This New Year brings more complexity to bond issuance as SEBI makes it cumbersome for DTs and Issuers

Due diligence, consents/NOC, Charge creation before listing coupled with mandatory listing deadline may be daunting compliance

FCS Vinita Nair | Senior Partner, Vinod Kothari & Company

When the going gets tough, the tough gets going; however, this may not hold good for issuers and debenture trustees (DT) in case of secured debentures intended to be issued and listed on or after January 1, 2021. SEBI, vide Circular dated November 3, 2020[1] (‘November 3 Circular’), has rolled out norms on several aspects of security creation and due diligence of asset cover in furtherance to the recent amendment made in ILDS Regulations[2] and DT Regulations[3] w.e.f. October 8, 2020. Among other things, the November 3 Circular requires creation of security interest before listing, and if one combines it with the standardization of timeline for listing of securities issued on private placement basis (effective from December 1, 2020) which requires application for listing to be made within 4 trading days of closure of issue, issuers will be fighting for breath in making listing applications on allotment. Additionally, DTs have been loaded with the responsibility of giving two certifications giving their affirmation of due diligence, mainly dealing with security cover creation and maintenance. One forms part of the disclosure document, another is to be submitted along with the listing application.

The inspiration for the changes is not difficult to understand – some of the recent defaults with financial sector issuers saw violations of asset cover norms and potential overlaps in assets for multiple issuances. However, it will be curious to see whether the revised norms will be easy to comply, given the fact that most of the issuances in India are from the financial sector, and the assets in all such cases are a fluid pool of receivables.

The November Circular deals with following:

  1. Documents/ Consents required at the time of entering into DT agreement;
  2. Due diligence by DT for creation of security;
  3. Disclosures in the offer document (OD) or Private Placement Memorandum (PPM)/ Information Memorandum (IM) and filing of OD or PPM/ IM by the Issuer
  4. Creation and registration of charge in relation to security by Issuer.

Thereafter, on November 13, 2020 SEBI issued circular on Monitoring and Disclosures by DT[4] (November 12 Circular) that is effective from quarter ended on December 31, 2020 for listed debt securities. The November 12 Circular deals with following:

  1. Monitoring of ‘security created’ / ‘assets on which charge is created’;
  2. Action to be taken in case of breach of covenants or terms of issue;
  3. Disclosure on website by DT;
  4. Reporting of regulatory compliance

This article discusses the impact that the both the aforesaid circulars will have on issue of secured debentures. The November Circular is applicable in case of public issue as well as private placement of debt securities. Having said this, it is well known fact that the market in India is essentially a market for private placements, mostly bespoke, mostly secured on loans and receivables.

Information to be provided at the time of entering DT Agreement

DT Agreement is entered into by the issuer with the DT in accordance with Regulation 13 of DT Regulations before the opening of the subscription list for issue of debentures. The agreement mainly contains an undertaking in relation to compliance with applicable law for allotment till redemption of debentures and the time limit within which the security shall be created. However, the November 3 Circular mandates furnishing of following documents by the issuer at the time of entering into DT Agreement. Additionally, the terms and conditions with respect to exercising due diligence shall also be included in the debenture trustee agreement.

The detailed list to be furnished is given in Annexure 1. Basis the nature of security, the DT is required to submit details periodically to the stock exchange as per November 12 Circular. Certain critical issues are discussed hereunder.

  1. In case of security created on moveable/ immoveable property, the issuer is required to give copy of evidence of registration with Sub-registrar, Registrar of Companies, Central Registry of Securitization Asset Reconstruction and Security Interest (CERSAI) etc even prior to issuance of debentures. [Para 4.1 of November 3 Circular].
  2. Further, in case of encumbered assets, Consent/ No-objection certificate (NOC) from existing charge holders. [Para 4.3(b) of November 3 Circular]. In several cases, issuers have common DT for all issuances and the charge is created in favour of DT. There should be suitable carve out or exemption in those cases as the DT cannot be furnishing Consent/ NOC to itself.
  3. In case of negative lien created by issuer, Consent/NOC is required to be obtained from existing unsecured lenders [Para 4.3(c) of November 3 Circular]. By definition, if the creditor is unsecured, there is no question of the creditor having any right over any asset. Hence, the question of any consent of unsecured lenders does not arise. In case of negative lien, the issuer agrees to keep the agreed quantum of assets free from encumbrance, therefore, the requirement of seeking consent/NOC is not justified.
  4. In case of corporate guarantee, the guarantor is required to furnish audited financial statements (not older than 6 months from the date of debenture trustee agreement) giving details of all contingent liabilities [Para 4.3(c) of November 3 Circular]. The issuers intending to list debt securities are permitted to submit limited reviewed financial results and not necessarily audited financial statements. However, the guarantor is required to furnish latest audited financial statements.

Submission of periodic reports by DT to Stock Exchange (SE)

As per November 12 Circular, the DT is required to submit following to the SE for every issuer.

Periodicity Nature of submission Timeline Format Remarks
Quarterly
  • Asset Cover Certificate;
  • Statement of value of pledged securities;
  • Statement of value of Debt Service Reserve Account or any other form of security offered;
Within 60 days from end of each quarter Annexure A to November 12 Circular
  • Details of all outstanding issuance is to be furnished.
  • Asset cover details to be furnished ISIN wise for secured as well as unsecured debt securities.
  • Formula for computation of asset cover has been provided in Table I for secured debt and Table II for unsecured debt in November 12 Circular.
  • The DT will also confirm compliance on the covenants and terms of issue.
Half yearly Net worth certificate of guarantor (in case of personal guarantee) Within 60 days from end of each half year NA  
Annually
  • Financials/ value of guarantor prepared on basis of audited financial statement etc. of the guarantor (secured by way of corporate guarantee)
  • Valuation report and title search report for immoveable/ moveable assets, as applicable.
Within 75 days from end of each financial year. NA  

Enabling provision in DTD

As per November 12 Circular, the DT is required to incorporate the terms and conditions of periodical monitoring in the DTD pursuant to which the issuer will be liable to share information to enable DT to submit details to the stock exchange as provided in table above. For existing debt securities, issuers and DT shall enter into supplemental/amended debenture trust deed within 120 days from November 12 2020 incorporating the changes in the DTD.  In  case,  a  listed  entity  has  more  than  one  DT  for  its  listed  debt securities, then DTs may choose a common agency for preparation of asset cover certificate.

