Partial Credit Enhancement: A Catalyst for Boosting Infrastructure Bond Issuances?
-Abhirup Ghosh (abhirup@vinodkothari.com)
What is partial credit enhancement?
Partial Credit Enhancement (PCE) is a risk-mitigating financial tool where a third party provides limited financial backing to improve the creditworthiness of a debt instrument. It ensures that investors are partially protected against default risk, making it easier for issuers to raise funds at better terms.
The key features of a PCE are as follows:
- Parties involved: A typical PCE structure would involve at least three parties:
- Issuer: A company or an entity that wants to raise funds by issuing debt instruments;
- PCE Provider or Credit Enhancer: A third party (usually a government agency or a financial institution with strong credibility) that provides the credit enhancement
- Investor(s): The one who invests in the debt instruments.
- Multiple forms: Can be structured in various forms, like guarantee, subordinated line of credit, investment in subordinated tranche, cash collateral etc.
- Limited coverage: Unlike full credit enhancement, PCE covers only a portion of the potential losses in case of default. The extent of coverage is pre-fixed and does not extend once the same is exhausted.
- Improved Credit Rating: PCE lowers the perceived credit risk, leading to an improved bond rating by credit rating agencies. A higher credit rating results in lower interest rates, benefiting the issuer.
Why has this become so important all of a sudden?
The concept of PCE has been in India for quite some time now, and is commonly used in securitisation transactions. However, the Finance Minister’s announcement during Union Budget 2025 about setting up of a PCE facility under the National Bank for Financing Infrastructure Development (NaBFID) has brought this into the limelight.
How does it help issuance of bonds by an infrastructure entity?
Infrastructure development is the backbone of economic growth, but funding large-scale projects such as highways, railways, power plants, and airports requires substantial capital. Infrastructure projects often face challenges in raising funds due to their long gestation periods, high risks, and lower credit ratings. PCE serves as an effective financial tool to improve the creditworthiness of infrastructure bonds, making them more attractive to investors. By providing a partial guarantee or security, PCE helps reduce the cost of borrowing and widens investor participation, ultimately facilitating infrastructure financing.
Challenges in Infrastructure Bond Issuances
Infrastructure bond issuances face several obstacles that make fundraising difficult. One of the primary challenges is low credit ratings. Infrastructure projects, especially those in their early stages, often receive sub-investment-grade ratings (such as BBB or lower), making them unattractive to investors. Additionally, these projects are subject to high perceived risks, including revenue uncertainty, regulatory hurdles, construction delays, and cost overruns. Since many infrastructure projects rely on user charges, such as tolls or metro fares, their cash flow projections can be unpredictable.
Another major issue is the long maturity period of infrastructure bonds. Most investors prefer short- to medium-term investments, whereas infrastructure bonds typically have tenures of 10 to 30 years. This mismatch reduces the appetite for such bonds in the market. Lastly, lack of institutional investor participation further limits the success of infrastructure bond issuances, as pension funds, insurance companies, and mutual funds prefer highly rated bonds with stable returns.
Enhancing Credit Ratings and Investor Confidence
One of the most significant ways PCE helps infrastructure bond issuances is by improving their credit ratings. When a bank or financial institution provides partial credit enhancement in the form of a guarantee or reserve fund, it reduces the default risk associated with the bond. This leads to a higher credit rating, making the bond more attractive to investors. For example, an infrastructure company with a BBB-rated bond issuance may improve its rating to A with a 20% PCE support, or AA with a 50% PCE support thereby increasing demand from investors. A higher rating not only boosts investor confidence but also expands the pool of potential buyers, including institutional investors such as pension funds and insurance companies.
Reducing Cost of Borrowing
By improving the credit rating of infrastructure bonds, PCE directly leads to a reduction in interest costs. Bonds with higher ratings attract lower interest rates, which helps infrastructure companies secure financing at more affordable terms. For instance, without PCE, a BBB-rated bond may require 12%, whereas a bond upgraded to an AA rating with PCE support may only require 9%. This reduction in interest rates can result in significant savings over the life of the bond. Lower borrowing costs also make infrastructure projects more financially viable, ensuring their timely execution and long-term sustainability.
Attracting Institutional Investors
Institutional investors, such as mutual funds, pension funds, and insurance companies, typically have strict investment guidelines that restrict them from investing in low-rated securities. Since many of these investors require bonds to be rated AA or higher, infrastructure bonds often struggle to meet these requirements. PCE helps bridge this gap by enhancing the credit rating, making infrastructure bonds eligible for investment by these large institutional players. This leads to greater liquidity and stability in the corporate bond market, ensuring a steady flow of capital to infrastructure projects.
Why is issuance of bonds helpful/ important for the infrastructure entity?
PCE contributes to the overall development of the corporate bond market by encouraging more issuers to raise funds through bonds rather than relying solely on bank loans. Traditionally, infrastructure financing in India has been dependent on banks, which exposes them to high asset-liability mismatches due to the long tenure of infrastructure projects. By facilitating infrastructure bond issuances, PCE helps shift the burden away from banks and towards a broader investor base. This not only diversifies funding sources but also enhances financial stability in the banking sector.
