Sale and leaseback transactions: Walking once again on Achilles’ Heels

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Vinod Kothari ( finserv@vinodkothari.com)

Sale and leaseback (SLB) transactions are one of the most innovative, and in the past history of lease transactions, one of the most maligned transaction types. All over the world, there have been hundreds of rulings where SLB transactions have been challenged; in many cases, there were upheld and their sanctity was preserved, in many other cases, they have been treated either as no valid lease transactions, or pure financing transactions.

Motivations

There may be various motivations for a lessee to get into an SLB:

  • Liquidity – while normal lease transactions do not lead to cash in the hands of the lessee, SLBs do, SLBs extend leasing to a device of unlocking of investment. The  money raised by SLBs is like general purpose corporate funding – it may be used for any purpose as the lessee may choose.
  • Putting assets off the books – A selling lessee may put the asset being sold off the books, if the SLB is properly structured as a sale and operating leaseback.
  • Financial restructuring – if the money raised by an SLB is used to pay off on-balance sheet liability, the SLB may have twin effects on the balance sheet. By putting fixed assets off the books, it reduces operating leverage, and by reducing liabilities, it reduces financial leverage.
  • Capturing revaluation gains – assume there are assets where the carrying values as per books are significantly lower as compared to the fair market value. In such cases, if the SLB is properly structured as operating leaseback (other conditions also need to be satisfied), the gain on the sale of the asset may be booked as realized gain (not just a revaluation surplus), and may be taken to shareholders’ equity.
  • Tax benefits – many SLBs, such as those of cars, furniture, etc., may be designed to accelerate the tax write off of the lessee by moving from depreciation to rental write off.
  • Acceleration of VAT set off – an entity having substantial amount of carry forward of input tax credit may accelerate the set off by making a sale of capital assets.

Why SLBs walk on Achilles’ heels:

An SLB transaction has the apparent looks of a financial transaction. There is only a transfer of legal title over the asset. The asset stays with the lessee. In practice, parties may take quite callous approach evaluating the asset, and may take a purely lessee exposure, in which case, most often lessor may not bother about valuation of the asset. In many cases in the past, assets have been found not even to be existing.

Besides, in many cases, lessees in SLBs have been motivated either by a funding motive, or one of booking profits on the sale of the asset. Therefore, lessees may have aggressively overvalued assets.

In India, one of the ill-famed example of SLBs has been the SLB of electric meters by state electricity boards (SEBs). SEBs, starved of funding, were advised to use the innovative funding device of leasing back electric meters that were installed in consumers’ premises. Leasing companies (and in fact, many entities not in leasing business at all), starved of tax benefits, were easily attracted to this option, as it was contended that electric meters qualify for 100% depreciation. Many SLB transactions of electric meters happened around 1996-1997. Many of these cases have already traveled long routes of litigation. Some High courts have challenged them as being pure financing devices. Some have respected them, merely based on the legal nature of the contract.

In one of the recent rulings before the Madras High court, electric meters were shown to have been bought on 30th March – hence, used for just one day. In fact, meters actually bought by the selling SEB only a few months back were heavily revalued too. Despite such glaring facts, the Madras High court still went by the legal form, and upheld the lessor’s claim to depreciation.

Electric meters is not the only thing – many weird assets such as glass bottles, gas cylinders, tools, jigs, and so on have been sold and taken back on lease. In recent past, we have noticed transactions structured to give lessees a rental write off – hence, SLBs of sanitary fittings, office fitouts, office interiors, wall panels, false ceilings, etc have commonly been done.

As most of these transactions are factually very weak, SLB transactions continue to look like money lending transactions.

Types of SLBs:

First of all, the most essential distinction will  be on – is it a new asset or old asset? Since it is SLB, sure enough, it is not a new asset being acquired by the lessee, but the moot question is – has the asset been subject to use for a long period? There are cases where lessees might have recently bought assets, and may now want to get them off the books. Needless to say, older the asset, more serious the concerns, as the chances of overvaluation, or sale of decrepit assets purely with financial motives, etc., go up.

From accounting viewpoint, SLBs may be sale and financial leasebacks, and sale and operating leasebacks. We discuss the implications under the caption accounting issues.

Note that the following is not a case of sale and leaseback – X has leased an asset to Y, and X now sells the leased asset to Z, such that now the lease continues between Z and Y.

Lease and leasebacks are also not sale and leasebacks. A lease and leaseback transaction may be structured from variety of viewpoints – longer lease out, and shorter leaseback, or financial lease out and operating leaseback, etc.

Legal issues

First key question is – is an SLB legally valid as a lease? US Supreme Court discussed the legal validity of SLBs in the famous ruling of Frank Lyon and Company. The questions on the legal validity of an SLB are in fact questions which are germane to the validity of any lease. By way of a quick check (each of the factors below are negatives):

  • The asset being sold might have become an immovable property.
  • The asset being sold may have become inseparable part of another asset.
  • The lessor may not have done anything to indicate that the lessor is really interested in the asset, or that the asset is a genuine purchase of an asset. Facts may indicate that the lessor merely went by the financials of the lessee.
  • The asset may have been subject matter of third party rights. For example, the asset might already have been leased to a third party, in which case, it cannot be sold without the concurrence of the third party. The asset might have been encumbered, and so on.
  • In  not-so-extreme cases, the asset may not at all exist, or may have outlived its life.

If facts are strong, there is nothing to challenge the legal validity of an SLB, merely because it is an SLB and not a lease of a new asset. Of course, the lessor must do everything that a prudent man would do, if really buying an asset for good value.

Income Tax issues

In case of assets which have already been depreciated by the lessee prior to their sale, income-tax law has an explanation below section 43 (1) whereby the tax WDV in the hands of the lessor will be the tax WDV in the hands of the selling lessee. That is to say, the actul sale price of the asset will be ignored, and the seller’s WDV will become the WDV of the acquiring lessor. Obvious enough, if the asset has not been depreciated by the seller, the provision does not apply. If the asset has been sold in the same financial year in which it is acquired, the seller does not claim tax depreciation.

Other than the above specific SLB-directed provision, in actual practice, tax officers question eligibility of financial lease transactions to depreciation for the lessor or rental write off for the lessee. The real culprit for tax purposes is not a financial lease, but such a lease which is a disguised financial transaction, particularly transactions containing options to buy at bargain prices. SLB transactions may especially be targeted as engineered to produce an artificial tax shelter – for example, a sale of office furniture which is taken back on lease.

VAT issues

VAT is one of the least understood implications – in fact, for VAT purposes, SLBs are no different from any other sales. Where capital assets are sold by the selling lessee, the sale is a taxable sale (assuming the seller is in some business where he generates taxable sales). Presumably, when the asset was acquired, it might have been acquired either under CST, or it might have been imported, or might have been acquired under some state VAT law (that is, the asset was acquired after introduction of VAT laws in the country). If the asset had suffered VAT at the time of its purchase, such VAT might have been eligible for set off (assuming the capital asset was not one of the negative-listed capital asset). If the asset was bought under CST or was an imported asset, the question of any VAT set off at the time of acquisition would not arise at all.

In any case, the sale of the asset would certainly be a local sale. The question of an SLB being an inter-state sale does not arise at all. The local sale will be chargeable to VAT. Of course, if the selling lessee has carry forward of input tax credit, the same can be claimed against the VAT on the sale of the capital asset.

