India has been adopted International Financial Reporting Standards (IFRS) in the form of Indian Accounting Standards (Ind AS) in a phased manner since 2016. Different implementation schedules have been issued by different regulatory authorities for different classes of companies and they are:
- Ministry of Corporate Affairs –
- For non-banking non-financial companies – Implementation schedule started from 1st April, 2016
- For non-banking financial companies – Implementation schedule started from 1st April, 2018
- Reserve Bank of India –
- For banking companies – The original scheduled start date was 1st April, 2018, subsequently, it was shifted to 1st April, 2019. However, a recent notification from the RBI has shifted the implementation schedule indefinitely.
- Insurance Regulatory Development Authority of India –
- For insurance companies – The implementation schedule starts from 1st April, 2020.
Consequent upon implementation of IFRS, it is logical that the regulatory framework for financial institutions will also require modifications to bring it in line with the provisions requirements under the new standards.
Though the Ind AS already been implemented in the NBFC sector, no modifications in the existing regulations have been made. Consequently, this has led to the creation of several ambiguities; and one such is regarding treatment of the Other Comprehensive Income (OCI), as per Ind AS 109, for the purpose of computing Tier 1 capital.
This write up will solely focus on the issue relating to treatment of OCI for the purpose of Tier 1 capital.
Other Comprehensive Income (OCI)
Before delving further into specifics, let us have a quick recap of the concept of the OCI. The format of income reporting under Ind AS has undergone a significant change. Under Ind AS, the statement of profit or loss gives us Total Comprehensive Income which consists of a) profit or loss for the period and b) OCI. While the first component represents the profit or loss earned by the reporting entity during the financial year, OCI represents unrealized gains or losses from financial assets of the reporting entity.
The intention of showing OCI in the books of the accounts, is that it protects the gains/losses of companies from oscillation. As the fair values of assets and liabilities fluctuate with the market, parking the unrealized gains in the OCI and not in the P/L account provides stability. In addition to investment and pension plan gains and losses, OCI also captures that the hedging transactions undertaken by the company. By segregating OCI transactions from operating income, a financial statement reader can compare income between years and have more clarity about the sources of income.
While profit or loss earned during the year forms part of the surplus or other reserves in the balance sheet, OCI is shown separately under the Equity segment of the balance sheet.
Capital Risk Adequacy Ratio
Moving on to the meaning of capital risk adequacy ratio (CRAR), it is a measurement of a bank’s available capital expressed as a percentage of a bank’s risk-weighted credit exposures. The CRAR is used to protect creditors and promote the stability and efficiency of financial institutions. This in turn results in providing protection against insolvency. Two types of capital are measured: Tier-I capital, which can absorb losses without a bank being required to cease trading, and Tier-II capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.
The concept of CRAR comes from the Basel framework laid down by the Basel Committee on Banking Supervision (BCBS), a division of Bank of International Settlement. The latest framework being followed worldwide is Basel III framework.
RBI has also adopted the Basel framework, however, with modifications to suit the economic environment in the country. The CRAR requirements have been made applicable to banks as well as NBFCs, however, the requirements vary. While banks are required to maintain 9% CRAR, NBFCs are required to maintain 15% CRAR.
To understand whether OCI should form part of CRAR, it is important to understand the components of CRAR.
Components of Tier I and II Capital as per RBI Master Directions for NBFCs
For the purpose of this write-up, requirements have been examined only from the point of view of NBFCs, as Ind AS is yet to be implemented for banking companies.
CRAR comprises of two parts – Tier I capital and Tier II capital. Each of the two have been defined in the Master Directions issued by the RBI, in the following manner:
(xxxii) “Tier I Capital” means owned fund as reduced by investment in shares of other non-banking financial companies and in shares, debentures, bonds, outstanding loans and advances including hire purchase and lease finance made to and deposits with subsidiaries and companies in the same group exceeding, in the aggregate, ten percent of the owned fund; and perpetual debt instruments issued by a non-deposit taking non-banking financial company in each year to the extent it does not exceed 15% of the aggregate Tier I Capital of such companies as on March 31 of the previous accounting year;
The term “owned funds” have been defined as:
“owned fund” means paid up equity capital, preference shares which are 9 compulsorily convertible into equity, free reserves, balance in share premium account and capital reserves representing surplus arising out of sale proceeds of asset, excluding reserves created by revaluation of asset, as reduced by accumulated loss balance, book value of intangible assets and deferred revenue expenditure, if any;
Tier II capital has been defined as:
(xxxiii) “Tier II capital” includes the following:
- preference shares other than those which are compulsorily convertible into equity;
- revaluation reserves at discounted rate of fifty five percent;
- General provisions (including that for Standard Assets) and loss reserves to the extent these are not attributable to actual diminution in value or identifiable potential loss in any specific asset and are available to meet unexpected losses, to the extent of one and one fourth percent of risk weighted assets;
- hybrid debt capital instruments;
- subordinated debt; and
- perpetual debt instruments issued by a non-deposit taking non-banking financial company which is in excess of what qualifies for Tier I Capital, to the extent the aggregate does not exceed Tier I capital.
