Debt Instruments and Government Securities — the ground floor

Debt is a promise with a deadline

A Debt Security is a written agreement to repay a loan, usually with interest, within a given time frame. The workbook also calls it a Debt Instrument — the two words mean the same thing here.

Depending on tenure, interest rate or who issued it, debt instruments split into bonds, debentures, commercial paper, government securities, treasury bills and more. Those in turn break down further: subordinate bonds, floating rate bonds/debentures, deep discount bonds, secured and unsecured debentures, zero coupon bonds, variable coupon rate bonds.

Who issues what matters:

• Financial institutions and corporate bodies issue bonds, debentures and commercial paper
• Governments — State or Central — issue government securities

What makes one debt instrument different from another is its features: the coupon/interest rate, the redemption/maturity date, whether it is secured or unsecured, and the put/call option if any. An Issuer may issue multiple debt instruments by varying the features of the instruments.

And here is the rule that matters most for a DP: any type of debt instrument can be admitted in the depository system. Bonds, debentures, commercial paper, certificates of deposit — irrespective of whether they are listed, unlisted, privately placed or even issued to a single holder — can be dematerialised.

How the system tells one bond from another

Two devices do this work: the ISIN and the descriptor.

Each debt security is given a unique identification in the depository system, which is linked to the special features of the security, through an ISIN and a descriptor. The description of each instrument is communicated to all DPs and Issuers/RTAs through circulars and reports.

The instrument descriptor indicates five things:

The workbook's worked example is worth reading slowly, because the exam can ask you to decode one:

ICICI BANK LIMITED SR-B98 14.25 UMD 14FB05 FVRS1LAC

• Issuer Name: ICICI Bank Limited
• Coupon Rate: 14.25%
• Instrument Name: Series B98 UMD
• Redemption date: 14/02/2005
• Face Value: ₹1,00,000

In addition, the depository forwards the complete details of the instrument to all Depository Participants vide circulars.

Getting a debt instrument admitted

An Issuer who wants demat facility for its debt instruments sends a request to the depositories detailing the type of instrument, along with a Letter of Intent.

On receipt, one of two agreements is signed:

• A tripartite agreement — between the depository, the Issuer and the Registrar & Transfer Agent
• A bipartite agreement — between the depository and the Issuer

Once admitted, these securities are made available for dematerialisation by the depository.

Debt works like equity, with one difference

The manner of operation of a debt instrument in the depository is identical to that followed for the equity segment. The only difference is that a debt instrument has a limited life.

That single difference generates most of the special handling. Four features follow from it.

Identification of the right ISIN. Two debt instruments can have exactly the same features and still be different securities. They are differentiated by a different coupon rate, or redemption date, or put/call exercise date, or interest payment schedule, or by being secured versus unsecured. Pick the wrong ISIN on a demat or remat request and you have processed a different bond entirely.

Letters of Allotment versus Debenture Certificates. On issue of secured debentures, the Issuer initially allots a Letter of Allotment (LOA) till the charges are created. On creation of the charge, debenture certificates are issued in lieu of the LOA. The depository allots an ISIN to the LOA, and on creation of the charge, the nomenclature of the ISIN of the LOA is changed to that of a debenture.

The workbook's example of that rename:

Note what survives: the same ISIN, now carrying a note of the period during which it was an LOA.

Time value of money. Debt instruments bear interest. Receiving the credit of a debt instrument into a demat account a day earlier will result in earning one day's interest. Therefore the execution date is crucial while executing any transfer instruction for a debt instrument. In equity a day's slippage is an inconvenience; in debt it is money.

Redemption date. On redemption, the ISIN associated with the instrument is de-activated in the depository system. The security does not linger — it is switched off.

Allotment, interest and options

Any new instrument can be issued directly in dematerialised form. Securities are directly credited into the accounts of the investor by the depository on receipt of allotment details from the Issuer or the Registrar & Transfer Agent.