As the asset is taken back on lease, there is clearly a VAT on lease rentals. This is also off-settable by lessee.

In the hands of the lessor, the VAT paid on the purchase of the asset is off-settable in the same manner as any other VAT.

Accounting standards

Accounting standards distinguish between SLB where the leaseback is financial, and SLB where the leaseback is operating.

If the leaseback is financial, the fact of sale of the asset is completely disregarded. No profit is booked on the sale of the asset, as there is no accounting sale of the asset at all. The amount of funding raised by the sale of the asset appears as a liability on the books of the lessee.

If the leaseback is operating lease, the asset goes off the books, and the funding realized does not come as a liability, Any gain or loss on the sale of the asset is a realized gain, and is taken to profit and loss. In fact, there is something even further: if the sale price is not fair market value of the asset, profits are recognized based on the fair market value of the asset.

Creating regulatory eco-system for SPACs in India

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– Ajay Kumar KV, Manager & Himanshu Dubey, Executive

[corplaw@vinodothari.com]

From a little-known word and a preserve of a select few finance professionals, the term Special Purpose Acquisition Companies (SPACs) is today a buzzword. The regulators across the globe are taking necessary actions to enable SPACs to raise money from investors – jurisdictions like the US, UK and Malaysia lead from the front. Having a sound regulatory framework is important because if investors are keen towards SPACs, and the regulators do not enable it, it is quite likely that the country will not be a friendly destination for SPACs. Hence, India’s securities regulator SEBI has recently constituted an Expert Group for examining the feasibility of SPACs in India, and the International Financial Services Center Authority (IFSCA) has issued IFSCA (Issuance and Listing of Securities) Regulations, 2021[1] which provides a regulatory framework for listing of SPACs within its jurisdiction.

In this write up, the authors take a look at the global legislative measures, and also outline the various changes in the regulations that may be needed in India to enable to make India a SPAC-friendly jurisdiction.

Contents

Introduction. 2

Important regulatory concerns. 3

  1. Sponsor’s contribution. 4
  2. Safekeeping of IPO proceeds. 4
  3. Acquisition Process. 4
  4. Managing conflict of interest 5
  5. Exit mechanism… 5
  6. Speculation on shares. 5
  7. Celebrity endorsements. 6

Regulatory framework in India. 6

Issues under the Act 6

Regulatory framework for SPACs as per the IFSCA (Issuance and Listing of Securities) Regulations, 2021. 9

Exploring some scenarios and the concomitant regulatory ramifications. 13

Regulatory framework on SPACs abroad. 16

  1. Malaysia. 16
  2. Canada. 18
  3. United Kingdom (UK). 19
  4. United States of America (USA). 21

Conclusion. 24

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Proposed framework for overseas Investments by entities and individuals

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Proposes segregation of regulatory and the operational part in rules and regulations respectively

FCS Vinita Nair |Senior Partner, Vinod Kothari & Company

Investments by Indian entities outside India is a very common phenomenon and several companies have presence outside India by virtue of forming a Joint Venture (‘JV’) and Wholly Owned Subsidiaries (‘WOS’)

With the enforcement of amendment proposed in Finance Act, 2015 in October, 2019[1] powers vested with Central Government (CG) and Reserve Bank of India (RBI) with respect to permissible Capital Account Transaction were revisited. Power to frame rules relating to Non-Debt instruments (‘NDI’) were vested with CG and to frame regulations relating to debt instruments were vested with RBI. The scope of NDI inter alia covers all investment in equity instruments in incorporated entities: public, private, listed and unlisted; acquisition, sale or dealing directly in immoveable property.

RBI intends to combine erstwhile FEMA (Transfer or Issue of Foreign Security) Regulations, 2004[2] (‘erstwhile ODI regulations’) and FEMA (Acquisition and Transfer of immoveable property outside India) Regulations, 2015[3] into FEMA (Non-debt Instruments – Overseas Investment) Rules, 2021[4] (‘NDI Rules’) and FEMA (Overseas Investment) Regulations, 2021[5] (‘OI Regulations’) and has rolled out the draft regulations for public comments to be sent by August 23, 2021[6].

NDI Rules v/s OI Regulations

NDI Rules will provide the regulatory framework for making of overseas investment covering the permissions, conditions for making overseas investment, restrictions from making Overseas Direct Investment (‘ODI’), pricing guidelines, transfer, liquidation and restructuring of ODI. While the NDI Rules will be framed by CG, however, the same will be administered by the RBI.

OI Regulations, on the other hand, will provide only the operational part covering conditions for undertaking Financial Commitment (‘FC’), other than investment in equity capital, consideration in case of acquisition or transfer of equity capital of a Foreign Entity (‘FE’), mode of payment, obligations of Persons Resident in India (‘PRII’), reporting requirements, consequence of delay in reporting and restrictions on further FC/ transfer.

Components of Overseas Investment

Under the erstwhile ODI regulations, currently in force, there is a concept of direct investment outside India in JV and WOS that excludes portfolio investment and FC. NDI Rules combine the two to define FC and separately defines the term Overseas Portfolio Investment (‘OPI’).  Overseas Investment (‘OI’) is FC + OPI.

The classification as ODI depends on the nature of instruments in which investment is made, the nature of the entity in which investment is made and whether control has been acquired or not.

The diagram below provides a snapshot of the same.

Approval requirement proposed

The NDI Rules provides investments that require prior approval of Central Government, RBI and NOC from lender banks/ regulatory body etc. The Erstwhile ODI Regulations only mandated prior approval of RBI in case eligibility conditions stipulated were not met by the Indian party or resident individual.

Other amendments proposed

  • ODI in technology ventures through an Overseas Technology Fund (OTF) permitted for listed IE with minimum net worth of Rs. 500 crore, for the purpose of investing in overseas technology startups engaged in an activity which is in alignment with the core business of such IE.
  • Limit of FC upto 400% of networth will not apply to FC made by “Maharatna” PSUs or “Navratna” PSUs or subsidiaries of such PSUs in foreign entities outside India engaged in strategic sectors. Strategic sectors defined to include energy and natural resources sectors such as Oil, Gas, Coal and Mineral Ores or any other sector that may be advised by CG.
  • Definition of net worth to be aligned with Companies Act, 2013.
  • Sub-limits for determination of FC (50% of performance guarantee, 100% of corporate guarantee) is proposed to be done away with.
  • Applicability of provisions in case of investments made in or by units in IFSC clarified.
  • Bona fide activity defined to mean such business activities legally permissible both in India and host jurisdiction.
  • Permissible range of 5% of the fair value arrived on an arm’s length basis as per any internationally accepted pricing methodology for valuation duly certified by a registered valuer as per the Companies Act 2013; or similar valuer registered with the regulatory authority in the host jurisdiction to the satisfaction of the AD bank provided along with period of validity of valuation certificate upto 6 months before the date of the transaction.
  • Reporting of FC and OPI to be done in distinct forms.
  • Prohibition on further FC to continue until any delay in reporting is regularized. The erstwhile ODI regulations restricted only in case of non-filing of Form APR.
  • Restriction on acquisition of immoveable property outside India will not apply in case the same is acquired on lease by PRII for a period not exceeding 5 years. Manner of transfer of immoveable properties also prescribed.
  • Source of funds for acquiring immoveable property outside India to include limit under Liberalised Remittance Scheme (LRS) and out of income/ sale proceeds of the assets, other than ODI.

