Market linked debentures (MLDs)

What a market linked debenture actually is

A market linked debenture is a structured debt instrument. Legally it is a debenture — you are lending money to the issuer — but the return is not a fixed 8% or 9% coupon. Instead it is tied by a formula to the performance of an underlying benchmark: most commonly the Nifty 50 or Sensex, sometimes gold (MCX gold), and sometimes the 10-year government-security yield. The issuer promises to pay you an amount at maturity that depends on where that benchmark ends up, subject to conditions written into the term sheet.

There are two families of MLD, and the difference is the single most important thing to check before you buy. A principal-protected MLD promises to return at least your original capital at maturity, whatever the benchmark does — the market link only affects your upside. A non-principal-protected MLD offers no such floor: if the benchmark falls through a defined level, you can get back less than you invested. In India the marketed retail product is almost always the principal-protected kind, but 'protected' here means protected by the issuer's promise, not by any government guarantee. If the NBFC that issued the MLD cannot pay, your protection is worth only what its balance sheet is worth.

Under the hood, a principal-protected MLD is really two instruments bolted together. The bulk of your money — often around 75-85% — is invested in plain debt (a zero-coupon bond or high-grade NCD) chosen so that it grows back to your full face value by maturity; that is the engine that protects your principal. The remaining slice is spent on options or derivatives on the chosen index; that is the engine that generates the market-linked upside. If the index does well, the options pay off and you earn a return on top of your capital. If the index does badly, the options expire worthless, but the debt engine has quietly rebuilt your principal. That structure is elegant — and it is also where the fees, the complexity and the return caps hide.

How the payoff works — a worked example

The easiest way to understand an MLD is to walk through a typical principal-protected, Nifty-linked issue. The numbers below are illustrative but reflect a common structure.

Say an NBFC issues a 3-year (36-month) principal-protected MLD with a face value of Rs 1,00,000. The Nifty 50 is at 24,000 on the issue date. The term sheet says: at maturity, if the Nifty is at or above 75% of its starting level (i.e. at or above 18,000 — meaning it has not crashed by more than 25%), you receive your Rs 1,00,000 back plus a fixed 30% return (Rs 30,000). If the Nifty is below 18,000, you receive only your Rs 1,00,000 back — no return, but no loss of capital. That fixed 30% over three years works out to roughly 9.1% a year (XIRR).

Notice the asymmetry, because it is the whole trade. Your upside is capped: whether the Nifty rises 25% or 60%, you still get the same Rs 30,000 — you do not get the full index gain. Your downside is a floor of zero return: if the Nifty falls hard, you get your money back but have earned nothing for three years while inflation ate into its real value. The 'protection' is real, but you pay for it by giving up both the full equity upside and any interest you would have earned in a plain bond over the same period.

Who issues MLDs and how you buy them

Almost all MLDs sold to Indian retail and HNI investors are issued by NBFCs and financial-services companies — think large diversified NBFCs and their wealth arms — rather than by the government or banks. Under SEBI's structured-products framework (originally the 2011 guidelines — SEBI circular CIR/IMD/DF/17/2011 dated 28 September 2011), an issuer must meet an eligibility bar including a minimum net worth of around Rs 100 crore. That keeps out fly-by-night issuers, but it does not make the paper risk-free: an MLD is an unsecured or secured claim on that specific NBFC, so its safety tracks the issuer's credit rating, not a sovereign guarantee.

MLDs are typically sold through private placement, distributed by private banks, wealth managers and online bond platforms (OBPPs), and — since the SEBI reforms — listed on the NSE or BSE debt segment in dematerialised form. Listing means you can, in principle, sell before maturity on the exchange. In practice the secondary market for MLDs is thin, so exiting early can mean accepting a poor price. Most buyers hold to maturity.

Two practical points before you commit. First, the return you see marketed (the '30% at maturity' or 'up to 12% XIRR') is contingent on the payoff condition being met — it is not a guaranteed coupon, so read the term sheet's barrier and participation rate, not just the headline. Second, the structure carries embedded costs (the gap between what your money earns inside the product and what you are paid) that are rarely spelled out. A plain corporate bond or a G-sec is far easier to price and compare.

The 2022-23 SEBI reforms that opened MLDs up

For most of their history MLDs were an HNI-only product, partly by design. A run of SEBI reforms changed three things and pulled them within reach of ordinary investors — just as the tax advantage was about to disappear.

The headline change was the minimum face value. Through its circular dated 28 October 2022 (SEBI/HO/DDHS/P/CIR/2022/00144), SEBI cut the minimum face value of privately placed listed debt securities — MLDs included — from Rs 10 lakh to Rs 1 lakh, effective 1 January 2023. (SEBI cut the floor again through a circular dated 3 July 2024, to Rs 10,000, but that lower limit applies only to plain-vanilla, interest-bearing debt; structured products such as MLDs are excluded, so the MLD minimum remains Rs 1 lakh. Confirm the current position with your platform before you buy.)

The other two changes were about investor protection. MLDs must carry a uniform, independent valuation — carried out by a valuation agency appointed by AMFI and disclosed at least weekly — so the figure you see is an independent, third-party valuation rather than an in-house or related-party estimate. (This AMFI-appointed valuation was mandated by a SEBI amendment of 13 July 2020; it superseded valuation by SEBI-registered credit rating agencies, which were barred from valuation work from 30 May 2020.) That matters if you ever want to exit before maturity, because you can see an arm's-length estimate of what the MLD is worth. SEBI also pushed new MLDs to be issued in dematerialised form and listed on an exchange, improving transparency over the earlier, largely unlisted market.

