‘High value’ debt listed entities under full scale corporate governance requirements

SEBI move nullifies MCA exemption; bond issuers face disproportional compliances

Vinod Kothari & Vinita Nair  | Vinod Kothari & Company

Giving bond markets in the country a push is an admitted policy objective; so much so that “large borrowers” are mandated to move a part of their incremental funding compulsorily to the bond markets. Just when privately placed bond issuance was looking very promising, augured by low interest rates and  increasing investors’ confidence, SEBI’s recent move of notifying SEBI (Listing Obligations and Disclosure Requirements) (Fifth Amendment) Regulations, 2021 (‘2021 Amendment’)to extend corporate governance requirements, largely equivalent to that applicable to equity listed entities, comes as an enigma. These new norms, incorporated in the post-listing corporate governance requirements imbibed in SEBI ( Listing Obligations and Disclosure Requirements) Regulations, 2015  (‘Listing Regulations’) become effective immediately on a “comply or explain” basis, and become binding from 1st April, 2023.

What is surprising is that the capital market regulator has thought of equating a debt listed entity with an equity listed one; potentially disregarding the essential difference between equity listing and bond listing. Equity listing is achieved by a public offer, which underlies widely dispersed retail investors’ interest. Bond listing, to the extent of 98%, is by way of private placement, which definitely means that bonds are placed with knowledgeable qualified institutional buyers. Also, it is a known fact that a large number of listed bond issuers are private limited companies, which are close corporations, with strictly private holding of capital. In light of these facts, extension of substantially the same regime for debt listed entities as that applicable to equity listing creates several irreconcilable compliance requirements, some of which are detailed out in this article. At a time when the need to push the country’s bond markets to new heights, ahead of a potential inclusion of India in global bond indices, is unquestionable, this regulatory move is both surprising as prejudicial. Surprising, because many of SEBI’s regulatory exercises, there was no public comments for these amendments.

The key to the potential prejudice that the regulatory move may cause to bond markets is the definition of “high value debt listed entities”, picking up a threshold of Rs. 500 crores. If the total value of listed bonds outstanding, purely from the corporate sector, is over Rs. 36 lakh crores[1], the amount of Rs. 500 crores is infinitesimal, less than 0.014% of the bond market, and therefore, the basis for taking this value as “high value” is seriously flawed.

Let us start with some facts. India’s bond market is largely a private placement, comprised of bespoke bond issues with limited number investors, majority of them being Qualified Institutional Buyers (QIBs). While technically, these bonds may be sourced through an electronic platform, the avowed fact is that bond issues by even the most frequent bond issuers are negotiated over the counter. Public issue of bonds is activity rarity. This is evident from Table 1: Listed debt issuance, by way of private placement vis-à-vis public issuance during last 3 years.

Regulatory regime before:

Regulation is always proportional to the regulatory concern: the regulatory concern in this case, obviously, is investor protection. Securities regulator is neither the prudential regulator for the bond issuers, nor does it lay the operational safeguards in working of companies. The key objective of the securities regulator is to ensure that the corporate governance does not entail risks to investors’ interest.

Further, the regulatory regime that existed hitherto is as follows: Once the debt securities are listed, companies were required to comply with Listing Regulations mainly Chapter II (dealing with principles relating to disclosures), Chapter III (dealing with common obligations for all listed entities and Chapter V (dealing with disclosure requirements on website, to debenture trustees, stock exchanges, submission of financial results and structure and terms of debt securities). Provisions relating to corporate governance were not applicable to debt listed entities.

It is also notable that debt listed entities were earlier only required to prepare half yearly financial statements, as opposed to quarterly financial statements applicable to equity listed entities.

The rest of the labyrinth of corporate governance provisions, dealing with composition of board of directors, non-executive chairperson, independent directors, constitution of the several board committees, shareholders’ approval for  related party transactions, etc. were not applicable to debt listed entities.

Present amendment

SEBI, in its Board meeting held on August 06, 2021 approved amendments to the Listing Regulations and notified 2021 Amendment with effect from September 8, 2021[2]. The amendments may be classed into (i) those applicable to a “high value” debt listed entity and (ii) those applicable to every entity having its non-convertible securities listed[3].

The 2021 Amendment has made corporate governance related provisions applicable to a listed entity which has listed its non-convertible debt securities and has an outstanding value of listed non-convertible debt securities of Rs. 500 crore and above as on March 31, 2021 (‘HVD entity’). Further, once the provisions become applicable, it will continue to apply even if subsequently the outstanding value falls below the threshold.