The above definitions of Tier I and II capital do not talk about OCI. However, the Directions were prepared before the implementation of Ind AS 109 and no clarity on the subject has come from RBI post implementation of Ind AS 109.
Therefore, for determining whether OCI should be made a part of Tier I or Tier II capital, we can draw reference from Basel III framework.
Components of Tier I capital as per Basel III framework 
As per Para 52 of the framework, the Tier I capital consists of:
Common Equity Tier 1 capital consists of the sum of the following elements:
- Common shares issued by the bank that meet the criteria for classification as common shares for regulatory purposes (or the equivalent for non-joint stock companies);
- Stock surplus (share premium) resulting from the issue of instruments included Common Equity Tier 1;
- Retained earnings;
- Accumulated other comprehensive income and other disclosed reserves;
- Common shares issued by consolidated subsidiaries of the bank and held by third parties (ie minority interest) that meet the criteria for inclusion in Common Equity Tier 1 capital. See section 4 for the relevant criteria; and
- Regulatory adjustments applied in the calculation of Common Equity Tier 1
Retained earnings and other comprehensive income include interim profit or loss. National authorities may consider appropriate audit, verification or review procedures. Dividends are removed from Common Equity Tier 1 in accordance with applicable accounting standards. The treatment of minority interest and the regulatory adjustments applied in the calculation of Common Equity Tier 1 are addressed in separate sections.
The Basel III norms clearly states that accumulated other comprehensive income forms a part of the Tier I capital.
It is very interesting to note that RBI had also adopted Basel III framework on July 1, 2015, however, the framework adopted and introduced is silent on the treatment of the OCI, unlike the original Basel III framework. The reason for the omission of the concept of OCI is that the framework was adopted in India way before Ind AS implementation and under the erstwhile IGAAP, there was no concept of OCI or booking of unrealized gains or losses in the books of accounts.
It is well understood that due to the very recent implementation of IndAS 109, the guidelines have not been revised in line with the IndAS. However, going by the spirit of Basel III regulation, this leaves us very little doubt what the treatment of OCI for the purpose of CRAR computation should be. Therefore, one can safely conclude that the OCI should form part of Tier I capital, unless, anything contrary is issued by the RBI subsequently.
By Pammy Jaiswal (email@example.com) (firstname.lastname@example.org)
The untiring efforts of SEBI as well as the Government in uplifting the bond market is quite commendable. SEBI has started taking long footsteps towards the accomplishment of the budget announcement by the Government for the year 2018-19. The steps include introduction of electronic bidding platform for privately placed debt securities, consolidation of ISIN of debt instruments and introduction of a secondary market for debt instruments. Accordingly, our country’s bond market is almost at par with the banking loans to stand at Rs. 422 billion dollars as compared to Rs. 561 billion dollars as on 31st March, 2018. However, majority of bonds issued in the country are on private placement basis. Despite gaining prominence, bond issued in India currently lacks an active secondary market
SEBI in its continued effort for deepening the bond market, issued a “circular” dated November 26, 2018 where it has mandated certain listed entities to mandatorily borrow a certain percentage of its borrowings through the issuance of debt securities.
While it is true that SEBI does not want to leave any stone unturned for strengthening the Indian bond market, however, there certain grey areas in the framework, which needs further clarification. In this paper, we intend to highlight these grey areas and potential answers to the problems.
Further, we have also prepared a summarised write-up on the said framework which can be viewed here.
- When will the framework under the circular be applicable?
The framework under the circular is applicable w.e.f. FY 2019-20 (where the FY is from April to March) or FY 2020 (where FY is from January to December).
- What is the meaning of the term ‘Large Corporate’?
The entities which fulfil all the three conditions given below based on the financials of the previous year are termed as Large Corporate or LC:
- Listed companies (specified securities, debt securities, non- convertible redeemable preference shares);
- Having long term (maturity of more than 1 year) outstanding borrowings excluding ECBs and borrowings between parent and subsidiary of Rs. 100 cr and above; and
- Carries a credit rating of AA and above of unsupported bank borrowings or plain vanilla bonds (highest rating to be considered in case of multiple ratings).
- Whether the applicability of the said circular has to be examined every year?
