SEBI’s Framework for listing of Commercial Papers

Munmi Phukon | Principal Manager, Vinod Kothari & Company

corplaw@vinodkothari.com

Introduction

SEBI on 22nd October, 2019 came out with a Circular to provide for the Framework for listing of Commercial Papers (CPs). The Circular is based on the recommendations of the Corporate Bonds & Securitization Advisory Committee (CoBoSAC) chaired by Shri H. R. Khan which was set up for making recommendations to SEBI on developing the market for corporate bonds and securitized debt instruments.

CPs are currently traded in OTC market though settled through the clearing corporations. Evidently, listing of CPs for trading in stock exchanges will enhance the investor participation which will in turn help the issuers to cope up with their short term fund requirements. SEBI’s current move in laying down the Framework is to ensure investor protection keeping in mind a prospective broader market for CPs. The Circular is mostly concerned about making elaborate disclosures at the time of submitting the application for listing and also some disclosures on a continuous basis post listing of the CPs.

As evident from the content of the Circular, some of the disclosure requirements proposed at the time of application for listing of the CPs are same as provided in the format of Letter of Offer as provided in the Operational Guidelines on CPs[1] (Operational Guidelines) prescribed by the Fixed Income Money Market and Derivatives Association of India (FIMMDA). However, there are certain additional requirements which are discussed in this article.

Disclosure requirements at the time of application for listing

Annexure I of the Circular provides for the disclosure requirements which the issuers are required to make at the time of submitting the application and the content of the same is quite elaborative which covers almost every aspect of an issuer. The broad segments of disclosures are as below:

General details of issuer
Under this heading, details such as, name, CIN, PAN, line of business group affiliation will be given. The issuer will also be required to give name of the managing director, CEO, CFO or president as chief executives. The disclosures are same as provided in the Operational Guidelines.

Details of directors
Details of current set of directors including inter alia their list of directorships and the details of any change in directors in the last 3 financial years and the current year shall be required to be disclosed.  Currently, the Operational Guidelines do not require these details.

Details of auditors
Details of current auditor and any change in directors in the last 3 financial years and the current year shall be required to be disclosed. Currently, the Operational Guidelines do not require these details.

Details of security holders
Under this category, the disclosure shall be made for top 10 equity shareholders, top 10 debt security holders and top 10 CP holders. However, the date of determination of the same has not been provided. Currently, the Operational Guidelines do not require these details.

Details of borrowings as at the end of latest quarter before filing of the application
Details of borrowings are divided into 3 parts-

a.      Details of debt securities and CPs. The Operational Guidelines require the details of CPs issued during last 15 months and also of the outstanding balance as on the date of offer letter.

b.      Details of other facilities such as secured/ unsecured loan facilities/bank fund based facilities, borrowings other than above, if any, including hybrid debt like foreign currency convertible bonds (FCCB), optionally convertible debentures / preference shares from banks or financial institutions or financial creditors. The details related to outstanding debt instruments and bank fund based facilities are same as provided in the Operational Guidelines however, it was silent on the hybrid instruments.

c.      Details of corporate guarantee or letter of comfort along with name of the counterparty on behalf of whom it has been issued, contingent liability including debt service reserve account (DSRA) guarantees/ any put option etc. Operational Guidelines do not require these details currently.

Information related to the concerned issue

The content is more or less similar to the details required to be provided in the Letter of Offer as provided in the Operational Guidelines. The additional requirements are as follows:

d.     Details of credit rating letter issued should not be older than one month on the date of opening of the issue and

e.      Copy of the executed guarantee.

Financial information
The stock exchanges shall be provided with the following financial information-

a.      Audited / Limited review of half yearly consolidated financial statements, if available;

b.      Financial statements along with auditor qualifications, if any, for last 3 years along with latest available financial results;

c.      Latest available quarterly financial results prepared under Regulation 33, if applicable;

d.     Latest audited financials not older than six months from the date of application. However, companies already complying with the Listing Regulations may submit unaudited financials with limited review.

The Operational Guidelines currently require the financial summary only of last 3 FYs to be provided in the letter of offer.

