MLD: Full Form, Meaning, Benefits and More

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Market Linked Debentures are debentures with a pay-off that is linked to the movement of another security or indices, such as the NSE Nifty 50 index or the 10y government security (G-sec) yield, rather than a fixed rate as a conventional coupon-bearing debenture.

 

A 30-month MLD, for instance, would pay the investor a predetermined IRR at the conclusion of the term if the Nifty 50 Index did not decrease by more than 75%. Market-Linked Investments may offer whole or partial market downside protection as well as increased return possibilities.

 

There is a kind of MLD known as principal protected (PP) MLDs, which ensures that subject to credit risk of the issuer, you will receive at least the principal sum at maturity, even if the other market’s performance is significantly unfavourable. However, it must be noted that this is subjected to no default of the issuer. Principal repayment cannot be assured and it is subjected to credit risk of the issuer. 

 

That is, your risk is protected since, in the worst-case scenario of the market not performing well, you will receive no return, but will be reimbursed for your principal subject to the issuer not being in default. The MLD’s terms specify the scope of returns from the outset, based on price movement in the underlying market.

 

This category has two jargons: variable and fixed coupons.

 

To be clear, the pay-off in an MLD is not fixed in the sense that it is tied to a benchmark underlying security or index. There is a genuine or perceptible relationship between variable coupon and the reference market.

 

This is primarily for equity market participation, where you may participate in the stock market’s gain, to the degree stipulated in the MLD’s conditions, but with the downside protection of PP structures.

 

Why Have MLDs Made a Come-Back? 

 

Following the IL&FS debacle, the availability of money to NBFCs from banks and mutual funds have dried up. However, NBFCs must acquire funds to support their expansion and to pay for the maturities of existing bonds.

 

 

As a result, they’ve gone the MLD way. The issuance of MLD benefits NBFCs in a variety of ways. They diversify their sources of funds as HNI’s and individual investors prefer MLDs due to taxation benefits. 

 

 

It allows the NBFC to issue an additional five ISINs in addition to the SEBI-mandated maximum of 12 NCDs maturing per financial year. Simply said, an NBFC can raise funds many times.

 

Each ISIN represents a loan instrument issued by the borrower. It also enables them to borrow 25% of their borrowed funds from the NCD market, as this is a regulatory requirement for large corporates.

 

MLDs allow debt to be serviced with a single payment at maturity, whilst most NCDs require issuers to pay interest on a monthly basis in the form of a predetermined coupon.

 

MLDs help issuers diversify their sources of funds as HNIs and individual investors may prefer MLDs due to taxation benefits. As more NBFCs queue up to raise money, more of these products are anticipated to be issued in the future. By the conclusion of the current fiscal year, CARE Ratings anticipate issuances to reach 14,000 crore.

 

What Does an MLD Offer?

 

There are two types of MLDs

  • Principal protected 
  • Non-principal protected 

 

They are usually provided for a period of 13 to 60 months and can be issued by entities having a net-worth of minimum INR 100 crores. Unlike bonds, which pay a fixed interest rate on a monthly, quarterly, half-yearly, or annual basis, MLDs pay no regular income.

 

How Does an MLD Work?

 

The only time you get paid from an MLD is when it matures. The following is how it works: An MLD is tied to an underlying asset, such as the Nifty stock market index or a 10-year government security instrument. The gain from an MLD is determined at maturity, depending on how its underlying security has moved, as there is no income to be obtained throughout its lifetime.

 

Let’s assume an investor holds an MLD tied to the Sensex movement with a commitment to receiving 10% interest. In case the  MLD matures and Sensex falls below 20% at the time of MLD issuance. The investor would get a payment equivalent to the principal and the interest for the period at the agreed rate.

 

On the other hand, if Sensex falls below 20% of its initial level at the time of issuance of an MLD, the investor will receive just the principal amount and no interest. It’s worth noting that Sensex may have gone up or down in the interim, but its ultimate position at the time of MLD’s maturity is taken into consideration to determine how much money it pays you at maturity.

 

Because an MLD is a debt product, it may have a credit rating, even if it is tied to an equity asset like Nifty. MLDs formerly come with a range of credit ratings ranging from ‘AAA’ to ‘AA’ or even an ‘A’ or ‘BBB” rating, the latter of which reflects the borrower’s moderate credit worthiness.

 

Each issuer has complete control over the underlying index or asset to which the investor’s pay-out is connected. This underlying index or asset might be the nifty, the bank nifty, the 10-year government bond yield, or gold. The goal is to pick a security that is frequently traded yet difficult to manipulate.

 

According to CARE Ratings, principal protected MLDs account for over 95% of issuances in the 9 months ending December 31, 2018. Investors prefer to put their money into a principle-protected MLD because they know their money will be safe. And they can only take risks on the positive side and credit risk.

What are the Benefits of MLDs?

 

  • Market-linked debentures can be constructed to achieve different goals under different circumstances;
  • This instrument is tax efficient. These are traded on stock exchanges, and capital gains on such debentures are taxed at 10% (plus surcharge and cess) if held for more than 12 months;
  • When compared to a pure equity investment, where there is a risk of capital loss, the principal is protected;
  • On the fulfilment of an underlying equity requirement, it has a higher return potential than standard fixed income.
  • Structure is at a sweet position as compared to two traditional asset types.

 

Risks Associated with MLDs

 

  • Profile of the Issuer;
  • Although the majority of arrangements are principal protected, the issuer’s capacity to repay is critical;
  • If issuers fail to repay the commitment, investors may incur a capital loss;
  • Before investing, perform a thorough research on the issuer’s underlying company, diversification, and key financial statistics.

 

What Is Valuation Methodology?

 

MLDs are a hybrid of derivatives and fixed-income securities. They are valued by CRISIL using the sum-of-the-parts approach. A typical MLD is made up of two parts:

 

1. Valuation of Bond Portion

 

The valuation of the bond portion is done by discounting the face value of INR 100, using the following formula:

Bond Portion = 100 / (1+RB %) ^T

Where

RB: Bond yield of corresponding time to maturity and credit quality of issuer

T: Residual time to defined maturity (in years)

 

2. Valuation of Option Portion

 

The valuation of the option portion is based on Monte Carlo simulation technique.

 

The Geometric Brownian Motion (GBM) Model along with implementation of the Local Volatility is used for simulating the underlying asset. In case of basket structures, the simulations are plotted using the Cholesky matrix which is derived from the correlation matrix.

 

Top Rated MLDs

 

According to CRISIL here are few of the top rated MLDs available in the market:

  • 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
  • Morgan Stanley India Capital Private Limited
  • Nomura Capital (India) Private Limited
  • Reliance Capital Limited
  • Religare Finvest Limited
  • Reliance Financial Limited
  • ECap Equities Limited
  • Edelweiss Finvest Private Limited
  • IIFL Wealth Finance Limited
  • Reliance Asset Reconstruction Limited
  • HDB Financial Services Limited
  • Kotak Mahindra Investments Limited
  • Asirvad Microfinance Limited
  • India Grid Trust
  • Motilal Oswal Home Finance Limited
  • Vivriti Capital Private Limited
  • Axis Finance Limited
  • Edelweiss Asset Reconstruction Company Limited
  • Muthoot Finance Limited
  • Manappuram Finance Limited
  • L&T Infrastructure Finance Company Limited
  • Incred Financial Services Limited
  • Shriram Transport Finance Company Limited
  • IIFL Finance Limited
  • Julius Baer Capital India Private Limited
  • Auxilo Finserve Private Limited
  • IIFL Home Finance Limited

Happy Winting!

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