LCs are required to check the applicability of the aforesaid circular every year and accordingly be termed as Large Corporates.
- What is the meaning of unsupported borrowings?
The circular talks about the credit rating of unsupported borrowings or plain vanilla bonds. Clause (iii) of para 2.2 states:
“have a credit rating of “AA and above”, where credit rating shall be of the unsupported bank borrowing or plain vanilla bonds of an entity, which have no structuring/ support built in; and in case, where an issuer has multiple ratings from multiple rating agencies, highest of such rating shall be considered for the purpose of applicability of this framework”
A supported borrowing may referred to as a borrowing backed by a collateral or some sort of a guarantee for ensuring its repayment. Therefore, an unsupported borrowing is nothing but an unsecured loan. The reason behind keeping the requirement of credit rating of AA and above for unsupported borrowing is to mandate entities having good credit ability for not only secured but also unsecured borrowings to issue specified percentage of their debt securities in accordance with this circular.
Further, only such highly rated entities shall encourage an investor to invest.
- What are the various stipulations with respect to bond issuances imposed by this circular?
There are basically two stipulations imposed under this circular:
For the first two years in which the framework becomes applicable (i.e. FY 2020 and 2021), the LC is required to raise a minimum of 25% of the long term borrowings (maturity of more than 1 year) in each of the FY (for which the entity becomes an LC) excluding ECBs and borrowings between parent and subsidiary (incremental borrowings) by way of issuance of debt securities
From the third year of the applicability (i.e. FY 2022 onwards), the LC is required to mandatorily required to raise a minimum of 25% of its increased borrowing in such year from the issuance of debt securities over a period of one block of two years.
Further, in case of any shortfall of borrowing in any year, such shortfall is required to be carried forward to the next year in the block.
- What is the manner of adjusting the shortfall in any FY?
As we go through the illustration given in Annexure C of the circular, it becomes clear that for the first year of implementation there is no concept of carrying forward the shortfall to the second year, since the LC is required to explain the reason for not being able to comply with the borrowing requirements.
Further, as regards the shortfall for the second year and onwards is required to be carried forward to the next year. Now let us try and understand the manner of adjustment from the below mentioned illustration:
X Ltd is an LC as on the last day of the previous year being 31st March, 2019.
[Rs. in cr]
[Not an LC]
|Increased Borrowing [IB]||200||500||700||600||650||100|
|Mandatory borrowing from debt securities of 25% of the IB[MB]||50||125||175||150||162.5||NIL|
|Actual Borrowing from debt securities [AB]||40||100||75||200||100||5|
|Adjustment of the shortfall of the previous year||NIL||NIL||NIL||100||50||112.5|
|Shortfall to carry forward||NIL||NIL||100||50||112.5||107.5|
Basically, the LC shall first adjust the AB towards the shortfall of the previous year of the current block and then check whether it has complied with the MB requirements. Further, the penalty shall be levied if there is the shortfall of the previous year in the current block could not adjusted with the AB of the second year of the current block.
- What are the penal consequence for non- compliance?
- For FY 19-20 & 20- 21, no penalty but explanation will be required;
- From FY 21-22 onwards, the minimum funding requirement has to be met over a block of 2 years.
- In case of any shortfall of the first year of the block is not met as on the last day of the next FY of the block, a monetary penalty of 0.2% of the shortfall amount shall be levied and paid to SE.
- The manner of payment of the penalty has not been provided in the circular but SEs are expected to bring the same.
- What are the disclosure requirements?
- The fact that the entity has fulfilled the criteria of being an LC based on the financials of previous year has to be disclosed to SE within 30 days of the beginning of the FY. Format as per Annexure A to the Circular.
- The details of incremental borrowings done in the FY has to be disclosed to SE within 45 days of the end of the FY. Formats as per Annexure B1 [(applicable for FY 19-20 & 20-21) and B2 (applicable for FY 21-22 onwards)] to the Circular.
- The aforesaid disclosures shall be certified both by the CS and CFO.
- The aforesaid disclosures shall also form part of the annual audited financial results.
- Any other specific requirements?
- The entity will need to choose any one of the Stock Exchanges (where the securities are listed) for payment of the penalty.
- The entity being an LC for the previous year and carrying a shortfall for that year in the current year for which the entity is not an LC shall also be required to make the requisite disclosures within 45 days of the end of the current year.
- Whether the requirements of the circular are relevant for all the LCs?
While the ambit of the circular is broad enough to cover both Non-Banking Financial Companies (‘NBFCs’) and Non-Banking Non-Financial Companies (‘NBNFCs’), the circular is more relevant for NBNFCs.