Material information
The following shall be disclosed-

a.      Details of all default/s and/or delay in payments of interest and principal of CPs, (including technical delay), debt securities, term loans, external commercial borrowings and other financial indebtedness including corporate guarantee issued in the past 5 financial years including in the current financial year.

b.      Ongoing and/or outstanding material litigation and regulatory strictures, if any.

c.      Any material event/ development having implications on the financials/credit quality including any material regulatory proceedings against the issuer/ promoters, tax litigations resulting in material liabilities, corporate restructuring event which may affect the issue or the investor’s decision to invest / continue to invest in the CP.

The disclosures in point (a) and (c) above are not required to be disclosed in the letter of offer as per Operational Guidelines.

Asset Liability Management (ALM) disclosures for NBFCs and HFCs

The Circular specifically provides for some additional disclosures for NBFCs and HFCs which are currently not required to be provided in the letter of offer prescribed by FIMMDA:

a.      NBFCs shall make disclosures as specified for NBFCs in SEBI Circular nos. CIR/IMD/DF/ 12 /2014[2], dated June 17, 2014 and CIR/IMD/DF/ 6 /2015, dated September 15, 2015. Further, “Total assets under management”, under the aforesaid Circular dated September 15, 2015 shall also include details of off balance sheet assets.

b.      HFCs shall make disclosures as specified for NBFCs in the said SEBI Circular no. CIR/IMD/DF/ 6 /2015, dated September 15, 2015, with appropriate modifications viz. retail housing loan, loan against property, wholesale loan – developer and others.

In terms of the SEBI Circular dated June 17, 2014, NBFCs are required to disclose the details with regards to the lending done by them, out of the issue proceeds of previous public issues, including details regarding the following:

a.      Lending policy;

b.      Classification of loans/advances given to associates, entities /person relating to Board, Senior Management, Promoters, Others, etc.;

c.      Classification of loans/advances given to according to type of loans, sectors, maturity profile, denomination, geographical classification of borrowers, etc.;

d.      Aggregated exposure to the top 20 borrowers with respect to the concentration of advances, exposures to be disclosed in the manner as prescribed by RBI in its guidelines on Corporate Governance for NBFCs, from time to time;

e.      Details of loans, overdue and classified as non-performing in accordance with RBI guidelines.

The Circular dated September 15, 2015 provides for the following additional disclosures:

a.      In case any of the borrower(s) of the NBFCs form part of the “Group” as defined by RBI, then appropriate disclosures shall be made as regards the name of the borrower, Amount of Advances /exposures to such borrower and Percentage of Exposure;

b.      A portfolio summary with regards to industries/ sectors to which borrowings have been made by NBFCs;

c.      Quantum and percentage of secured vis-à-vis unsecured borrowings made by NBFCs;

d.      Any change in promoter’s holdings in NBFCs during the last financial year beyond a particular threshold (RBI has prescribed such a threshold level at 26% at present).

Continuous disclosures after listing of CPs

Annexure II of the Circular provides for the disclosure requirements which shall be observed on a continuous basis. The details of such disclosures are broadly as below:

a.      Submission of financial results

i.          For issuers which are required to follow Chapter IV of SEBI LODR Regulations i.e. whose specified securities are listed, the financial results shall be in the format as prepared and submitted under Regulation 33. The issuers will also be required to disclose along with the financial results the additional line items as required under Regulation 52(4). This shall also apply to an issuer which is required to prepare financial results for the purpose of consolidated financial results in terms of Regulation 33;

·      The line items as provided under Regulation 52(4) are as below:

o  credit rating and change in credit rating (if any);

o  asset cover available, in case of non- convertible debt securities;

o  debt-equity ratio;

o  previous due date for the payment of interest/ dividend for non-convertible redeemable preference shares/ repayment of principal of non-convertible preference shares /non- convertible debt securities and whether the same has been paid or not; and,

o  next due date for the payment of interest/ dividend of non-convertible preference shares /principal along with the amount of interest/ dividend of non-convertible preference shares payable and the redemption amount;

o  debt service coverage ratio;

o  interest service coverage ratio;

o  outstanding redeemable preference shares (quantity and value);

o  capital redemption reserve/debenture redemption reserve;

o  net worth;

o  net profit after tax;

o  earnings per share:

 ii.          For issuers which are required to comply with provisions of Chapter V of the Regulations only i.e. whose NCDs/ NCPSs are only listed, the financial results shall be prepared and submitted as per regulation 52; and

iii.          Issuers who only have outstanding listed CPs shall prepare and submit financial results in terms of Regulation 52.