The tax change that killed the appeal (Section 50AA)

This is the section that matters most, so be clear on it. Before 1 April 2023, MLDs enjoyed a genuine arbitrage. Because a listed MLD is a listed security, a gain on one held for more than 12 months was treated as long-term capital gain and taxed at just 10% (without indexation). Sell a plain bond or break an FD and the interest was taxed at your full slab — up to 30%. So a top-bracket investor could take essentially bond-like returns and pay 10% instead of 30% tax. That gap, not the market link itself, was the real reason MLDs sold.

The Finance Act 2023 inserted Section 50AA to shut this down. From 1 April 2023, any gain on the transfer, redemption or maturity of a market linked debenture is deemed to be a short-term capital gain and taxed at your applicable income-tax slab rate — regardless of how long you held it, and with no indexation. Crucially, there is no grandfathering: MLDs you bought before April 2023 are still taxed under Section 50AA when you redeem or sell them today. The old 10% LTCG rate is simply gone for MLDs.

One more consequence: because the entire return is now a capital gain (not interest), there is no TDS on it for a resident investor — you self-report the gain and pay the tax at your slab when you file. (Separately, Finance Act 2023 also removed the old TDS exemption on interest from listed securities, so conventional listed bond coupons now attract 10% TDS — but that is about plain coupons, not the MLD capital gain.) The tables below show the before-and-after in dead-simple terms.

The catches to weigh

Even setting tax aside, an MLD asks you to accept several trade-offs that a plain bond does not. Line them up honestly before deciding.

None of these are dealbreakers on their own. Together, they mean an MLD has to clear a high bar to beat a simple portfolio of a good corporate bond plus a small index allocation — a bar that was easy to clear when the tax was 10% and much harder now that it is your full slab.

• Credit risk sits with the issuer: 'principal-protected' means protected by an NBFC's promise, not by the government. Check the issuer's credit rating and treat AA/A paper with appropriate caution.
• Capped upside: you rarely get the full index return. The payoff formula limits how much you can earn even in a strong market, in exchange for the downside floor.
• Zero-return downside: in a principal-protected MLD, the worst case is usually getting your money back with no growth — a real loss after inflation and after the interest you forwent elsewhere.
• Opacity and cost: the payoff formula, the embedded derivative cost and the issuer's margin are hard to see. You cannot easily compare two MLDs the way you compare two bond yields.
• Thin liquidity: despite listing, the MLD secondary market is shallow, so selling before maturity can mean a poor price. Assume you will hold to maturity.
• No periodic income: most MLDs pay nothing until maturity, so they suit lump-sum, hold-to-maturity money — not investors who need regular cash flow.
• Tax is now slab-rate: the feature that justified all of the above for HNIs is gone. Post-tax, an MLD no longer beats a plain bond just because it is an MLD.

The honest verdict: who MLDs are still for

With Section 50AA in force, the blunt truth is that the main reason to own an MLD — the old sub-slab tax rate — no longer exists. An MLD gain is now taxed at your slab, just like the interest on a fixed deposit, and no better than a gain on an unlisted bond or debenture (those too are deemed short-term at slab under Section 50AA, for transfers on or after 23 July 2024). If anything, an MLD is now taxed worse than a plain listed corporate bond: sell a listed bond on the exchange after more than 12 months and the gain is long-term capital gain at 12.5% without indexation (post-23 July 2024), whereas an MLD gain is always short-term at your slab, however long you hold it. So the question is no longer 'do I want the tax break?' but 'do I specifically want this contingent, capped, index-linked payoff enough to accept the credit risk, the complexity and the poor liquidity?' For most retail investors, the honest answer is no.

There is still a narrow case. If you genuinely want a defined structure — 'my capital is protected and I get an equity-linked kicker if the market holds up' — and you understand you are buying a structured bet rather than a tax shelter, a principal-protected MLD from a strong issuer can fit as a small satellite holding. Investors in the 0-5% tax slab are also barely affected by the change, since slab tax at those rates is close to (or below) the old 10%, so for them the tax argument was never the point anyway.

For nearly everyone else, simpler tools do the same job at lower cost and with more transparency. If you want safe fixed income, a plain corporate bond or a government security is easier to price, and a listed bond sold on the exchange after a year is actually taxed more lightly than an MLD — its gain is long-term at 12.5% without indexation, versus the MLD's slab rate. If you want low-cost diversified debt with a defined maturity, a target-maturity option like the Bharat Bond ETF is cleaner. And if you want equity upside, a small direct allocation to an index fund — taxed at 12.5% LTCG, better than the MLD's slab rate — captures more of the move without a cap. The combination of a plain bond plus a pinch of index exposure now beats the MLD on tax, cost and clarity for the vast majority of investors.

• Still worth a look if: you specifically want a principal-protected, index-linked structure as a small satellite holding, from a high-rated issuer, and can hold to maturity.
• Roughly tax-neutral for: investors in the 0-5% slab, for whom the 2023 change barely moves the needle.
• Probably not for you if: you were drawn by the old 10% tax rate (it's gone), need regular income or liquidity, or want the full equity upside.
• Simpler alternatives: a plain corporate bond or G-sec for safe income; the Bharat Bond ETF for defined-maturity debt; a small index-fund allocation for equity upside taxed at 12.5%.