Maintenance of security cover for secured debt made transparent by SEBI

Debenture trustees responsible for monitoring the security cover and covenants effective October 1, 2022

– Vinita Nair, Senior Partner | corplaw@vinodkothari.com

Background

Securities and Exchange Board of India (‘SEBI’) is carrying out radical changes in relation to monitoring the security cover and covenants with respect to listed debt securities. Recently, SEBI amended SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) and SEBI (Debenture Trustees) Regulations, 1993 (‘DT Regulations’) and SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (‘NCS Regulations’) in order to substitute the concept of ‘asset cover’ with ‘security cover’ and accordingly, prescribed the requirement of maintenance and reporting of the security cover in case of listed secured debentures[1].

Monitoring of security cover has always been the key responsibility of the DT and therefore, SEBI in November 2020, had prescribed norms for independent due diligence by DTs for the purpose of creation of security[2] and for periodical monitoring of the security created and enhanced disclosures by DTs[3]. Thereafter, in August, 2021[4] SEBI rolled out the norms for security and covenant monitoring using Distributed Ledger Technology (‘DLT’) and in March, 2022 prescribed operational guidelines for security and covenant monitoring wherein system generated unique identifier (Asset ID) will be generated for each security offered by issuer in order to enable the DTs and Credit Rating Agencies (‘CRAs’) for better tracking[5]. Lastly, on August 4, 2022[6] SEBI issued enhanced guidelines for DTs and listed issuer companies on security creation and initial due diligence which inter-alia provides directions to harmonize the process of creation of security.

Present Circular

A debenture will be considered ‘secured’ upon maintenance of adequate security cover. Until now, the listed entities were required to furnish the details as part of the financial results. However, the manner of computing the same, value of assets considered and those not considered was not available for the debt holders to inspect. Non-maintenance or breach of the same or the covenants will trigger event of default and therefore, it becomes crucial for the listed entities. There were operational challenges faced in complying with certain provisions of regulations and circulars issued in past with respect to security cover and covenant monitoring. In order to address the same and to align with recent amendments made in April, 2022 in Listing Regulations, DT Regulations and NCS Regulations in relation to security cover, SEBI, on May 19, 2022[7], issued Present Circular prescribing norms for the following:

1. Revised format of the security cover certificate (effective w.e.f. October 1, 2022);
2. Monitoring of covenants (effective w.e.f. October 1, 2022);
3. Disclosure by DTs (effective w.e.f. May 19, 2022);
4. Revision in timelines of submission of security cover certificate, valuation report and quarterly compliance report and regulatory compliance by DTs (effective w.e.f. May 19, 2022);
5. Monitoring of Recovery Expense Fund (‘REF’) by DTs (effective w.e.f. May 19, 2022);

In this article, we intend to discuss on the requirements that will become effective from October 1, 2022 and highlight the points pending clarification, if any.

Common format for Security Cover certificate for DTs and Listed Entities

In terms of regulation 54 read with regulation 56(1)(d) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, listed entities are required to disclose security cover to Stock Exchange(s) and Debenture Trustee. The format for preparation of security cover for listed debt securities was prescribed as per Annexure A of SEBI Circular dated November 12, 2020 which was applicable to the DTs and not to the listed entity.

Issuers are required to make the following disclosures w.r.t. security cover:

a.   Reg. 54 (2) and (3) of SEBI LODR: Listed entities are required to disclose about maintenance of security cover as part of financial results submitted to the stock exchange, in the format prescribed by SEBI. No format had been prescribed for the same.

b.   Reg. 56 (1) (d) of SEBI LODR: Listed entities are required to furnish to the debenture trustees a half yearly certificate from the statutory auditors regarding maintenance of security cover, in the format prescribed by SEBI. No format had been prescribed for the same.

c.   Reg. 15 (1) (t) (i) of the Debenture Trustee Regulations: In terms of the said provisions, the DTs are required to carry out due diligence and monitor the security cover.

While the Present Circular has prescribed a format in Annexure in substitution of Annexure A of SEBI Circular dated November 12, 2020 (as it states so), as no separate format has been prescribed till date for the purpose of Reg. 54, it is to be assumed that the format is common for submission by listed entities as well as DTs. It seems that the DTs will certify based on the certificate provided by the listed entity.

The circular further provides that the certificate has to be provided separately for each DT. Where assets of group entities are not involved, the certificate is to be prepared on standalone basis. Otherwise, table on net summary on a consolidated level to be provided for holistic picture.

