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Highlights of SEBI’s temporary relaxations for Rights Issue

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Ambika Mehrotra & Ankit Vashishth

corplaw@vinodkothari.com

In line with various other relaxations introduced by the Securities and Exchange Board of India (‘SEBI’), amid the global pandemic, it has now come up with a Circular dated 21st April, 2020 [1]granting temporary relief under certain provisions of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR regulations’) in respect of Rights Issue. The rights issues opening on or before March 31, 2021 will get benefited from the said Circular.

It goes without saying that during the period of this of economical breakdown, the industrial undertakings are in need of funds for various purposes. In this hour of crisis, SEBI’s move seems to ease out the stringent requirements in the statues which hamper the facility of raising funds by companies especially through rights issue.

The amended provisions broadly serve the intent of having a relatively flexible eligibility criteria for a fast track rights issue and lesser chances of refund of the amount in case of non- receipt of subscription amount.

A snapshot of the relaxations and their impact is enlisted below: –

Eligibility conditions related to Fast Track Rights Issues

Relevant Regulation

 

 Pre- amendment Post-amendment Impact Analysis
99(a) the equity shares of the issuer have been listed on any stock exchange for a period of at least three years immediately preceding the reference date

 

 the equity shares of the issuer have been listed on any stock exchange for a period of at least eighteen months immediately preceding the reference date

 

 Relaxation in the pre-condition with respect to listing of equity shares from 3 years to 18 months.
99(c ) the average market capitalisation of public shareholding of the issuer is at least two hundred and fifty crore rupees

 

 the average market capitalisation of public shareholding of the issuer is at least one hundred crores

 

 Companies with smaller market size i.e. more Rs. 100 crore and above also permitted to enter into Fast Track Issue.
99(f) and its proviso the issuer has been in compliance with the equity listing agreement or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, for a period of at least three years immediately preceding the reference date:

 

Provided that if the issuer has not complied with the provisions of the listing agrîment or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, relating to composition of board of directors, for any quarter during the last three years immediately preceding the reference date, but is compliant with such provisions at the time of filing of letter of offer, and adequate disclosures are made in the letter of offer about such non-compliances during the three years immediately preceding the reference date, it shall be deemed as compliance with the condition;

 the issuer has been in compliance with the equity listing agreement or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, for a period of at least eighteen months immediately preceding the reference date:

 

Provided that if the issuer has not complied with the provisions of the listing agreement or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, relating to composition of board of directors, for any quarter during the last eighteen months immediately preceding the reference date, but is compliant with such provisions at the time of filing of letter of offer, and adequate disclosures are made in the letter of offer about such non-compliances during the three years immediately preceding the reference date, it shall be deemed as compliance with the condition;

 

 The timeline for being in compliance with listing regulations has been reduced from 3 years to 18 months.

 

This is in line with the requirement under Regulation 99(a) wrt listing of equity shares for a period of atleast 18 months instead of 3 years.
99(h) No show-cause notices have been issued or prosecution proceedings have been initiated by the SEBI and pending against the issuer or its promoters or whole-time directors as on the reference date. No show-cause notices, excluding under adjudication proceedings, have been issued by the SEBI and pending against the issuer or its promoters or whole-time directors as on the reference date.

 

In cases where against the issuer or its promoters/ directors/ group companies,

 

i.     a show cause notice(s) has been issued by the Board in an adjudication proceeding or

 

ii.   prosecution proceedings have been initiated by the Board;

necessary disclosures in respect of such action (s) along-with its potential adverse impact on the issuer shall be made in the letter of offer.

 Regulation 99(h) restricts the company to make fast track rights issue in case there had been any show-cause notices or prosecution proceedings issued/initiated against the company/ its promoters/ WTDs.

 

The temporary relaxation however allows the company to be eligible for rights issue to the extent where adjudication proceedings or prosecution proceedings in respect of the above as well as the group companies are concerned, on making the required disclosures in this regard and its adverse impact, in the letter of offer
99(i) the issuer or promoter or promoter group or director of the issuer has not settled any alleged violation of securities laws through the consent or settlement mechanism with the Board during three years immediately preceding the reference date;

 

 

 

 The issuer or promoter or promoter group or director of the issuer has fulfilled the settlement terms or adhered to directions of the settlement order(s) in cases where it has settled any alleged violation of securities laws through the consent or settlement mechanism with the Board. Prior to the relaxation, any violation in the securities laws by the issuer/ promoter/ promoter group/ director made the issuer ineligible. This however has now been relaxed to permit the issue in case the above violators, having violated the securities laws at anytime during the past have fulfilled the settlement terms or followed the directions under the settlement order(s)
99(j) The equity shares of the issuer have not been suspended from trading as a disciplinary measure during last 3 years immediately preceding the reference date. The equity shares of the issuer have not been suspended from trading as a disciplinary measure during last 18 months immediately preceding the reference date. In line with Regulation 99(a) and (f)
99(m) There are no audit qualifications on the audited accounts of the issuer in respect of those financial years for which such accounts are disclosed in the letter of offer For audit qualifications, if any, in respect of any of the financial years for which accounts are disclosed in the letter of offer, the issuer shall provide the restated financial statements adjusting for the impact of the audit qualifications.

 

Further, that for the qualifications wherein impact on the financials cannot be ascertained the same shall be disclosed appropriately in the letter of offer.

 Prior to the Circular, any qualification in the audit report led to ineligibility. This condition has now been re-framed to make the companies eligible on providing the restated financial statements adjusting for the impact of the audit qualifications or providing clarifications in case such impact cannot be ascertained

Relaxation with respect to Minimum Subscription:

Relevant Regulation

 

 Pre- amendment Post-amendment Remarks
86(1) The minimum subscription to be received in the issue shall be at least ninety per cent. of the offer through the offer document. The minimum subscription to be received in the issue shall be at least seventy five percent of the offer through the offer document.

 

Provided that if the issue is subscribed between 75% to 90%, issue will be considered successful subject to the condition that out of the funds raised atleast 75% of the issue size shall be utilized for the objects of the issue other than general corporate purpose.

 The minimum subscription amount has been reduced from 90% to 75%.

However, the Circular seems to put another restriction on the utilization of atleast 75% of the funds for the objects of the issue other than general corporate purpose if the actual subscription goes beyond 75% but within 90% of the offer.

Minimum threshold for not filing draft letter of offer

Relevant Regulation

 

 Pre- amendment Post-amendment Remarks
Applicability of the Regulations:

 

3(b)

 rights issue by a listed issuer; where the aggregate value of the issue is ten crore rupees or more;

 

 rights issue by a listed issuer; where the aggregate value of the issue is twenty-five crores or more;

 

 The conditions prescribed in Chapter III of ICDR Regulations shall not apply in case of Rights Issue carrying an issue size of less than Rs. 25 crores.
 

