Summary of the cartload of amendments introduced towards DTs and corporate bonds

SEBI implements measures proposed in the Consultation Paper on Corporate Bonds and Debenture Trustees

-Aanchal Kaur Nagpal, Executive & Burhanuddin Dohadwala, Manager

Introduction:

Owing to a wide array of defaults by various companies owning debt obligations SEBI, in order to secure the interest of the debenture holders, introduced various measures, particularly in respect of Debenture Trustees (‘DTs’), as they are the ultimate saviors of the debenture holders.

An effective mechanism in place for DTs would ultimately lead to better protection of the interests of the debenture holders increasing investor confidence.

SEBI had issued a consultation paper dated February 25, 2020 (‘Consultation Paper’)[1] to seek comments/ views on the measures that were expected to strengthen the regulatory framework for corporate bonds, secure the interest of the debenture holders, enhance the role of the DTs and empower them to effectively discharge their responsibilities towards the debenture holders of listed debt issues/ proposed to be listed debt issues.

The increased events of default by a few financial institutions and the lapses/ complications on the part of DTs in the expeditious enforcement of the security brought to the fore, the need for a review of the present regulatory framework for DT.

With the given challenges/hurdles observed in:

Charge creation;
Enforcement of security of the secured debentures;
Delay in enforcing the security in the event of default;
Inter Creditor Agreement (‘ICA’);
Creation of floating charges and
Other related issues in the recent cases of default,

SEBI intended to review the regulatory framework for DTs and put in place various provisions that would further secure the interests of the debenture holders of listed debt issues, enable the DTs to perform their duties in the interest of the investors more effectively and promptly in case of default.

Implementation of the proposed changes in the Consultation Paper:

SEBI implemented the amendments/changes as discussed in the consultation paper by way of the following:

SEBI (Debenture Trustees) (Amendment) Regulations, 2020[2] dated 8^th October, 2020 (‘DT Amendment Regulations’);
SEBI (Issue and Listing of Debt Securities) (Amendment) Regulations, 2020[3] dated 8^th October, 2020 (‘ILDS Amendment Regulations’);
SEBI (LODR) (Third Amendment) Regulations, 2020[4] dated 8^th October, 2020 (‘LODR Regulations’);
Standardisation of procedure to be followed by Debenture Trustee(s) in case of ‘Default’ by Issuers of listed debt securities dated 13^th October, 2020[5]; (‘SOP for DTs’)
Contribution by Issuers of listed or proposed to be listed debt securities towards creation of Recovery Expense Fund dated 22^nd October, 2020[6] , effective from January 01, 2021; (‘Circular on recovery fund’)
Creation of Security in issuance of listed debt securities and ‘due diligence’ by debenture trustee; (Dated November 03, 2020[7]), effective for new issues proposed to be listed on or after January 01, 2021, (‘Circular on creation of security’).

Thus, all the above provisions are to be read together with the Consultation Paper. We have tried to provide a holistic view of the proposals in the Consultation Paper as well the implementation of the same through the table below:

Sr. No.	Point of consideration	Recommendation by the Consultation Paper	Implementation Status	Our remarks/comments
Creation of Identified Charge
1)	NBFCs create a floating charge on their entire receivables for all its lenders on a pari passu basis. Lack of identification of the charged assets leads to difficulty in enforcement of security. Also, possibility that the good assets are enforced by banks while debenture holders are left with sub-par assets.	Creation of charge on identified assets viz. Identified receivables, investments, cash to be created by NBFCs instead of a floating charge on entire books. Debentures to be treated as secured only on creation of identified charge.	Implemented. 1) Circular on creation of security – Documents/Consent required at the time of entering into DTA; – Due diligence by DT for creation of security; – Disclosures in the offer document or private placement memorandum/ IM and filing of OD or PPM/IM by the Issuer; -Creation and registration of charge of security by Issuer prior to listing.	Due diligence: – No clarity as to who will bear DD expenses, in case issuer, then increased cost – Exemption to be provided for issuers having common DT for several issuances as DTs cannot obtain their own comments or objections as required under Para 6.1 (b) (ii) of the Circular. – Since issue opens and closes on the same day in case of private placement, issuers to start with the stated process much before opening of the offer. Creation of charge- Registration of charge within 30 days of creation, failure to be considered as breach of covenants/terms of issue. [unlike time limit of 120 days provided under Companies Act, 2013] To read our detailed analysis on the Circular, kindly refer to our article – ‘This New Year brings more complexity to bond issuance as SEBI makes it cumbersome’[1]
Due diligence of identified assets and Asset cover certificate
2a)	· Pursuant to regulation 15(1)(t) of the DT Regulations, asset cover certificates are submitted to the DT on a quarterly basis by the independent auditor and on a yearly basis by a statutory auditor. · These aid in monitoring the adequacy of assets charged against the debt issued. · Format of these certificates varies for every DT and mostly indicate only a statement confirming that 100% asset cover us maintained rather than a detailed list of assets.	· Asset cover certificates by the statutory auditor to be submitted on a half yearly basis. · Asset cover certificate to be made more granular to enhance monitoring of quality of assets by including the entire list of identified assets as security. · If quality of any asset deteriorates/ asset if pre-paid, then issuer to replace such assets and maintain asset cover as per DTD. · Certificate to also certify compliance with all covenants in the IM/ DTD.	Implemented 1) DT Amendment Regulations As per amended Rule 15(1)(t) of DT Regulations, in case of listed debt securities secured by book debts/ receivables, the DT is required to obtain a certificate from the statutory auditor, giving the value of receivables/ book debts including compliance with covenants of the IM/ offer document in the manner as specified by the Board. 2) DT Amendment Regulations Listed entities are required to forward a half-yearly certificate regarding maintenance of 100% asset cover in respect of listed NCDs. Not applicable to: – Bonds secured by a Government guarantee.	· While it is imperative for DTs to follow a pro-active approach in monitoring of the asset cover, if the requirement to specify the entire list of identified assets (as required under the Consultation Paper) would have been implemented, the same would have made the certificate too bulky considering the amount of identified assets in the list. · Thus, SEBI has specified that the value of the assets would be mentioned. · Further, issuers may develop a shared database of receivables for the DT to monitor variations in the assets on a real time basis which could also be subject to detailed/sample checking by the statutory auditor.
2b)		Quality to be maintained as per following parameters: · Establishing a delinquency rate (‘DR’) benchmark (to be used as a factor for monitoring asset quality) by the DT at the time of signing of DTD. · If DR breaches threshold, issuer to replace such assets with standard assets. · Covenant for maintaining of quality of assets, conditions for replacing delinquent assets to be included in IM and DTD for transparency.	Yet to be implemented.	Guidance for determination of DR benchmark should be prescribed.
Calling of Event of Default (EoD)
3)	· Determination of EoD is inconsistent among DTs. · Some call DTs at DTD level and some at ISIN level. · The above is owing to varied practices for issuing debentures- multiple ISINs are issued under one umbrella IM/DTD or single ISIN is split across multiple tranches with different IMs.	· Event of default (‘EoD’) to include breach of any covenant mentioned in IM/ DTD. · EoD to be called at ISIN level. This is because if a single investor is invested in a debenture under an ISIN, he has full right to enforce security under that ISIN.	Implemented by 1) DT Amendment Regulations Amended regulation 15(2)(b), event to include breach of covenants of offer document/IM and DTD. 2) SOP for DTs EoD shall be reckoned at ISIN level as all terms and conditions are same throughout a single ISIN. (para A.3)	–
Inter-Creditor Agreement (ICA)