 

Our other videos and write-ups may be accessed below:

YouTube:

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

Other write-up relating to corporate laws:

https://vinodkothari.com/category/corporate-laws/fema/

 

 

[1] https://egazette.nic.in/WriteReadData/2019/213265.pdf

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=2126&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10257&Mode=0

[4] https://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=4024

[5] https://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=4023

[6] https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=52026

SPACs – Value Proposition & Regulatory Framework

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– Megha Mittal

[mittal@vinodkothari.com]

The concept of Special Purpose Acquisition Companies (‘SPACs’) has gained significant attention and importance in India in recent times – from a subject preserved to select classes, the surge in transactions over 2020, has made it pave its way to every investor’s dictionary. And with all the spotlight that SPACs have attracted, the numbers seem to only lend to the hype. To begin with, the global SPAC IPO proceeds in 2020 alone is estimated to be $83 billion USD[1] with a total of 251 listings. This figure is further projected to grow to a massive 711 listings in 2021 with an average IPO size of USD 294.5 Million as on 15th August, 2021[2].

Globally, SPACs have become the investment vehicle of choice, more-so by startups looking for funding; and the US has been the flag bearer of the SPAC industry, leading from the front. Following shortly behind are economies like UK, Malaysia and Canada; and while India is playing catch-up, it seems to be speeding up quick enough, at least on the regulatory front.

For the uninitiated, a SPAC, often referred to as a Blank-check Company or a Shell Company, is a non-operating company with the admitted intent (read: special purpose) of acquiring of a potential target within a stipulated timeline[3].

In this article, while dealing with the basic regulatory framework via-a-vis SPACs, the author seeks to analyse the motivation(s) behind such transactions from all perspectives – the acquirer’s, the acquiree’s and the investors’.

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Checklist for issuance of listed debt securities on private placement basis

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Non-convertible debentures issued on private placement basis are one of the most practiced ways of raising finance by the companies in India. Considering the notification of SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021, effective from 16th August, 2021, the companies may be under a perplexity of how to comply with the requirements of the newly notified regulations. We have summarised the procedure into a checklist below for reference.

Checklist for issuance of  listed and unsecured NCDs on Private Placement Basis
Serial No. Particulars  Relevant provisions  Remarks
Eligibility conditions:
A. Eligibility requirements under the Companies Act, 2013:
1. Offer can be made to a maximum of 200 persons
2. No advertisement can be made in the newspapers
3. The Company shall not make a fresh offer or invitation unless the allotment with respect to any offer or invitation made earlier have been completed, or withdrawn or abandoned by the Company.
B. Eligibility requirements under SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021
No issuer shall make an issue of non-convertible securities if as on the date of filing of draft offer document or offer document:
(a) the issuer, any of its promoters, promoter group or directors are debarred from accessing the securities market or dealing in securities by the Board;
(b) any of the promoters or directors of the issuer is a promoter or director of another company which is debarred from accessing the securities market or dealing in securities by the Board;
(c) any of its promoters or directors is a fugitive economic offender; or
(d) any fine or penalties levied by the Board /Stock Exchanges is pending to be paid by the issuer at the time of filing the offer document:
1 Convening of a Board Meeting:
i. To consider and approve issue of debentures including the terms and conditions of issue for the entire FY ;
ii. To authorise the Board Borrowing Committee/ other relevant committee [Optional] for the following:
a. Appointment of RTA and execute tripartite agreement [Reg 9]
b. Appointment of Credit Rating Agency and obtain Credit Rating. [Reg 10]
c. Opening of Separate Bank Account with Schedule Bank [Proviso to Section 42(6)].
d. To identify group of persons to whom Debentures are proposed to be issued [Section 42(2)]
e. To approve Private Placement offer letter
f.Appointment of Depository [Reg 7]
g. For allotment of NCDs
h. other matters relevant to the issue of NCDs
i.To appoint a debenture trustee before the issue of letter of offer for subscription of the debentures [Reg 8]
j. To obtain in-principle approval from stock exchanges [Reg 6]		 Section 179(3) of CA
Section 42, 71 & SS-1
2 Approval of shareholders Sec. 71, 42, Rule 14(1) of Companies (PAS) Rules,2014, Rule 18 of SHA Rules not required if blanket approval already taken and issue is within the limit as per  second proviso to Rule 2 of Companies (Prospectus and Allotment of Securities) Rules, 2016
3 Filing of MGT-14  Rule 14(1) of Companies (PAS) Rules, 2014 Within 30 days of passing of the Board Resolution/ Shareholders resolution
4 a. Preparation and finalisation of Disclosure Document;
b. Preparation and finalisation of DTD, DTA/ Debenture Subscription Agreement.
5 Obtain consent from Trustee Before issue of offer document
6 To convene Board Borrowing Committee/ other relevant committee meeting for the following:                                                                                                                         a. Approval of draft offer document/ Disclosure Document/ Information Memorandum, Debenture Trust Deed, Debenture Trustee Agreement,Application Form
b. Identification of RTA
c. Approval of List of proposed Allotees
d. Approval for opening of Escrow Account (if already opened then noting of the same)
e. All other matter as delgated by the Board as mentioned in Point 1 above.		 Section 42(3) of CA with Rule 14 (3) of Companies (Prospectus and allotment of Securities) Rules, 2014 In terms of Rule 18(1)(c) & (5) of the Companies (Share Capital and Debentures) Rules, 2014 [Section 71(5)], the debenture trustee shall be appointed and DTD shal be executed at any time within 60 days of allotment of debentures. Accordingly, this may be done after the allotment of NCDs also.
7 Creation of debenture redemption reserve Section 71(4) read with Rule 18 (7)(b)(iv)(B) The value of debenture redemption reserve shall be 10% of the value of outstanding debentures.

DRR shall not be required in case of NBFCs [Rule 18 (7) (iv)(A) of Deposit Rules
8 Creation of recovery expense fund Reg 11 read with SEBI Circular https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/oct-2020/1603361431987.pdf#page=1&zoom=page-width,-16,792 deposit an amount equal to 0.01% of the issue size with designated stock exchange upto  a maximum of Rs. 25 lakhs.
9 Obtain credit rating Reg 10
10 Agreement with depository for dematerialisation Reg 7
11 Private placement offer-cum-application shall be sent to the identified investors Sec. 42 of CA 13
12 Maintain a complete record of persons to whom the Private Placement offer letter is sent in form PAS-5. Rule 14(4) of PAS Rules
13 Receipt of application money Section 42 of CA
14 Filing of Master Creation form with NSDL/CDSL -for demat issuance
15 Filing of listing application with stock exchanges and debenture trustees –
(a) Placement Memorandum;
(b) Memorandum of Association and Articles of Association;
(c) Copy of the requisite board/ committee resolutions authorizing the borrowing and list of authorised signatories for the allotment of securities;
(d) Copy of last three years Annual Reports;
(e) Statement containing particulars of, dates of, and parties to all material contracts and agreements;
(f) An undertaking from the issuer stating that the necessary documents for creation of the charge, wherever applicable, including the Trust Deed has been executed within the time frame prescribed in the relevant regulations/Act/rules etc. and the same would be uploaded on the website of the designated stock exchange, where such securities have been proposed to be listed;
(g) In case of debt securities, an undertaking that permission / consent from the prior creditor for a second or pari passu charge being created, wherever applicable, in favour of the debenture trustee to the proposed issue has been obtained; and
(h) Any other particulars or documents that the recognized stock exchange may call for as it deems fit:		 Reg 44
16 Allotment of NCDs after holding a meeting of Borrowing Committee/ other relevant committee Section 42 of CA
17 Filing of PAS-3 with ROC Section 42(8) read with Rule 14(6) of Companies Prospectus and allotment of securities) Rules, 2014
18 Payment of fees to stock exchanges Reg 13(2) at the time of listing

This is a general checklist for companies desiring to list its debt securities. For NBFCs and HFCs, the requirements may differ depending upon their specifically applicable regulations.