Interest payment for debt instruments is handled in the same way as corporate benefits are handled for equity. The Issuer, through its RTA, either:

• credits the interest or redemption proceeds directly into the bank account of the investor, based on the bank details linked with the demat account at the time of payment; or
• sends an interest warrant directly to the investor, at the address details provided in the demat account

That phrase "at the time of payment" is the practical warning to give clients: an address or bank change made after the record date will not help.

Call and put options are simply early exits:

Exercising a call or put option only prepones the redemption date of an instrument. And if a company exercises a call option, the procedure followed is the same as one followed in normal redemption — on fulfilling the prescribed procedure, the Issuer through its RTA pays the redemption proceeds to the investor directly.

Do you need a separate demat account for debt?

No. The depositories have no restriction on existing accounts being used for demat of debt instruments. It depends upon the convenience of investors whether they want to open a separate account for debt instruments.

The procedure for dematerialisation of a debt instrument is the same as that for equity shares. The investor opens an account with a DP, fills a Dematerialisation Request Form (DRF) available with the DP, and submits it with the physical certificates. Before the certificates are handed over to the DP for demat, the investor must ensure they are marked "submitted for dematerialisation".

And one point that catches people out: a DP does not provide a separate Transaction Statement for debt instruments. A single transaction statement reflects all the holdings and transactions in a particular account, irrespective of the type of instrument.

Certificate of Deposit — the ₹1 lakh instrument

The minimum size to be subscribed or transacted by an investor through the depository system is ₹1 lakh. The investor has the choice of holding a CD in a separate account or all its holdings in one account.

Dematerialisation. Currently, Certificates of Deposit are issued only in dematerialised form with depositories. The procedure is identical to that followed for direct credit of equity shares during an IPO, bonus or rights issue — the investor simply provides the demat account number along with the DP ID to the Issuer.

Settlement. The seller authorises its DP through Delivery Instructions to debit his account and transfer the security into the account of the buyer, who may hold an account with the same DP or any other DP. The buyer receives the securities immediately if he has given a one-time standing instruction to his DP. Settlement of funds between the parties is settled outside the depository.

Redemption. CDs are extinguished directly from the beneficial owner accounts of investors through corporate action for the purpose of redemption.

The rule that made all this mandatory: as per the RBI Monetary and Credit Policy of 2002-03, effective June 30, 2002, banks and FIs are required to issue CDs only in the dematerialised form.

Commercial Paper — the ₹5 lakh instrument, counted in units

An investor can subscribe to a minimum of ₹5,00,000 or multiples thereof, as the face value of a Commercial Paper in the depository system is taken as ₹5,00,000.

Then comes the twist that generates arithmetic questions: the securities (CP) will be credited in the investor's account in terms of units. The workbook's own example — if the investor invests ₹5 crore in a CP issue, then 100 units will be credited to his account.

So the unit count is always investment ÷ ₹5,00,000. As with CDs, the investor has the choice of holding Commercial Paper in a separate account or all its holdings in one account.

Dematerialisation — and the Issuing & Paying Agent. CP demat introduces a party who appears nowhere else in this chapter:

1. Allotment of Commercial Paper can be made directly in dematerialised form with the Depositories
2. Investors provide the demat account number along with the DP ID to the Issuer
3. The Issuer provides these details to the Issuing & Paying Agent (IPA)
4. On the date of allotment, the IPA provides the IPA certificate and also shares a file containing details of the investors, including demat account number and quantity of CPs to be credited
5. Based on the details received from the IPA, the Issuer provides relevant documents to the depositories and initiates the corporate action through its RTA to credit the CPs directly into the demat accounts of the investors

Settlement. Buyer and seller decide upon price and quantity. The seller authorises its DP through delivery instructions to debit his account and transfer the securities into the account of the buyer, who may hold an account with the same or any other DP. The buyer receives the securities immediately if he has provided a standing instruction to his DP. Settlement of funds is between the parties and is as per their mutual convenience.