4a)	Since, security interest of debenture holders is pari passu to other lenders, DTs are approached by banks to join the Inter-Creditor Agreement (‘ICA’) for resolution plan of a borrower. However, a DT would face multiple challenges in respect of interests of the debenture holders while joining an ICA. (same has been discussed below)	DTs to join ICA subject to the approval of the debenture holders. Also, the same is subject to various conditions along with an opportunity to the DTs to exit the ICA at various stages and in various circumstances as if it never signed the same. In such cases, the resolution plan would not be binding on the DTs. (same has been discussed below)	Implemented 1) DT Regulations As per the inserted regulation 15(7), the DT may enter into ICAs on behalf of the debenture holders subject to the approval of the debenture holders and conditions as specified by SEBI. Inclusion of manner of voting/conditions of joining ICAs in schedule I. 2) SOP for DTs All the conditions as stipulated in the Consultation Paper have been adopted in the SOP. (para C.7).	Discussed below
4b)		A debenture holder representative committee consisting of debenture holders having majority investment may be formed after default by the issuer in order to fast track the ICA process.	1) SOP for DTs DTs may form a representative committee of the investors to participate in the ICA or to enforce the security or as may be decided in the meeting.	Clarity should be given by SEBI as to composition of the committee-whether the same will consist of debenture holders having majority across series/ISIN or series-wise/ISIN-wise should be laid in the regulations.
Voting mechanism
5a)	Procedural delay viz. a long notice period of 21 days to receive consent for future course of action, would further delay enforcement of security by the DT, especially in case of joining an ICA where the review period under RBI norms is 1 month for signing the ICA.	· Notice period for receiving consent of debenture holders to be reduced to 15 days from 21 days. · Negative consent for enforcement of security and positive consent for joining ICA to be taken simultaneously in the same letter. · Proof of dispatch and delivery to be maintained by the DT.	1) ILDS Amendment Regulations The amended regulation 18(2) specifies 15 days’ notice period. 2) SOP for DTs Process for seeking consent will be as follows: – DTs to send 3 days’ notice to the debenture holders from the EoD. – Positive and negative consent to be taken together as specified in the Consultation Paper – Consent to be given 15 days. – Meeting to be convened of all holders within 30 days from EoD.(shall not be applicable in case of public issue) – Necessary action to be taken by DT based on consent received. – Consent of majority of investors shall mean ‘75% of investors by value of outstanding debt and 60% of investors by number at ISIN level’.	Since the implications of entering/exiting ICA or going for enforcement actions might be huge; as such, an ordinary resolution might not suffice and a stricture approval should be specified. Keeping that mind, SEBI has adopted an even stricture approach from a special resolution, by specifying dual condition in value and number. SEBI has adopted the requisite consent for debenture holders from RBI norms on ICA.
5b)	Contact details received from RTAs are not updated leading to difficulty in communication with the debenture holders. Email-ids also not available as providing the same is not mandatory for debenture holders leading to hindrance in conducting e-voting.	Email-ids to be provided mandatorily for debenture holders in case of private placement.	Yet to be implemented.	—
Creation of a recovery fund
6)	In case of a default, DTs are required to fulfill their obligations to act in the interest of the debenture holders as well as enforcement of security even if they are able to recover their fees from the issuer. The expenses towards the above the same are currently borne by the debenture holders in most cases. Due to lags in receiving the money on time, there is a delay in the enforcement of the security.	· A recovery fund to be created towards at the time of issue of debentures that will be used by DTs for recovery · Proceeding expenses. · Value of fund= 0.01% of issue subject to maximum of 25 lakhs per issuer. · The same will not be applicable on ‘AAA rated’ bonds. However, in case of downgrading of rating, issuer will be obligated to create such fund. · Amount to be returned to the issuer at the time of maturity in case of no default.	Implemented 1) ILDS Amendment Regulation The inserted regulation 26(7) of ILDS Regulations specifies that a recovery expense fund will be created in the manner specified by SEBI and also inform the DT about the same. Amendment in schedule I to insert details of creation of recovery expense fund and the details and purpose thereof. 2) DT Amendment Regulations Duties of DTs to include ensuring the implementation of the conditions relating recovery expense fund under regulation 15(1)(h). 3) Circular on Recovery fund Details relating to creation, operation, maintenance and refund of the recovery fund has been specified.	The statutory auditor should certify, besides the asset cover, that the recovery fund is being adequately maintained, and well demarcated from other general funds of the company.
Disclosures on the website by DTs