Further, you may read our article on the NCS Regulations here.

A comparison of the NCS Regulations from erstwhile ILDS Regulations can be accessed here.

A presentation on the various structures of debt securities can be viewed here – https://vinodkothari.com/2021/09/structuring-of-debt-instruments/

Use of dual recourse instruments for SME finance: The Making of European Secured Notes

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– Vinod Kothari and Abhirup Ghosh (finserv@vinodkothari.com)

The European financial regulators are working on a new funding instrument whereby banks and primary lenders can raise refinance against their portfolio of SME loans, by issuing a bond which is directly linked with such portfolios, called European Secured Notes (ESNs). ESNs are a dual recourse instrument, following the time-tested structure of covered bonds.

Covered bonds, developed more than 250 years ago in Europe, use dual recourse structure. The first recourse, against the issuer, is prone to the risk of bankruptcy of the issuer. In that situation, the investors have recourse against the assets of the issuer, and that recourse is made immune from other bankruptcy claims or priorities. This ring-fencing is granted either by explicit legislation, or by use of contract law flexibility. Covered bonds are currently used, to an overwhelming extent, for prime residential mortgage loans. Given their bankruptcy-protected asset backing, covered bonds allow the issuer to get a rating higher than the issuer’s own default rating. This phenomenon, called “notching up”, may cause the ratings on the bonds to go up over the rating of the issues by some 6 to 9 notches.

European regulators are trying to build on the methodology of covered bonds to see if a similar instrument can be used by banks to refinance their SME loan pools.

Development of European Secured Notes:

There have been past instances, sporadically, of dual recourse bonds, on lines similar to ESNs,. A notable instance was Commerzbank’s SME-backed structured covered bond programme established in 2013 but fully repaid in 2018[1]. Besides this, there were several issuances in France, though they are no longer used.

There has been a multi-issuer platform called French “Euro secured Note issuer” (ESNI), established in 2014 and supported by the Banque de France. Though the programme was open to all French and European Banks, only four French banks opted for this. There were around 20 issuances totalling to over Euro 10 Bn. Banque de France acted as the monitor for the asset quality of the SME loans. It used its internal rating model to examine the assets and score them. The scoring, in combination with haircuts on such assets established the minimum over-collateralisation level.

The Italian regulators also proposed to come up with an enabling regulatory framework to permit domestic issuers to issue Obbligazioni Bancarie Collateralizzate (OBC);  however, this seems to have been stranded into oblivion.

Similar efforts were made by the Spanish regulators when they amended the covered bonds framework in 2015.

The work done all this while might have been the inspiration for the European Commission when it proposed the use of ESN as a financial instrument backed by SME loans and infrastructure loans, to be used by banks, as a part of the Capital Markets Union proposals in 2017[2].

Subsequently, the Commission requested a report from the European Banking Authority to set out probable structures of ESNs, which was issued in July 2018[3].

It was originally meant to be kept on the backburner until 2024, however, with the COVID 19 pandemic, the European Parliament asked the European Commission to accelerate the introduction of ESNs to help financing the recovery from the pandemic.

In April 2021, the ESN Task Force, that is, ECBC along with EMF, issued the ESN Blueprint[4]. It appears that ESNs may be rolled out ahead of the original implementation schedule.

Structure of ESNs

Originally, at the time of conceptualisation, there were two structures which were contemplated:

  1. A structure that mirrors the structure of covered bonds,
  2. A structure that mirrors the structure of ABS

However, EBA suggested the first structure in its report.

The key recommendations of the EBA on the structure are as follows:

  1. Dual recourse – The bond must grant the investor a claim on the covered bond issuer, and if it fails to pay, a priority claim on the cover pool limited to the fulfilment of the payment obligations. Further, if the cover pool turns to be insufficient to fulfil the payments, the investor shall have recourse back to the insolvency estate of the issuer, which shall rank pari passu with the claims of the unsecured creditors.
  2. Segregation of cover assets – The next important suggestion was with respect to the segregation of cover assets. The segregation of assets could be either be achieved through registration of the cover pool into a cover register or by transferring them to a special purpose vehicle (SPV). Note that registration of covered bonds is required by several European jurisdictions, as well as Canada.
  3. Bankruptcy-remoteness of the covered bond: The legal/ regulatory framework should facilitate the bankruptcy-remoteness by not requiring acceleration of payments in case of issuer default.
  4. Administration of the covered bond programme after the issuer’s insolvency or resolution: The legal/regulatory covered bond framework should provide that upon issuer’s default or resolution the covered bond programme is managed in an independent way and in the preferential interest of the covered bond investor.
  5. Composition of cover pool: The cover pool should comprise of non-defaulted SME loan and leasing exposures. Further, the pool should be dynamic. Given the high risk associated with SME loans, the EBA recommended incorporating strict eligibility criteria at both loan and pool levels in the form of:
    • selected SME exposures
    • sufficient granularity,
    • concentration limit,
    • quality standards.
  6. Coverage principles and legal/regulatory overcollateralization: The claims against the cover pool should not exceed the receivables arising out of the cover pool. Further, the EBA considered a minimum over-collateralisation must be prescribed for SME ESNs. In this regard, the EBA recommended a minimum over-collateralisation of 30%.

Use of capital market instruments for refinancing SME loans:

“SMEs are important actors in economic growth and transformation, creating positive value for the economy and contributing towards sustainable and balanced economic growth, employment and social stability”[5]. The use of capital market instruments for refinancing SME loans has been engaging the attention of policymakers and regulators alike. The extent of penetration of bank finance to SMEs is far from optimal, and additionally, there are gaping differences across geographies.

Direct access of SMEs to capital markets for debt funding is quite limited, since most of the SMEs do not have the size to be able to attract the attention of institutional investors in the capital market. An OECD-World Bank report notes that “individual SMEs issuances do not easily align with the risk appetite and prudential requirements of institutional investors.”[6] On the other hand, institutional investors may easily participate in bonds or similar instruments which refinance or repackage SME lenders’ loan portfolios. The aforesaid OECD-World Bank report envisages 4 types of capital market instruments for SME refinancing –corporate bonds issued by SME lenders, securitisation of SME loans, SME covered bonds, and SME loan & bond funds, as collective investment schemes.

Issuance of bonds by banks, for on-lending to SMEs or refinancing SME loan portfolios, is quite common in many countries. Such bonds are, however, linked with the performance and rating of the issuer bank.