Due diligence by DT for creation of security

The due diligence may be carried out by the DTs by itself or through its advisers or experts. The DT, by itself or through its appointed agencies viz. chartered accountant firm, registered valuer, legal counsel etc., is required to prepare one or more reports viz. valuation report, ROC search report, title search report/ appraisal report, asset cover certificate, any other report/ certificate as applicable etc. The DT is also required to independently assess that the assets for creation of security are adequate for the proposed issue of debt securities. DTs are required to maintain records and documents pertaining to due diligence exercised for a minimum period of 5 years from redemption of the debt securities.

List of documents to be verified during due diligence and the format of due diligence certificate in given as Annexure 2. Certain issues in relation to the same is discussed hereunder:

  1. There is no clarity on who is to bear the cost of due diligence. If the same is to be borne by the issuer, the issue expense will increase. The issuer will be required to provide due diligence certificates obtained from DT, one at the time of filing the OD or PPM/IM and another at the time of filing the listing application.
  2. In case of creation of further charge on assets, the DT is required to intimate to existing charge holders via email about the proposal to create further charge on assets by Issuer seeking their comments/ objections, if any, to be communicated to the DT within next 5 working days. [Para 6.1 (b) (ii) of November 3 Circular]. Further, information about the consents is required to be furnished in the OD or PPM/IM.

In several cases, issuers have common DT for all issuances and the charge is created in favour of DT. There should be suitable carve out or exemption in those cases as the DT cannot be intimating and seeking its own comments/objections.

In case of private placement, where the issue opens, closes and debentures are allotted on same day, the process will have to be commenced much before opening of offer, given the requirement to wait for 5 working days.

Disclosure in OD or PPM/IM by issuer

The issuer is required to disclose following in the OD or PPM/IM:

  • “Debt securities shall be considered as secured only if the charged asset is registered with Sub-registrar and Registrar of Companies or CERSAI or Depository etc., as applicable, or is independently verifiable by the debenture trustee.”
  • Terms and conditions of DT agreement including fees charged by debenture trustees(s), details of security to be created and process of due diligence carried out by the debenture trustee;
  • Due diligence certificate (To be furnished at the time of filing OD or PPM/IM)

Creation of security

The November 3 Circular mandates creation of charge prior to listing. Due diligence certificate confirming execution of DTD and creation of charge is required to be furnished along with listing application.

The November 3 Circular, further mandates registration of charge within 30 days of creation. Failure to register the charge within 30 days of creation (as opposed to 120 days permitted under Act, 2013) will be considered as breach of covenants/terms of the issue by the Issuer.

What will be the consequence of breach of covenant? Whether it will deemed as an event of default requiring redemption? In our view, this may not be required. As per November 12 Circular, in case of breach of covenants or terms of the issue by listed entity, the DT shall  take  steps  as  outlined  in  para  6.1  and  6.3  of  SEBI  Circular SEBI/HO/MIRSD/CRADT/CIR/P/2020/203 dated October 13, 2020[5] (October Circular). Para 6.1 and 6.3 of the October Circular mandates DT to send notice to investors within 3 days of event of default and convene meeting of the investors within 30 days of the event of default. The DT shall thereafter take necessary action as decided in the meeting of holders of debt securities in this regard. One needs to ascertain if meeting of debenture holders is relevant for delay in creation of charge.

As evident from the format of certificate given at the time of listing, the DTD is required to be executed before listing (as opposed to 3 months from the date of closure of an issue or an offer under ILDS Regulations and CA, 2013)

Disclosure on website by DT

The consultation paper provided for certain mandatory disclosures to be made by DT on the website. The November 12 Circular provides list of disclosures to be made along with the format prescribed in Annexure B thereto.

Disclosure prescribed in Consultation Paper Disclosure required to be made as per November 12 Circular Periodicity and Timeline Information to be furnished as per the format prescribed
Quarterly Compliance Reports received from the issuers Monitoring of Asset cover certificate and  Quarterly  compliance  report  of the listed entity Quarterly basis. Within 60 days of end of each quarter.
  • Confirmation about receipt of periodical status/ performance report from listed entity to be provided;
  • Information about utilisation certificate, asset cover certificate and asset cover ratio maintained is required to be furnished.
Compliance status on the receipt of asset cover from the issuers, maintenance of various funds by the issuers Covered above    
Defaults by the company Status of information regarding any default  by  listed  entity  and  action taken by debenture trustee Annually. Within 75 days of end of financial year. Details of default, date of intimating and sending notice to debenture holders, results of voting, date of meeting, date of enforcement, date of other actions viz. joining ICA, appointment of nominee director etc to be furnished.
Status of the proceedings of the cases under default Covered above    
Compliance status of each covenant-issue wise on a half yearly basis Status  of  information  regarding breach  of  covenants/terms  of  the issue,  if  any  action  taken  by debenture trustee Half yearly basis. Within 60 days of end of each half year. Details of covenants/ terms of issue breached during HY, details of security to be enforced, date of actual breach, detecting the breach and date of intimation to debenture holders, SE, SEBI etc to be provided.
Revision in Credit ratings Continuous    basis within  T+1  day  from receipt of information Details of immediate previous credit rating and revised credit rating, along with hyperlink of the press release of the CRA to be furnished.
Status  of  payment  of  interest/ principal by the listed entity Continuous    basis within  T+1  day  from receipt of information Status of Payment (Default / Delayed / Non-Cooperation, No Information etc. to be furnished along with date of information given to SE and CRA by DT and other actions taken by DT.
Details of Debenture issues handled by debenture trustee and their status Half yearly basis. Within 60 days of end of each half year. Details of issues accepted during HY, issues fully redeemed during HY, issues outstanding during HY and cumulative issue handled during HY to be furnished.
Complaints  received  by  debenture trustee(s) including default cases Half yearly basis. Within 60 days of end of each half year. Details of complaints pending prior to, received during, resolved during and pending at the end of half year to be furnished.
  Status  regarding  maintenance  of accounts    maintained    under supervision of debenture trustee Annually. Within 75 days of end of financial year. Details of maintenance of DRR, DRF, recovery expense fund, Accounts/ funds in case of municipal debt securities to be provided.
  Monitoring of Utilization Certificate Annually. Within 75 days of end of financial year. Information about utilisation certificate furnished on quarterly basis while monitoring asset cover.