Given the details of bonds issuance and present outstanding indicated above, there would be several entities that would be regarded as an HVD entity. In view of SEBI’s requirements under Large Corporate Borrower framework, entities with any of its securities listed, having an  outstanding  long  term  borrowing  of  Rs.  100  crores  or  above and with credit rating of ‘AA and above’[4], will have to mandatorily raise 25% of its incremental borrowing by ways of issuance of debt securities or pay monetary penalty/fine of 0.2% of the shortfall in the borrowed amount at the end of second year of applicability[5].

If one were to argue it is the mere size of debt funding that brings in corporate governance requirements, then even a company that borrows from banks and financial institutions to the extent of Rs. 500 crores should, a priori, have been subjected to similar requirements. If moving from loans to bonds attracts severe corporate governance requirements, not applicable otherwise, there is a clear disincentive to moving bond markets, which is conflicting directly with SEBI’s own requirement of a “large borrower framework”.

We discuss some of the new requirements imposed on HVD entities, and demonstrate how some of these are completely non-reconciling with the type of entities to which they would apply.

Complete overhaul of Board composition

The Board of an HVD entity should comprise of prescribed number of independent directors (‘IDs’) depending on the nature of office of the Chairperson. Appointment of IDs in case of private companies and wholly owned public limited companies will require inducting requisite number of external persons on its Board. In case of a promoter Chairperson, half of its Board should comprise of IDs. A private company is a private matter, in terms of its shareholding. It cannot have an “independent” shareholder. Hence, boards of private companies, as per law, may only have 2 directors. SEBI, on the contrary, mandates 6 directors. Regrettably, the very “privacy” of a private company is compromised with the mandated presence of independent directors. Indeed, there are external investors who contributed to the debt of the entity, but they did with the explicit understanding that the corporate governance of a private company is remarkably different from that of a widely held company. If a private company has to behave and be governed almost like a widely held public company, then there may be a very strong disincentive for such companies to access bond markets.

The requirement of IDs is not merely getting some guests into the boardroom: IDs are required to be independent of management, should meet the eligibility criteria and are responsible to protect the interest of the minority shareholders. In case of several HVD entities there would be no minority shareholders whatsoever: therefore, the IDs would be left wondering as to how the IDs discharge the very same obligations as applicable to an entity with a few lakh shareholders.

The procedure to be followed by a listed entity for appointment of an ID under Listing Regulations is also very elaborate. The Nomination and Remuneration Committee (‘NRC’) is required to prepare a description of the needed capabilities and skill sets after doing a gap analysis, identify candidates basis the prepare description, justify to the Board and shareholders how the proposed incumbent meets the criteria and then recommend their appointment.

The listed entities are not only required to obtain declaration of independence from the IDs but also assess the veracity of the same. Further, the provisions stipulate conducting familiarization programme periodically, obtain Directors and Officer’s insurance for the IDs (otherwise applicable only to top 500 equity listed entities w.e.f. Jan 1, 2022), and ensure that a separate meeting of IDs are carried out.

Need to constitute 4 Committees

The HVD entity, irrespective whether a private company or a closely held company, is required to have an Audit Committee, NRC, Risk Management Committee (otherwise applicable only to top 1000 listed entities based on market capitalization,  but strangely applicable to the entire population of HVD entites) and even a Stakeholder’s Relationship Committee (‘SRC’).

Section 178 of CA, 2013 also mandates constituting SRC only where there are 1000 shareholders, debenture holders, deposit-holders and any other security holders at any time during a financial year. And there are quite a few debt listed entities that have not triggered this requirement even after 8 years of enforcement of CA, 2013.

Under Listing Regulations as well, the role of SRC is mainly to resolve investor grievances, oversee steps taken by the listed entity to reduce quantum of unclaimed dividend, effective exercise of voting rights, monitoring adherence to service standards by RTA, which may not be even relevant to HVD entities that are private companies or closely held public companies. Strangely, the requirement of having SRC will be applicable to debt listed entities having a handful of debt investors, and purely in-house shareholders.

Remuneration related approvals

Requirement to seek shareholder’s approval by way of special resolution is applicable in case of continuing with directorship of a non-executive director (‘NED’) of 75 years and above, or remunerating one NED to the extent of more than 50% of annual remuneration of all NEDs in a financial year, or paying of remuneration to the promoter directors serving in executive capacity in case (i) the annual remuneration payable to such executive director exceeds Rs. 5 crore or 2.5 per cent of the net profits of the listed entity, whichever is higher; or (ii) where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5 per cent of the net profits of the listed entity.

