Market Linked Debentures (MLDs) are fixed income instruments whose returns are tied to a specific security or market index, such as a government securities, gold index fund, or Nifty Index fund.
Consider the following example:
- Company X planned to issue an MLD in order to raise 5 crore in capital.
- Company X offered to pay 8% interest on the condition that the price of government securities not fall below 20%.
- If the price of the government asset does not fall below 20%, the investor will get 8% interest in addition to the principle at maturity.
- However, if the condition is not met, the investor would forfeit the interest payment and will be paid only the principle. These are commonly known as Principal Protected MLDs.
It’s similar to betting on the market, equities, or government assets to gain indirect exposure and larger profits. Their maturation period spans from one to five years. They can be listed or unlisted, secured or unsecured, and secured or unsecured. SEBI is in charge of it.
Because these instruments are sophisticated and require a minimum investment of 25 lakhs or more, they are not appropriate for individual investors with a low risk appetite. Wealthy Individuals Individuals aiming to diversify their portfolios or seeking higher returns while taking risks can invest in structured products.
MLDs are often offered by investment banks and distributors for a 1 or 2 percent commission and are issued in an offline mode. They may be offered on an exchange as well, although they are highly illiquid and are rarely traded on these exchanges.
What are the Advantages of MLDs?
One of the most significant advantages of investing in MLDs is the tax savings available to high-net-worth individuals (HNIs). According to the regulations, long-term capital gains on listed bonds held for more than a year are taxed at 10%. As a result, listed MLDs are tax-efficient.
For example, if you sell an 8 percent MLD after a year in the secondary market, you can make 7.2 percent as opposed to a fixed deposit that is taxed at 30% for a person in that tax band, thus earning 5.6 percent post tax on an 8 percent fixed deposit. This scenario, however, will not work if the instrument is kept until maturity because it would not be tax efficient. As a result, some corporations establish arrangements to purchase them before maturity so that investors can take advantage of tax breaks.
- MLDs allow you to participate in the market’s upside without worrying about the negative risk. The greatest an investor can lose in Principal Protected MLDs is the interest income based on the market index or government securities. They will, however, receive their principal, which will act as a cushion against the market’s fall.
- It enables indirect access to other markets such as the equity market, gold market, government securities market, and so on.
MLDs have advantages over other types of debt for issuers.
- There would be no liquidity crisis because there will be no fixed regular payment of coupons during the lifetime of MLDs.
- In the case of a non-convertible debenture, issuers may issue up to 5 additional ISINs in addition to the maximum of 12 ISINs in a fiscal year.
- MLDs assist issuers in meeting SEBI criteria for fund raising through the issuing of Debt Securities by Large Entities (25 percent of borrowing via Capital market).
- Exemption from the electronic book method for private placement securities issue. This is one of the primary reasons why issuers use MLDs to raise funds.
What are the Risks in MLDs?
There is no such thing as a free lunch. This philosophy is etched in stone in the realm of finance. The appealing post-tax yield comes at a cost: risk.
Credit Risk: With such instruments, there is always the possibility that the corporation would default on either its interest payments or principal repayment, resulting in credit risk. When investing in them, one should exercise caution and look at the credit ratings assigned to MLDs of various companies.
Risk of Loss: Loss is only protected up to the extent of guarantee provided by NBFCs. However, in the event of a default, one may suffer significant damages.
Liquidity Risk: Such investments are also subject to liquidity risk. These instruments are typically illiquid and trade on secondary markets only infrequently.
Regulatory Risk: If tax rules change, the tax benefit will be lost, leaving investors exposed.
Complexity Risk: Some of these instruments are exceedingly difficult to decode and will not be easily understood by inexperienced investors.
Before making an investment, investors should thoroughly examine the conditions on which the interest is based.
Market Linked Debentures are intriguing structures that can provide high rates of return when compared to certain fixed-income assets and allow you to participate in the equity market Index’s gain. However, these are complicated instruments that should be thoroughly studied before investing in them. If you understand the complexities, have a high risk tolerance, and want to take advantage of tax breaks, you should consider investing in Market Linked Instruments.
MLDs can be used to achieve regulatory arbitrage (in the form of relaxations from EBP, ISIN regulations, etc.) by employing arrangements in which the debentures ‘look’ to be market-linked, but are not in fact, because the relationship itself is illusory.
List of Top 10 Market Linked Debentures (MLDs) in India
- Edelweiss Alternative Asset Advisors Ltd.
- Citicorp Finance (India) Limited
- Credit Suisse Finance (India) Private Limited
- DSP Merrill Lynch Capital Ltd
- ECL Finance Limited
- Edelweiss Finance & Investments
- Fusion Microfinance Private Limited
- India Infoline Finance Limited
- Karvy Financial Services Limited
- Macquarie Finance (India) Private Limited
Also Read: Why there is a need of Structured Products? What is Twin-Win and its Benefits?