Tough time ahead

As per SEBI Circular dated October 5, 2020[6] effective for issuance made on or after December 1, 2020, listing of private placement will be required to be done within 4 trading days from closure of issue, failing which, the issuer will not be able to utilize issue proceeds of its subsequent two privately placed issuance until final listing approval is received from stock exchanges and penalty will be separately payable. Given the procedural compliances given in the November Circular, it will be challenging for the issuer as well as DT to achieve the timeline.

While, SEBI has rolled out stringent norms for issue and listing of secured debentures, one will have to see how equipped the DTs are to carry out the due diligence and ensure adherence by issuer to these stringent timelines, given the quantum of secured debt issuance done by various issuers. Additional compliances imposed on the DT in terms of November 12 Circular will further add actionables for the DT and also on the issuers as the said information will be required to be furnished by the issuer. Disclosures regarding performance of the DTs, as was proposed in the consultation paper, has not been enforced yet.

In view of increased complexity in issuance of secured debentures, Corporates may consider opting for unsecured debt issuances. Further, Issuers and DTs will have to pull up socks to comply with several actionables lined up this New Year.

 

Annexure 1

Sr. No. Nature of securities extended by Issuer Information/Documents required to be furnished to Debenture Trustee
1. Movable property and Immovable property
  • Details of assets including title deeds (original/ certified true copy by issuers/ certified true copy by existing charge holders, as available) or;
  • title reports issued by a legal counsel/ advocates;
  • copies of the relevant agreements/ Memorandum of Understanding;
  • copy of evidence of registration with Sub-registrar, Registrar of Companies, Central Registry of Securitization Asset Reconstruction and Security Interest (CERSAI) etc.
2. Unencumbered assets
  • An undertaking that the assets on which charge is proposed to be created are free from any encumbrances.

 

3. Encumbered assets Following consents along-with their validity as on date of their submission:

  • Details of existing charge over the assets along with details of charge holders, value/ amount, copy of evidence of registration with Sub-registrar, Registrar of Companies, CERSAI, Information Utility (IU) registered with Insolvency and Bankruptcy Board of India (IBBI) etc. as applicable;
  • Consent/ No-objection certificate (NOC) from existing charge holders for further creation of charge on the assets or relevant transaction documents wherein existing charge holders have given conditional consent/ permission to the Issuer to create further charge on the assets, along-with terms of such conditional consent/ permission, if any;
  • Consent/ NOC from existing unsecured lenders, in case, negative lien is created by Issuer in favour of unsecured lenders.
4. Personal guarantee or any other document/ letter with similar intent
  • Details of guarantor viz. relationship with the Issuer;
  • Net worth statement (not older than 6 months from the date of debenture trustee agreement) certified by a chartered accountant of the guarantor;
  • List of assets of the guarantor including undertakings/ consent/ NOC as mentioned in Sr. No. 2 and 3 above;
  • Conditions of invocation of guarantee including details of put options or any other terms and conditions which may impact the security created;
  • Executed copies of previously entered agreements for providing guarantee to any other person, if any.
5. Corporate guarantee or any other document/ letter with similar intent
  • Details of guarantor viz. holding/ subsidiary/ associate company etc.;
  • Audited financial statements (not older than 6 months from the date of debenture trustee agreement) of guarantor including details of all contingent liabilities;
  • List of assets of the guarantor along-with undertakings/ consent/ NOC as mentioned in Sr. No. 2 and 3 above;
  • Conditions of invocation of guarantee including details of put options or any other terms and conditions which may impact the security created;
  • Impact on the security in case of restructuring activity of the guarantor;
  • Undertaking by the guarantor that the guarantee shall be disclosed as “contingent liability” in the “notes to accounts” of financial statement of the guarantor;
  • Copy of Board resolution of the guarantor for the guarantee provided in respect of the debt securities of the Issuer;
  • Executed copies of previously entered agreements for providing guarantee to any other person, if any.
6. Securities such as equity shares etc.
  • Holding statement from the depository participant along-with an undertaking that these securities shall be pledged in favour of debenture trustee(s) in the depository system.
7. Any other form of security
  • Debt Service Reserve Account etc.

Table 1: Information/Documents required to be furnished to Debenture Trustee

Annexure 2

The due diligence w.r.t. creation of security shall inter-alia include the following:

Nature of Security and things required to be verified by DT Manner of verification
1.  Assets provided by the issuer for creation of security are:

a.  free from any encumbrances; or

b.  necessary permissions or consents has been obtained from existing charge holders

 

1.  Verify from Registrar of Companies, Sub-registrar, CERSAI, IU or other sources where charge is registered/disclosed as per terms.

2.  In case where existing charge holders have given a conditional consent/ permission to the issuer to create further charge on the asset, DT will be required to verify following:

a.  Verify whether such conditional consent/ permission given to issuer by existing charge holders is valid as per terms of transaction documents;

b.  Intimate to existing charge holders via email about the proposal to create further charge on assets by Issuer seeking their comments/ objections, if any, to be communicated to the DT within next 5 working days.

2.  Personal guarantee, corporate guarantee and any other guarantees/form of security. Verify from relevant filings made on websites of MCA, Stock Exchange(s), CIBIL, IU etc. and obtain appraisal report, necessary financial certificates viz. from the statutory auditor in case of corporate guarantee, certificate from Chartered Accountant in case of personal guarantee, as applicable, of the guarantor/ issuer.