 

b.      Disclosure of material events

The issuers shall disclose the following details to the stock exchange(s) as soon as possible but not later than 24 hours from the occurrence of event (or) information:

i.          Details such as expected default/ delay/ default in timely fulfilment of its payment obligations for any of the debt instrument;

ii.          Any action that shall affect adversely, fulfilment of its payment obligations in respect of CPs;

iii.          Any revision in the credit rating;

iv.          A certificate confirming fulfilment of its payment obligations, within 2 days of payment becoming due.

c.      ALM Statements for issuers who are NBFCs/HFCs

NBFCs and HFCs will be required to simultaneously submit to the stock exchanges the latest ALM statements as and when they submit the same to respective regulator(s) viz RBI/NHB, as applicable.

d.     CEO/ CFO Certification

A certificate from the CEO/CFO shall be submitted by the issuers to the recognized stock exchange(s) on quarterly basis certifying that CP proceeds are used for disclosed purposes, and adherence to other listing conditions.

Conclusion

As mentioned above, the disclosure requirements as provided in the Circular are meant for assisting the investors in taking an informed decision. Since the requirements are new, it is expected that apart from the stock exchanges, FIMMDA/ RBI will also come out with the revised Operational Guidelines/ Directions in order to bring more clarity on this aspect.

 

 

 

 

 

 

 

 

 

 

 

[1] http://www.fimmda.org/modules/content/?p=1033
[2] https://www.sebi.gov.in/sebi_data/attachdocs/1403065620622.pdf

Partial Credit Guarantee Scheme

A Business Conclave on  “Partial Credit Guarantee Scheme” was organised by Indian Securitisation Foundation jointly with Edelweiss on September 16,2019 in Mumbai.

On this occasion, the presentation used by Mr. Vinod Kothari is being given here:

http://vinodkothari.com/wp-content/uploads/2019/09/partial-credit-enhancement-scheme-.pdf

 

We have authored few articles on the topic that one might want to give a read. The links to such related articles are provided below:

Government credit enhancement for NBFC pools: A Guide to Rating agencies

Vinod Kothari Consultants P Ltd (finserv@vinodkothari.com)

 

The partial credit enhancement (PCE) Scheme of the Government[1], for purchase by public sector banks (PSBs) of NBFC/HFC pools, has been discussed in our earlier write-ups, which can be viewed here and here.

This document briefly puts the potential approach of the rating agencies for rating of the pools for the purpose of qualifying for the Scheme.

Brief nature of the transaction:

  • The transaction may be summarised as transfer of a pool to a PSB, wherein the NBFC retains a subordinated piece, such that the senior piece held by the PSB gets a AA rating. Thus, within the common pool of assets, there is a senior/junior structure, with the NBFC retaining the junior tranche.
  • The transaction is a structured finance transaction, by way of credit-enhanced, bilateral assignment. It is quite similar to a securitisation transaction, minus the presence of SPVs or issuance of any “securities”.
  • The NBFC will continue to be servicer, and will continue to charge servicing fees as agreed.
  • The objective to reach a AA rating of the pool/portion of the pool that is sold to the PSB.
  • Hence, the principles for sizing of credit enhancement, counterparty (servicer) risk, etc. should be the same as in case of securitisation.
  • The coupon rate for the senior tranche may be mutually negotiated. Given the fact that after 2 years, the GoI guarantee will be removed, the parties may agree for a stepped-up rate if the pool continues after 2 years. Obviously, the extent of subordinated share held by the NBFC will have to be increased substantially, to provide increased comfort to the PSB. Excess spread, that is, the excess of actual interest earned over the servicing fees and the coupon may be released to the seller.
  • The payout of the principal/interest to the two tranches (senior and junior), and utilisation of the excess spread, etc. may be worked out so as to meet the rating objective, provide for stepped-up level of enhancement, and yet maintain the economic viability of the transaction.
  • Bankruptcy remoteness is easier in the present case, as pool is sold from the NBFC to the PSB, by way of a non-recourse transfer. Of course, there should be no retention of buyback option, etc., or other factors that vitiate a true sale.
  • Technically, there is no need for a trustee. However, whether the parties need to keep a third party for ensuring surveillance over the transaction, in form of a monitoring agency, may be decided between the parties.