 

Proviso to Reg. 3

 Provided that in case of rights issue of size less than ten crore rupees, the issuer shall prepare the letter of offer in accordance with requirements as specified in these regulations and file the same with the Board for information and dissemination on the Board’s website. Provided that in case of rights issue of size less than twenty-five crore rupees, the issuer shall prepare the letter of offer in accordance with requirements as specified in these regulations and file the same with the Board for information and dissemination on the Board’s website. The change is made considering the revised limit of applicability of the Regulations for a rights issue.
 

 

 

 

60

 Unless otherwise provided in this Chapter, an issuer offering specified securities of aggregate value of ten crore rupees or more, through a rights issue shall satisfy the conditions of this Chapter Unless otherwise provided in this Chapter, an issuer offering specified securities of aggregate value twenty-five crore rupees or more, through a rights issue shall satisfy the conditions of this Chapter. The change is made considering the revised limit of applicability of the Regulations for a rights issue.

One-time Relaxation on opening of issue

In addition to the above Circular, SEBI has also issued another circular on the same date i.e. April 21, 2019[2] for granting one-time relaxation on the basis of the representations received from various stakeholders with respect to the opening of issue period within 12 months from the date of issuance of the observations by SEBI, for an Initial Public Offer (IPO), Further Public Offer (FPO) or Rights Issue as per Regulation 44, 140 and 85 respectively of the ICDR Regulations, expiring during this period of lockdown i.e. between March 1, 2020 and September 30, 2020 to be extended by 6 months, from the date of expiry of the above-mentioned observations received from SEBI.

However, the extension to this issue opening period shall be granted on obtaining an undertaking from lead manager of the issue confirming compliance with Schedule XVI of the ICDR Regulations with respect to the nature of changes in the offer document which require filing of updated offer document, while submitting the updated offer document to SEBI.

Conclusion

These temporary relaxations will surely bring in a sigh of relief for the stakeholders including the companies intending to raise funds through rights issue, during this interim period of disruption due the outbreak of COVID-19, considering the stagnancy of operations in the country.

Read our related articles below –

SEBI ICDR Regulations, 2018– Snapshot on changes in rights, bonus, QIP and preferential issue;

Key amendments in relation to Rights, Bonus, QIP and Preferential Issue under SEBI (ICDR) Regulations, 2018;

SEBI (ICDR) Regulations, 2018-Key Amendments;

Covid-19 – Incorporated Responses | Regulatory measures in view of COVID-19.

[1] https://www.sebi.gov.in/legal/circulars/apr-2020/relaxations-from-certain-provisions-of-the-sebi-issue-of-capital-and-disclosure-requirements-regulations-2018-in-respect-of-rights-issue_46537.html

[2] https://www.sebi.gov.in/legal/circulars/apr-2020/one-time-relaxation-with-respect-to-validity-of-sebi-observations_46536.html

COVID- 19 AND DEBENTURE RESTRUCTURING

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-Munmi Phukon, Pammy Jaiswal and Richa Saraf (corplaw@vinodkothari.com)

ICRA has published a report on 23.04.2020[1], listing out some 328 entities[2] who have availed or sought a payment relief from the lending institutions or investors. The list also includes names of such entities that have received an in-principle approval from investors in their market instruments (like non-convertible debentures)- prior to the original due date- for shifting the original due date ahead, but where a formal approval from the investors was received either after the original due date or is still pending to be received.

Earlier, Securities and Exchange Board of India (SEBI) had, vide circular no. SEBI/ HO/ MIRSD/ CRADT/ CIR/ P/ 2020/53 dated 30.03.2020[3], addressed to the credit rating agencies (CRAs), granted certain relaxation from compliance with certain provisions of the circulars issued under SEBI (Credit Rating Agencies) Regulations, 1999 due to the COVID-19 pandemic. The circular stipulated that appropriate disclosures in this regard shall be made in the press release, seemingly, the report published by ICRA is a part of the disclosure requirement specified by SEBI.

In view of the COVID crisis, companies in large numbers are approaching investors or will be approaching investors for restructuring of the debentures, therefore, it becomes pertinent to discuss- how the restructuring is carried on? whether a meeting of debenture holders will be required to be convened? what will be the consequences if the restructuring is not done? and other related questions. Below we discuss the same.

Force Majeure– An Excuse to Default?

In financial terms, “default” means failure to pay debts, whether principal or interest. Under ISDA Master Agreement[4], failure by the party to make, when due, any payment is listed as an event of default and one of the termination events. However, the ISDA Master Agreement provides that in case of a force majeure event, payments can be deferred. Most of the standard agreements, contain specific clauses pertaining to force majeure, where the party required to perform any contractual obligation is required to intimate the other party as soon as it becomes aware of happening of any force majeure event. While in some cases, due to impossibility of performance, the agreement itself is frustrated; in some other cases, the obligations are merely deferred till the event persists.

Our article “COVID- 19 and The Shut Down: The Impact of Force Majeure” can be accessed from the link: http://vinodkothari.com/2020/03/covid-19-and-the-shut-down-the-impact-of-force-majeure/

Consequences of default- Rights available to debenture holders:

A debenture holder has several options available in case of default: (a) insolvency proceedings; (b) enforcement of security interest; (c) proceedings for recovery of debt due. Below we discuss the same:

– Right to call for meeting of debenture holders: Rule 18 (4) of the Companies (Share Capital and Debentures) Rules, 2014 stipulates that the meeting of all the debenture holders shall be convened by the debenture trustee on:

  • requisition in writing signed by debenture holders holding at least 1/10th in value of the debentures for the time being outstanding; or
  • the happening of any event, which constitutes a breach, default or which in the opinion of the debenture trustees affects the interest of the debenture holders.

– Right to make an application before NCLT: Section 71(10) of the Companies Act, 2013 provides that on failure of the company to redeem the debentures on the date of their maturity or failure to pay interest on the debentures when it is due, an application may be filed by any or all of the debenture holders or debenture trustee, seeking redemption of the debentures forthwith on payment of principal and interest due thereon.

– Application under IBC: Section 5(7) of IBC defines a “financial creditor” to mean any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to, and Section 5(8) of IBC defines “financial debt” as a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument. Thus, debenture holders are treated as financial creditors for the purpose of IBC and may exercise all the rights as available to a financial creditor.