Table 2: Due diligence by DT at the time of creation of security

 

Contents of due diligence certificate

To be furnished at the time of filing OD or PPM/IM To be furnished at the time of filing listing application
  • Adequate provision has been made to provide adequate security for the debt securities to be issued;
  • Issuer has obtained necessary permissions/consents for creation of security, further charge;
  • Issuer has made all relevant disclosures, including all covenants proposed to be included in OD or PPM/IM.
  • Issuer has given an undertaking that charge shall be created in favour of DT.
  • The issuer has created charge over its assets in favour of DTs;
  • The issuer has executed Debenture Trust Deed (DTD) and DT agreement;
  • The issuer has given undertaking for registration of charge within 30 days of creation.

Table 3: Contents of Due diligence certificate to be furnished by DT

 

[1] https://www.sebi.gov.in/legal/circulars/nov-2020/creation-of-security-in-issuance-of-listed-debt-securities-and-due-diligence-by-debenture-trustee-s-_48074.html

[2] SEBI (Issue and Listing of Debt Securities) Regulations, 2008

[3] SEBI (Debenture Trustees) Regulations, 1993

[4] https://www.sebi.gov.in/legal/circulars/nov-2020/monitoring-and-disclosures-by-debenture-trustee-s-_48159.html

[5] https://www.sebi.gov.in/legal/circulars/oct-2020/standardisation-of-procedure-to-be-followed-by-debenture-trustee-s-in-case-of-default-by-issuers-of-listed-debt-securities_47855.html

[6] https://www.sebi.gov.in/legal/circulars/oct-2020/standardization-of-timeline-for-listing-of-securities-issued-on-a-private-placement-basis_47790.htm

 

Other reading materials on the similar topic:

  1. ‘SEBI responds to payment defaults by empowering Debenture Trustees’  can be read here
  2. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkothari.com

Our website: www.vinodkothari.com

Our Youtube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

 

SEBI subtly mandates debt listed companies to prepare quarterly financial results

Stock exchange circular stipulates submission of financials not older than 6 months

Aanchal Kaur Nagpal | Senior Executive, Vinod Kothari & Company

 

NSE, vide clarification dated 14th July, 2020[1], has clarified that audited financials or unaudited financials with limited review, submitted by issuers for listing of their privately placed debentures, including for the stub period, shall not be older than 6 months from the date of the private placement disclosure document.

Schedule I to SEBI (ILDS) Regulations, 2008 mandates furnishing financial parameters upto latest half year in the offer document in addition to providing abridged version of audited consolidated (wherever available) and standalone financial information ( like profit & loss statement, balance sheet and cash flow statement) for at least last three years and auditor qualifications , if any and abridged version of latest audited / limited review half yearly consolidated (wherever available) and standalone financial information (like profit & loss statement, and balance sheet) and auditors qualifications, if any.

There was no express requirement that the half yearly financial results being submitted cannot be older than 6 months. In case of Commercial Paper (‘CPs), SEBI had expressly specified that the audited financial statements to be submitted by an issuer intending to list its CPs, shall not be older than 6 months from the date of the application of listing. [Para 5.2 of Annexure I of SEBI Circular on Framework for Listing CPs dated 22nd October, 2019[2]]

Carve out from the above requirement was provided, as amended vide SEBI Circular dated December 24, 2019[3], to listed issuers who were in compliance with SEBI (LODR) Regulations, 2015. Such listed entities could file unaudited financials with limited review for the stub period in the current financial year, subject to making necessary disclosures in this regard including risk factors.

Impact:

While a clarification in the above context was much needed, however the requirement for financials to be not older than 6 months would pose difficulties on debt-listed companies.

Debt listed entities are required to prepare financials (unaudited or audited) on a half yearly basis within 45 days (except in case of advance intimation) from the end of each half year [Regulation 52(1) of LODR Regulations] while equity listed entities are required to prepare the financials on a quarterly basis within 45 days from the end of each quarter and within 60 days from the financial end of the year for annual financials.

The aforementioned clarification will not impact the following companies:

  1. Equity-listed entities intending to list their privately placed debentures as they would be preparing quarterly financials;
  2. Debt-listed entities that are subsidiaries of equity-listed entities as they would be required to prepare quarterly financials for the purpose of consolidation with their holding equity-listed entity.

However, debt listed entities that are neither subsidiaries of equity listed entities nor having their specified securities listed, won’t be able to raise funds pursuant to issuance of NCDs if the financials are older than 6 months.

Debt-listed entities are required to prepare their financials within the following due dates:

Period of Financials Due Date Period during which financials would be more than 6 months old
Half year ended 31st March 15th May 1st April to 14th May
Half year ended 30th September 15th November 1st October to 14th November

For e.g. a debt listed entity won’t be able to list debt securities on Oct 1 based on financial results of March 31. Such companies will have to either prepare quarterly financials till June 30 or get the half yearly results for September 30 finalized on priority.

Clarity or Complication?

The said NSE clarification serves as a complication rather than a clarity. The said circular strains the ability to raise funds by debt-listed entities. NBFCs too would take a huge hit due to the said restriction on raising funds during periods where latest financials are not available. Where the world is already in a crisis due to the COVID-19 pandemic, liquidity of the debt market becomes all the more crucial.

On one hand, SEBI has mandated Large Corporates to raise minimum 25% of their incremental borrowings, by way of issuance of debt securities (as defined under SEBI ILDS Regulations), and on the other restriction by way of the said clarification has been imposed wherein the debt listed entities will have to prepare financials on a quarterly basis to be able to issue and list privately placed debt securities as and when there is requirement of funds.

[1] https://www.sebi.gov.in/legal/circulars/dec-2019/framework-for-listing-of-commercial-paper-amendments_45448.html

[2] https://www1.nseindia.com/content/debt/NSE_Circular_14072020_1.pdf

[3] https://www.sebi.gov.in/legal/circulars/oct-2019/framework-for-listing-of-commercial-paper_44715.html

SEBI completely restricts Retail Investors from AT1 instruments

Qasim Saif | Executive

finserv@vinodkothari.com

Perpetual Non-Cumulative Preference Shares (PNCPS’) and Innovative Perpetual Debt Instruments (IPDIs) / Perpetual Debt Instruments (PDIs) (commonly referred to as AT1 instruments) are a kind of perpetual bonds without any redemption date that banks issue to meet their long term capital as well as their Additional Tier-I capital requirements. These instruments are treated as quasi-equity instruments, providing a unique blend of characteristics, that is, coupling the perpetual availability of funds with fixed periodic payments.