And it will not be a case of wide shareholder participation with institutional shareholders exercising voting rights basis the guidance from proxy advisors etc. as several of HVD entities could be private companies or closely held public limited companies.

Further, prior approval of public shareholders is required in case any employee including key managerial personnel or director or promoter of a listed entity enters into any agreement for himself /herself or on behalf of any other person, with any shareholder or any other third party with regard to compensation or profit sharing in connection with dealings in the securities of such listed entity.

Formulation of codes and policies

Code of conduct for Board and senior management personnel, policy for determination of material subsidiary, policy for determination of materiality of and dealing with related party transactions, archival policy for website are some of the additional codes and policies that HVD entities will have to frame.

Paradoxical regulation: Related Party Transactions (‘RPTs’) to require minority shareholder approvals

While framing a policy for determination of materiality of and dealing with RPTs and half yearly disclosure of RPTs to stock exchange might seem feasible, the 2021 Amendment also stipulates only IDs in the Audit Committee to approve RPTs. Further, in case of material RPTs, at the time of seeking shareholder’s approval all related parties are prohibited from voting to approve the RPT i.e. either they may vote against or abstain from voting altogether.

This is completely paradoxical. A debt listed entity may be a subsidiary of a holding company. The holding company, being a “related party”, will be excluded from voting. If the related parties are to be excluded from voting at the general meeting of a private company, it is quite likely that there will be no shareholders whose votes may be counted!


Subsidiary related governance

An HVD Entity will be required to ascertain material subsidiary, induct an ID on the board of super material subsidiary (that contribute 20% of consolidated income or net worth), place details of significant transactions undertaken by unlisted subsidiary before its Board, place the financials of unlisted subsidiaries before its Audit Committee and seek prior approval of shareholders in case of disposal of shares resulting in losing of control over the entity by the HVD entity or selling/leasing/ disposing 20% of the assets of such material subsidiary in a financial year.

Group governance may be more relevant for entities where the listed entity is answerable for creation of shareholder value. In case of a debt listed entity, the expectation of the investors is not creation of shareholder value but ability to timely service the debt and redeem the principal.


Will this be a deterrent for new issuers or small players from opting for the listed debenture route? Whether these enhanced corporate governance norms provide greater comfort and assurance to the investors in securing timely repayment of their monies? Will it increase trading in debt securities in the secondary market? It is assumed that SEBI must have considered these before enforcing the 2021 Amendment and only time could reveal the effectiveness of these provisions.






[1] The total corporate bond outstanding as on June, 2021[1] is about 36,27,667.18 crores represented by 26,350 outstanding instruments of 3903 issuers. The actual number of issuers, instruments and outstanding amount will be higher, if one were to include unlisted debt issuance as well.

[2] https://www.sebi.gov.in/legal/regulations/sep-2021/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-fifth-amendment-regulations-2021_52488.html

[3] As per SEBI (Issue and Listing of Non-convertible Securities) Regulations, 2021 means debt securities, non-convertible redeemable preference shares, perpetual non-cumulative preference shares, perpetual debt instruments and any other securities as specified by the Board;

[4] As per para 2.2 of https://www.sebi.gov.in/legal/circulars/nov-2018/fund-raising-by-issuance-of-debt-securities-by-large-entities_41071.html

[5] a listed entity identified as a LC, as on last day of FY “T-1”, shall  have to  fulfil  the  requirement  of  incremental borrowing for FY “T”, over FY”T” and “T+1”.

Our other resources on related topics –

  1. https://vinodkothari.com/2021/09/high-value-debt-listed-entities-under-full-scale-corporate-governance-requirements/
  2. https://vinodkothari.com/2021/09/presentation-on-lodr-fifth-amendment-regulations-2021/
  3. https://vinodkothari.com/2021/09/debt-listed-entities-under-new-requirement-of-quarterly-financial-results/
  4. https://vinodkothari.com/2021/09/full-scale-corporate-governance-extended-to-debt-listed-companies/



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Our  our Book on Law and Practice Relating to Corporate Bonds and Debentures, authored by Ms. Vinita Nair Dedhia, Senior Partner and Mr. Abhirup Ghosh, Partner can be ordered though the below link:



Presentation on LODR Fifth Amendment Regulations, 2021

Our other resources on related topics –

  1. https://vinodkothari.com/2021/09/high-value-debt-listed-entities-under-full-scale-corporate-governance-requirements/
  2. https://vinodkothari.com/2021/09/corporate-governance-enforced-on-debt-listed-entities/
  3. https://vinodkothari.com/2021/09/debt-listed-entities-under-new-requirement-of-quarterly-financial-results/
  4. https://vinodkothari.com/2021/09/full-scale-corporate-governance-extended-to-debt-listed-companies/

Full scale corporate governance extended to debt listed companies


View link of the gazette notification here

Our other resources on related topics –

  1. https://vinodkothari.com/2021/09/high-value-debt-listed-entities-under-full-scale-corporate-governance-requirements/
  2. https://vinodkothari.com/2021/09/corporate-governance-enforced-on-debt-listed-entities/
  3. https://vinodkothari.com/2021/09/debt-listed-entities-under-new-requirement-of-quarterly-financial-results/
  4. https://vinodkothari.com/2021/09/presentation-on-lodr-fifth-amendment-regulations-2021/

Credit Default Swaps (Global and Indian Scenario)

Credit default swaps (what is happening in global markets and the recommendations of the working group)

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Our other resources on related topics –

      1. https://vinodkothari.com/wp-content/uploads/RBIa%CC%82%C2%80%C2%99s-Guidelines-on-Credit-Default-Swaps-for-Corporate-Bonds.pdf
      2. https://vinodkothari.com/2021/02/rbi-issues-draft-directions-on-credit-derivatives/
      3. https://vinodkothari.com/isda_new_definition_credit-derivs_impact/
      4. https://vinodkothari.com/2013/12/secnews-110810/
      5. https://vinodkothari.com/rbi-new-cds-guidelines-feeble-effort-start-non-starting-product/

Use of dual recourse instruments for SME finance: The Making of European Secured Notes

– Vinod Kothari and Abhirup Ghosh (finserv@vinodkothari.com)

The European financial regulators are working on a new funding instrument whereby banks and primary lenders can raise refinance against their portfolio of SME loans, by issuing a bond which is directly linked with such portfolios, called European Secured Notes (ESNs). ESNs are a dual recourse instrument, following the time-tested structure of covered bonds.

Covered bonds, developed more than 250 years ago in Europe, use dual recourse structure. The first recourse, against the issuer, is prone to the risk of bankruptcy of the issuer. In that situation, the investors have recourse against the assets of the issuer, and that recourse is made immune from other bankruptcy claims or priorities. This ring-fencing is granted either by explicit legislation, or by use of contract law flexibility. Covered bonds are currently used, to an overwhelming extent, for prime residential mortgage loans. Given their bankruptcy-protected asset backing, covered bonds allow the issuer to get a rating higher than the issuer’s own default rating. This phenomenon, called “notching up”, may cause the ratings on the bonds to go up over the rating of the issues by some 6 to 9 notches.

European regulators are trying to build on the methodology of covered bonds to see if a similar instrument can be used by banks to refinance their SME loan pools.

Development of European Secured Notes:

There have been past instances, sporadically, of dual recourse bonds, on lines similar to ESNs,. A notable instance was Commerzbank’s SME-backed structured covered bond programme established in 2013 but fully repaid in 2018[1]. Besides this, there were several issuances in France, though they are no longer used.

There has been a multi-issuer platform called French “Euro secured Note issuer” (ESNI), established in 2014 and supported by the Banque de France. Though the programme was open to all French and European Banks, only four French banks opted for this. There were around 20 issuances totalling to over Euro 10 Bn. Banque de France acted as the monitor for the asset quality of the SME loans. It used its internal rating model to examine the assets and score them. The scoring, in combination with haircuts on such assets established the minimum over-collateralisation level.

The Italian regulators also proposed to come up with an enabling regulatory framework to permit domestic issuers to issue Obbligazioni Bancarie Collateralizzate (OBC);  however, this seems to have been stranded into oblivion.

Similar efforts were made by the Spanish regulators when they amended the covered bonds framework in 2015.

The work done all this while might have been the inspiration for the European Commission when it proposed the use of ESN as a financial instrument backed by SME loans and infrastructure loans, to be used by banks, as a part of the Capital Markets Union proposals in 2017[2].

Subsequently, the Commission requested a report from the European Banking Authority to set out probable structures of ESNs, which was issued in July 2018[3].

It was originally meant to be kept on the backburner until 2024, however, with the COVID 19 pandemic, the European Parliament asked the European Commission to accelerate the introduction of ESNs to help financing the recovery from the pandemic.