7)	While the DT Regulations mandate various duties on DTs, investors are generally not aware of the monitoring by the DTs as well as the compliance status of issuers regarding covenants of the IM.	DTs to be mandatorily required to provide minimum disclosures on their website viz. Quarterly compliance report, defaults by the issuer, compliance status of asset cover, maintenance of various funds by the issuer, status of proceedings of cases under default etc. This would enhance transparency and hold the DTs responsible.	Yet to be implemented	The intention behind such disclosures is to promote transparency in the performance of DTs. Keeping the same in mind, SEBI should instruct issuers to provide the link of such website in the IM as well as annual report of the issuer, in addition to the disclosure of details of the DT [as required under regulation 53(e) of LODR regulations] for the information of the investors.
Disclosures regarding Performance of DTs
8)	There exists no performance indicators to enable investors to ascertain the performance of a DT.	Disclosure to be made by DTs w.r.t. the following parameters to reflect their performance: – timeliness of action taken Monitoring of covenants Effectiveness in enforcing securities or taking remedial actions in case of default, etc.	Yet to be implemented	· DTs should also report at prescribed intervals that they have monitored the asset cover in the prescribed duration, and have obtained auditor’s certificate, and in their independent assessment, there is no deterioration in the asset cover, both in terms of value and quality. In case, they have observed any deterioration, the same should be disclosed, and reported along with steps taken to rectify the same.
Public Disclosure of all covenants by the issuer in IM
9)	· There are instances where issuers enter into separate agreements with debenture holders containing additional/ specific covenants that do not form part of the principal IM. · These agreements, known as ‘side letters’ contain an accelerated payment clause” which states that if the borrower violates the terms of the covenants, including default or · downgrade of debt, such lender is entitled to · demand immediate repayment. · Such clauses hamper the interests of the issuer as well as other lenders.	· All covenants including the ‘accelerated payment clause’ · Shall be incorporated in the IM. · Issuer to inform DT of such covenants for monitoring the same. · Also, para 3.11 states that the IM should disclose that it has no side letter with any debenture holder except as disclosed in the · IM and on the stock exchange website where the debt is listed.	Implemented by the ILDS Amendment Regulations amended schedule I of the ILDS Regulations to include details of all covenants of the issue (including side letters, accelerated payment clause, etc.	Instead of allowing side letter to be a part of the IM, the concept of side letter should be discouraged totally. All covenants should be there in the IM only. The issuer should also be made to undertake in the IM that it has not signed any side letter and that all covenants as included in the IM are the only covenants agreed to by the issuer.
Standardization of Debenture Trust Deed (DTD)
10)	A DTD consists of standard covenants as specified under DT Regulations and as per form SH-12 under Companies Act, 2013 as well as customized clauses specific to an issuer. DTDs are lengthy and thus should be standardized to make them comprehensible and easy to read and understand.	DTD to be bifurcated into two parts: – Part A: generic and standard clauses common to all DTs. – Part B: specific and customized clauses relevant to the particular issue for which the DTD is executed. (same as per offer document of mutual funds)	Implemented 1) ILDS Amendment Regulations Regulation 15(2) has been amended to provide that the trust deed shall consist of 2 parts: a) Part A containing statutory/standard information pertaining to the debt issue b) Part B containing details specific to the particular debt issue 2) DT Amendment Regulations Regulation 14 amended to include that trust deed shall consist of 2 parts: (same as ILDS Amendment Regulations)	SEBI should provide clarity as to what clauses would fall under part B.
Enhanced Disclosures
11)	Details about the terms of the debentures, duties of DTs and redressal mechanisms in case of default, are not known to the investors. The investors thus are not fully aware of the risks undertaken while investing.	In order to enhance transparency, the issuer is required to provide additional disclosures in the IM such as: – A risk factor to state that while the debenture is secured against a charge to the tune of 100% of the principal and interest amount in favour of DT, the possibility of recovery of 100% of the amount will depend on the market scenario at the time of enforcement of security. – That the issuer has no side letter – Pari passu charge of the investors, etc.	Partly Implemented 1) ILDS Amendment Regulations Schedule I of the ILDS Regulations has been amended to include a note as to the risk factor.	SEBI to also make necessary amendments in order enable inclusion of other disclosures as well.
Framework and Standard Operating Procedure(SOP) for imposing fines
12)	There have been a lot of instances of non-co-operation of the issuers as well as violations of the LODR Regulations by the issuer. Actions and adjudication proceedings initiated in this regard by the DT, usually take up a lot of time and the, non-compliance may continue during such proceedings as well.	An SOP to be prepared that would list out penalties for specific violations by the issuer. This would enable better compliance and co-operation on the part of the issuer.	Yet to be implemented	–