As for securitisation of SME loans, the overall contribution of SME loans as an asset class in the global securitisation volumes will be in the region of 2%, which obviously dwarfs in comparison to popular asset classes such as residential mortgage loans. Post the GFC, several European jurisdictions have used securitisation of SME loans, but looking at the huge proportion of retained securitisations (see Graph below), it is quite evident that such activity was motivated by the objective of refinancing by ECB. This low volume is despite the fact that  asset backed securitisation is the most natural choice to fund SME loans through capital market, as they provide three benefits:

  1. Provide funding to the banks
  2. The assets move off the books of the originator, depending on the structure
  3. Can be tailor made to the specifications of the investor
  4. Regulatory capital relief

In the recent times, SME ABS issuances in Europe peaked in 2019, of which almost 97% were issued in retained format.

Source: Scope Ratings[7]

Outside of Europe, Korea and India have seen several securitisations of SME loan pools.

Relevance of dual recourse instrument for SME funding

Covered bonds are mostly supported by legislation to provide bankruptcy protection in European jurisdictions. In several other jurisdictions, the flexibility of the common law structure is utilised for providing bankruptcy protection. However, the essential premise in either case is the same –which is the ability of the cover pool to be a backstop for redemption of the bonds, in the event of failure of the issuer to pay them. Therefore, the pool of assets have to be liquid and robust to be able to pay off the bondholders.

There is substantial difference between mortgage pools backing up covered bonds, and SME loans. SME loans have lesser granularity, heterogeneity, and higher historical default rates. The servicing of SME loans from the viewpoint of ongoing collections is also not as easy as in case of mortgage loans. However, these will be ultimately be the factors that would have to be borne in mind by the rating agencies while sizing up the level of over-collateraliation and fixing the level of rating notch-ups for SME-loan-backed covered bonds. As a matter of principle, if there is a market for securitisation of SME loans as demonstrated by recent global transactions, a covered bond structure only tries to marry the benefits of securitisation and corporate bonds. Hence, introducing covered bonds backed by SME loans may be the right idea.

The robustness of covered bond with a history of over 250 years is explained, other than by the legislative protection, by the good quality of the cover pool. The transparency of loan-level performance data of SME loans is much lesser than mortgage loans. Even more importantly, the question is the ability and liquidity of the cover pool, given the insolvency of the issuer, to redeem the bonds. SME loans do not have as liquid secondary market, and the migration of servicing to an alternate servicer makes the liquidity of such loan pools even more difficult. The layering of a credit guarantee support by credit guarantee schemes, which exist practically in every jurisdiction in the world, could also be considered as a credit support.

Should there be a legislative bankruptcy protection, which removes these loan pools completely from the bankruptcy estate and makes the same available to covered bond investors only? This question becomes a complicated one, involving inter-creditor rights. Insolvency for other creditors becomes deeper if there are more bankruptcy-protected instruments.

The urgency for ESNs is also a part of the post-Covid worries of regulators all over the world, and clearly, SMEs are seen as a huge agent of post-Covid revival. However, the need for availability of more liquidity for SMEs has always been crucial. Therefore, the introduction of SME-loan-backed covered bonds may be an agenda items for countries outside of Europe too.

[1] https://www.scoperatings.com/ScopeRatingsApi/api/downloadstudy?id=dfa74ad6-f1ca-4860-a916-bc0638846bb1

[2] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52017DC0292

[3] https://www.eba.europa.eu/sites/default/documents/files/documents/10180/2087449/6fe04a31-ec0b-4ea1-9508-258ad2cf72d8/EBA%20Final%20report%20on%20ESNs.pdf

[4] https://hypo.org/app/uploads/sites/3/2017/05/ECBC-ESN-Blueprint-April-2021.pdf

[5] IOSCO Report, 2015, titled SME Financing Through Capital Markets, at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD493.pdf

[6] https://www.oecd.org/g20/topics/development/WB-IMF-OECD-report-Capital-Markets-Instruments-for-Infrastructure-and-SME-Financing.pdf, page 46

[7] https://www.scoperatings.com/ScopeRatingsApi/api/downloadstudy?id=dfa74ad6-f1ca-4860-a916-bc0638846bb1

Our other resources on Covered Bonds:

https://vinodkothari.com/2021/07/covered-bonds-the-story-of-the-indianised-version-of-a-global-instrument/ 

https://vinodkothari.com/covered_bonds-2/ 

https://www.youtube.com/watch?v=XyoPcuzbys4

Discontinuation of manual disclosures under PIT Regulations

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corplaw@vinodkothari.com

 

 

September 09, 2020 Circular: https://www.sebi.gov.in/legal/circulars/sep-2020/automation-of-continual-disclosures-under-regulation-7-2-of-sebi-prohibition-of-insider-trading-regulations-2015-system-driven-disclosures_47523.html

June 16, 2021 Circular: https://www.sebi.gov.in/legal/circulars/jun-2021/automation-of-continual-disclosures-under-regulation-7-2-of-sebi-prohibition-of-insider-trading-regulations-2015-system-driven-disclosures-for-inclusion-of-listed-debt-securities_50572.html 

August 13, 2021 Circular:https://www.sebi.gov.in/legal/circulars/aug-2021/automation-of-continual-disclosures-under-regulation-7-2-of-sebi-prohibition-of-insider-trading-regulations-2015-system-driven-disclosures-ease-of-doing-business_51848.html

 

 

SEBI eases disclosure requirements under SAST Regulations

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corplaw@vinodkothari.com

August 13, 2021 notification: https://egazette.nic.in/WriteReadData/2021/228973.pdf

Adjudication order: https://www.sebi.gov.in/enforcement/orders/mar-2020/adjudication-order-in-respect-of-two-entities-in-the-matter-of-yes-bank-ltd-_46477.html

NCS Regulations versus ILDS Regulations

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Comparitive between consolidate framework and erstwhile provisions relating to private placement.

Henil Shah | Assistant Manager and Parth Ved | Executive corplaw@vinodkothari.com

SEBI vide its notification dated August 09, 2021 introduced SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (‘NCS Regulations’), NCS Regulations have merged the provisions of SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (‘ILDS Regulations’), and SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013 (‘NCRPS Regulations’). The notified regulations in ambits covers framework pertaining to issue of non-convertible debentures (‘NCDs’), non-convertible preference shares (‘NCPS’), perpetual debt securities (‘PDIs’), and listed commercial paper.

The NCS regulations shall be effective from 7th day from the date of their publication in the official gazette i.e. 16th August, 2021.

In this article, we present a comparison between the erstwhile ILDS regulations and NCS Regulations from the point of view of a private placement of NCDs.

NCS Regulations v/s ILDS Regulations

Sr.No NCS Regulations ILDS Regulations Our Remarks  
 1 Reg. 5: Eligible Issuer 

(1)   No issuer shall make an issue of non-convertible securities if as on the date of filing of draft offer document or offer document:

a.       the issuer, any of its promoters, promoter group or directors are debarred from accessing the securities market or dealing in securities by the Board;

b.      any of the promoters or directors of the issuer is a promoter or director of another company which is debarred from accessing the securities market or dealing in securities by the Board

c.       the issuer or any of its promoters or directors is a wilful defaulter;

d.      any of the promoters or whole-time directors of the issuer is a promoter or whole-time director of another company which is a wilful defaulter

e.       any of its promoters or directors is a fugitive economic offender; or

f.        any fine or penalties levied by the Board /Stock Exchanges is pending to be paid by the issuer at the time of filing the offer document:

g.       Provide that the:

(i)    restrictions mentioned at (b) and (d) above shall not be applicable in case of a person who was appointed as a director only by virtue of nomination by a debenture trustee in other company.