As per Section 6 of IBC-“Where any corporate debtor commits a default, a financial creditor, an operational creditor or the corporate debtor itself may initiate corporate insolvency resolution process in respect of such corporate debtor in the manner as provided under this Chapter”.  Accordingly, the debenture holders (whether secured or not) may apply for initiation of corporate insolvency resolution process against the company under Section 7 of IBC. In fact the Central Government has, vide notification no. S.O. 1091(E) dated 27th February, 2019, notified that such right may also be exercised by the debenture holder, through a debenture trustee.

– Right to enforce security interest: The right of foreclosure is a counter-part of right of redemption. Just like a company has a right of redeeming the security after payment of debt amount, a secured debenture holder has a right of foreclosure or sale in case of default in redemption. In the case of Baroda Rayon Corporation Limited vs. ICICI Limited[5] and in Canara Bank vs. Apple Finance Limited[6], Bombay High Court upheld the right of the debenture trustee to sell off the properties of the company for the benefit of the debenture holders.

Here, it is pertinent to understand how the debenture holders shall exercise the right of foreclosure. The law distinguishes between security interests based on the nature of the collateral. For instance, in case of security interests on immovable properties, Chapter IV of Transfer of Property Act, 1882 applies.  Further, the security interest, in case of secured debentures, can be enforced in the following manner: (a) In case the debenture holder is a bank/ financial institution, as per the provisions of Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002; and (b) In case the debenture holder is not a bank/ financial institution, as per the common law procedures.

– Other remedies: Any default in the terms of the debentures is a breach of contract, and the debenture holder may sue the company for breach of contract as per the provisions of Contract Act, 1872, and further seek for compensation as per the terms of the debenture, or in absence of specific term in the agreement, compensation may be claimed as per the provisions of Section 73 of the Contract Act, 1872.

Issues cropping up due to COVID- 19 and the resolution thereof:

In view of the COVID pandemic one of the issue that was arising was that the issuers of debt instruments who were not able to fulfil the obligations as per the terms of the debentures or redeem the same on the maturity date were running to courts for seeking interlocutory reliefs, seeking to restrain the debenture holders from exercising any rights against the defaulting issuer. In the case of Indiabulls Housing Finance Ltd. vs. SEBI[7], the petitioner prayed for an ad interim direction to restrain any coercive action against it, with respect to the repayment to be made by it to its non-convertible debenture holders. In the said case, granting the prayer, the Hon’ble Delhi High Court directed maintenance of status quo with respect to the repayments to be made by the petitioner to the NCD holders.

Further, there was a lack of clarity on how rating and valuation of a security would be revised in view of the default or the restructuring? Therefore, SEBI has issued the following circulars:

  • SEBI, vide a circular no. SEBI/ HO/ MIRSD/ CRADT/ CIR/ P/ 2020/53 dated March 30, 2020[8], granted certain relaxation from compliance with certain provisions of the circulars issued under SEBI (Credit Rating Agencies) Regulations, 1999 due to the COVID-19 pandemic.

With respect to recognition of default, the circular stipulates that CRAs recognize default  based  on  the guidance issued  vide  SEBI circular dated May 3, 2010[9] and November 1, 2016[10], however, based on its assessment, if the CRA is of the view that the delay  in  payment  of  interest/principle  has  arisen  solely  due  to  the  lockdown  conditions   creating   temporary   operational   challenges   in   servicing   debt, including due to procedural delays in approval of moratorium on loans by the  lending institutions, CRAs may not consider the same as a default event and/or  recognize default.

  • Further, SEBI has, vide its circular no. SEBI/HO/IMD/DF3/CIR/P/2020/70 dated 23.04.2020[11], reviewed certain provisions of  the  circular  dated  09.2019[12] issued under  SEBI  (Mutual  Funds)  Regulations,  1996. In the circular, SEBI has stipulated that based  on  assessment,  if  the valuation  agencies appointed  by Association of Mutual Funds in India are of the view that the delay in payment of interest/principal or extension of  maturity of  a  security  by  the  issuer has  arisen  solely  due  to  COVID-19 pandemic  lockdown  creating   temporary   operational   challenges   in   servicing   debt, then valuation  agencies may  not  consider  the  same as  a  default for the  purpose of valuation of money market or debt securities held by mutual funds.

Restructuring Process and the Formalities associated thereto:

In the context of COVID, the restructuring of debentures shall mean nothing but deferral of the date of redemption. The terms of the debentures, including the maturity date, etc is specified in the terms of issuance. The terms of issuance also provides how the variation in terms can be effectuated. Therefore, it is pertinent that to make any changes in terms of debentures, the relevant clauses in the issuance terms are considered.

In terms of Reg. 59 (2) of the SEBI LODR Regulations, 2015, any material modification to the structure of debentures in terms of coupon redemption etc. are required to approved by the Board of Directors and the debenture trustee (DT). Further, in terms of Reg. 59(1), prior approval of the stock exchange(s) shall also be required for such material modification which shall be given by the stock exchange(s) only after obtaining the approval of the Board and the DT.

In addition to the approval as aforesaid, in terms of Regulation 15(2)(b) of SEBI DT Regulations, DT is required to call a meeting of the debenture holders on happening of any event which in the opinion of the DT affects the interest of the holders. Similar provision is there in the Companies (Share Capital and Debenture) Rules, 2014 also [sub- rule (4) of Rule 18].

Unlike the requirements of obtaining shareholders’ consent by way of special/ ordinary resolution for various matters including variation of rights thereof, there is no explicit provision  for obtaining of a consent of the debenture holders for restructuring of the debentures under the Companies Act, 2013 (‘CA 13’). However, the provisions of SS 2 being, mutatis mutandis, applicable to a meeting of debenture holders also, all the provisions w.r.t convening/ conducting of general meeting such as, sending of notice, explanatory statement etc. as applicable to general meetings shall apply to the meeting of debenture holders.

However, looking at the current crisis situation, where calling of a physical meeting is not possible, and issuers will be required to hold the meeting of the debenture holders, in case consent by e-mail is not possible due to the large number of debenture holders, through video conferencing mode. The modalities for participation (like voting, two-way communication, recording, etc.) and other compliances related of sending of notices etc. may be in the manner clarified by the MCA Circular dated 13.04.2020[13].

In a nutshell, the procedural requirements to be followed for restructuring of debentures shall be as provided hereunder.

S. No

 

 Relevant Provisions Actionable/ Compliance Remarks
1. Regulation 50 (3) of LODR Regulations Prior intimation to the stock exchange (SE) for the meeting board of directors, at which the restructuring is proposed to be considered.

 

 2 working days in before the board meeting.