Redemption. Under the RBI Commercial Paper Directions, 2017, issued by RBI on August 10, 2017 and the Operational guidelines on Commercial Paper issued by FIMMDA (Fixed Income Money Market and Derivatives Association of India) on October 5, 2017, the old redemption route was abolished. Investors are no longer required to transfer commercial paper held in their beneficial owner accounts to the IPA's Redemption account. Commercial Papers are extinguished directly from the beneficial owner accounts of investors through corporate action for the purpose of redemption.

One duty in the secondary market: for all secondary market transactions, the seller will forward the copy of the IPA certificate to the buyer.

And the demat mandate: as per the RBI Monetary and Credit Policy 2001-02, effective June 30, 2001, banks, financial institutions (FIs), primary dealers (PDs) and satellite dealers (SDs) are permitted to make fresh investments and hold CP only in dematerialised form, and outstanding investments in scrip form were also to be converted into demat by October 2001.

Finally, the general rule that saves a lot of memorisation: for any buying or selling of demat debt instruments, the procedures involved for delivery or receipt of debt instruments are the same as those involved for equity shares.

Government Securities — a different world with RBI at the centre

Government securities means securities created and issued by the Central Government or a State Government for the purpose of raising a public loan.

There are various types of Government Securities issued by RBI. This includes Dated Securities, Treasury Bills, Sovereign Gold Bonds, Floating Rate Bonds, Inflation Indexed Bonds and others.

The maturity split is the single most-asked fact in this section:

All the activities relating to the issue of government securities — issue management, settlement of trade, distribution of interest and redemption — are handled by the Reserve Bank of India through its Public Debt Office (PDO). Not SEBI. Not the depository. RBI.

Although only corporate and institutional investors subscribe to government securities, individual investors have also been permitted to subscribe to these securities.

SGL: Primary and Secondary

An investor in government securities has the option to have securities issued either in physical form or in book-entry form (commonly known as SGL form). There are two types of SGL facilities, viz., Primary SGL and Secondary SGL.

That last line is the mechanism worth holding on to. RBI sees one lump sum. The entity offering the facility keeps the client-level breakdown.

Where the depository fits

The depositories in India have been given permission to maintain Constituent SGL accounts of investors through their DPs. And the convenience that follows is real: any client account opened with a DP may be used for dealing in government securities. Thus, equity shares, mutual fund units and G-Secs can be dealt with through a single account.

Government securities, like other securities, may be held either in physical form or as electronic entries in an SGL account. They come into the depository system in three ways:

1. On account of dematerialisation of physical securities
2. On account of transfer from SGL accounts maintained by other eligible entities
3. On fresh issue of securities in dematerialised form

Dematerialising a physical G-Sec certificate

Physical G-Sec certificates are registered in the name of the holder with any one of the PDOs of RBI. Two hard restrictions apply at the counter:

• The DP will accept a request for dematerialisation from registered holders only
• Requests for partial dematerialisation of a certificate are not entertained

The client submits the DRF for G-Secs (DRF-GS) with:

1. Physical certificates of securities to be dematerialised
2. The Form of Transfer — the RBI prescribed form to effect transfer of securities held in physical form. The DP ensures it is printed on a single sheet of semi security paper, and the form can be obtained from the concerned depository through e-mail

The DP must ensure the client has filled on the DRF-GS: the option exercised as "Submitting Physical G-Sec to …(depository name)"; Account No.; Account Holder Name; Name of the Security; Face Value of Securities to be Dematerialised (in words and figures); Certificate Number. The workbook notes some of these details may not be required by both the depositories — and that in the case of CDSL, the DRF is the same for G-Secs as is used for other securities.