Despite having unique characteristics, the AT1 bonds are seen with distrust by investors because such instruments are more likely to default and in some circumstances carry more risk of non-repayment than equity. The return on such bonds is higher than tier 2 bonds however is significantly lower than the return on equity.

Recently, the AT1 bonds were all over the news when the Reserve Bank of India wrote down the liability towards the AT1 bonds issued by Yes Bank, without affecting the equity shareholders, resulting in a large number of people, including senior citizens, losing their savings who were lured to invest in AT1 bonds instead of fixed deposits, with a promise to pay higher returns. Our detailed write-up on this topic can be viewed here.

This write-up, however, deals with the recent changes brought in by SEBI for the listing of AT1 bonds.

Amendments proposed by SEBI

Though the AT1 Bonds are regulated by RBI guidelines issued in consonance with Basel III norms, however public issues and listing of these bonds are regulated by SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013.

SEBI on October 6, 2020,[1] issued a circular containing additional guidelines in regards to the issuance, listing and trading of AT1 Instruments. The additional guidelines are based on recommendations of the Corporate Bonds and Securitization Advisory Committee set up by SEBI. The Circular shall come into force with effect from October 12, 2020.

The additional guidelines prescribed and its analysis is as follows-

  1. Mandatory issuance through electronic book building platform

SEBI vide circular dated January 05, 2020,[2] mandated issuance of debt securities exceeding rupees two hundred crores to be undertaken through the electronic book building platform (“EBPF”). Now, SEBI has mandated that the issuance of AT1 instruments shall be compulsorily done through EBPF irrespective of the issue size.

Further, the January 2020 Circular did not include AT1 bonds, however, the October Circular has specifically included AT1 bonds within its ambit.

EBPF is deployed in large size issue because of the novelty of the system and higher cost as compared to other alternatives. However, the latest amendment on the use of EBPF irrespective of the issue size will increase smaller issuances costly, therefore, making them unviable.

  1. Only QIBs shall be allowed to participate in an issue

The most important change is that now only QIBs shall be allowed to participate in the issuance of AT1 bond; retail and other non-QIB investors have been excluded from the list of eligible investors to AT1 bonds.  The amendement is made with an intent to safeguard the retail investors from the risk possed by such instruments, as these complex instruments carry certain risk that are not generally not understood by the common people

The QIBs are better equipped for analyzing potential risk and whether or not such issuance is worth investing compared to other classes of the investor, this would hence form the first line of defense to protect the other investors, who would be benefited with skills and resources of QIBs.

This change however directly conflicts with the RBI Guidelines on this issue, which allows banks to issue AT1 bonds to retail investors with permission of its board via amendments to implementation of Basel III Capital Regulations in Indian on date September 1, 2014[3]

In any event, if the AT1 bonds are taken for listing, the conditions under SEBI Circular will have to be fulfilled and therefore, the issuances shall have to be restricted to QIBs only.

It shall be noted that the restriction is only on the issuance of securities and non-QIB investors can still purchase the securities from the open market.

However, there might be still concerns that such QIBs might engage in selling securities by misleading investors as it was alleged in the case of Yes Bank.

  1. Allotment and trading lot fixed

SEBI has further specified the minimum allotment of AT1 instruments shall not be less than rupees one crore and further the minimum trading lot is also fixed at rupees one crore.

As mentioned above that though retail investors may not be able to participate in issuances, they might purchase the bonds from stock markets, to further deter retail investment in such instruments the trading lot has also been fixed at rupee one crore.

The fixing of minimum allotment size may not be of major importance as the issuance would only be to QIBs who, usually invest larger sums of money, however, minimum allotment size is generally kept in parity with trading lot size to create a uniform lot of securities and avoid forming of odd lots, hence fixing of minimum allotment size is mainly to bring it with parity with trading lot size.

  1. Increased disclosure requirements

Issuers of AT1 bonds are required to make disclosures as prescribed under Schedule I of SEBI (NCPRS) Regulations, in addition to that the issuer shall now have to make disclosures that are prescribed under Annex I and provisions of circulars mentioned in Annex II of the October Circular.

Along with that specific disclosures about the following shall have to be made in the offer document:

  1. Details of all the conditions upon which the call option will be exercised by them for AT1 instruments
  2. Risk factors, to include all the inherent features of these AT1 instruments such as discretion of issuer in terms  of  writing down the principal  / interest, to skip interest payments, to make an early recall etc. without commensurate right for investors to legal recourse,even if suchactions of the issuer mightresult in potential loss to investors.
  3. Point of Non-Viability clause: The absolute right, given to the RBI, to direct a bank to write down the entire value of the outstanding  AT1 instruments/bonds,  if it thinks the bank has passed the Point of Non-Viability or requires a public sector capital infusion to remain a going concern.

These additional disclosures will give the investors a better understanding of the instrument and what they are signing up for.

Impact on currently listed AT1 Bonds

The majority of additional guidelines are in respect of securities that would be now be issued hence would have no impact on bonds already issued/listed on securities market. However, the conditions with respect the trading lot could impact the holders of AT1 bonds as they might have investments, not in multiple of one crore, which might result in the creation of odd lots.

Generally, special windows are provided by stock exchanges where investors can sell their odd lots to the market maker, intermediaries, or other concerns hence a special window, in this case, might be provided to deal with odd lots that might be created due to additional guidelines.

Conclusion

Given the tone of the changes made by the SEBI, it is very clear that the changes are highly inspired by the events that led to retail investors burning their hands in the case of Yes Bank. Most of the changes seem to carry the intent of deterring the retail investors from investing in these securities. The following paragraph from the circular makes the situation clear:

“Given the nature and contingency impact of these AT1 instruments and the fact that full import of the discretion is available to an issuer, may not be understood in the truest form by retail individual investors.”