Brief characteristics of the Pool

  • For any meaningful statistical analysis, the pool should be a homogenous pool.
  • Surely, the pool is a static pool.
  • The pool has attained seasoning, as the loans must have been originated by 31st March, 2019.
  • In our view, pools having short maturities (say personal loans, short-term loans, etc.) will not be suitable for the transaction, since the guarantee and the guarantee fee are on annually declining basis.

Data requirement

The data required for the analysis will be same as data required for securitisation of a static pool.

Documentation

  • Between the NBFC and the PSB, there will be standard assignment documentation.
  • Between the Bank and the GoI:
    • Declaration that requirements of Chapter 11 of the GFR have been satisfied.
    • Guarantee documentation as per format given by GOI

[1] http://pib.gov.in/newsite/PrintRelease.aspx?relid=192618

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Government Credit enhancement scheme for NBFC Pools: A win-win for all

Vinod Kothari (vinod@vinodkothari.com)

The so-called partial credit enhancement (PCE) for purchase of NBFC/HFC pools by public sector banks (PSBs) may, if meaningfully implemented, be a win-win for all. The three primary players in the PCE scheme are NBFCs/HFCs (let us collectively called them Originators), the purchasing PSBs, and the Government of India (GoI). The Scheme has the potential to infuse liquidity into NBFCs while at the same time giving them advantage in terms of financing costs, allow PSBs to earn spreads while enjoying the benefit of sovereign guarantee, and allow the GoI to earn a spread of 25 bps virtually carrying no risks at all. This brief write-ups seeks to make this point.

The details of the Scheme with our elaborate questions and answers have been provided elsewhere.

Modus operandi

Broadly, the way we envisage the Scheme working is as follows:

  1. An Originator assimilates a pool of loans, and does tranching/credit enhancements to bring a senior tranche to a level of AA rating. Usually, tranching is associated with securitisation, but there is no reason why tranching cannot be done in case of bilateral transactions such as the one envisaged here. The most common form of tranching is subordination. Other structured finance devices such as turbo amortisation, sequential payment structure, provisions for redirecting the excess spread to pay off the principal on senior tranche, etc., may be deployed as required.
  2. Thus, say, on a pool of Rs 100 crores, the NBFC does so much subordination by way of a junior tranche as to bring the senior tranche to a AA level. The size of subordination may be worked, crudely, by X (usually 3 to 4) multiples of expected losses, or by a proper probability distribution model so as to bring the confidence level of the size of subordination being enough to absorb losses to acceptable AA probability of default. For instance, let us think of this level amounting to 8% (this percentage, needless to say, will depend on the expected losses of respective pools).
  3. Thus, the NBFC sells the pool of Rs 100 crores to PSB, retaining a subordinated 8% share in the same. Bankruptcy remoteness is achieved by true sale of the entire Rs 100 crore pool, with a subordinated share of 8% therein. In bilateral transactions, there is no need to use a trustee; to the extent of the Originator’s subordinated share, the PSB is deemed to be holding the assets in trust for the Originator. Simultaneously, the Originator also retains excess spread over the agreed Coupon Rate with the bank (as discussed below).
  4. Assuming that the fair value (computation of fair value will largely a no-brainer, as the PSB retains principal, and interest only to the extent of its agreed coupon, with the excess spread flowing back to the Originator) comes to the same as the participation of the PSB – 92% or Rs 92 crores, the PSB pays the same to the Originator.
  5. PSB now goes to the GoI and gets the purchase guaranteed by the latter. So, the GoI has guaranteed a purchase of Rs 92 crores, taking a first loss risk of 10% therein, that is, upto Rs 9.20 crores. Notably, for the pool as a whole, the GoI’s share of Rs 9.20 crores becomes a second loss position. However, considering that the GoI is guaranteeing the PSB, the support may technically be called first loss support, with the Originator-level support of Rs 10 crores being separate and independent.
  6. However, it is clear that the sharing of risks between the 3 – the Originator, the GoI and the Bank will be as follows:
  • Losses upto first Rs 8 crores will be taken out of the NBFC’s first loss piece, thereby, implying no risk transfer at all.
  • Losses in excess of Rs 8 crores, but upto a total of Rs 17.20 crores (the GoI guarantee is limited to Rs 9.20 crores), will be taken by GoI.
  • It is only when the loss exceeds Rs 17.20 crores that there is a question of the PSB being hit by losses.
  1. Thus, during the period of the guarantee, the PSB is protected to the extent of 17.2%. Note that first loss piece at the Originator level has been sized up to attain a AA rating. That will mean, higher the risk of the pool, the first loss piece at Originator level will go up to protect the bank.
  2. The PSB, therefore, has dual protection – to the extent of AA rating, from the Originator (or a third party with/without the Originator, as we discuss below), and for the next 10%, from the sovereign.
  3. Now comes the critical question – what will be the coupon rates that the PSB may expect on the pool.
    1. The pool effectively has a sovereign protection. While the protection may seem partial, but it is a tranched protection, and for a AA-rated pool, a 10% thickness of first loss protection is actually far higher than required for the highest degree of safety. What makes the protection even stronger is that the size of the guarantee is fixed at the start of the transaction or start of the financial year, even though the pool continues to amortise, thereby increasing the effective thickness.
    2. Assume risk free rate is R, and the spreads for AAA rated ABS are R +100 bps. Assume that the spreads for AA-rated ABS is R+150 bps.
    3. Given the sovereign protection, the PSB should be able to price the transaction certainly at less than R +100 bps, because sovereign guarantee is certainly safer than AAA. In fact, it should effectively move close to R, but given the other pool risks (prepayment risks, irregular cashflows), one may expect pricing above R.
    4. For the NBFC, the actual cost is the coupon expected by the PSB, plus 25bps paid for the guarantee.
    5. So as long as the coupon rate of the pool for the NBFC is lower than R+75 bps, it is an advantage over a AAA ABS placement. It is to be noted that the NBFC is actually exposing regulatory and economic capital only for the upto-AA risk that it holds.