 

(excl. date of intimation and date of meeting)
2. Sec. 173 of CA 13 BM to be convened by the Company for proposed restructuring including the revised terms subject to approval of the stock exchanges and the debenture holders.

 

 Through VC considering the COVID 19 Guidelines issued by the Govt. Our FAQs in this regard may be found at : https://www.google.com/url?q=http://vinodkothari.com/2020/03/board-meetings-during-shutdown/&sa=D&source=hangouts&ust=1587820272757000&usg=AFQjCNEictCwK_-LNnlH7oiB1GMmdRzO6w

 
3. Regulation 59(2)(a) of LODR Regulations

 

 Obtain approval of the DT Before applying to SEs.
4. Regulation 59 of the Listing Regulations Seek prior approval from the stock exchange

 

 After taking the consent of the board of directors and DT.

 
5. Regulation 15(2) of DT Regulations, 1993 Separate meeting of debenture holders to be called for deferment in repayment due to liquidity crunch in the hour of crisis.

 

 The meeting may be called by the company itself or through the DT.

Since the scope of SS 2 issued by ICSI includes meetings of debenture holders also, the company will have to observe the requirements of SS 2 in convening the meeting of debenture holders. However, considering the current crisis situation, such meeting may be convened through VC facility as clarified by MCA Circular dated 13th April, 2020. Our FAQs in this regard may be found at http://vinodkothari.com/2020/04/general-meetings-by-video-conferencing-recognising-the-inevitable/

 
6. Regulation 51 (2) of the Listing Regulations Intimation to the stock exchanges being an action that shall affect payment of interest or redemption of NCDs

 

 

 ASAP but not later than 24 hours of Board decision.

 Documentation Requirements:

In usual circumstances, if any variation is carried out in the debenture terms, the parties enter into an addendum, amending the clauses contained in the debenture subscription agreement (and also, in the trust deed/ security documents, if required), however, given the current scenario and the lock down, it is not possible for parties to sign and execute the agreements. Since the restructuring already has the approval of the majority debenture holders, it is deemed that the resolution “overrides the terms of issuance”. Thus, in our view, the resolution passed by the debenture holders approving the restructuring should suffice, and modification in the agreements may not be required.

[1] https://www.icra.in/Rationale/ShowRationaleReport/?Id=94320

[2] The rating agency has stated that the list is not a comprehensive one, as information about some rated entities are not readily available as of now, and separate disclosures will be made w.r.t. such entities.

[3]https://www.sebi.gov.in/legal/circulars/mar-2020/relaxation-from-compliance-with-certain-provisions-of-the-circulars-issued-under-sebi-credit-rating-agencies-regulations-1999-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi-_46449.html

[4] https://www.sec.gov/Archives/edgar/data/1065696/000119312511118050/dex101.html

[5] 2002 (2) BomCR 608, (2002) 2 BOMLR 915, 2003 113 CompCas 466 Bom, 2002 (2) MhLj 322

[6] AIR 2008 Bom 16, (2007) 77 SCL 92 Bom

[7]https://images.assettype.com/barandbench/2020-04/6ec54849-0188-4fe3-a841-88c2861124d5/Indiabulls_vs_SEBI.pdf

[8]https://www.sebi.gov.in/legal/circulars/mar-2020/relaxation-from-compliance-with-certain-provisions-of-the-circulars-issued-under-sebi-credit-rating-agencies-regulations-1999-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi-_46449.html

[9] https://www.sebi.gov.in/legal/circulars/may-2010/guidelines-for-credit-rating-agencies_1467.html

[10]https://www.sebi.gov.in/legal/circulars/nov-2016/enhanced-standards-for-credit-rating-agencies-cras-_33585.html

[11]https://www.sebi.gov.in/legal/circulars/apr-2020/review-of-provisions-of-the-circular-dated-september-24-2019-issued-under-sebi-mutual-funds-regulations-1996-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi_46549.html

[12] https://www.sebi.gov.in/legal/circulars/sep-2019/valuation-of-money-market-and-debt-securities_44383.html

[13] http://www.mca.gov.in/Ministry/pdf/Circular17_13042020.pdf

 

Please click below for youtube presentation on the above topic:

 

Our other content related to COVID-19 disruption may be referred here: http://vinodkothari.com/covid-19-incorporated-responses/

Our other articles relating to restructuring on account of COVID-19 disruption may also be viewed here:

Consensual restructuring of debt obligations, due to COVID disruption, not to be taken as default, clarifies SEBI

Restructuring of debt securities not to be treated as default, clarifies SEBI

Our presentation can be viewed here – https://vinodkothari.com/2021/09/structuring-of-debt-instruments/

Loan products for tough times

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-Vinod Kothari (vinod@vinodkothari.com)

Economic recoveries in the past have always happened by increasing the supply of credit for productive activities. This is a lesson that one may learn from a history of past recessions and crises, and the efforts made by policymakers towards recovery. [See Appendix]

The above proposition becomes more emphatic where the disruption is not merely economic – it is widespread and has affected common life, as well as working of firms and entities. There will be major effort, expense and investment required for restarting economic activity. Does moratorium merely help?  Moratorium possibly helps avoiding defaults and insolvencies, but does not help in giving the push to economic activity which is badly needed. Entities will need infusion of additional finance at this stage.

The usual way governments and policy-makers do this is by releasing liquidity in the banking system. However, there are situations where the banking system fails to be an efficient transmission device for release of credit, for reasons such as stress of bad loans in the banking system, lack of efficient decision-making, etc.

In such situations, governments and central banks may have to do direct intervention in the market. Governments and central banks don’t do lending – however, they create institutions which promote lending by either banks or quasi-banks. This may be done in two ways – one, by infusion of money directly, and two, by ways of sovereign guarantee, so as to do credit risk transfer to the sovereign. The former method has the limit of availability of resources – governments have budgetary limitations, and increased public debt may turn counter-productive in the long-run. However, credit risk transfer can be an excellent device. Credit risk transfer also seems to be creating, synthetically, the same exposure as in case of direct lending by the sovereign; however, there are major differences. First, the sovereign does not have to go for immediate borrowings. Second and more important, the perceived risk transfer, where credit risk is shifted to the sovereign, may not actually hit in terms of credit losses, if the recovery efforts by way of the credit infusion actually bear fruit.

The write-up below suggests a product that may be supported by the sovereign in form of partial credit risk guarantee.

Genesis of the loan product

For the sake of convenience, let us call this product a “wrap loan”. Wrap-around mortgage loans is a practice prevalent in the US mortgage market, but our “wrap loan” is different. It is a form of top-up loan, which does not disturb the existing loan terms or EMI, and simply wraps the existing loan into a larger loan amount.