In April 2021, the ESN Task Force, that is, ECBC along with EMF, issued the ESN Blueprint[4]. It appears that ESNs may be rolled out ahead of the original implementation schedule.

Structure of ESNs

Originally, at the time of conceptualisation, there were two structures which were contemplated:

  1. A structure that mirrors the structure of covered bonds,
  2. A structure that mirrors the structure of ABS

However, EBA suggested the first structure in its report.

The key recommendations of the EBA on the structure are as follows:

  1. Dual recourse – The bond must grant the investor a claim on the covered bond issuer, and if it fails to pay, a priority claim on the cover pool limited to the fulfilment of the payment obligations. Further, if the cover pool turns to be insufficient to fulfil the payments, the investor shall have recourse back to the insolvency estate of the issuer, which shall rank pari passu with the claims of the unsecured creditors.
  2. Segregation of cover assets – The next important suggestion was with respect to the segregation of cover assets. The segregation of assets could be either be achieved through registration of the cover pool into a cover register or by transferring them to a special purpose vehicle (SPV). Note that registration of covered bonds is required by several European jurisdictions, as well as Canada.
  3. Bankruptcy-remoteness of the covered bond: The legal/ regulatory framework should facilitate the bankruptcy-remoteness by not requiring acceleration of payments in case of issuer default.
  4. Administration of the covered bond programme after the issuer’s insolvency or resolution: The legal/regulatory covered bond framework should provide that upon issuer’s default or resolution the covered bond programme is managed in an independent way and in the preferential interest of the covered bond investor.
  5. Composition of cover pool: The cover pool should comprise of non-defaulted SME loan and leasing exposures. Further, the pool should be dynamic. Given the high risk associated with SME loans, the EBA recommended incorporating strict eligibility criteria at both loan and pool levels in the form of:
    • selected SME exposures
    • sufficient granularity,
    • concentration limit,
    • quality standards.
  6. Coverage principles and legal/regulatory overcollateralization: The claims against the cover pool should not exceed the receivables arising out of the cover pool. Further, the EBA considered a minimum over-collateralisation must be prescribed for SME ESNs. In this regard, the EBA recommended a minimum over-collateralisation of 30%.

Use of capital market instruments for refinancing SME loans:

“SMEs are important actors in economic growth and transformation, creating positive value for the economy and contributing towards sustainable and balanced economic growth, employment and social stability”[5]. The use of capital market instruments for refinancing SME loans has been engaging the attention of policymakers and regulators alike. The extent of penetration of bank finance to SMEs is far from optimal, and additionally, there are gaping differences across geographies.

Direct access of SMEs to capital markets for debt funding is quite limited, since most of the SMEs do not have the size to be able to attract the attention of institutional investors in the capital market. An OECD-World Bank report notes that “individual SMEs issuances do not easily align with the risk appetite and prudential requirements of institutional investors.”[6] On the other hand, institutional investors may easily participate in bonds or similar instruments which refinance or repackage SME lenders’ loan portfolios. The aforesaid OECD-World Bank report envisages 4 types of capital market instruments for SME refinancing –corporate bonds issued by SME lenders, securitisation of SME loans, SME covered bonds, and SME loan & bond funds, as collective investment schemes.

Issuance of bonds by banks, for on-lending to SMEs or refinancing SME loan portfolios, is quite common in many countries. Such bonds are, however, linked with the performance and rating of the issuer bank.

As for securitisation of SME loans, the overall contribution of SME loans as an asset class in the global securitisation volumes will be in the region of 2%, which obviously dwarfs in comparison to popular asset classes such as residential mortgage loans. Post the GFC, several European jurisdictions have used securitisation of SME loans, but looking at the huge proportion of retained securitisations (see Graph below), it is quite evident that such activity was motivated by the objective of refinancing by ECB. This low volume is despite the fact that  asset backed securitisation is the most natural choice to fund SME loans through capital market, as they provide three benefits:

  1. Provide funding to the banks
  2. The assets move off the books of the originator, depending on the structure
  3. Can be tailor made to the specifications of the investor
  4. Regulatory capital relief

In the recent times, SME ABS issuances in Europe peaked in 2019, of which almost 97% were issued in retained format.

Source: Scope Ratings[7]

Outside of Europe, Korea and India have seen several securitisations of SME loan pools.