As per a CII report (2022), the infrastructure financing gap is estimated at over 5% of GDP. Approx. 80% of the investment in infrastructure space is by government agencies (80%), and the remaining 20% comes from private developers.
As per the National Infrastructure Pipelines, the total investment target was set at INR 111 trillion (USD 1.34 trillion) for the period between FY 20 and FY 25; and only 6-8% (INR 6.66-8.88) of the such targets were expected to be met by bond issuances. Reliance on bond markets is planned to the extent of 6% to 8% (INR 6.66 – 8.88 trillion). As per the said estimates, the average annual issuances should have been INR 1.480 trillion. However, between FY18 and FY22, the issuance of infrastructure bonds has been at INR 5.37 trillion, that is, an average of INR 1.07 trillion per annum, that is a shortfall of ~30% compared to the target.
Furthermore, the issuances have been highly concentrated in the top 5 PSUs. The charts below show the annual bond issuances between FY 18 – FY 22, and share of issuance by top 5 PSUs and others:
Source: CRISIL
The market is dominated by highly rated issuers. In general approx. 75% of bond issuers are rated AAA, and more than 90% of the issuances are by AA and above rated entities. The reason for this dominance by highly rated issuers is the fact that for practical purposes, the most acceptable rating in the infra bonds space is AA, as long term investors like insurance companies, pension funds etc. are by regulation required to invest in AA or above rated papers.
PCE support from a credible source will help a lot of infrastructure operators, who are stopped at the gate, with ratings in the range of A, with easy access to the market.
Existing scheme for PCE – why has it not found takers
The existing scheme for PCE was notified by the RBI in 2015. In a nutshell, the scheme provides for the following:
Form of PCE: To be structured as a non-funded, irrevocable contingent line of credit. This facility can be drawn upon in the event of cash flow shortfalls affecting bond servicing.
Limitations: The total PCE extended by a single bank cannot exceed 20% of the bond’s total size; however, overall, the PCE provided by all banks, in aggregate, cannot exceed 50% of the bond’s total size.
Further, PCE can be provided only to bonds which have a pre-enhanced rating of BBB- or above.
Capital Requirements: The bank providing PCE does not hold capital based only on its PCE amount. Instead, it calculates the capital based on the difference between:
- The capital required before credit enhancement.
- The capital required after credit enhancement.
The objective is to ensure that the PCE provider should absorb the risks that it covers in the entire transaction. Illustrating with an example:
Assume that the total bond size is Rs. 100 crores for which PCE to the extent of Rs. 20 crore is provided by a bank. The pre-enhanced rating of the bond is BBB which gets enhanced to AA with the PCE. In this scenario:
- At the pre-enhanced rating of BBB (100% risk weight), the capital requirement on the total bond size (Rs.100 crores) is Rs.9.00 crores.
- The capital requirement for the bond (Rs.100 crores) at the enhanced rating (AA, i.e., 30% risk weight)) would be Rs.2.70 crores.
- As such, the PCE provider will be required to hold the difference in capital i.e., Rs.6.30 crores (Rs.9.00 crores – Rs.2.70 crores).
As can be seen, the capital has to be maintained on the total bond issuance, and not just the exposure. Ironically, this capital has to be maintained until the outstanding principal of bonds falls below the extent of PCE provided. Usually, the bonds are amortising in nature – that is, the actual exposure of the guarantor continues to come down. Given, however, that default in bonds may be back-ended, the capital has still to be maintained till the redemption of the bonds. This requires the PCE provider to maintain huge regulatory capital for a significantly long period of time; which also gets reflected in the ultimate cost to the beneficiary, therefore, making it unviable.
How to make it work?
The FM’s announcement though comes with a lot of promise, as it shows a positive intent. But to make things work, there are quite a few things that should be put into place:
- Specific applicability: Currently, the PCE framework applies only to banks. For NaBFID to commence its PCE operations, it would be ideal to receive explicit approval from the RBI, even if the requirement is minor or procedural in nature.
- Limitations: Currently, the RBI’s PCE framework restricts a single entity to providing only 20% of the total 50% PCE limit for a bond issuance. It is recommended that a single institution, such as NaBFID, be allowed to provide the entire PCE, which would enhance flexibility. The existing framework is not particularly attractive for banks in India. In the infrastructure finance sector, a 20% PCE contribution from a single entity may not be sufficient to secure a strong rating from credit rating agencies. Removing this 20% sub-limit would grant NaBFID greater flexibility while also reducing the time required to identify multiple institutions to fulfill the remaining PCE. Additionally, this change would lead to a reduction in operational expenses associated with coordinating multiple PCE providers.
- Capital treatment: The current setting of capital requirement makes the transactions very costly. There has to be an alternative way of achieving the objective. Setting the capital requirement as a fixed proportion of the outstanding bond value may not be appropriate, as defaults can occur at any stage. A more effective approach would be to apply the capital treatment for structured credit risk transfer under the Basel III framework, that is SEC ERBA. Under Basel III, capital requirements are not linked to the total bond issuance size but are instead based on the rating of the tranche and the extent of exposure undertaken. This method ensures that capital is aligned with the actual risk exposure, rather than a fixed percentage of the bond size. Additionally, it accounts for the possibility of defaults occurring later in the bond’s lifecycle, providing a more efficient risk management framework.