Let us assume the following example of, say, a loan against a truck or a similar asset:

Original Loan amount 1000000
Rate of interest 12%
Tenure 60 Months
EMIs ₹ 22,244.45
Number of months the loan has already run 24 Months
Number of remaining months of original loan term 36 Months
Principal outstanding (POS) on the date of wrap loan ₹ 6,69,724.82

For the sake of convenience, we have not considered any moratorium on the loan[1]. The customer has been more or less regular in making payments. As on date, he has paid 24 EMIs, and is left with 36. Now, to counter the impact of the disruption, the lender considers an additional loan of Rs 50000/-. Surely, for assessing the size of the wrapper loan, the lender will have to consider several things – the LTV ratio based on the increased exposure and the present depreciated value of the asset, the financial needs of the borrowers to restart his business, etc.

With the additional infusion of Rs 50000, the outstanding exposure now becomes Rs 719725/-. We assume that the lender targets a slightly higher interest for the wrapper part of the loan of Rs 50000, say 14%. The justification for the higher interest can be that this component is unsecured. However, we do not want the existing EMI, viz., Rs 22244/- to be changed. That is important, because if the EMIs were to go up, there will be increasing pressure on the revenues of the borrower, and the whole purpose of the wrap loan will be frustrated.

Therefore, we now work the increased loan tenure, keeping the EMIs the same, for recovering the increased principal exposure. The revised position is as follows:

POS on the date of wrap loan ₹ 6,69,724.82
Additional loan amount 50000
Interest on the additional loan 14%
Blended interest rate 12.139%
Revised loan tenure 39.39 months
total maturity in months (rounded up) 40 months
Number of whole months                        39 months
Fractional payment for the last month ₹ 8,664.67

Note that the blended rate is the weighted average, with interest at the originally-agreed rate of 12% on the existing POS, and 14% on the additional amount of lending. The revised tenure comes to 39.39 months, or 40 months. There will be full payment for 39 months, and a fractional payment in the last month.

Thus, by continuing his payment obligation for 3-4 more months, the borrower can get Rs. 50000/- cash, which he can use to restart his business operations.

The multiplier impact that this additional infusion of cash may have in his business may be substantial.

Partial Sovereign Guarantee for the Wrapper Loan

Now, we bring the key element of the structure. The lender, say a bank or NBFC, will generally be reluctant to take the additional exposure of Rs 50000, though on a performing loan. However, this may be encourage by the sovereign by giving a guarantee for the add-on loan.

The guarantee may come with minimal actual risk exposure to the sovereign, if the structure is devised as follows:

  • The sovereign’s portion of the total loan exposure, Rs 719725, is only Rs 50000, which is less than 10%. A safe limit of 10% of the size of the existing exposure may be kept, so that lenders do not aggressively push top-up loans.
  • Now, the sovereign’s portion, which is only Rs 50000/- (and in any case, limited to 10%), may either be a pari-passu share in the total loan, or may be structured as a senior share.
  • If it is a pari-passu share, the question of the liability for losses actually coming to the sovereign will arise at the same time as the lender. However, if the share of the sovereign is a senior share, then the sovereign will get to share losses only if the recoveries from the loan are less than Rs 50000.

The whole structure may be made more practical by moving from a single loan to a pool of loans. The sovereign guarantee may be extended to a pool of similar loans, with a prescription of a minimum number, maximum concentration per loan, and other diversity parameters. The moment we move from a single loan to a pool of loans, the sharing of losses between the sovereign and the originator will now be on a pool-wide basis. Even if the originator takes a first loss share of, say, 10%, and the sovereign’s share comes thereafter, the chances of the guarantee hitting the sovereign will be very remote.

And of course, the sovereign may also charge a reasonable guarantee fee for the mezzanine guarantee.

Since the wrapper loan is guaranteed by the sovereign, the lender may hope to get risk weight appropriate for a sovereign risk. Additional incentives may be given to make this lending more efficient.

Appendix

Economic recovery from a crisis and the role of increased credit supply: Some global experiences

  1. Measures by FRB during following the Global Financial Crisis:

‘The first set of tools, which are closely tied to the central bank’s traditional role as the lender of last resort, involve the provision of short-term liquidity to banks and other depository institutions and other financial institutions. A second set of tools involved the provision of liquidity directly to borrowers and investors in key credit markets. As a third set of instruments, the Federal Reserve expanded its traditional tool of open market operations to support the functioning of credit markets, put downward pressure on longer-term interest rates, and help to make broader financial conditions more accommodative through the purchase of longer-term securities for the Federal Reserve’s portfolio.’[2]

  1. Liquidity shocks may cause reverse disruption in the financial chain:

‘During a financial crisis, such “liquidity shock chains” can operate in reverse. Firms that face tightening financing constraints as a result of bank credit contraction may withdraw credit from their customers. Thus, they pass the liquidity shock up the supply chain; that is, their customers might cut the credit to their customers, and so on…..Thus, the supply chains might propagate the liquidity shocks and exacerbate the impact of the financial crisis.’[3]

  1. Measures taken during Global Financial Crisis – US Fed publication – From Credit Crunches to Financial Crises:

Therefore, many of the policy remedies proposed to alleviate credit crunches were, in fact, used during the early stages of the 2008 financial crisis to mitigate potential credit availability problems. These remedies included capital infusions into troubled banks, the provision of liquidity facilities by the Federal Reserve, and, in the initial stress test, a primary focus on raising bank capital rather than allowing banks to shrink assets to maintain, or regain, required capital ratios.[4]

  1. Observations of Banca Italia on the 2008 Crisis

‘First, the effect of credit supply on value added is not detectable in the years before the great recession, indicating that credit supply is more relevant during an economic downturn. Second, the reduction in credit supply also explains the decline in employment even if the estimated effect is lower than that on value added. As a result, we can also detect a significant impact on labor productivity, while there is no effect on exports and on firm demographics. Third, the role of credit supply does vary across firms’ size, economic sectors, degree of financial dependence and, consequently, across geographical areas. Specifically, the impact is concentrated among small firms and among those operating in the manufacturing and service sectors. The impact is also stronger in the provinces that depend more heavily on external finance’[5]

 

[1] In fact, the wrap loan could have been an effective alternative to the moratorium

[2] https://www.federalreserve.gov/monetarypolicy/bst_crisisresponse.htm

[3] http://siteresources.worldbank.org/INTRANETTRADE/Resources/TradeFinancech01.pdf