Additional guidelines would without doubt restrict retail investment in AT1 bonds however, the added conditions in likelihood would jeopardize whatever little interest investors had on this product. Though the protection of investors is a goal of SEBI, so is the promotion of capital markets in India; hence, the regulation might be welcomed on the investor protection front but there are serious doubts on how good it will do for the development of the AT1 bonds market in India.

Links to related articles –

http://vinodkothari.com/2020/03/at1-bonds-blessed-with-perpetuity-or-cursed-with-mortality/

http://vinodkothari.com/2019/03/should-oci-be-included-as-a-part-of-tier-i-capital-for-financial-institutions/

[1] https://www.sebi.gov.in/legal/circulars/oct-2020/issuance-listing-and-trading-of-perpetual-non-cumulative-preference-shares-pncps-and-innovative-perpetual-debt-instruments-ipdis-perpetual-debt-instruments-pdis-commonly-referred-to-as-additi-_47805.html

[2] https://www.bseindia.com/downloads1/SEBI_EBP_Circular_Jan_5_2018.pdf

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=9202&Mode=0

SEBI rationalizes eligibility and disclosure requirements for rights Issue in ICDR Regulations

Snapshot of SEBI Board Meeting dated 29th September, 2020

(corplaw@vinodkothari.com)

SEBI in its Board Meeting held on 29th September, 2020 has approved amendments in various Regulations which shall come into effect by way of amendment in the respective Regulations. The brief highlights of the same are as below:

Strengthening role of Debenture Trustees

SEBI, in the recent past, has brought in certain amendments in order to strengthen the role of DTs so as to protect interest of debenture holders. The latest amendment in the existing DT Regulations was made by SEBI (Debenture Trustees) (Amendment) Regulations, 2017 which aimed to streamline provisions of DT Regulations with the CA, 2013 and other SEBI Regulation and also to enable DTs to secure the interest of investors.

The Board Meeting approved that DTs shall convene meeting of debenture holders for enforcement of security, joining of inter-creditor agreement (ICA) etc. The requirement of forming a ICA comes from the RBI Prudential Framework for Resolution of Stressed Assets and the Resolution Framework for COVID-19 related stress. By virtue of these notifications, there is a mandatory requirement of Inter-Creditor Agreements (ICA) by the lending institution governed by the RBI, for the purpose of invocation of a resolution plan of any defaulting borrower. The aforesaid frameworks recognize that even other lenders to the borrower which are other than the lending institutions, such as debenture trustee, may sign the ICA, if they so desire. In line with the same, SEBI is proposing the DTs to convene meeting for joining ICA to safeguard the interests of the debenture holders.

Keeping the same intent, DTs are also bestowed with the responsibility of monitoring the asset cover for debentures and obtain half yearly certificate from statutory auditor. The Board approved following additions to the responsibility of DTs:

  • DTs to exercise independent due diligence of the assets of the company on which charge is being created
  • DTs shall convene meeting of debenture holders for taking required action for enforcement of security, joining the inter-creditor agreement etc.
  • Carry out continuous monitoring of asset cover including obtaining mandatory certificate from statutory auditor on half yearly basis
  • Creation of recovery expense fund at the time issuance of debt securities for utilisation in the event of default or to take legal action to enforce the security.

Pursuant to the text of the Board Meeting, it seems that SEBI is going to introduce a new concept of ‘recovery expense fund’ for creating fund for expenses that might be required to recover debts due to debenture holders in case of default.

Apart from the aforesaid, the existing provisions of the Companies Act, 2013 does have a requirement of transferring funds by specified class of companies to Debenture Redemption Reserve (‘DRR’) and also transfer certain amount of funds for debentures maturing during the next year to specified account/securities (‘hereinafter referred to as DRF’). However, these funds/reserves are for recovery of debts, whereas, recovery expense fund is a pool of fund for incurring expenses for recovering debts by DTs. Nevertheless, introduction of a separate fund requirement for any event of default seems to be a new compliance burden on companies. Further, whether such fund has to be created as an internal book entry transfer within the company like in case of DRR or transfer it outside the company in trust of the DT, is something we have to look for. Definitely, companies like NBFCs and HFCs which are frequently involved in raising funds through debentures shall have a new compliance to be ensured, if such amendment is made effective.

Amendments in SEBI (Delisting of Equity Shares) Regulations, 2009

SEBI (Delisting of Equity Shares) Regulations 2009 provides for voluntary delisting of equity shares from stock exchanges which provide the overall framework for voluntary delisting by a promoter or acquirer through a process referred to as Reverse Book Building. The Board Meeting has approved of exempting listed subsidiary from complying with the book building process if following conditions are met:

  1. The listed subsidiary is a wholly owned subsidiary of the company by virtue of scheme of arrangement
  2. The listed subsidiary is a subsidiary of the company for a minimum of 3 years
  3. The listed subsidiary and the holding company should be in the same line of business
  4. The shares of listed subsidiary and the holding company should be listed on recognised stock exchange for a minimum of 3 years
  5. Votes casted by public shareholders of listed subsidiary for delisting of securities should be 2 times in favour of the number of votes cast against it.
  6. The company should be compliance of provisions relating to scheme of arrangement under SEBI (LODR) Regulations, 2015

The process of Reverse Book Building is a price discovery mechanism in order to provide a price on which the public shareholders can exit from the company. Accordingly, the intent of exempting a wholly-owned listed subsidiary from undergoing the said mechanism seems logical by virtue of the fact that such a company will have a sole shareholder.

Disclosure by Informants under PIT Regulations

SEBI vide SEBI (PIT) (Third Amendment) Regulations, 2019 had introduced Chapter III under the existing PIT Regulations providing for a mechanism to submit by a person, a voluntary information with SEBI about alleged violation of insider trading laws. The procedural requirements to be followed by an informant while submitting the information with SEBI have been provided in the said chapter along with the format of the disclosure prescribed under Schedule D of the Regulations.