- Credit risk transfer: The PCE framework should specifically allow credit risk transfer by the PCE provider – this will help the PCE provider reduce its exposures, and consequently, extent of capital to be maintained on the PCE provided. This will help in reducing the cost of the PCE support as well.
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Can CICs invest in AIFs? A Regulatory Paradox
-Anshika Agarwal (finserv@vinodkothari.com)
Core Investment Companies (CIC) and Alternative Investment Funds (AIF) are two very common modes to channelise investments in the Indian market. Both are regulated by different regulators; while CICs are regulated by the RBI, AIFs are regulated by the SEBI. Under their respective regulatory frameworks, both are technically permitted to invest in one another. However, this permissibility introduces an intriguing paradox, especially for a CIC, which is allowed to invest in group companies. It points out that this approach effectively creates two investment pools—one directly under the CICs and another through the AIFs. This dual-pool structure complicates what could otherwise be a straightforward process, introducing unnecessary layers of complexity, thus deviating from the primary purpose of CICs to hold and manage investments efficiently within group companies.
The following article examines the implications of Paragraph 26(a)1 of the Master Direction – Core Investment Companies (Reserve Bank) Directions, 2016 (“CIC Master Directions”), but before delving into the specifics, it may be worthwhile to discuss in brief the concepts of AIF and CIC.
What are AIFs (Alternative Investment Funds)?
AIFs have gained prominence as a pivotal part of the financial ecosystem, providing investors with access to diverse and innovative investment opportunities. The key features of an AIF are as follows:
- An AIF is a privately pooled investment vehicle, therefore, it cannot raise money from public at large through a public issue of units;
- The investors could be Indian or foreign – there is no bar on the nature of the investor who can invest.
- The investments made by the fund should be in accordance with the investment policy.
- There are three categories of AIFs, depending on the kind of investments they make, and each category is regulated differently:
- Category 1 which invests in start up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified.
- Category 2 which does not fall in Category I and III and which does not undertake leverage or borrowing other than to meet day to day operational requirements and as permitted in these regulations. It includes private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other regulator shall be included.
- Category 3 which employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.
What are Core Investment Companies (CICs)?
CICs are a specialized subset of Non-Banking Financial Companies (NBFCs) established with the primary purpose of holding and managing investments in group companies. CICs do not engage in traditional financial intermediation but play a vital role in maintaining financial stability within the ‘group companies’. CICs are governed under the CIC Master Directions to ensure that their activities align with regulatory standards.
Below given graph explains the regulatory permissibility of the kind of investments a CIC can make:
In addition with the aforesaid, it may further be noted that CICs are permitted to carry out the following financial activities only:
- investment in-
- bank deposits,
- money market instruments, including money market mutual funds that make investments in debt/money market instruments with a maturity of up to 1 year.
- government securities, and
- bonds or debentures issued by group companies,
- granting of loans to group companies and
- issuing guarantees on behalf of group companies.
It may be noted that the RBI’s FAQs on Core Investment Companies, particularly Question 92 has clarified about the 10% of Net Asset –
“What items are included in the 10% of Net assets which CIC/CIC’s-ND-SI can hold outside the group?
Ans: These would include real estate or other fixed assets which are required for effective functioning of a company, but should not include other financial investments/loans in non group companies.”
Who are included in Group Companies?
The term “group companies” is defined under Para 3(1)(v) of the CIC Master Directions. It refers to an arrangement involving two or more entities that are related to each other through any of the following relationships:
| Subsidiary – Parent (as defined under AS 21), Joint Venture (as defined under AS 27), Associate (as defined under AS 23), Promoter-Promotee (as per the SEBI [Acquisition of Shares and Takeover] Regulations, 1997 for listed companies), Related Party (as defined under AS 18), Entities sharing a Common Brand Name, or Entities with an investment in equity shares of 20% or more |
The Issue with Paragraph 26(a): The paradox
Para 26A of the CIC Master Directions deals with Investments in AIFs. The language of the provisions suggest that CICs are permitted to invest in AIFs. However, this provision introduces a significant legal contradiction that undermines the regulatory framework governing CICs. According to the Doctrine of Colorable Legislation, a legal principle ensuring legislative consistency, what cannot be achieved directly cannot be permitted indirectly. By allowing CICs to invest in AIFs, Para 26(a) effectively circumvents the explicit restriction on investments outside group companies. This indirect allowance is inconsistent with the foundational objectives of the CIC Master Directions and creates substantial legal and operational confusion.
Can there be an AIF which in turn invests in the group only?
Under the SEBI (Alternative Investment Funds) Regulations, 2012, the primary objective of an Alternative Investment Fund (AIF) is to pool funds from investors and allocate them across diverse investment opportunities. However, structuring an AIF to invest predominantly or exclusively in entities within the same group raises concerns regarding compliance with SEBI’s regulatory framework, particularly its diversification. SEBI imposes strict investment concentration limits, as outlined in one of its Circular3.
