FAQs on Borrowing by Large Corporates: Unveiling the Perplexity!

By Pammy Jaiswal (pammy@vinodkothari.com) (corplaw@vinodkothari.com)

Background

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[1] 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[2] 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.

FAQ Section

  1. 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).

  1. 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).
  1. 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.

  1. 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.

  1. What are the various stipulations with respect to bond issuances imposed by this circular?

There are basically two stipulations imposed under this circular:

      1.Initial requirement:

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

   2.Continual requirement:

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.

  1. 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]

  2020 2021 2022 2023 2024

 

2025

[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
Penalty NIL NIL NIL NIL NIL 107.5* 0.2%

= 0.215

 

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.

  1. 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.
  1.     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.
  1.     Any other specific requirements?
  1. The entity will need to choose any one of the Stock Exchanges (where the securities are listed) for payment of the penalty.
  2. 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.

 

  1. 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%

  1. 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 [3]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.

  1. 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.

  1. 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.

  1. 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.

  1. 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

 

Conclusion

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.


[1] CRISIL’s yearbook on Indian bond market

[2] https://www.sebi.gov.in/legal/circulars/nov-2018/fund-raising-by-issuance-of-debt-securities-by-large-entities_41071.html

[3] https://www.sebi.gov.in/reports/reports/jul-2018/consultation-paper-for-designing-a-framework-for-enhanced-market-borrowings-by-large-corporates_39641.html

Will SEBI succeed in trying to create a much needed vibrant Bond Market?

By Rajeev Jhawar (rajeev@vinodkothari.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.

Rationale

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 [1]

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.

Compliance

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.


[1] https://www.sebi.gov.in/legal/circulars/nov-2018/fund-raising-by-issuance-of-debt-securities-by-large-entities_41071.html

Integration of Financial Markets and Capital Markets

RBI revamps Directions for issuance of Commercial Paper

By Richa Saraf, legal@vinodkothari.com

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

Masala bonds: taking stock of developments so far

By Vallari Dubey (vallari@vindokothari.com)

Background

The Reserve Bank of India (RBI), on September 29, 2015, vide circular RBI/2015-16/193 had issued guidelines allowing Indian companies, Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) to issue rupee-denominated bond (masala bonds) overseas. Consequently, RBI, on April 13, 2016, vide circular RBI/2015-16/372 had reduced the tenure of such bonds to 3 years (previously 5 years) and allowed borrowing upto Rs. 50 billion (previously $ 750 million) under the automatic route. Now vide circular RBI/2016-17/316, RBI has again modified the tenure of these bonds. Interestingly, the tenure has now been segregated into 3 years and 5years respectively; while 3 years are for Masala Bonds raised upto USD 50 million equivalent in INR per financial year and 5 years for bonds raised above USD 50 million equivalent in INR per financial year.

Since its inception only Housing Development Finance Corporation Limited (HDFC) and National Thermal Power Corporation Limited (NTPC) have successfully listed its masala bonds on the London Stock Exchange worth INR 78 billion1 ($1.21 billion) and INR 20 billion ($300 million) respectively. Though HDFC’s masala Bonds are traded on London Stock Exchange (LSE), NTPC’s bonds are traded on both LSE and Singapore Stock Exchange (SGX).

Read more

RBI adds more masala to the bonds: issues circular to further rationalise Masala Bonds Framework, by Vallari Dubey

The Reserve Bank of India vide its powers given under Section 10(4) and Section 11(1) of the Foreign Exchange Management Act, 1999, has issued a circular A. P. (DIR Series) Circular No.47, dated 7th June, 2017[1] bringing in fresh amendments to the existing provisions for ‘Issuance of Rupee denominated bonds overseas’ and as we call it in normal parlance, ‘Masala Bonds’. Read more

SEBI formalises guidelines for issuance of Green Debt Securities in India, by Abhirup Ghosh

The Securities and Exchange Board of India (SEBI) on 30th May, 2017 came out with a circular stating the disclosure requirements for issuance and listing of Green Debt Securities in India (hereinafter referred to as “Circular”)[1]. Earlier in December, 2015, SEBI had come out with a concept paper for issuance of Green Bonds in India (hereinafter referred to as “Concept Paper”)[2]. The Concept Paper brought out the need for enhanced disclosures for issuance of green bonds so as to differentiate it from other form of debt securities issued and listed in India and the Circular is largely in line with the concept paper. Read more