Content of the Security Cover certificate

• Particulars of assets and liabilities has been provided in the certificate.
• Description of the asset for which the certificate relates;
• Book value of the assets and outstanding book value of debt having exclusive charge for debt for which the certificate relates;
• Book value of the other assets and outstanding book value of debt having exclusive charge for all corresponding debt other than for which the certificate relates;
• Confirmation on existence of pari-passu charge, book value of assets and outstanding book value of debt having pari-passu charge for debt for which the certificate relates;
• Book value of the other assets and outstanding book value of debt having pari-passu charge for all corresponding debt other than for which the certificate relates;
• Details of Assets not offered as security;
• Elimination of debt amount considered more than once (due to exclusive plus pari passu charge);
  • In order to match the liability amount with financials, it is necessary to eliminate the debt which has been counted more than once (included under exclusive charge column as also under pari passu). On the assets side, there shall not be elimination as there is no overlap.
• Market value of assets charged on exclusive basis for items covered by the certificate;
• Carrying/ book value for exclusive charge assets where market value is not ascertainable or applicable, for items covered by the certificate
  • Bank balance, DSRA.
• Market Value for pari-passu charge assets, for items covered by the certificate;
  • Assets which are considered at Market Value like Land, Building, Residential/ Commercial Real Estate to be stated at Market Value. Other assets having charge to be stated at book value/Carrying Value.
• Carrying/ book value for pari-passu charge assets where market value is not ascertainable or applicable, for items covered by the certificate
  • Bank balance, DSRA.
• Basis the above, cover on book value and cover on market value to be ascertained.

The format provides for computation of only exclusive and pari-passu charge and not for senior and subordinated security cover. It may be possible that the ranking of NCD holders is senior or junior and the manner of computation of the cover will vary in those cases. Further, as the format requires providing details of cover on book value as well as market value, the footnote does not indicate when the security cover will be regarded as in compliance with the terms of offer document/ Information Memorandum and/or Debenture Trust Deed i.e. in which scenario it will be deemed adequate.

Lastly, the Present Circular is not clear on if the certificate is to be furnished ISIN specific to every DT. Summary table providing ISIN wise details, as provided in SEBI Circular dated November 12, 2020 comprising of following columns, has not been provided:

a.    Sr. No

b.    ISIN

c.     Details of listed debt securities

d.    Type of charge

e.    Principal amount outstanding as on DD-MM-YYY

f.     Interest accrued as on DD-MM-YYYY

g.    Security cover required (as per the formula provided in the circular)

h.    Security cover available as on DD-MM-YYYY

Therefore, it may be regarded that if the security cover is adequate for all the debt secured with specific DT, it will be deemed to be compliant at ISIN level, unless SEBI prescribes otherwise.

Manner of preparation of security cover certificate

A.   Certificate by statutory auditors

Listed entities are required to prepare the security cover certificate and the statutory auditor of the listed entity are required to certify the book values of the assets provided in such certificate on a quarterly basis. The requirement seems to be in addition to the corresponding required under Reg. 15 (1) (t) (ii) of Debenture Trustee Regulations, where statutory auditors of the listed entity are required to furnish a certificate on a half yearly basis regarding security cover including compliance with the covenants of the Offer Document/ Information memorandum in the manner as may be specified by SEBI from time to time.

B.   Determining market value – manner & frequency

The format stipulates providing details of the market value. The market value column requires values including reference date based on which the market value has been arrived at. However, as major issuers of debt securities are financial sector entities and the security offered are the loans/receivables and there may not be a ready market for the same to derive the market value. Market value may not be ascertainable in all cases, therefore, SEBI has allowed providing the carrying value/book value along with the justification for not providing the market value. The frequency of valuation of asset classes is on a quarterly basis except in cases where SEBI has prescribed particular frequency. The issuers will have to ascertain the assets offered as security and undertake valuation to be able to submit for the quarter ending December 31, 2022.

C.    Security cover in case of assets not paid for

Security cover is to be prepared on standalone basis in case the same comprises solely of assets of the listed entity. Further, assets not paid for are not to be included as part of the security cover calculation. It seems to indicate that the assets in respect of which acquisition is not yet complete or the payment of the purchase consideration has not been made by the listed entity, such assets shall not be included as part of any security cover calculation.