The aforesaid provisions however do not provide for any limitation period for submitting such an information with SEBI. Accordingly, SEBI has decided to provide for a time period of 3 years. The manner of calculating the said period shall come clear only once the amended text is released.  Further, the Meeting approved to make changes in Schedule D of the Regulations so as to require informants to specifically disclose details such as:

  1. Details of securities;
  2. Trades by suspect;
  3. UPSI based on which insider trading is alleged;

Disclosure of forensic audit by listed entities

SEBI has in the past ordered forensic audit for various companies, however, there was no requirement of disclosing the same by the company to the investors at large, except if considered material by the company under Part B of Schedule III of SEBI (LODR) Regulations, 2015. Accordingly, SEBI at its Board Meeting has decided to direct companies to disclose initiation and submit report of forensic audit along with comments of management to the stock exchange without applying any test of materiality.

Though it is not clear as of now, however, it seems that SEBI will introduce this disclosure requirement as an amendment to Schedule III Part A Para A of SEBI (LODR) Regulations, 2015 as it is to be disclosed by the company without applying any test of materiality i.e. deemed to be material.

SEBI intends to bring transparency for investors especially public investor holding larger interest in listed entities to have information about lapses in the company, which otherwise was not being disclosed by the company. SEBI requires every listed entity to disclose following w.r.t. forensic audit:

  1. Initiation of forensic audit along with name of entity initiating forensic audit along with reasons, if any
  2. Final forensic audit report on receipt by the listed entity along with comments of the management.

Eligibility and disclosures under rights issue rationalized

– Qasim Saif, Executive

corplaw@vinodkothari.com

Background

SEBI has on 23rd September 2020 released a press release[1] intimating about amendments to be made in SEBI ICDR Regulations, 2018 (“ICDR Regulations”/ “Regulations”) 2018. Further, on 28th September 2020, SEBI issued a notification bringing the SEBI (ICDR) (Fourth Amendment) Regulations, 2020[2] (“Amendment”) which was notified in official gazette on 1st October 2020. The Amendment is specifically focused for matters in relation to rights issue by listed entities. Several changes have been made which includes increasing the threshold for applicability, truncated disclosures in the letter of offer, removing the requirement for appointing a compliance officer, etc. At various places, the amendment is for the purpose of clarification or straightening of language of the Regulations.

In this article we have discussed the major amendments along with the probable impact.

Areas for amendments

1.     Increase in issue size for checking applicability

Erstwhile, ICDR Regulations were applicable in case of a rights issue for a size exceeding INR 10 crores. Further, the draft letter of offer (“draft LOF”) in such cases is required to be filled with SEBI for its observations. In other cases, i.e. where the issue size is less than INR10 crores the letter of offer (“LOF”) is to be filled with SEBI for information and dissemination on the SEBI’s website in accordance with Regulation 3. As a matter of temporary relaxation, SEBI vide its Circular dated 21st April, 2020 (April Circular) increased the aforesaid threshold to INR 25 crore for issues opening on or before March, 2020.

By virtue of the Amendment, the limit of INR 10 crores under Regulation 3 has been increased to INR 50 crores.  This would mean that while the general conditions and compliance will now be applicable to issue size of INR 50 crore or more, listed companies with a lower issue size will be required to file the LOF with SEBI for informative purpose.

As a result of the Amendment, while the applicability threshold has been increased, however, the companies with a lower issue size are still required to prepare the LOF in terms of the requirements of the ICDR Regulations and file the same with SEBI. Accordingly, while the change will surely be of relief to the entities which are now outside the applicability these Regulations, however, preparation of the LOF in terms of these Regulations will still be required.

Further to this, it should also be noted that practically filling of draft LOF for the purpose of obtaining observations from SEBI and then making prescribed changes generally takes several months. Accordingly, now since many entities will not be required to take the observations from SEBI, the same should help entities raise funds faster.

2.     Relaxation in eligibility to make right issue, for members of promoter group and promoter or director of company who are director in entities, which were earlier debarred by SEBI

Regulation 61 of ICDR Regulations state that an issuer shall not be eligible to make a rights issue of specified securities:

a) if the issuer, any of its promoters, promoter group or directors of the issuer are debarred from accessing the capital market by the Board;

b)if  any  of  the  promoters  or  directors  of  the  issuer  is  a  promoter  or  director  of  any  other company which is debarred from accessing the capital market  by the Board.

c) if any of its promoters or directors is a fugitive economic offender.

Further, explanation to the said Regulations state that “the  restrictions  under  (a)  and  (b)  above  will  not  apply  to  the  promoters  or directors  of  the  issuer  who  were  debarred  in  the  past  by  the  Board  and  the period  of debarment is already over as on the date of filing of the draft letter of offer.”

However, the language of the said explanation did not cover promoter group or other entities where the promoter or director of the issuer holds similar and which is debarred by SEBI. This lacuna in the language of the existing text gives an impression to result in a permanent restriction on right issue if the members of the promoter group were debarred or unless the concerned person vacated the post in the other entity which was debarred by SEBI from accessing the capital market.

The explanation shall now read as follows “the  restrictions  under  (a)  and  (b)  above  will  not  apply  to  the  persons  or  entities  mentioned therein  who  were  debarred  in  the  past  by  the  Board  and  the period  of debarment is already over as on the date of filing of the draft letter of offer.” After the amendment, all the mentioned persons or entities are now covered under the explanation and hence on completion of period of debarment, the issuer shall be eligible to undertake the right issue.

The above amendment is much needed clarification in the language rather than a relaxation

3.     Firm arrangement towards 75% of finance of capital expenditures only

Regulation 62 (1) (c) of ICDR Regulations require that issuer shall make  firm  arrangements  of  finance  through  verifiable  means  towards  seventy  five per cent of the stated means of finance for the specific project proposed to be funded from right issue,  excluding  the  amount  to  be  raised  through  the  proposed  rights  issue  or through existing identifiable internal accruals.

The Amendment introduces an explanation to the said clause stating “For the purpose of this regulation ‘finance for the specific project’ shall mean finance of capital expenditures only.”

The addition of explanation provides a clarity on calculation of amount that the company has to make firm arrangement for. The explanation also provides a simplification in compliance, as in most projects the capital expenditure are highly predictable unlike revenue expenditure that vary significantly and may not be estimated accurately.