The ISIN for a G-Sec is determined by relating the security description available on the physical certificate with the ISIN description given by the depository. The physical certificate carries:

• Nomenclature (Description) of the stock — e.g. 13.85% Government Stock 2001
• Book Debt Certificate No. — e.g. BY34, where BY stands for issuing office Bombay
• Face Value
• Date of redemption
• Date of Issue
• Name of Holder

What the DP scrutinises

• Compare the order of holders' names on the DRF-GS and certificates with the client account
• Whether the certificate details mentioned on the DRF and the physical certificates enclosed tally
• Verification of the client's signature on the DRF with the specimen signature recorded by the DP during account opening
• In the case of Trusts and Corporate Bodies, the DP shall ensure the registration number of the signatories in the form of transfer is mentioned. Any signature difference may result in rejection of the transfer by RBI
• ISIN
• Security descriptor
• Whether the Face Value mentioned in the DRF-GS tallies with what is mentioned on the certificates

The ISIN activation loop

The DP captures the demat request for the G-Sec if the ISIN already exists in the depository system. Depositories obtain details of new government securities from RBI based on circulars issued by RBI and activate the ISINs.

If the ISIN for that specific G-Sec has not been activated, the DP informs the G-Sec cell of the depository by emailing a standard letter along with a photocopy of the certificate or the SGL credit advice. Based on this communication, the ISIN is activated in the depository system.

Two forms rules go with it: in case of different Loan Codes, clients must submit separate DRF-GS and Form of Transfer, but if the certificate numbers of the stock are in consecutive order for a single Loan Code, a single Form of Transfer may be used.

Which PDO issued it?

On receipt of the certificates, the DP ascertains whether PDO Mumbai or any other PDO has issued the certificates. In the case of certificates issued by a PDO outside Mumbai, the DP will accept them provided the Form of Transfer has been attested by the respective PDOs.

On finding the forms and security count in order, the DP issues an acknowledgement slip duly signed and stamped to the client. But in case the certificates are mutilated, or they are defaced in such a way that the material information is not readable, the DP does not accept the certificates for dematerialisation.

Entry, verification and despatch

The DP fills in details on the DRF-GS pertaining to ISIN and Loan Code, and has to ensure that the ISIN and Loan Code are verified at two levels. After verification the request is entered in the DP system, and the DP must ensure that the number of the security is entered in the quantity field.

A Dematerialisation Request Number (DRN) is generated by the system, which has to be entered in the space provided in the DRF-GS. A person other than the person who entered the data should verify the details entered in the system for the DRN. The DP then releases the request to the depository module.

Then two handling rules that are unique to G-Secs:

• The DP has to endorse on the reverse of the certificate by writing "Tendered for Cancellation and credit to SGL A/c No. _____, Mumbai"
• The DP is instructed not to punch holes on the face of G-Secs. This is unlike the procedure for forwarding other securities to the respective R&T

The DP has to despatch the certificates along with the request form, after duly authenticating the DRF-GS, to the depository within seven working days of accepting them from the client. The depository fills in and signs the relevant portion of the Form of Transfer and submits the documents to RBI for credit in the Constituent SGL account of the depository. On receiving the necessary confirmation from RBI, the depository confirms acceptance of the request for dematerialisation, and the DP informs the client of the changes in the client's account.

When it gets rejected

The depository acts as an R&T Agent and discharges RTA functions for G-Secs. On receipt of the physical certificates with the DRF-GS and the Form of Transfer, the G-Sec cell of the depository matches the details provided in the DRF-GS with the electronic message received by the depository's system. In case of a mismatch, the G-Sec cell rejects the demat request generated in the system and sends the physical certificates along with a letter to the DP intimating them of the mismatch.

The G-Sec cell also rejects the dematerialisation request in case RBI rejects the transfer on account of signature mismatch, or in case the signatories are not registered with RBI. In such cases the DP intimates the client of the rejection by letter or fax, along with the rejection memo sent by the depository's G-Sec cell.

Bringing balances in from another SGL account

An investor may already hold balances in book entry form (Primary SGL or Constituent SGL) with another entity and want them moved into the depository's account. Even this process is handled through the dematerialisation module of the depository.