Win-win for all

If the structure works as above, it is a win-win for all:

  • For the GoI, it is a neat income of 25 bps while virtually taking no real risks. There are 2 strong reasons for this – first, there is a first loss protection by the Originator, to qualify the pool for a AA rating. Secondly, the guarantee is limited only for 2 years. For any pool, first of all, the probability of losses breaching a AA-barrier itself will be close to 1% (meaning, 99% of the cases, the credit support at AA level will be sufficient). This becomes even more emphatic, if we consider the fact that the guarantee will be removed after 2 years. The losses may pile up above the Originator’s protection, but very unlikely that this will happen over 2 years.
  • For the PSB, while getting the benefit of a sovereign guarantee, and therefore, effectively, investing in something which is better than AAA, the PSB may target a spread close to AAA.
  • For the NBFC, it is getting a net advantage in terms of funding cost. Even if the pricing moves close to AAA ABS spreads, the NBFC stands to gain as the regulatory capital eaten up is only what is required for a AA-support.

The overall benefits for the system are immense. There is release of liquidity from the banking system to the economy. Depending on the type of pools Originators will be selling, there may be asset creation in form of home loans, or working capital loans (LAP loans may effectively be that), or loans for transport vehicles. If the GoI objective of buying pools upto Rs 100000 crores gets materialised, as much funding moves from banks to NBFCs, which is obviously already deployed in form of assets. The GoI makes an income of Rs 250 crores for effectively no risk.

In fact, if the GoI gains experience with the Scheme, there may be very good reason for lowering the rating threshold to A level, particularly in case of home loans.

Capital treatment, rating methodologies and other preparations

To make the Scheme really achieve its objectives, there are several preparations that may have to come soon enough:

  • Rating agencies have to develop methodologies for rating this bilateral pool transfer. Effectively, this is nothing but a structured pool transfer, akin to securitisation. Hence, rating methodologies used for securitisation may either be applied as they are, or tweaked to apply to the transfers under the Scheme.
  • Very importantly, the RBI may have to clarify that the AA risk retention by Originators under the Scheme will lead to regulatory capital requirement only upto the risk retained by the NBFC. This should be quite easy for the RBI to do – because there are guidelines for securitisation already, and the Scheme has all features of securitisation, minus the fact that there is no SPV or issuance of “securities” as such.

Conclusion

Whoever takes the first transaction to market will have to obviously do a lot of educating – PSBs, rating agencies, law firms, SIDBI, and of course, DFS. However, the exercise is worth it, and it may not take 6 months as envisaged for the GoI to reach the target of Rs 1 lakh crores.


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