(ii)  restrictions mentioned in (a) and (b) above shall not be applicable if the period of debarment is over as on date of filing of the draft offer document with the Board.

(iii)   restrictions mentioned at (c) and (d) shall not be applicable in case of private placement of non-convertible securities

(2)    No issuer shall make a public issue of non-convertible securities if as on the date of filing of draft offer document or offer document, the issuer is in default of payment of interest or repayment of principal amount in respect of non-convertible securities, if any, for a period of more than six months.

 

   ILDS Regulations didn’t laid out any specific eligibility criteria for the issue to list its NCDs issued on private placement basis.

Under the NCS Regulations, the condition that the issuer shall not be debarred from accessing the securities market or dealing in securities has been extended to promoter group entity as well. Further, certain additional conditions such as the promoter or WTD shall not be a promoter or WTD of a company which is a wilful defaulter, no promoters or directors shall be fugitive economic offenders or no fines or penalties are pending at the time of filing of offer document have been inserted.

Associating payment of fines and penalties with listing might not be a feasible idea; as there might be situations where the issuer may have raised disputes/concerns on liability to pay such fines/penalties.
2 Reg. 6: In-principal approval

The issuer shall make an application to one or more stock exchange(s) and obtain an in-principle approval for listing of its non-convertible securities from the stock exchange(s) where such securities are proposed to be listed:

Provided that where the application is made to more than one stock exchange, the issuer shall choose one among them as the designated stock exchange.

 

 

 

 Reg. 19(3): Mandatory listing

Where the issuer has disclosed the intention to seek listing of debt securities issued on private placement basis, the issuer shall forward the listing application along with the disclosures specified in Schedule I to the recognized stock exchange within fifteen days from the date of allotment of such debt securities.

 Under ILDS Regulations there was no specific requirement to obtain in-principal approval form stock exchange for listing, an application along with disclosure specified in the regulations did the trick.

However, moving forward the issuers will be required to obtain a prior in-principal approval for listing.

Actionable: Going forward issuers will be required to obtain in-principal approval.
 3 Reg. 8: Debenture Trustee

 

The issuer shall appoint a debenture trustee in case of an issue of debt securities.

 – There was no clarity under ILDS w.r.t appointment of debenture trustee for private placement of debt securities. Notification of NCS regulations brings clarity on appointment of debenture trustee.
4 Reg. 12: Electronic Issuances

An issuer proposing to issue non-convertible securities through the on-line system of the stock exchange(s) and depositories shall comply with the relevant applicable requirements as may be specified by the Board.

 – Applicability of issuance through EBP platform in case of private placement comes from SEBI circular dated. Considering the benefits of EBP platform SEBI in its Consultation Paper, proposed to reduce the limit from 200 Crores to 100 Crores. Accordingly, changes are being carried out under para  of Operational Circular for issue and listing of Non-Convertible (NCS) Securitised Debt Instruments (SDI) Security Receipts (SR), Municipal Debt Securities and Commercial Paper (CP) dated August 10, 2021 (‘Operational Circular’)
5 Reg. 15: Rights to recall or redeem prior to maturity

 

Framework for right to recall and right to redemption prior to maturity.

 

 

 

 ILDS Regulations, provided framework for right to recall (i.e. Call Option) and right of redemption (i.e. Put Option) prior to maturity, in case of public issue of NCDs. In case of private placement of NCDs, the same was entirely guided by the terms of issue.

However, the NCS regulations have now stipulated that provisions relating to call and put option shall equally apply in case of public issuances as well as private placement.

This seems to take away the flexibility that issuers enjoyed in certain cases for issuers of privately placed debentures for example, where an interest rate in case of delay on part of the issuer could be avoided or kept at a minimal rate, the same will be charged at 15% interest rate.

Aside, also note that put option is a feature only applicable in case of NCDs and not NCPs.
6 Reg. 18(1): Trust Deed

 

The issuer and the debenture trustee shall execute the trust deed within such timelines as may be specified by the Board.

 

 

 

 – Timeline and format for execution of debenture trust deed was not expressly mentioned for private placement in the ILDS.

The NCS Regulations have aligned with requirement for SEBI circular dated November 03, 2021.

It may be noted that reg.59(3) of NCS Regulations save all the circulars, etc. issued under previous regulations as if the same were issued under NCS Regulations.
7 Reg. 23(3): Obligations of the Issuer  

The issuer shall apply for Securities and Exchange Board of India Complaints Redress System (SCORES) authentication in the format specified by the Board and shall use the same for all issuance of non-convertible securities.

 – The requirement was not specifically mentioned in the ILDS Regulations, however the requirement of registering on SCORES also comes from SEBI (Listing Obligation and Disclosure Requirement), 2015.
8 Reg. 43(2): Creation of Security

The charge created in respect of the secured debt securities shall be disclosed in the offer document along with an undertaking that the assets on which charge or security has been created to meet the hundred percent security cover is free from any encumbrances and in case the assets are encumbered, the permissions or consent to create first, second or pari passu charge on the assets has been obtained from the existing creditors to whom the assets are charged, prior to creation of the charge:

Provided that sub regulation (2) shall not apply if the charge is created on additional assets other than the assets comprising of hundred percent security cover.

 

 Reg. 21B: Creation of Security 

 

The issuer shall give an undertaking in the Information Memorandum that the assets on which charge is created are free from any encumbrances and in cases where the assets are already charged to secure a debt, the permission or consent to create a second or pari-passu charge on the assets of the issuer has been obtained from the earlier creditor.

 The regulations provide that in case of additional security cover (that is, beyond 100%), sub-reg (2) shall not apply. it may imply that the issuer need not give an undertaking with respect to the additional security cover being free of encumbrances or the issuer having obtained prior consents.

However, it must be noted that where additional security cover so provided is a subject asset under any other financing agreements entered into with any other person or lenders, the agreement may provide for obtaining prior consent of such lender

In that case, it might be impractical (and also, not in accordance with law) to say that the issuer can proceed to create encumbrance without obtaining consent of the lender therefore, irrespective of whether any undertaking is given in the offer document, the issuer would need to comply with any contractual covenants wrt to such “additional” security cover

 
9 Reg. 44(1): Listing Application

The  issuer  shall  forward  the  listing application along with the disclosures as per this regulation to the stock exchange(s) within such days as may be specified by the Board from the date of closure of the issue:

 Reg. 19(3): Mandatory Listing 

 

Where the issuer has disclosed the intention to seek listing of debt securities issued on private placement basis, the issuer shall forward the listing application along with the disclosures specified in Schedule I to the recognized stock exchange within fifteen days from the date of allotment of such debt securities.

 The provision in the NCS regulation is aligned with timelines for listing notified via SEBI circular dated October 05, 2020 now subsumed into Operational Circular.
10 Reg. 44(3) & (4):  Due diligence

(3) Debenture trustee shall submit a due diligence certificate to the stock exchange in the format as specified in Schedule IV of these regulations.