The client submits a request (DRF-GS) along with an SGL credit advice and a request letter for "Value free transfer".

On the DRF-GS the client enters the option exercised as "Transfer of SGL securities to …(depository name)" (not applicable to CDSL), Account No., Account Holder Name, Name of the Security, and Face Value of Securities to be Transferred (in words and figures). Each depository may have its own additional requirements.

The DP should ensure that the SGL account from where the BO wishes to transfer securities to the depository's Constituent SGL account is registered with PDO at RBI, Mumbai. This is ascertained by examining the prefix to the SGL account number, which shall begin with the prefix "BY".

The scrutiny mirrors the physical route — signature verification, order of holders' names, Loan Code and Face Value, separate DRF-GS where the ISIN or Loan Code differs, ISIN and Loan Code verified at two levels, quantity in the quantity field, DRN generated and written on the form, and verification by a person other than the one who entered the data.

Then the RBI leg, which is where this route differs:

1. The DP provides the details of the demat request generated to the G-Sec Cell of the depository in a specified format
2. On receipt, an email is sent to the SGL counterparty requesting initiation of the transfer request in the RBI system
3. The transfer request is initiated in the RBI E Kuber system by the SGL counterparty and intimated to the depository
4. The depository confirms the request in the RBI E Kuber system, post which the balances are credited in the Constituent SGL account of the depository
5. The demat request is then confirmed in the depository system and the electronic balances are credited to the demat account of the holder
6. The DP may inform the client of the changes in the client's account

Settlement of G-Sec trades

Within the depository, the procedure for transfer of government securities is exactly similar to that of transfer of equity shares. Nothing new to learn.

Settlement of RBI trades is different, and note the footnote first: this facility is not enabled at CDSL. It applies where the counterparty holds G-Sec balances in book entry form with another SGL entity.

Purchase by a depository client:

• The buying client submits inter-SGL trade purchase instructions in the prescribed format to the DP, and makes the necessary funds available to the depository
• The DP executes a dematerialisation instruction for the quantity purchased, at least one day prior to the day of trade settlement at RBI, and forwards the purchase instruction form to the depository
• The depository executes the designated form and submits it to RBI
• On settlement day, RBI credits the Constituent SGL account of the depository and debits its current account for funds
• On receiving information about the crediting of securities from RBI, the depository confirms the receipt of securities to the client

Sale by a depository client:

• The selling client submits an Inter-SGL Trade Sale Instruction in the prescribed format
• The DP executes a rematerialisation instruction for the quantity sold, at least one day prior to the day of trade settlement at RBI, and forwards the sale instruction form
• On settlement day, RBI debits the SGL-2 account of the depository and credits its current account for the purchase consideration
• The depository credits the current account of the DP with the sale consideration and intimates the DP. The DP, on receiving the intimation, credits the amount to the account of the client

Notice the elegant symmetry: a purchase runs through the demat module; a sale runs through the remat module. Securities coming into the depository system are a demat; securities leaving it are a remat — regardless of whether anyone touches paper.

NDS-OM for retail investors. A facility is available to demat account holders of bank Participants who are SGL Account Holders and direct members of NDS-OM and CCIL. With this, retail individual investors holding demat accounts with bank Participants are able to purchase or sell government securities through the NDS-OM system. Previously, access for trading in the secondary market on NDS-OM was limited to only those maintaining SGL/CSGL accounts. NSDL has integrated the NDS-OM web module with its e-services facility, allowing bank Participants to offer web trading so investors can trade online in G-Secs using their existing NSDL demat account.

Inter-Depository Transfers of G-Secs

Inter Depository Transfers — between Constituent Subsidiary General Ledger Accounts of depositories — are eligible for Value Free Transfer (VFT) if such transfers arise out of trades on exchanges between demat account holders of different depositories. In such cases depositories shall put in place suitable mechanisms to ensure the bonafide nature of these transfers before effecting the VFT, under RBI Circular No. RBI/2018-19/78 IDMD.CDD.No.1241/11.02.001/2018-19 dated November 16, 2018.