NBFCs are financial institutions and are engaged in lending and investing activities in their day to day operations and therefore, the major chunk of the working capital and long term funding requirements anyways come from issuance of debt securities considering the leverage issues.
Therefore, one may construe that the circular is more relevant for NBNFCs since they are not mandated to borrow from the issue of debt securities as the funding requirements of these entities can also be fulfilled by banks. Further, the circular should have laid down a specified threshold on the increased borrowing which if met should be required to constitute of debt securities also to the tune of 25%
- Whether relaxation is for any first two year of implementation or the year mentioned in the circular?
This circular was lead by a consultation paper issued by SEBI on July 20, 2018 which clearly stated that “A “comply or explain” approach would be applicable for the initial two years of implementation. Thus, in case of non-fulfilment of the requirement of market borrowing, reasons for the same shall be disclosed as part of the “continuous disclosure requirements”
However, the circular is clear on the initiation point of the said framework i.e. April, 2019, accordingly, one may take a view that the FY 2020 and 2021 shall mandatorily be the first two years in which the relaxation of comply or explain can be taken. Any entity which gets covered by the aforesaid circular at a later date shall have to mandatorily comply with the borrowing requirements and be liable to penalty in case of non-compliance.
- Whether the term ‘increased borrowings’ shall also cover Pass Through Certificates (‘PTCs’)?
As per the circular, “incremental borrowings” have been defined to include borrowings during a particular financial year with original maturity of more than 1 year, excluding ECBs and ICDs between a parent and its subsidiaries.
Further, IND AS 109, treats PTCs as collateralized borrowings only. Here it is pertinent to note that the question of showing the investor’s share in PTC as financial liability arises only because the securitised pool of assets fails the de-recognition test.
Originator has no obligation towards the investors of the PTC. The investors are exposed to the securitised pool of assets and not to the originator. Therefore, merely because the investor’s share appears on the balance sheet of the originator as financial liability, as per Ind AS 109, does not mean they are debt obligations of the originator.
Accordingly, incremental borrowings shall not include PTCs.
- In cases where an entity ceases to be an LC in one year and again gets covered by the circular in subsequent years, whether the initial disclosure to the stock exchange shall be required to be given again?
In our view, such entity should provide the exchange with the initial disclosure for the purpose and to enable the stock exchange to continuously monitor the compliance of the framework.
- How will the stock exchange be apprised that an entity is no more an LC
Ideally there should be an intimation to the exchange stating that the entity is no more an LC and accordingly the mandatory borrowing requirements should not be made applicable on for such FYs in which it is not an LC.
Further, this intimation may also indicate that the entity shall inform the exchange in terms of para 4.1 once it qualifies to be an LC.
- What is the role of the stock exchange in terms of para 5 of the circular?
- The exchange shall collate the information about the LC and submit the same to the Board within 14 days of the last day of the annual financial results;
- The exchange shall collect the fine as mentioned under para 3.2(ii); and
- The said fine shall be remitted by the exchange to the SEBI IPEF within 10 days of the end of the month in which the fine was collected
SEBI has laid down penal provisions for not complying with the circular. However, if the issue size of mandatory borrowing is too small, then there may be a possibility that LCs may think of doing their cost benefit analysis between the issue cost and the penalty amount. Therefore, SEBI should set a minimum threshold for increased borrowings and cover only those LCs to raise funds through bond market who exceed such threshold.
By Rajeev Jhawar (email@example.com) [Updated as on November 27, 2018]
In a vibrant market, resides a healthy economy. On the Budget day, India sought to expand its bond market beyond the traditional ambit of sovereign debt. In pursuant to this, Securities and Exchange Board of India(SEBI) has initiated to diversify borrowings of Indian corporates by mandating to raise at least a quarter of their incremental funds from the bond market.
The regulator came out with a circular dated 26 November 2018, based on the concept paper released on 20 July,2018; targeting all listed entities (whose specified securities, or debt securities or non-convertible redeemable preference share are listed on SEBI’s recognized stock exchange) thereby addressing the liquidity problem persisting in the bond market, with an intention to create a robust secondary market for the debt securities in India.
For the entities following April-March as their financial year, the framework shall come into effect from April 01, 2019 and for the entities which follow calendar year as their financial year, the framework shall become applicable from January 01, 2020.
The requirements brought by SEBI and corresponding inferences
The regulator proposes that the Large Corporates (LC) that are listed companies (whose specified securities or debt securities or non- convertible redeemable preference shares are listed) (excluding Scheduled Commercial Banks) will have to compulsorily raise 25% of their incremental borrowings (being fresh long term borrowings during the FY) from the bond market in the financial year for which they are being identified as LC, as a part of corroborating the same. The term financial year here would imply April-March or January-December as may be followed by the entity.