[4] https://www.bostonfed.org/-/media/Documents/Workingpapers/PDF/economic/cpp1505.pdf

[5] https://www.bancaditalia.it/pubblicazioni/temi-discussione/2016/2016-1057/en_tema_1057.pdf

 

Our other content relating to COVID-19 disruption may be referred here: http://vinodkothari.com/covid-19-incorporated-responses/

Our FAQs on moratorium may be referred here: http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

The Rise of Stablecoins amidst Instability

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-Megha Mittal

(mittal@vinodkothari.com) 

The past few years have witnessed an array of technological developments and innovations, especially in Fintech; and while the world focused on Bitcoins and other cryptos, a new entrant ‘Stablecoin’ slowly crept its way into the limelight. With the primary motive of shielding its users from the high volatility associated with cryptos, and promises of boosting cross-border payments and remittance, ‘Stablecoins’ emerged in 2018, and now have become the focal point of discussion of several international bodies including the Financial Standards Board (FSB), G20, Financial Action Task Force (FATF) and International Organization of Securities Commission (IOSCO).

Additionally, the widespread notion that the desperate need of cross-border payments and remittances during the ongoing COVID-crisis may prove to be a defining moment for stablecoins, has drawn all the more attention towards the need of establishing regulations and legal framework pertaining to Stablecoins.

In this article, we shall have an insight as to what Stablecoins, (Global Stable Coinss) are, its modality, its current status of acceptance by the international bodies, and how the ongoing COVID crisis, may act as a catalyst for its rise.

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MCA extends timeline for companies following calendar year

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– by Megha Saraf

megha@vinodkothari.com

Updated as on 24th April, 2020

While currently the world is suffering due to the pandemic COVID-19, our regulatory authorities have been continuously providing reliefs/ relaxations to all corporate houses from making various compliances required under the statutory laws. While some of the major relaxations such as conducting extraordinary general meeting of shareholders through VC, making contribution to PM-CARES Fund as a notified CSR expenditure or making compliances under Listing Regulations have already been notified, MCA has come up with yet another Circular[1] granting relaxation from holding AGMs to such companies that follows calendar year as their financial year.

Can there be a different financial year apart from April-March?

Section 2(41) of the Companies Act, 2013 (“Act, 2013”) lays down the definition of “financial year” as, “in relation to any company or body corporate, means the period ending on the 31st day of March every year, and where it has been incorporated on or after the 1st day of January of a year, the period ending on the 31st day of March of the following year, in respect whereof financial statement of the company or body corporate is made up:

Provided that where a company or body corporate, which is a holding company or a subsidiary or associate company of a company incorporated outside India and is required to follow a different financial year for consolidation of its accounts outside India, the Central Government may, on an application made by that company or body corporate in such form and manner as may be prescribed, allow any period as its financial year, whether or not that period is a year:”

XX

There are corporate groups where the structure of shareholding is such, that the holding company is situated outside India and is having Indian subsidiaries. The provisions of law provide that where the relationship between the group is such, that it requires the Indian company to follow a different financial year for the purpose of consolidation of its accounts with the accounts of the company situated outside India, such Indian company can have a different financial year. However, such company needs to apply to the Tribunal for the same.

What is the timeline for holding AGMs?

Section 96 of the Act, 2013 provides that a company is required to hold an AGM within 6 months from the date of closing of the financial year. However, a newly incorporated company can have its first AGM within 9 months of the closure of the financial year.

Are there such companies following a different financial year?

Source[2]: Business Standard: 226 firms to march to a new accounting year

Yes. As per the above graph, there are nearly 226 companies in India that follow a different financial year. Out of the 226 companies, 74 are such companies whose calendar year is the financial year i.e. January- December.

What is the relaxation?

Currently, only companies that follows calendar year as financial year have been granted a 3-months relaxation from holding their AGMs i.e. such companies are allowed to hold their AGMs till 30th September, 2020 instead of June, 2020. Further, the due dates of all other related compliances such as filing of annual returns or financial statements which are required to be done within 60 days/ 30 days as applicable shall be construed accordingly.

What if the company is a listed entity?

Regulation 44(5) of the SEBI (LODR) Regulations, 2015 provides that where the listed entity is within top 100 listed entities based on market capitalization, they have to hold their AGM within 5 months from the closure of the financial year i.e. by August 31, 2020. However, considering the present situation and the need for social distancing, conducting AGMs within such time was becoming a challenge for large corporates. Keeping this in mind, SEBI has granted relief to such entities by extending the requirement by 1 month i.e. till September 30, 2020. However, there was no clarity on what if such entity is a listed entity and follows calendar year as their financial year and is among the top 100 listed entities.

SEBI has now also clarified the same vide its Circular[3] dated 23rd April, 2020 and the present timeline may be summarized as follows:

Sl. No. Type of company Time line under the Companies Act, 2013 Time line under the  SEBI (LODR) Regulations, 2015 Extended timeline
1 Listed company following Apr- Mar as F.Y. Within 6 months from end of FY i.e. 30th September, 2020 Does not provide No extension
2 Listed company following Jan-Dec as F.Y. Within 6 months from end of FY i.e. till 30th June, 2020 Does not provide Extended by 3 months i.e. till 30th September, 2020
3 Listed company following Apr- Mar as F.Y. and amongst top 100 listed entities General provision- Within 6 months from end of FY i.e. 30th September, 2020 Within 5 months from end of FY i.e. till 31st August, 2020 Extended by 1 month i.e. till 30th September, 2020
4 Listed company following Jan- Dec as F.Y. and amongst top 100 listed entities General provision- Within 6 months from end of FY i.e. 30th September, 2020 Within 5 months from end of FY i.e. till 31st May, 2020 Extended till 30th September, 2020 under both laws

 

Therefore, all types of companies can conduct their AGMs till 30th September, 2020.

Our other articles on related subject may be found here.

[1] http://www.mca.gov.in/Ministry/pdf/Circular18_21042020.pdf

[2] https://www.business-standard.com/article/companies/226-firms-to-march-to-a-new-accounting-year-113100300666_1.html

[3] https://www.sebi.gov.in/legal/circulars/apr-2020/relaxation-in-relation-to-regulation-44-5-of-the-sebi-listing-obligations-and-disclosure-requirements-regulations-2015-lodr-on-holding-of-annual-general-meeting-agm-by-top-100-listed-entitie-_46552.html

COVID and Insolvency Reforms – Trends and Expectations

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An entity/individual is amenable to committing a default during the disaster period. Therefore, in such difficult times, it becomes important to save businesses, which can later save the economy. The Indian Government and the judiciary have undertaken several intermittent measures with respect to insolvency regime.