For Category I and II AIFs, no more than 25% of their investable funds can be allocated to a single investee company, while Category III AIFs are restricted to 10%. These regulations inherently prevent AIFs from focusing solely on group entities unless the investment structure strictly adheres to these limits. For CICs intending to invest in AIFs, these restrictions pose significant limitations if the goal is to channel funds primarily into group companies.
Can AIFs be a Group Entity in a CIC’s Group Structure?
Technically, the answer is affirmative—AIFs can be part of a group entity within a group if it satisfies any of the conditions mentioned in the definition. However, if CICs invest in AIFs within the same group structure, it fails to resolve the underlying issue. AIFs often invest outside the group companies, exposing CICs indirectly to entities external to the group. This contradicts the core purpose of CICs, which is to focus investments within their own group companies. Such a structure not only undermines the original intent of CICs but also raises compliance concerns. The RBI adopts a pass-through approach in these cases and is likely to view such practices as non-compliant.
Conclusion
The regulatory paradox of allowing CICs to invest in AIFs under Para 26(a) of the CICs Master Direction raises important questions about the practicality and purpose of this provision. At its core, CICs are meant to simplify and streamline the management of investments within their group companies. However, the inclusion of AIFs creates an unnecessary layer of complexity, dividing investments into dual investment pools and making it harder to track, manage, and maintain transparency.
This arrangement doesn’t just complicate operations, it also moves CICs away from their original purpose. By routing investments through AIFs, CICs are exposed to entities outside their group, which can lead to compliance risks, regulatory confusion, and inefficiencies. Even from a taxation perspective, the setup offers no real benefits, adding financial burdens without meaningful gains. Paragraph 26(a) of the CICs Master Direction has been taken from the SBR Master Direction, which is applicable to NBFCs. However, including it in the CICs Master Direction, which provided regulation specifically for CICs NBFC does not appear to serve any purpose. Even if it were to be amended, its relevance of stating the same for CICs NBFC would still remain questionable.
- Reserve Bank of India, Master Direction – Core Investment Companies (Reserve Bank) Directions, 2016. Available at:https://www.lawrbit.com/wp-content/uploads/2021/05/Master-Direction-Core-Investment-Companies-Reserve-Bank-Directions-2016.pdf (Accessed: 19 January 2025). ↩︎
- FAQs on Core Investment Companies, available at: https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=836 (Accessed: 19 January 2025). ↩︎
- SEBI (Alternative Investment Funds) Regulations, 2012 available at: https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-alternative-investment-funds-regulations-2012-last-amended-on-march-6-2017-_34694.html ↩︎
SEBI approves cartload of amendments
– Team Corplaw | corplaw@vinodkothari.com
SEBI in its Board meeting dated December 18, 2024, has approved amendments pertaining to BRSR, HVDLEs, DTs, SMEs, Intermediaries, etc. This article gives a brief overview of the approved amendments.
Ease of Doing Business for BRSR
- Scope of BRSR Core for Value Chain Partners shrunk
- Value chain partners now consist of individuals comprising 2% or more of the listed entity’s purchases and sales (by value) instead of 75% of listed entity’s purchases/sales (by value).
- Further, the listed entity may limit disclosure of value chain to cover 75% of its purchases and sales (by value), respectively.
- Deferred applicability of ESG disclosures for the value chain partners & its limited assurance by one financial year
- Applicability of ESG disclosures for the value chain deferred from FY 24-25 to FY 25-26.
- Applicability of limited assurance deferred from FY 25-26 to FY 26-27.
- Voluntary disclosure of ESG disclosures for the value chain partners & its limited assurance instead of comply-or-explain
- Top 250 listed entities by market cap can now comply with the ESG disclosures for the value chain partners & its limited assurance on a voluntary basis in place of comply-or-explain.
- Term ‘Assurance’ replaced with ‘assessment or assurance’ to prevent unwarranted association with a particular profession (specifically audit profession).
- Assessment defined as third-party assessment undertaken as per standards to be developed by the Industry Standards Forum (ISF) in consultation with SEBI.
- Reporting of previous year numbers voluntary in case of first year of reporting of ESG disclosures for value chain.
- Addition of disclosure pertaining to green credits as a leadership indicator under Principle 6 – Businesses should respect and make efforts to protect and restore the environment of BRSR
Immediate actionables for Listed entities:
- Entity to re-assess its value chain partners as per the revised definition.
- Entity forming part of top 250 listed entities by market cap to undertake third party assessment of its BRSR Core disclosure for FY 24-25 as per the standards to be developed by ISF.
- To disclose about the green credits procured/generated by the entity during FY 24-25.
Debenture Trustee (‘DT’) Regulations:
- Introduction of provisions relating to ‘Rights of DTs exercisable to aid in the performance of their duties, obligations, roles and responsibilities’, which broadly indicates (as proposed in the CP):
- Calling information/ documents from issuer w.r.t. the issuance;
- Calling documents from various intermediaries;
- Calling of and utilization of Recovery Expense Fund, with consent of holders.