D.   Details of debt not backed by security

It is provided that in order to adequately capture details regarding other debt securities, viz. unsecured debentures, subordinated debt, other debt issuances which fall in the lower priority order in the waterfall mechanism for liquidation/ resolution proceeds, an additional column named “Debt not backed by any assets offered as security” shall be incorporated in the security cover certificate and the same shall be covered under such column. The purpose of providing security cover is only for secured debentures. The fact that subordinated debt, perpetual bonds, unsecured debentures have no asset backing is provided in the term sheet/ offer document itself.  Therefore, this disclosure may not serve any purpose. The security cover certificate should not include details of unsecured debt in any manner as it is neither an asset cover certificate nor a solvency certificate.

E.    Due diligence by DTs

Debenture trustee are required to certify the market value of assets based on the due diligence carried out by it or its appointed agencies and are required to submit the security cover certificate as per Annexure I on quarterly basis. Debenture Trustee are to certify the security cover in respect of the secured debt securities, where they are acting as debenture trustees.

Further, in case of reduction in the computed value of security cover in comparison to the previous quarter or previously calculated security cover, the Debenture Trustee to record the reason for such variation in the security cover certificate. Clarification, if any, in this regard, may be obtained by DTs from listed entity. As the cover is computed basis the book value and market value, it seems that reduction in any of the same will require furnishing of clarification to the DT.

In case of qualification/ disclaimer in the security cover certificate, the DT is required to ensure that it doesn’t impair the rights of the debenture holders in terms of the security provided. In case it does, the DT is required to take corrective action.

Monitoring of covenants

While the requirement of security cover certificate is applicable only in case of secured debt securities, in terms of Para B (7) of the Present Circular, the listed entity is required to furnish compliance status on a quarterly basis with respect to financial covenants of the listed debt securities duly certified by the statutory auditors, to the DTs. This is in deviation of the requirement under Reg. 15 (1) (t) (ii) (a) of the DT Regulations which mandates obtaining a certificate from the statutory auditor of the issuer, in case of listed secured debt, regarding security cover including compliance with the covenants of the Offer Document/Information Memorandum on a half yearly basis. Accordingly, in view of the author, the requirement of furnishing this certificate should apply only in case of listed secured debt and not otherwise.

Financial covenants may include maintenance of a ratio or percentage upto or below a particular limit, for e.g. debt service coverage ratio, net NPA/ tangible net worth, Debt equity ratio etc. as may be specified by the DT and must have been captured in the DTD.

The DTs are required to monitor breach of covenants in terms of Reg 15 (f) of DT Regulations. The present circular specifies various actionables for the DTs, right from framing internal policies for monitoring with clearly defined roles and responsibilities for its employees, to preparing category wise list of covenants applicable viz. financial, affirmative, negative covenants etc. and furnish status report to the stock exchange and upload on its website on quarterly basis.

Conclusion

The format for security cover certificate is now notified and effective from October 01, 2022. It is likely that the DTs may require companies to submit for quarter ended September 30, 2022 in the revised format. Similarly, listed entities are required to check if there are any financial covenants associated with any of its listed secured debt issuance. If yes, then statutory auditor’s certificate for compliance with the same will be required for onward submission to the DTs. As the same will be published along with the financial results, there will be greater transparency for the stakeholders in terms of manner of computation of the security cover certificate.

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[1] Refer our snippet at https://vinodkothari.com/2022/04/sebi-does-away-with-the-concept-of-asset-cover-security-cover-to-be-maintained-for-secured-ncds/

[2] SEBI Circular dated November 3, 2020: https://www.sebi.gov.in/legal/circulars/nov-2020/creation-of-security-in-issuance-of-listed-debt-securities-and-due-diligence-by-debenture-trustee-s-_48074.html

[3] SEBI Circular dated November 12, 2020: https://www.sebi.gov.in/legal/circulars/nov-2020/monitoring-and-disclosures-by-debenture-trustee-s-_48159.html

[4] SEBI Circular dated August 13, 2021: https://www.sebi.gov.in/legal/circulars/aug-2021/-security-and-covenant-monitoring-using-distributed-ledger-technology_51855.html

[5] Refer our write up on the DLT Circular at https://vinodkothari.com/2022/04/sebi-issues-operational-guidelines-for-security-and-covenant-monitoring-using-dlt/

[6] SEBI Circular dated August 4, 2022: https://www.sebi.gov.in/legal/circulars/aug-2022/enhanced-guidelines-for-debenture-trustees-and-listed-issuer-companies-on-security-creation-and-initial-due-diligence_61629.html

[7] Present Circular: https://www.sebi.gov.in/legal/circulars/may-2022/revised-format-of-security-cover-certificate-monitoring-and-revision-in-timelines_59051.html