(4) The stock exchange(s) shall list the debt securities only upon receipt of the due diligence certificate from the debenture trustee as per format specified by the Board.

Regulation 44 provides for:

  1. The issuer has made adequate provisions for and/or has taken steps to provide for adequate security for the debt securities to be issued.
  2. The issuer has obtained the permissions / consents necessary for creating security on the said property (ies).
  3. The issuer has made all the relevant disclosures about the security and also its continued obligations towards the holders of debt securities.
  4. All disclosures made in the offer document with respect to the debt securities are true, fair and adequate to enable the investors to make a well informed decision as to the investment in the proposed issue.

 

 –
  1. The format of Schedule IV provides for format of due diligence certificate to be given by the debenture trustee before opening of the issue.
  2. This certification was not specifically present under ILDS Regulations for private placements; however, in case of November 03, 2020 circular due diligence required due diligence to be undertaken by the debenture trustee in case of issuance of secured debentures. Therefore, NCS Regulations now have a specific clause for due diligence in case of private placement also. 
  3. Similar requirement was applicable for public issues under reg. 6(8) of ILDS Regulations.
  4. This certification is required to be given at the time of filing of private placement memorandum/ information memorandum/ before opening of the issue and at the time of filing of listing application by issuer  in case of private placement; however, for public issues, this certificate is given at the time of at the time of filing the draft offer document with the stock exchange(s) and prior to opening of the public issue of debt securities.

 
11 Reg. 47(2): Filing of shelf placement memorandum

 The shelf placement memorandum shall indicate a period not exceeding one year as the period of validity of such memorandum which shall commence from the date of opening of the first offer of debt securities under that memorandum, and in respect of a second or subsequent offer of such debt securities issued during the period of validity of that memorandum, no further placement memorandum is required.

 Reg. 21A(2): Filing of Shelf Disclosure Document

An issuer filing a Shelf Disclosure Document under sub-regulation (1), shall not be required to file disclosure document, while making subsequent private placement of debt securities for a period of 180 days from the date of filing of the shelf disclosure document.

 The time validity of shelf prospectus in case of private placement of debt securities has been increased from 180 days to 1 year.

 

This is a welcome move, as this will eliminate hassles for frequent issuers to file shelf prospectus multiple times.

 

 

Disclosure Requirements:

The NCS Regulations provides for a separate sets of disclosure requirements in case of both public issue and private placement. Template for disclosure required to be made in case of private placement of NCS are provided in the schedule of the NCS regulations. Following is a comparison of disclosure required to be made in terms of NCS Regulations vs ILDS Regulations and NCRPs Regulations. In general the NCS widens the purview of information to be disclosed for the purpose of enhancing disclosure being made further streamlining aligning the same.   

Sr. No NCS Regulation (Schedule II) ILDS Regulations (Schedule I) NCRPS Regulations

(Schedule I)
1 1. Instructions

Following general instructions for preparation of draft offer document are specified:

  1. All information shall be relevant and updated as on the date of the offer document.
  2. Source of all statements & claims shall be disclosed.
  3. Terms such as “market leader”, “leading player”, etc. shall be used only if these can be substantiated by citing a proper source.
  4. Use simple English and technical terms if any, w.r.t. business shall be clarified in simple terms.
  5. There shall be no forward-looking statements that cannot be substantiated.
  6. Consistency shall be maintained in the style of disclosures.
  7. For currency of presentation, only one standard financial unit shall be used.
 There were no such specific instructions. There were no such specific instructions.
Para 2.2: The front page shall contain:

  1. Name, logo, CIN, PAN, date and place of incorporation, registration number issued by any regulatory authority, address of registered and corporate offices, telephone number, website, email.
  2. Name, telephone number, email of compliance officer, CS, CFO and Promoters.
  3. Name, addresses, logo, telephone number, email and contact person of debenture trustee, CRA,
  4. Name, logo, address of Registrar to the issue (RTA) along with its telephone number, fax number, website and email address.
  5. Date and type of placement memorandum.
  6. Nature, number, price and amount of securities offered and issue size (base issue or green shoe),
  7. Aggregate amount proposed to be raised through all the stages of offers of NCS through shelf placement memorandum
  8. Issue schedule – Date of opening, closing, earliest closing (if any) of issue.
  9. Credit rating (along with cross reference of press release) and all ratings obtained for the private placement.
  10. Name of stock exchange where securities are proposed to be listed.
  11. Details about eligible investors.
  12. Coupon / dividend rate and payment frequency, redemption date and amount and details of debenture trustee.
  13. Nature and issue size, base issue and green shoe option, if any, shelf or tranche size, each as may be applicable.
  14. Details about underwriting including amount underwritten.
  15. Inclusion of compliance clause w.r.t. EBP platform, if applicable.
 There was no specific requirement to state the following information on front page.

Para 3.A.a: However, following disclosures were to be made where relevant:

Name and address of the following:

  1. Registered and corporate office of issuer;
  2. Compliance officer, CFO of issuer;
  3. Arrangers, if any;
  4. Trustee of the issue;
  5. RTA;
  6. Credit Rating Agency(ies) of the issue;
  7. Auditors of the issuer.
 Para II.A: A prominent disclosure in bold writing on the cover page of offer document stating the following:

“Instruments offered through the offer document are non-convertible redeemable preference shares and not debentures/bonds. They are riskier than debentures / bonds and may not carry any guaranteed coupon and can be redeemed only out of the distributable profits of the company or out of the proceeds of a fresh issue of shares made, if any, by the company for the purposes of the redemption”

 

Para II.B.i: However, following disclosures were to be made where relevant:

Name and address of the following:

  1. Registered and corporate office of issuer;
  2. Compliance officer, CFO of issuer;
  3. Arrangers, if any;
  4. Trustee of the issue;
  5. RTA;
  6. Credit Rating Agency(ies) of the issue;
  7. Auditors of the issuer.
2 Para 2.3.1: Insertion of clause relating to Issuer’s Absolute Responsibility as per the text provided in Schedule II. There was no such clause specified in the regulations but issuer generally put a disclaimer clause. There was no such clause specified in the regulations but issuer generally put a disclaimer clause.
3 Para 2.3.2: Details of Promoters of the Issuer:

A complete profile of all the promoters, including their name, date of birth, age, personal addresses, educational qualifications, experience in the business or employment, positions/posts held in the past, directorships held, other ventures of each promoter, special achievements, their business and financial activities, photograph, PAN.

A declaration confirming that the PAN, Aadhaar Number, Driving License Number, Bank Account Number(s) and Passport Number of the promoters and PAN of directors have been submitted to the stock exchanges on which the non-convertible securities are proposed to be listed, at the time of filing the draft offer document.

 Para 3.A.h: Earlier, only promoter holding as on the latest quarter end was required to be disclosed.

Declaration confirming submission of information pertaining  to personal details of promoters/ directors of promoters to SEs is a new requirement.

 Para II.B.viii: Earlier, only promoter holding as on the latest quarter end was required to be disclosed.

Declaration confirming submission of information pertaining  to personal details of promoters/ directors of promoters to SEs is a new requirement.
4 Para 2.3.4: Name(s) and in-principle approval of the stock exchange(s) where the NCS are proposed to be listed and in case of more than one stock exchange, specify the designated stock exchange.