- Corresponding obligations on the issuers to submit necessary information/documents to DTs.
VKCo comments: In addition to the corresponding obligations on the issuer, CP also proposed to mandate Depositories and Stock exchanges to provide requisite information to DTs, which is yet to be approved. The right to call information from issuers and market participants including corresponding obligations on them will enable DTs to perform their functions efficiently.
- Introduction of standardized format of the Debenture Trust Deed (‘DTD’)
- To be issued by Industry Standards Forum with SEBI consultation;
- In case of deviation from the format of DTD, disclosure is to be made for investor review. (CP proposed to disclose deviation as insertion of a key summary sheet of deviation in GID/KID)
VKCo comments: While the introduction of model DTD is appreciated, the draft model DTD proposed in the CP was not aligned with the general market practices followed by the DTs as well as the applicable laws such as SEBI Listing Regulations, NCS Regulations, Indian Trust Act, etc.
- Activity-based Regulation for DTs:
- DTs are to undertake only such activities regulated by other financial sector regulators/ authorities (as SEBI specifies);
- Hive off non-regulated activities to a separate entity – within 2 years;
- Sharing of resources between DT and hived-off entity is allowed, subject to segregation of legal liabilities;
- Hived-off entity can use DT’s brand/logo – only for a period of 2 years (CP suggested 1 year); Both DT and hived-off entity to abide by SEBI’s code of conduct during such period.
- Refer to our discussion on CP in SEBI unveils new reforms for Debenture Trustees
Applicability of CG norms on HVDLEs
Under this segment of changes discussed by SEBI, most of the proposals are in alignment with the Consultation Paper dated 31st October, 2024, except for few changes in relation with PSUs coming together with public enterprises under Public Private Partnership.
- Threshold for being identified as HVDLE increased from 500 Crores to 1,000 Crores to align with the criteria of Large Corporates
VKCo Comments: The proposal to enhance the extant threshold is encouraging in terms of governing the maximum value of outstanding debt while at the same time achieving the same without bearing the burden of compliance by an increased number of purely debt listed entities. Subsequently, effective implementation of such a proposal aligns it with the identification criteria of Large Corporates.
- Introduction of a separate chapter for entities having only debt listed, and sunset clause for applicability of CG norms
VKCO Comments: While this proposal is noteworthy, however, instead of rolling out a new chapter, there could have been certain modifications in the existing regulations by way of a proviso to align with the needs of an HVDLE. Further, one also needs to wait to see the fine print -of the provisions once the same is issued.
VKCo Comments: The proposal is welcome since it clearly sets the HVDLEs free from the barrier of once an HVDLE so always an HVDLE. This proposal sets a clear nexus between the compliance and the size of the debt outstanding, for the protection of which in the very first place, the compliance triggered.
- Optional constitution of RMC, NRC, and SRC and delegation of their functions to the AC and Board respectively.
VKCo Comments: Given the close construct of debt listed entities, it is often observed that the constitution of such committees becomes more of a hardship than in smoothing compliance and discussing specific matters. Accordingly, it looks appropriate to redirect the functions of NRC and RMC to the Audit Committee and that of the SRC to the Board.
- HVDLEs to be included in the counting of maximum no. of directorships, memberships and chairmanships of committees. However, this shall exclude directorships arising out of ex-officio position by virtue of statute or applicable contractual framework in case of PSUs and entities set up under the Public Private Partnership (PPP) mode respectively, in the count. The said exclusion was not in the CP.
VKCo Comments: The rationale completely aligns with the proposal made and seems to be justified. Further, as far as the exclusion is concerned, this seems more from excluding those members who are part of the board not on the basis of their appointment but their current tenure being served in a particular position in the company.
- RPT Approval by way of NOC from DT (who obtains it from holders), before going for shareholders’ approval [w.e.f. 1st April, 2025]
VKCo Comments – While the CP suggested two ways of seeking approval for material RPTs of an HVDLE. The Board has only considered the alternative mode of first seeking NOC of DT and thereafter approaching the shareholders. Further, as discussed in our related write up on the CP, there does not seem to be any incentive to first approach the DT and thereafter the DT to approach the NCD holders. Instead the approval of the NCD holders can be taken up directly by the HVDLE.
- Submission of BRSR on a voluntary basis
VKCo Comments: The inclusion of a voluntary provision in the legislation with respect to a comprehensive report like BRSR is not likely to be submitted given the huge details under the BRSR. However, an opportunity to submit BRSR can be a game changer for an HVDLE from the perspective of being able to raise funds based on its reporting standards in this regard.
One of the changes discussed by the Board is relaxation to HVDLEs set up under the PPP mode from composition requirements of directors. While this was not a part of the CP, however, even if we have to understand that change proposed, this looks like relaxing the composition requirement of the Board of Directors.