4.     Removing the requirement to appoint a Compliance officer.

The Regulation 69 (8) of the ICDR Regulations require appointment of Compliance Officer by the issuer who  shall  be  responsible  for  monitoring  the compliance of the securities laws and for redressal of investors’ grievances. The said regulation has been omitted by the amendments.

Further the name of Part IV of Chapter III of ICDR Regulations has been suitably changed from “Appointment of Lead Managers, Other Intermediaries and Compliance Officer” to “Appointment of Lead Managers and Other Intermediaries”

Removing the requirement to appoint a compliance officer is a much needed amendment since the lead manager/ designated lead manager to the issue is any way required to ensure compliance with several applicable laws. Accordingly, it was a redundant practice to designate a compliance officer separately for a rights issue.

5.     Changes in Disclosure requirements

Regulation 70 of ICDR Regulations require that certain disclosure be made under LOF and Draft LOF. The SEBI has proposed that specified entities shall be required to make disclosures in format provided under Part A or Part-B of Schedule VI.

Disclosure requirements under Part B of Schedule VI have been rationalized to avoid duplication of information in LOF, especially the information which is already available in public domain and is disclosed by the companies in compliance with the disclosure requirements under SEBI listing regulations.

However, the Issuer not fulfilling the conditions above will be required to make disclosures in the format given in Part B-1 of Schedule VI, the disclosures in Part B-1 would be more detailed than that in Part B, however it shall be truncated as compared to Part A, that is applicable for IPO or FPO.

The Part-B of Schedule VI states that following entities shall be eligible to make disclosers under the given format –

1) Issuer has been filing periodic reports, statements and information in compliance with listing regulations for the last one year (instead of the last three years as required earlier) immediately preceding the date of filing Draft LOF or LOF as the case may be.

2) Statement above shall be available on website of Stock Exchanges.

3) the  issuer  has  investor  grievance-handling  mechanism  which  includes meeting of the Stakeholders’ Relationship Committee at frequent intervals, appropriate delegation of power by the board of directors of the issuer as regards  share  transfer  and  clearly  laid  down  systems  and  procedures  for timely and satisfactory redressed of investor grievances

The mentioned rationalization of disclosures would not only save the listed entities from duplication of task of providing same information that is already disclosed repeatedly but will also ease the accessing of reports by the stakeholders. The decluttering of the disclosures would be beneficial for all, Issuer, investor as well as regulators.

6.      Relaxation in Minimum 90% subscription criteria

Regulation 86(1) of ICDR Regulations require that the minimum subscription to be received in the right issue shall be at least ninety per cent of the offer through the offer document, the said limit was temporally relaxed to 75% by the April Circular.

The amendment proposes to remove mandatory requirement of minimum 90% subscription in case the issue is for the purpose of financing other than capital expenditure for a project, provided that the promoters undertake to subscribe fully to their portion of rights entitlement.

The said relaxation should help the issuers looking for financing their business by right issue, specifically for general financing needs of business. The condition that the promoters would be needed to subscribe their entitlements completely would help safeguard the interest of other subscribers.

7.     Application in plain paper to contain all the disclosures under the ICDR Regulations

Regulation 78 of ICDR Regulation allow shareholders to make application on plain paper in case he/she has not received application from for the right issue. SEBI has included a proviso to the regulation stating that “SCSBs shall accept such application forms only if all details required for making the application as per these regulations are specified in the plain paper application”.

On a general basis an application form contains following details to be entered by the shareholder-

– Name of Issuer

– Name and address of the Equity Shareholder including joint holders;

– Registered Folio Number/DP and Client ID no.;

– Number of Equity Shares held as on Record Date;

– Number of Rights Equity Shares entitled to;

– Number of Rights Equity Shares applied for;

– Number of additional Rights Equity Shares applied for, if any;

– Total number of Rights Equity Shares applied for;

– Total amount paid

– Particulars of cheque/demand draft;

– Savings/Current Account Number and name and address of the bank where the Equity Shareholder will be etc.

8.     FTRI in case of pending Show Cause Notice

Regulation 99 of the ICDR Regulations provide for eligibility criteria for Fast Track Rights Issue (FTRI). FTRI is a faster method of raising funds through right issue whereby the issuer is not required to file draft LOF to SEBI for observations, this makes the process of right issue comparatively faster, enabling issuer to get funds faster.

Clause (h) of the aforesaid regulation restricts the rights issue in case show cause notice have been issued or prosecution proceedings have been initiated by the  Board  and  pending  against  the  issuer  or  its  promoters  or  whole-time  directors.

The amendment provides that the above clause shall now exclude the cases where notice is issued in regards to proceedings for imposition of penalty. However it shall be necessary that disclosures along with potential adverse impact on the issuer are made in the letter of offer.

The said amendment would help compliant companies against whom SCN is issued for violations that are not of serious nature and require only imposition of penalty. As discussed FTRI facilitates faster and cheaper raising of finance by the company, the relaxation would promote the companies to undertake right issue for fund raising activities.

Conclusion

Rights issue has been constantly gaining popularity in India with corporate giants such as Reliance Industries, Shriram Transport Finance and Bajaj electrical have chosen the same as a way to raise funds during the pandemic. In order to promote the right issue as a way of raising funds and ease the funding for listed companies the SEBI has made the amendment.

The Amendments are in the directions to make the offer by way of rights issue easier and do away with disclosures or compliance requirements which were duplicated or redundant. Further, the relaxation in minimum subscription and eligibility criteria for FTRI should come to the rescue of the listed entities to raise funds in the times when most businesses are facing liquidity issues.

[1] https://www.sebi.gov.in/sebiweb/home/HomeAction.do?doListing=yes&sid=6&ssid=23&smid=0

[2] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/sep-2020/1601363043311.pdf#page=1&zoom=page-width,-16,610

Our related write ups can be viewed here-

http://vinodkothari.com/2020/04/highlights-of-sebis-temporary-relaxations-for-rights-issue/

http://vinodkothari.com/2020/04/mof-amends-fdi-norms-for-rights-issue-and-insurance-sector/

[1] https://www.sebi.gov.in/sebiweb/home/HomeAction.do?doListing=yes&sid=6&ssid=23&smid=0

[2] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/sep-2020/1601363043311.pdf