Points for consideration:

There are certain issues in the Consultation Paper that if not thought through would pose various complications in their implementation.

1) Creation of charge on identified assets

The Consultation Paper aims to discourage floating charge on the entire balance sheet and requires that debentures are to be secured by way of a charge on identified assets which would include identified receivables, investment and cash. Further, the debentures would be considered secured only if the charge is created on identified assets of the NBFC.

The rationale for the above is that, unlike other Companies where there are fixed charges created, NBFCs usually create a floating charge in favour of lenders. The problem arises when all such lenders are secured by way of pari passu charge on the entire receivables of the NBFC. The same leads to lack of identified/ specific security interest for each lender leading to difficulty in the enforcement of the same. Further, there is a change that the higher quality assets are handed over to banks and other major lenders, leaving only the sub-par assets in favour of the debenture holders.

Our comments:

Receivables are floating assets and are dynamic in nature. The intention of SEBI is to mandate NBFCs to create a pool of assets as identified asset towards secured debentures. Thus, creating a demarcated pool of receivables as security interest in debentures would not be possible as the pool would still keep fluctuating due to various transactions such as repayment, prepayments and default.

Thus, even if there is an identified pool created, the same would still be a floating charge due to various fluctuations.

In our view, the approach adopted by the Consultation Paper is akin to covered bonds where there is a pool of assets (identified assets) monitored by a pool monitor (DT). Hence it is suggested that SEBI gives recognition to covered bonds.

Amendment under IBC:

Currently, IBC does not make any express distinction on the basis of floating or fixed charge, and both such charges are treated as secured debentures in the waterfall under IBC. However, flaoting charges are subservient to fixed charges. Thus, an amendment would be required under IBC regarding the same.

The above recommendation is still required to be implemented

2) Joining the ICA by the DTs on behalf of the debenture holders

Firstly, the ICA applies to institutional investors alone. Hence debenture holders that would fall under the above category would only be allowed to be a part of such ICA.

Secondly, the rights of debenture holders also depend on the nature of the charge- when the same is exclusive or pari passu. It is only when the rights are par passu that the debenture holders will be required to be a part of the ICA.

The recommendations under the Consultation paper have been implemented by the SOP for DTs wholly.

The provisions relating to the same allow a way-out to the DTs in various circumstances and exit the ICA altogether, for instance, if the resolution plan is not in accordance with SEBI regulations, if terms of ICA are contravened by any party, if the resolution plan is not finalized within 180 days from the review period (with an extension upto 365 days). Under these circumstances, if the DT exits the CIA it will treated as if it never entered the ICA and the same will not be binding.

Now the above leads to various problems:

If the DT will be treated as exiting the ICA altogether, would that mean that DT could now take independent action? Since the language used is ‘ it will be treated as if the DT never entered the ICA’. [Lenders as party to the ICA, along with dissenting lenders, are prohibited from initiating any other legal action/ proceeding against the borrower, including proceedings under IBC]
If the DT initiates insolvency proceedings under IBC, how will the lenders be a part of the committee of creditors since they are barred from taking any other action?
How would the DT enforce security that is equally in favour of the other lenders as well?
In case of joint financing of a secured asset, consent of a minimum of 60% (in value) of creditors is required under SARFAESI to initiate enforcement action. Therefore, the debenture holders may not be having a practical solution by exiting the ICA.
Lastly, resolution of an entity is a collective process, and the process might require collective compromises as well. If creditors are provided exceptions, it is difficult to find success of either of the proceedings. Individual actions against the company can erode the asset base to the prejudice of the Company.