CHANGES NOT APPROVED:
- Compulsory filing of CG compliance report in XBRL format
VKCo Comments: This proposal was with an objective to align and standardize the filing of quarterly CG compliance report for bringing parity as in the case of equity listed entities
- Exemption to entities not being a Company
VKCo Comments: While SEBI refers to the introduction of similar exclusion for equity listed entities, however, it has also mentioned the subsequent amendment wherein the same was omitted. The proposal not being notified is in alignment with the position of equity listed entities, however, the same would have been a welcome change since it would have helped such entities to give preference to their principal statutes and not an ancillary one like LODR.
Our detailed write up on the CP can be accessed here.
Amendments in the definition of UPSI – making the law more prescriptive
- Inclusion of 17 items in definition of UPSI: The illustrative list of USPI in reg. 2 (1) (n) of the PIT Regulations has been expanded to include 17 items from the list of material events laid out in Part A of Schedule III of the Listing Regulations [Originally proposed in the CP – 13 items]
- Threshold limits under reg. 30 made applicable: materiality thresholds specified in reg. 30 (4) (i) (c) of the Listing Regulations have been made applicable for identification of events as UPSI
- As per the current practice, any event that is likely to materially affect the price of the securities can be identified as UPSI
- Extended timelines for making entries in SDD: for an event of UPSI that emanates outside the company, entries can be made in the SDD within 2 days of occurrence. Further closure of the trading window will not be mandatory in such cases.
- This has been introduced as a part of EODB
- As per the current practice entries in the SDD have to be made promptly
Refer to our discussion on CP in: Laundry List: SEBI’s proposal to elongate list of deemed UPSIs
Share-hawkers of digital era: Legality of platforms offering unlisted shares
– SEBI cautions investors from transacting in securities of unlisted public companies on electronic platforms
– Burhanuddin Kholiya (corplaw@vinodkothari.com)
From rental rooms to cabs to domestic furniture, almost everything is made available using technological aggregators. But the moment one tries to sell securities on public platforms, the chances of potential investors being duped by dream merchants increase – something which regulators have very carefully barred over the years. Hence, unless it is a recognised stock exchange, making securities available on public platforms constitutes “offer for sale”. Sometimes, people look at the number of investors as less than 200 and tend to argue that is not a deemed public offer, but it is important to understand that if the offer has gone to people in general, the actual number of investors who bite the bait does not matter.
Many platforms encourage investments in unlisted or pre-IPO stocks. At times bunching either securities or investors. SEBI, in its press release dated December 9, 2024, warned investors against transacting on such platforms, emphasizing the risks involved and clarifying that these platforms operate outside SEBI’s regulatory framework.
Regulatory framework for platforms:
On the intermediaries front, stock brokers are permitted to deal only on recognised stock exchanges and are prohibited from facilitating trading outside these exchanges. In 2022, SEBI extended its regulatory framework to Online Bond Platform Providers (‘OBPP’) by mandating them to register as stock brokers in the debt segment and restricted their offerings to listed debt securities or debt proposed to be listed through a public offering. Only recognized stock exchanges are authorised to provide a platform for fund raising and trading in securities of “to be listed” and “listed” companies.
Apart from above, today, numerous platforms have emerged offering unlisted securities to the public at large. However, being unregulated, it poses significant risks to investors. While SEBI’s mandate may not extend to unlisted securities, it continues to caution investors about platforms dealing with such securities. Recognizing the potential risks and lack of oversight, SEBI and the Registrar of Companies (ROC) have issued several orders against platforms offering unlisted securities to the public. These actions aim to protect investors from being misled and address violations of private placement & public issue related provisions under the Companies Act, 2013.
Modus Operandi of unlisted share brokers
Unlisted securities are primarily traded by way of a transfer. Traditionally, the transfer of securities is a private arrangement between two identified parties, namely the transferor and the transferee, who explicitly agree on the sale and purchase of a fixed number of securities.
The key distinction between transfer of securities and public offer of securities lies in the pre-identification of parties, exclusive offer and defined terms.
Therefore, when securities are offered for sale to unidentified persons without limiting the number of purchasers, this could effectively constitute an indirect public offer (which also includes an offer for sale).
As pointed out above, many unregistered platforms offering unlisted securities have emerged. These platforms often target unidentified persons and provide no limit on the number of purchasers, effectively transforming such offers into indirect public offers in the form of “offer for sale”.
Listing securities for sale on a publicly accessible platform may, intentionally or unintentionally, transform a private arrangement into an offer resembling a public offer. Unlike private transfers, public offers are subject to stringent regulatory requirements, such as issuing prospectus, detailed disclosures, and continuous regulatory oversight. Failing to adhere to these requirements could undermine investor protection and market integrity.
Structuring of Transactions as “Secondary Sale”
The practice of structuring transactions as secondary sales is an innovative strategy employed by fintech platforms to broaden market access while navigating regulatory challenges. However, this approach raises significant concerns about compliance, investor protection, and market integrity. Striking a balance between innovation and regulatory compliance is essential to establish a transparent, fair, and robust investment ecosystem.