As the authorities try to provide all possible relief amidst the ongoing crisis, what we need is probably a holistic mitigation framework to deal with all possible problem areas – as we can see for other countries as well. Countries across the globe have promulgated relaxations under their respective insolvency laws, both personal and corporate. In general, the insolvency and winding up proceedings have the same trigger event, which is default. A cursory reading of the amendments/propositions with respect to insolvency laws across countries would indicate a certain level of commonness in the measures, e.g.  there is a moratorium on presumption/determination of default, increase in the minimum limit of default, etc.

An important thing to note is that the relaxations do not extend to entities which had been in default before the event of disaster – that is, a disaster cannot be an excuse to cover a default which did not happen because of the disaster. Therefore, a pre-existing default is not saved from the COVID mitigation laws. Country-wise study of reforms with respect to insolvency laws are in the detailed article below.

In view of the worldwide reforms and the imminent necessity, we are of the view that certain basic amendments in law can help, for instance, the definition of ‘default’ under s. 3(12) may be amended as to exclude default occurring during the disaster period. Alternatively, a proviso can be inserted under s. 4(1) and s. 78 to provide that a default occurring during such period as the Central Government may, by notification, specify, being period associated with a national disaster, shall not be treated as a default for the purpose of the said sections. “Disaster” shall have the meaning as ascribed thereto in section 2 (d) of the Disaster Management Act, 2005.

Incidental amendments may also be necessary in the SARFAESI Act. The definition of default under s. 2(1)(j) of the said Act can be defined so as to provide that a default occurring during such period as the Central Government may, by notification, specify, being period associated with a national disaster, shall not be treated as a default for the purposes the above clause.

The aspects as above have been discussed in detail in the article below.

The Great Lockdown: Standstill on asset classification

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– RBI Governor’s Statement settles an unwarranted confusion

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Background

In the wake of the disruption caused by the global pandemic, now pitted against the Great Depression of 1930s and hence called The Great Lockdown[1], several countries have taken measures to try and provide stimulus packages to mitigate the impact of COVID-19[2]. Several countries, including India, provided or permitted financial institutions to grant ‘moratorium’, ‘loan modification’ or ‘forbearance’ on scheduled payments of their loan obligations being impacted by the financial hardship caused by the pandemic.

The RBI had announced the COVID-19 Regulatory Package[3] on 27th March, 2020. This package permitted banks and other financial institutions to grant moratorium up to 3 months beginning from 1st March, 2020. We have covered this elaborately in form of FAQs.[4]

However, there was ambiguity on the ageing provisions during the period of moratorium. That is to say,  if an account had a default on 29th February, 2020, whether the said account would continue to age in terms of days past due (DPD) as being in default even during the period of moratorium. Our view was strongly that a moratorium on current payment obligation, while at the same time expecting the borrower to continue to service past obligations, was completely illogical. Such a view also came from a judicial proceeding in the case of Anant Raj Limited Vs. Yes Bank Limited dated April 6, 2020[5]

However, the RBI seems to have had a view, stated in a mail addressed to the IBA,  that the moratorium did not affect past obligations of the customer. Hence, if the account was in default as on 1st March, the DPD will continue to increase if the payments are not cleared during the moratorium period.

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Would the doses of TLTRO really nurse the financial sector?

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-Kanakprabha Jethani | Executive

Vinod Kothari Consultants P. Ltd

(kanak@vinodkothari.com)

Background

In response to the liquidity crisis caused by the covid-19 pandemic, the Reserve Bank of India (RBI) through a Press Release Dated April 03, 2020[1] announced its third Targeted Long Term Repo Operation (TLTRO). This issue is a part of a plan of the RBI to inject funds of Rs. 1 lakh crores in the Indian economy. Under the said plan, two tranches of LTROs of Rs. 25 thousand crores each have already been undertaken in the months of February[2] and March[3] respectively. This move is expected to restore liquidity in the financial market, that too at relatively cheaper rates.

The following write-up intends to provide an understanding of what TLTRO is, how it is supposed to enhance liquidity and provide relief, who can derive benefits out of it and what will be its impact. This article further views TLTROs from NBFCs’ glasses to see if they, being financial institutions, which more outreach than banks, avail benefit from this operation.

Meaning

LTRO is basically a tool to provide funds to banks. The funds can be obtained for a tenure ranging from 1 year to 3 years, at an interest rate equal to one day repo. Government securities with matching or higher tenure, would serve as a collateral. Usually, the interest rate of one day repo is lower than that of other short term loans. Thus, banks can avail cheaper finance from the RBI.

Banks will have to invest the amount borrowed under TLTROs in fresh acquisition of securities from primary or secondary market (Specified Securities) and the same shall not be used with respect to existing investments of the bank.

In the current LTRO, the RBI has directed that atleast 50% of the funds availed by the bank have to be invested in investment grade corporate bonds, commercial papers and debentures in the secondary market and not more than 50% in the primary market.

Why were the existing measures not enough?

Ever since the IL&FS crisis broke the liquidity supply chain in the economy, the RBI has been consistently putting efforts to bring back the liquidity in the financial system. For almost a year, the RBI kept cutting the repo rate, hoping the cut in repo rates increases banks’ lending power and at the same time reduces the interest rate charged by them from the customers. Despite huge cuts in repo rates, the desired results were not visible because the cut in repo rates enhanced banks’ coincide power by a nominal amount only.

Another reason for failure of repo rate cuts, as a strategy to reduce lending rates, was that repo rate is one of the factors determining the lending rate. However, it is not all. Reduction in repo rates did affect the lending rate, but the effect was overpowered by other factors (such as increased cost of funds from third party sources) and thus, the banks’ lending rates did not reduce actually.

Further, various facilities have been introduced by the RBI to enhance liquidity in the system through Liquidity Adjustment Facility (LAF) which includes repo agreements, reverse repo agreements, Marginal Standing Facility (MSF), term repos etc.

  • Under LAF, banks can either avail funds (through a repurchase agreement, overnight or term repos) or extend loans to the RBI (through reverse repo agreements). Other than providing funds in the time of need, it also allows the banks to safe-keep excess funds with the RBI for short term and earn interest on the same.
  • Under MSF (which is a new window under LAF), banks are allowed to draw overnight funds from the RBI against collateral in the form of government securities. The rate is usually 100 bps above the repo rate. The amount of borrowing is limited to 1% of Net demand and Term Liabilities (NDTL).
  • In case of term repos, funds can be availed for 1 to 13 days, at a variable rate, which is usually higher than the repo rate. Further, the funds that can be withdrawn under such facility shall be limited to 0.75% of NDTL of the bank.