As per the circular,large corporates would refer to entities
- having outstanding long-term borrowings of Rs. 100 crores or above.Further, long term borrowings would mean any outstanding borrowing with original maturity of more than 1 year excluding external commercial borrowings(ECBs) and inter corporate borrowings between a parent and subsidiary and,
- a credit rating of “AA and above”, where credit rating shall be of the unsupported(unsecured) bank borrowing or plain vanilla bonds of an entity, which have no structuring/ support built in; and in case, where an issuer has multiple ratings from multiple rating agencies, highest of such rating shall be considered for the purpose of applicability of this framework.
Lower rated corporates have been exempted from the framework for the time being due to the limited demand for such securities. It is believed that if the 25% norm is followed religiously, it would tantamount to increase bond flotation as more companies would be able to access the debt market. Besides, the government might limit corporates’ dependence on banks and the risk associated with it. However, there is a need for an expansion in the investor base for implementation of these rules.
There is no secondary market for corporate bonds in India to speak of. The sorry state of affair could be because of illiquid debt market, bad press in case of default, risk averse attitude as well as dearth of investor’s awareness. On the bright aspect, bonds are ideal way to raise financing for a certain kind of long-gestation infrastructure project. Typically, infrastructure projects are capital-intensive and long-gestation. It takes years to roll out toll-roads, build flyovers and set up massive power generating plants. The project developer has no cash flow to service debt until the project is running and banks may not be considered a viable source as bank funding is short tenure, which would result in asset-liability mismatch.
It is also believed that a sound corporate bond market, would take a lot of pressure off banks, which are reeling under bad debts. Retail investors will also get a chance to invest in such projects via debt funds. In short, large exposure to risk would be substantiated with huge rewards.
Further, in order to ensure investors faith in the company, the rating of ‘AA and above’ has been given preference as corporates with such high rating would have less chance to default on its obligations towards the investors which was demonstrated in the consultation paper also.
Impact on Financier’s Interest
The entry barrier for lower rated corporate bonds would be demolished because the proposal might escalate the pool of investment grade issuers. So far, the small borrowers resorted mostly to institutional finance and inter-corporate deposits. The bond avenue would serve as an alternative for them to raise finance at a reasonable price keeping in mind investor’s perpetual keenness to diversify their investments. It may be useful to classify BBB-rated corporate bonds as investment grade and thus allow pension funds and insurance companies to enter that space.
Disclosure requirements for large entities 
A listed entity, identified as a Large Corporate(LC) under the instant framework, shall make the following disclosures to the stock exchanges, where its security(ies) are listed:
- Within 30 days from the beginning of the FY, disclose the fact that they are identified as a LC, in the format as provided in the circular;
- Within 45 days of the end of the FY, the details of the incremental borrowings done during the FY, in the formats as provided in the circular;
- The disclosures made shall be certified both by the Company Secretary and the Chief Financial Officer, of the LC;
- Further, the disclosures made shall form part of audited annual financial results of the entity.
The LCs would need to disclose non-compliance as part of “continuous disclosure requirements”.For FY 19-20 & 20-21, the aforesaid requirement has to be met on an annual basis as on the last day of the FY.In case of failure, explanation as regards to the shortfall has to be made to the stock exchange (SE).
For FY 19-20 & 20- 21, no penalty but explanation will be required.From FY 21-22 onward, the minimum funding requirement has to be met over a block of 2 years. In case of any shortfall of the first year of the block is not met as on the last day of the next FY of the block, a monetary penalty of 0.2% of the shortfall amount shall be levied and paid to SE.The manner of payment of the penalty has not been provided in the Circular but SEs are expected to bring the same.The entity identified as a large corporate shall choose any one of the Stock Exchanges (where the securities are listed) for payment of the penalty.
The Stock Exchange(s) shall collate the information about the Large Corporates, disclosed on their platform, and shall submit the same to the Board within 14 days of the last date of submission of annual financial results.
Whether SEBI’s attempt would prove to be a boon or a bane, is likely to be seen as days unfold.
By Richa Saraf, firstname.lastname@example.org
The Reserve Bank of India (RBI) vide Notification No. MRD.DIRD.01/CGM (TRS) – 2017 dated August 10, 2017 has issued Reserve Bank Commercial Paper Directions, 2017 (“New Directions”). The new guidelines are in supersession of the existing directions on Commercial Paper in the Master Directions on Money Market (Section II) RBI/FMRD/2016-17/32 dated July 7, 2016 (“Old Directions”). The following table captures the difference between the old and new directions:- Read more