In this model, a fintech platform, operating through its legal entity, subscribes to securities offered via private placement by a company. Often, these platforms are the sole or principal investors in such placements. Once the securities are acquired, the platform lists them on its portal as available for investment by way of transfers from itself to individual investors, presenting them as secondary market transactions ostensibly outside the scope of public offer regulations. The interface almost resembles a broking app, where one can click and ‘buy 1 share’ instantly.
In some cases, the platform and the warehousing entity are separate. Additionally, some platforms claim that the transferors comprise of promoters, employees, KMPs of those enlisted public companies.
Motivations behind structuring as Secondary Sale are twofold:
1. Avoiding Public Offer Regulations:
Public offers of securities are subject to extensive regulatory oversight, including stringent disclosure requirements and mandatory listing. By structuring transactions as secondary sale, platforms consider to bypass these regulations.
2. Enabling Retail Investor Access:
Structuring investments as secondary sale allows platforms to make securities available to retail investors who might otherwise be ineligible to participate in private placements.
Making securities available to large number of unverified investors
As discussed earlier, an offer that can be accepted by anyone effectively qualifies as a public offer, regardless of how it is officially labeled. In contrast, private placements are designed for a limited, pre-identified group of investors and are subject to stricter regulatory controls to maintain their exclusivity.
Fintech platforms, however, challenge this distinction by leveraging technology to make securities accessible to a broad audience of unverified users, thereby creating a regulatory gray area. By listing securities on their portals—accessible to anyone who registers—these platforms effectively transform private placements into publicly available investment opportunities.
Moreover, these platforms often lack stringent verification processes to ensure that users meet the criteria for accredited or eligible investors. Instead, they use digital advertising, user-friendly applications, and social media campaigns to promote investment opportunities, indirectly engaging in general solicitation. This practice, while sometimes technically compliant, directly conflicts with the principles governing private placements, which prohibit public solicitation.
These practices raise significant concerns regarding investor protection and compliance with the existing regulatory framework. By making securities easily accessible to a wide, largely unverified audience, fintech platforms blur the line between private and public offerings. This not only undermines the purpose of private placement regulations but also exposes retail investors to potential risks without the safeguards typically associated with public offers.
While fintech platforms argue that their practices promote financial inclusion and innovation, they also highlight the urgent need for regulatory clarity. Striking a balance between fostering innovation and ensuring compliance is critical to maintain market integrity and protect investors.
Pricing Mechanism: Misalignment with Market Practices
Fintech platforms often claim that the pricing of unlisted shares is driven by demand and supply, similar to listed securities. However, this approach diverges significantly from standard practices for valuing privately placed securities, which typically rely on Fair Market Value (FMV) mechanisms.
Unlisted securities, being inherently illiquid and less transparent, are usually valued based on financial fundamentals, such as earnings, book value, or discounted cash flows, rather than speculative demand and supply dynamics. The reliance on a demand-supply pricing mechanism for illiquid securities can result in significant price distortions. Prices may be artificially inflated or deflated, often without any material change in the underlying company’s fundamentals.
This speculative approach to pricing can mislead investors into believing that the listed price represents a fair valuation of the security. In reality, such pricing mechanisms expose investors to risks of overvaluation or mispricing, especially in the absence of robust valuation methodologies.
Furthermore, the process for investors seeking to liquidate their unlisted shares on these platforms is often vague and lacks the transparency necessary for informed decision-making. Without clear guidelines on how prices are determined or how liquidity is managed, investors may face challenges in accurately assessing the risks and returns associated with their investments.
Violation of private placement & public issue norms
The aforementioned two modes of issuance differs from each other on various parameters:
| Parameters | Private Placement | Public Offer |
| Meaning | Offer or invitation to a select group of persons to subscribe to securities, excluding the general public. | Includes IPO or FPO of securities to the public or an offer for sale of securities by an existing shareholder through issue of prospectus. |
| Who can invest? | Restricted to pre-identified investors addressed in the private placement offer-cum-application letter. | Open to the public at large. |
| Maximum number of investors | 200 persons in a financial year, excluding QIBs and employees offered securities pursuant to ESOP scheme under Section 62 (1) (b) of CA, 2013. | No maximum limit on number of investors. |
| Offer Communication | Communicated directly to the identified investor; cannot be advertised to the general public. | Communicated via advertisements, circulars, or a prospectus to the public. |
| Process | Conducted via a private placement offer-cum-application, adhering to specific conditions outlined in Section 42 of Act. | Requires a prospectus with mandatory disclosures and regulatory oversight, governed by SEBI (ICDR) Regulations, 2018 |
In terms of Section 25(2) of CA, 2013 a private placement will be considered as securities being offered for sale to the public if it is shown that an offer of the securities or any of them was made within 6 months after the allotment or agreement to allot; or on the date when offer was made, the consideration was not received by the company in respect of the securities. Therefore, subscribing to private placement merely with the intent to warehouse temporarily and downsell to the public will attract the public issue norms. Penal provisions for flouting private placement norms, not following public issue norms are quite stringent.