Although these measures do introduce liquidity to the financial system, they do not provide banks with ‘durable liquidity’ to provide a seamless asset-liability match, based on maturity. On the other hand, having funds in hand for a year to 3 years definitely is a measure to make the maturity based assets and liabilities agree. Thus, giving banks the confidence to lend further to the market.

Bits and pieces to be taken care of

The TLTRO transactions shall be undertaken in line with the operating guidelines issued by the RBI through a circular on Long Term Repo Operations (LTROs)[4]. A few points to be taken care of are as follows:

  • The RBI conducts auctions (through e-Kuber platform) for extending such facility. Banks have to bid for obtaining funds from such facility. The minimum bid is to be of Rs. 1 crore and the allotment shall be in multiples of Rs. 1 crore.
  • The investment in Specified Securities is to be mandatorily made within 30 days of availment of funds. In case the bank fails to deploy funds availed under TLTRO within 30 days, an incremental interest of repo rate plus 200 basis points shall be chargeable, in addition to normal interest, for the period the funds remain un-deployed.
  • The banks will have to maintain the amount of specified securities in its Hold-to-Maturity (HTM) portfolio till the maturity of TLTRO i.e. such securities cannot be sold by banks until the term of TLTRO expires. Further, in case bank intends to hold the Specified Securities after the term of TLTRO expires, the same shall be allowed to be held in banks’ HTM portfolio.

Impact

The TLTRO operation of the RBI is expected to bring about a relief to the financial sector. The LTRO auctions conducted recently received bids amounting to several times the auction amount. Thus, a clear case of extreme demand for funds by banks can be seen. Although, the recent auctions are yet to reap their fruits, the major benefits that may arise from this operation are as follows:

  • The liquidity in the banking system will get increased. Resultantly, the banks’ lending power would increase. Thus, injecting liquidity into the entire economy.
  • Since, the marginal cost of funds of the banks will be based on one-day repo transactions’ rate, the same shall be lower as compared to other funding options of similar maturity. A reduced cost of funds for the banks will compel banks to lend at lower rates. Thus, making the short-term lending cheaper.

The picture from NBFCs’ glasses

Barely out of the IL&FS storm, the shadow bankers had not even adjusted their sails and were hit by another crisis caused by the covid-19 disruption. While the RBI is introducing measures for these lenders to cope with the crisis such as moratorium on repayment instalments[5], stay on asset reclassification based on the moratorium provided etc. The liquidity concerns of NBFCs remain untouched by these measures.

Word has it, the TLTRO is expected to restore liquidity in the financial system. Only banks can bid under LTRO auctions and avail funds from the RBI. This being said, let us look at how an NBFC would fetch liquidity from this.

Banks would use the funds availed under TLTRO transactions to invest in Specified Securities of various entities. Let us assume a bank avails funds of Rs. 1 crore under LTRO. Out of the funds availed, the bank decides to invest 50% in Specified Securities of companies in non-financial sector and 50% in entities in financial sector. Assuming that the entire 50% portion is invested in Specified Securities of 20 NBFCs equally. Each NBFC gets 2.5% of the funding availed by the Bank.

In the primary market

For the purchase of Specified Securities through primary market, the question of prime importance is whether it is feasible for an NBFC to come up with a fresh issue in the current scenario of lockdown. It is not feasible for an NBFC to plan an issue, obtain a credit rating, and get done with all other formalities within a period of 30 days. Thus, the option of fresh issue would generally be ruled out. Primary issues in pipeline may get banks as their investors. However, existence of such issues in pipeline are very low at present.

If an NBFC decides to go for private placement and gets it done within a span of say around a week, it can succeed in getting fresh liquidity for its operations. However, looking at the bigger picture, the restriction of investing only in investment grade securities bars the banks from investing in NBFCs which have lower rating i.e. usually the smaller NBFCs (more in number though). So the benefit of the scheme gets limited to a small number of NBFCs only. Thus, the motive of making liquidity reach the masses gets squashed.

In the secondary market

Above was just a hypothetical example to demonstrate that only a fraction of funds given out under LTRO would actually be used to bring back liquidity to the stagnant NBFC sector. It is important to note here that the liquidity is being brought back through purchase of securities from the secondary market, which does not result in introduction of any additional money to the NBFCs for their operations.

The liquidity enhancement in secondary market would also be limited to Specified Securities of investment grade. Thus, as already discussed, only the bigger size NBFCs would get the benefit of liquidity restoration.

Conclusion

The TLTRO is a measure introduced by the RBI to enhance liquidity in the system. Although it provides banks with liquidity, the restrictions on the use of availed funds bar the banks to further pass on the liquidity benefit. As for NBFCs, the benefit is limited to making the securities of the NBFCs liquid and the introduction of fresh liquidity to the NBFC is likely to be minimal.

Further, the benefit is also likely to be limited to bigger NBFCs, destroying the motive of making liquidity reach to the masses. A few enhancements to the existing LTRO scheme, such as directing the banks to ensure that the investment is not concentrated in a few destinations or prescribing concentration norms might result in expanding liquidity reach to some extent and would create a chain of supply of funds that would reach the masses through the outreach of such financial institutions.

News Update:

The RBI Governor in his statement on April 17, 2020[6], addressed the problem of narrow outreach of liquidity injected through TLTRO and announced that the upcoming TLTRO (TLTRO 2.0) would come with a specification that the proceeds are to be invested in investment grade bonds, commercial paper, and non-convertible debentures of NBFCs only, with at least 50 per cent of the total amount availed going to small and mid-sized NBFCs and MFIs. This is likely to ensure that a major portion of the investments go to the small and mid-sized NBFCs, thus expanding the liquidity outreach.

 

[1] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49628

[2] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49360

[3] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49583

[4] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49360

[5] Our detailed FAQs on moratorium on loans due to Covid-19 disruption may be referred here: http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

[6] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/GOVERNORSTATEMENTF22E618703AE48A4B2F6EC4A8003F88D.PDF

 

Our write-up on stay on asset classification due to covid-19 may be referred here: http://vinodkothari.com/2020/04/the-great-lockdown-standstill-on-asset-classification/

Our other write-ups on NBFCs may be referred here: http://vinodkothari.com/nbfcs/

Relaxation i.r.o investor related services due to COVID-19

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corplaw@vinodkothari.com

Below is a brief snippet of the relaxations provided by SEBI in the wake of the COVID-19 outbreak.

Click here for the Circular dated 13th April, 2020.

Corporate meetings during COVID-19 disruption version 2- Presentation and Webinar

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