IDTs of Government Securities apply to Central Government Securities, State Development Loans, Treasury Bills and Sovereign Gold Bonds issued by RBI on behalf of Central and State Governments.

In NSDL: participants must obtain a one-time self-declaration from the demat account holders that the transaction involved is a bonafide transfer instruction before executing IDT instructions in G-Secs. The Participant shall verify the declaration before execution of every IDT instruction by retrieving such confirmation from its records, and IDT of Government Securities is allowed only in demat accounts that have the one-time self-declaration flag enabled. The NSDL DPM allows market transfers for G-Secs between the depositories through the "Inter Depository Transfer" module.

In CDSL: the current Market type and Settlement details in respect of Corporate Bond settlement apply. IDT in Government Securities except Sovereign Gold Bonds (SGB) is permitted only for that market type and settlement details. In the case of SGB, IDT is permitted for any market type and settlement details. IDT in Government Securities is permitted for a minimum quantity of one unit. Inter-depository debit transactions are allowed only for those clients whose One Time Self Declaration — that transactions in the account are bonafide — is obtained by the DP through electronic or physical mode and recorded in the CDSL system.

The batch timings. Inter-depository transfers of Government Securities are processed in three batches on weekdays and one batch on 1st/3rd/5th Saturdays:

The depository deadline is always 15 minutes after the Participant deadline. That pattern makes the whole table memorable.

The RBI circular also requires Participants to ensure board approved risk management processes and audit oversight are applied before transactions in Government Securities are accepted, and to confirm the same to depositories. Participants are required to report compliance of the same.

Interest and redemption on G-Secs

The DP must ensure that changes in the beneficial owner's account — such as change in bank details, change of address — are updated well in advance of the due date of interest payment and/or the redemption payment due date.

Then two deadlines that differ from each other, and are worth learning as a pair:

The depository makes the payment directly to the clients, or to the bank account of the clients, as per the instructions received from the clients.

Rematerialisation of G-Secs

An investor in government securities holding electronic balances in the depository's Constituent SGL account can convert them into physical certificates, or into book entry form, by the process of rematerialisation. The workbook heads this section "Conversion of securities in Depositories SGL II to Physical Securities" — SGL II, not SGL-1.

The sequence:

1. An application is made to the depository, through the DP, in the Rematerialisation Request Form (RRF-GS)
2. The DP checks the form for completeness, correctness and validity, and ensures that sufficient free security balance is available in the account of the client
3. If the form is in order and there is sufficient balance, the DP accepts the RRF-GS, blocks the balance of the client to the extent of the requested quantity, and intimates the request to the depository
4. On receipt of such request, the depository blocks the balance of the client in the depository system to the extent of the quantity sought to be rematerialised
5. The DP forwards the RRF-GS to the depository within seven days of accepting such request from the client
6. The depository forwards the rematerialisation request to RBI in the prescribed form, in case a physical certificate is required by the client
7. On receipt of the debit confirmation from RBI, the depositories confirm acceptance of the RRF-GS and forward the physical certificates along with the form of transfer to the client directly

Where the request was for transfer to an SGL account with another eligible entity, the route changes at the end: the depository confirms acceptance of the RRF to the DP after obtaining approval from RBI. On receipt of such confirmation from RBI, the depository removes the balance from the client's account, and the DP then informs the client accordingly.

Objections on remat. The depository's G-Sec cell, on receipt of the RRF-GS, matches the Rematerialisation Request Number given on the RRF-GS with the electronic message received by the depository's system linked to its shareholders system. In case of a mismatch, the G-Sec cell will send a letter to the DP intimating them of the mismatch. The DP has to resolve the mismatch.

That last sentence is a workbook review question, asked almost verbatim. The DP resolves it — not the depository, not SEBI, not RBI.