained in taxable and tax exempt formats and the latter are preferred because they generate investment exempt from federal as well as state and local income taxes. Investors who are subject to the alternative minimum tax or AMT should include interest income from certain municipal bonds while engaged in calculation of tax. There are two types of municipal bonds.

Ammunition for Growth

Capital market regulatory SEBI has indicated that municipal bonds will add to instruments wherein provident funds, pension funds and insurance companies can place their money here. Though various municipal authorities in the country have issued these bonds, total funds raised by them is pegged at INR 1353 crore only. The municipal corporation of Bangalore was the firs to issue a municipal bond of INR 125 crore with a State guarantee in the year 1997. Access to the capital market began in January 1998 when the AMC or Ahmedabad Municipal Corporation issued the first municipal bonds in the nation without any guarantee from the State government for the financing of infrastructure projects in the city.

So far, no provision has been made for the listing and trading of muni bonds on stock exchanges but this is set to change. According to the guidelines of the Urban Development Ministry, bonds carrying interest rate of a maximum of 8% per annum can be eligible for notification as tax free bonds. SEBI’s corporate bonds and securitisation advisory committee are of the view that the fixed rate of 8% may not attract investors. More flexibility is needed in establishment of interest rate cap through linkages to a benchmark rate, according to a concept paper. As per the proposed norms, those municipal authorities which have negative net worth and defaulted from payment to financial institutions will not be allowed to issue the bonds.

Corporate municipal entities or directors restrained or prohibited by SEBI will also lack eligibility. As per the draft regulations, lowest subscription limit should not be below 75% of the issue size. Following non receipt of minimal subscription, application money received in the public issue must then be refunded to applicants within 12 days from closure of the issue.

Delay by the issuer in making a refund will cause the subscription amount with 10% interest rate per annum for the delayed period to be given. SEBI has also said the following “An issuer, proposing to issue debt securities shall maintain 100 per cent asset cover sufficient to discharge the principal amount at all times for the debt securities issued.”

“Therefore, to meet their financing needs, the municipalities have to seek recourse to other means including issuance of municipal bonds,” the SEBI paper also said.