The issuer shall specify the stock exchange where the recovery expense fund is being/has been created as specified by SEBI.

 Para 3.A.p: Names of all the recognised stock exchanges where the debt securities are proposed to be listed clearly indicating the designated stock exchange. Para II.B.xii: Names of all the recognized stock exchanges where NCRPS are proposed to be listed clearly indicating the designated stock exchange
5 Para 2.3.6: Name, logo, address, website, email, telephone number and contact person of debenture trustee, CRA, RTA, Statutory Auditor, legal counsel, Guarantor, arranger, if any. Para 3.A.a: Earlier, details w.r.t. Legal counsel and Guarantor was not included in the regulation.

Further, the requirement of putting a logo, though not expressly mentioned, was anyways followed.

 Para II.B.i: Earlier, details w.r.t. Legal counsel and Guarantor was not included in the regulation.

Further, the requirement of putting a logo, though not expressly mentioned, was anyways followed.
6 Para 2.3.8 Financial Information 

A columnar representation of the audited financial statements on a standalone and consolidated basis for a period of 3 completed years.

Combined financial statements need to be disclosed for the periods when such historical financial statements are not available if the issuer being a listed REIT/listed InvIT has been in existence for a period less than three completed years.

Issuers (other than unlisted REITs / InvITs) who are in existence for less than 3 years may disclose financial statements subject to the following conditions:

i. The issue is made on the EBP platform irrespective of the issue size; and

ii. The issue is open for subscription only to QIB.

Listed issuers may disclose unaudited financial information for the stub period instead of audited financial statements in the format as prescribed in LODR Regulations with limited review report, subject to necessary disclosures in the placement memorandum.

 – –
7 Para 2.3.10.c: Equity share capital history for the last three years:

  1. Date of allotment
  2. No. of equity shares
  3. Face value
  4. Issue price
  5. Consideration (Cash, other than cash, etc)
  6. Nature of allotment
  7. Cumulative no. of equity shares, equity capital and equity share premium
  8. Remarks
 Para 3.A.c.iii: Equity share capital history for the last five years:

  1. Date of allotment
  2. No. of equity shares
  3. Face value
  4. Issue price
  5. Consideration (Cash, other than cash, etc)
  6. Nature of allotment
  7. Cumulative no. of equity shares, equity capital and equity share premium
  8. Remarks
 Para II.B.iii.3:Equity share capital history for the last five years:

  1. Date of allotment
  2. No. of equity shares
  3. Face value
  4. Issue price
  5. Consideration (Cash, other than cash, etc)
  6. Nature of allotment
  7. Cumulative no. of equity shares, equity capital and equity share premium
  8. Remarks
8 Para 2.3.10.f: Details of the shareholding of the Company as at the latest quarter end, as per the format specified under LODR regulations. Para 3.A.d.i:Details of the shareholding of the Company as on the latest quarter end was to be provided as per format specified in the Schedule. Para II.B.iv.1: Details of the shareholding of the Company as on the latest quarter end was to be provided as per format specified in the Schedule.
9 Para 2.3.10.g: % comparison of top 10 holders of NCS with total NCS outstanding to be disclosed along with name, total no. of equity shares and no. of shares in demat form.. Para 3.A.g.iv: Only the name of the top 10 debenture holders and their holding amount was required to be disclosed. Para II.B.iv.2: Only the name of the top 10 debenture holders and their holding amount was required to be disclosed.
10 Requirement of providing the amount of corporate guarantee issued by the Issuer along with name of the counterparty (like name of the subsidiary, JV entity, group company, etc) on behalf of whom it has been issued has been omitted. Para 3.A.g.v: The amount of corporate guarantee issued by the Issuer along with name of the counterparty (like name of the subsidiary, JV entity, group company, etc) on behalf of whom it has been issued was required to be specified. Para II.B.vii.4: The amount of corporate guarantee issued by the Issuer along with name of the counterparty (like name of the subsidiary, JV entity, group company, etc) on behalf of whom it has been issued was required to be specified.
11 Para 2.3.13.e: ISIN of outstanding Commercial Paper needs to be disclosed along with maturity date and amount. Para 3.A.g.vi: Only outstanding amount and maturity dates of Commercial Paper were required to be disclosed. Para II.B.vii.5: Only outstanding amount and maturity dates of Commercial Paper were required to be disclosed.
12 Para 2.3.15: Where the issuer is a NBFC or HFC additional disclosures on Asset Liability Management (ALM) shall be provided for the latest audited financials:

  1. Details w.r.t. lending done out of the issue proceeds of earlier issuances of debt securities (whether public issue or private placement) by NBFC.
  2. Portfolio Summary of borrowings made by NBFC.
  3. Quantum and percentage of Secured vs. Unsecured borrowings.
  4. Any change in promoters holding in NBFC during last FY beyond the threshold prescribed by RBI.
  5. Segment wise break up and Type of loans.
  6. Geographical location wise details of borrowers.
  7. Segment wise details of Gross NPA.
  8. Residual maturity profile wise details of assets and liabilities into several bucket.
  9. Disclosure of latest ALM statements to stock exchange.
 – –
13 Para 2.3.25: Risk factors 

Risk factors shall be disclosed in the descending order of materiality.

It should include but not limited to:

  1. Risks in relation to NCS.
  2. Risks in relation to the security created in relation to the debt securities, if any.
  3. Refusal of listing of any security of the issuer during last three years by any of the stock exchanges in India or abroad.
  4. Limited or sporadic trading of NCS of the issuer on the stock exchanges.
  5. In case of outstanding debt instruments or deposits or borrowings, any default in compliance with the material covenants such as creation of security as per terms agreed, default in payment of interest, default in redemption or repayment, non-creation of DRR, default in payment of penal interest wherever applicable.
  6. If secured, any risks in relation to maintenance of security cover or full recovery of the security in case of enforcement.
 Disclosure of risk factors is required to be  provided in terms of summary sheet however, no specific pointers were pointed out. Reg.23(5): The banks were required to disclose relevant risk factors in case of issue of Perpetual Non-Cumulative Preference Shares and Perpetual Debt Instruments.

 

You may also refer to our following articles on related subjects

  • Consolidation of SEBI regulations on non-convertible securities

https://vinodkothari.com/2021/08/consolidation-sebi-non-convertible-securities/ 

  • Presentation on Corporate Bonds and Debentures

https://vinodkothari.com/2021/03/presentation-corporate-bonds-debentures/

  • SEBI’s stringent norms for secured debentures

https://vinodkothari.com/2020/11/sebis-stringent-norms-for-secured-debentures/

  • Market-Linked Debentures – Real or Illusory?

https://vinodkothari.com/2021/01/market-linked-debentures-real-or-illusory/

  • FAQs on Commercial Paper

https://vinodkothari.com/2019/11/faqs-on-commercial-paper/

Our  our Book on Law and Practice Relating to Corporate Bonds and Debentures, authored by Ms. Vinita Nair Dedhia, Senior Partner and Mr. Abhirup Ghosh, Partner can be ordered though the below link:

https://www.taxmann.com/bookstore/product/6330-law-and-practice-relating-to-debentures-and-corporate-bonds