3) Certification of covenants under the asset cover certificate

As per regulation 56(1)(d) of the amended SEBI LODR Regulations,

The listed entity shall forward the following to the debenture trustee promptly

(d) a half-yearly certificate regarding maintenance of hundred percent asset cover or asset cover as per the terms of offer document/Information Memorandum and/or Debenture Trust Deed, including compliance with all the covenants, in respect of listed non-convertible debt securities, by the statutory auditor, along with the half-yearly financial results:

Thus the question arises as to what does ‘including compliance with all the covenants’ mean and what kind of covenants are required to be certified.

As per the rationale provided under the Consultation Paper and Discussion (Agenda) in the SEBI Board Meeting dated 29th September, 2020

Consultation paper:

(i) Requirement for the asset cover certificate falls under the head ‘Due diligence and monitoring of asset cover by DT’ in the consultation paper;

(ii) As per para 3.2.2 of the consultation paper,

Point c- Issuer shall disclose the covenants of maintaining the quality of assets, conditions of replacing the bad/ delinquent assets in IM and DTD to create transparency and reduce the information gap regarding the covenants of the charge creation and the process thereafter.

Point d-The asset cover shall also certify the compliance with all the covenants mentioned in the IM or DTD, as applicable.

Thus, both the above points should be read in conjunction.

SEBI Board Meeting dated 29th September, 2020

(i) Also reference should be made to paras 9.2.2, 9.2.3, 9.2.6, 9.2.7, 9.2.8 of the Agenda of the Board Meeting.

(ii) As per para 9.2.6, However, certain types of undertakings in support of creation of charge such as personal guarantee, negative lien are not registered with any independent agencies and hence there exists the issue of verification of such undertakings. Therefore, disclosures with respect of these undertaking need to be made in the offer document/ Information Memorandum.

Amended regulation 56(1)(d)- a half-yearly certificate regarding maintenance of hundred percent asset cover or as per the terms of offer document/ Information Memorandum including compliance with all the covenants, in respect of listed non-convertible debt securities, by the statutory auditor, along with the half-yearly financial results.

Our view:

Thus, on a holistic reading, it is observed that SEBI intends to monitor the quality of the charged asset. For the same, SEBI has instructed issuers to include undertakings i.e. covenants, in support of creation of charge such as personal guarantee, negative lien in the offer document/ IM/ DTD and compliance with such covenants needs to be ensured. Thus, ‘including compliance with all covenants’ under the amended regulation 56(1)(d) should be read in reference to maintenance of asset cover.

Therefore, statutory auditors will be required to only certify those covenants that revolve around the asset cover of debt securities.

Conclusion

SEBI has focused in strengthening the role of DT in case of default by issuers of listed debt securities. Thus, the measures as stated above are truly in the right direction and would help in easing the strained enforcement of rights of debenture holders. While most of the measures are a welcome moves, there are some moves that may be too ambitious and would definitely require thorough consideration.

Our write-up/video can be accessed below:

1. SEBI responds to payment defaults by empowering Debenture Trustees:

http://vinodkothari.com/2020/10/sebi-responds-to-payment-defaults-by-empowering-debenture-trustees/

2. This New Year brings more complexity to bond issuance as SEBI makes it cumbersome

http://vinodkothari.com/2020/11/sebis-new-year-gift-to-dts-and-issuers-makes-issue-of-secured-debentures-cumbersome/

3. Youtube Channel:

https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

4. Other write-ups:

http://vinodkothari.com/category/corporate-laws/

[1] http://vinodkothari.com/2020/11/sebis-new-year-gift-to-dts-and-issuers-makes-issue-of-secured-debentures-cumbersome/

[1] https://www.sebi.gov.in/reports-and-statistics/reports/feb-2020/consultation-paper-on-review-of-the-regulatory-framework-for-corporate-bonds-and-debenture-trustees_46079.html

[2] http://egazette.nic.in/WriteReadData/2020/222323.pdf