Conclusion
While securities of public companies are freely transferable, it cannot be traded on unregulated platforms. The fintech platform’s current modus operandi raises concerns about pricing practices, process transparency, and regulatory compliance. SEBI’s advisory underscores the need for vigilance, as these platforms often lack regulatory oversight, investor safeguards, and transparency. Unlike public issues, which ensure grievance redressal mechanisms like SCORES and SMART ODR transactions on these platforms leave investors without formal recourse. The numerous platforms offering unlisted equity shares need to revisit in view of SEBI’s caution letter.
Technical hiccups in payments: Is it a default and impact the credit rating?
SEBI Circular prescribes uniform approach to be ensured by CRAs
Vinita Nair, Senior Partner & Palak Jaiswani, Manager | corplaw@vinodkothari.com
Default in payment of interest or redemption amounts has far reaching repercussions for an issuer of debt securities. A delay of 1 day even of 1 rupee (of principal or interest) from the scheduled repayment date is considered as default in terms of SEBI Master Circular for Credit Rating Agencies (CRAs) and the same triggers an immediate downgrade of the rating of the issuer. After a default is cured and the payments are regularized, the CRA would generally upgrade the rating from default to non-investment grade after a period of 90 days based on the satisfactory performance by the company during this period.
Inability on the part of the issuer to ensure payment in case of incorrect bank details or dormant a/c of the debenture holders resulting in bounce back of the amounts intended to be credited is a common phenomenon experienced by issuers especially in case of servicing publicly issued debentures involving retail investors. Till date, these were considered as technical default and dealt with by the CRAs in accordance with the policies framed by it. Unlike a financial default, where the issuer fails to make payments due to insufficient funds, technical defaults occur despite the issuer having sufficient funds to fulfill its payment obligations.
SEBI Circular dated November 18, 2024 issued in line with the recommendations of the working group for CRAs for EoDB provides guidance on the manner of identification of technical default and verification and disclosures to be ensured by CRAs thereafter. In terms of the SEBI Circular, failure to remit payment due to absence of correct information or due to incorrect or dormant investor account furnished by the investor(s) or due to notice/ instruction received from a government authority to freeze the account of investor(s) will be considered as technical default.
Is technical default a default?
According to SEBI Listing Regulations, a “default” occurs when there is non-payment of interest, dividend, or principal amount on the pre-agreed date, recognized at the first instance of delay. Default is triggered when the issuer fails to pay due to insufficient funds. In contrast, a technical default happens when payment is delayed due to factors like incorrect bank account details or frozen accounts, despite the issuer having adequate funds. The Working Group also highlighted in the SEBI Circular, that instances mentioned above (as technical default) arise where the non-payment is due to reasons beyond the control of the issuer.
It is also to be considered that similar technical issues arise in case of payment of dividends, wherein the Company is unable to credit the amount in the bank account of the members due to incorrect account details provided by them. However, such cases are not treated as default.
While the term used the word ‘default’, it is actually a case of technical delay
Impact on credit ratings
CRA Master Circular requires CRAs to closely monitor the servicing of debt obligations by the issuer and review the ratings, through various modes:
- stock exchange intimations made by the issuer- Regulation 57 of Listing Regulations requires issuers to inform stock exchanges on the status of payment (interest/redemption) within one working day from the due date;
- payment status intimated by the debenture trustees (para 3 of Chapter VIII of DT Master Circular and para 28.2.1 of CRA Master Circular);
- no default statements submitted by issuer on a monthly basis (para 9.3.1 of CRA master Circular)
Credit ratings reflect the creditworthiness of an issuer. Defaults trigger a downgrade to the default grade, significantly affecting the issuer’s reputation. For issuers having multiple ISINs, there may be numerous instances of technical delays, but the same does not indicate financial distress on the part of the issuer. Treating technical delays as default will lead to unjustified rating downgrades and have a negative impact on the issuer’s reputation. Technical delays, caused by factors like incorrect account details or frozen accounts, do not reflect the issuer’s financial health and cannot be treated at par with financial default.
The SEBI Circular omits the term “technical default” from the scope of policy in respect of the upgrade of default rating to investment grade rating framed by CRAs and highlights the instances of non-payment due to reasons beyond the issuer’s control.
Steps to be followed by CRAs for technical defaults:
Conclusion:
While the SEBI Circular gives clarity on the treatment of technical defaults and obligations of the CRA in this regard, clear actionable on the part of the issuer has not been specified. Therefore, in those instances, the issuer should provide the above details to the CRA for onward disclosure. Further, the details to be provided under Reg. 57 inter alia requires providing ‘reasons for non-payment/ delay in payment’. The feasibility of reporting the same in case of technical defaults is not clear as several times the issuer becomes aware of the failure to credit the amount after 1-2 days.
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Team Vinod Kothari & Company | corplaw@vinodkothari.com
Refer to our related resources below:
- Trust, but verify: AIFs cannot be used as regulatory arbitrage (updated as on October 9, 2024)
- AIFs ail SEBI: Cannot be used for regulatory breach
- Cat I & II AIFs can borrow to meet temporary shortfall in investment drawdown
- RBI bars lenders’ investments in AIFs investing in their borrowers
- Some relief in RBI stance on lenders’ round tripping investments in AIFs