Relevance of dual recourse instrument for SME funding

Covered bonds are mostly supported by legislation to provide bankruptcy protection in European jurisdictions. In several other jurisdictions, the flexibility of the common law structure is utilised for providing bankruptcy protection. However, the essential premise in either case is the same –which is the ability of the cover pool to be a backstop for redemption of the bonds, in the event of failure of the issuer to pay them. Therefore, the pool of assets have to be liquid and robust to be able to pay off the bondholders.

There is substantial difference between mortgage pools backing up covered bonds, and SME loans. SME loans have lesser granularity, heterogeneity, and higher historical default rates. The servicing of SME loans from the viewpoint of ongoing collections is also not as easy as in case of mortgage loans. However, these will be ultimately be the factors that would have to be borne in mind by the rating agencies while sizing up the level of over-collateraliation and fixing the level of rating notch-ups for SME-loan-backed covered bonds. As a matter of principle, if there is a market for securitisation of SME loans as demonstrated by recent global transactions, a covered bond structure only tries to marry the benefits of securitisation and corporate bonds. Hence, introducing covered bonds backed by SME loans may be the right idea.

The robustness of covered bond with a history of over 250 years is explained, other than by the legislative protection, by the good quality of the cover pool. The transparency of loan-level performance data of SME loans is much lesser than mortgage loans. Even more importantly, the question is the ability and liquidity of the cover pool, given the insolvency of the issuer, to redeem the bonds. SME loans do not have as liquid secondary market, and the migration of servicing to an alternate servicer makes the liquidity of such loan pools even more difficult. The layering of a credit guarantee support by credit guarantee schemes, which exist practically in every jurisdiction in the world, could also be considered as a credit support.

Should there be a legislative bankruptcy protection, which removes these loan pools completely from the bankruptcy estate and makes the same available to covered bond investors only? This question becomes a complicated one, involving inter-creditor rights. Insolvency for other creditors becomes deeper if there are more bankruptcy-protected instruments.

The urgency for ESNs is also a part of the post-Covid worries of regulators all over the world, and clearly, SMEs are seen as a huge agent of post-Covid revival. However, the need for availability of more liquidity for SMEs has always been crucial. Therefore, the introduction of SME-loan-backed covered bonds may be an agenda items for countries outside of Europe too.

[1] https://www.scoperatings.com/ScopeRatingsApi/api/downloadstudy?id=dfa74ad6-f1ca-4860-a916-bc0638846bb1

[2] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52017DC0292

[3] https://www.eba.europa.eu/sites/default/documents/files/documents/10180/2087449/6fe04a31-ec0b-4ea1-9508-258ad2cf72d8/EBA%20Final%20report%20on%20ESNs.pdf

[4] https://hypo.org/app/uploads/sites/3/2017/05/ECBC-ESN-Blueprint-April-2021.pdf

[5] IOSCO Report, 2015, titled SME Financing Through Capital Markets, at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD493.pdf

[6] https://www.oecd.org/g20/topics/development/WB-IMF-OECD-report-Capital-Markets-Instruments-for-Infrastructure-and-SME-Financing.pdf, page 46

[7] https://www.scoperatings.com/ScopeRatingsApi/api/downloadstudy?id=dfa74ad6-f1ca-4860-a916-bc0638846bb1

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Moving towards sustainable finance through sustainable bonds

SLBs awe-inspiring issuers and investors !

Payal Agarwal, Executive (payal@vinodkothari.com)

ESG or Environmental, Social and Governance concerns are been on a high focus in recent times. The issues are not only been addressed by the environmentalists, but the corporate world is also becoming more and more attentive towards the ESG concerns and devising various ways and means to collate them with their operational activities. One of the various such treads in this regard is the issuance of ESG focussed bonds, which is gradually becoming a popular trend in the global economy, India being no exception. These bonds give a boost to sustainable finance, helping issuers raise finance and investors ensuring their investments fulfil their sustainability goals.

Legal framework in India

In India, the green bonds[1] are one of the most popular and legally recognised means of raising sustainable finance. SEBI, vide its circular dated May 30, 2017 has issued “Disclosure Requirements for Issuance and Listing of Green Debt Securities” which are in addition to the general requirements under the SEBI (Issue and Listing of Debt Securities) Regulations, 2008.

Amidst the constant push towards business sustainability and responsibility conduct through reporting for listed entities[2], India also recognised the need for such ESG debt securities in the Consultation Paper released on draft International Financial Service Centres Authority (Issuance and Listing of Securities) Regulations. The said consultation paper provides for a framework for issuance and listing of securities, including ESG debt securities in the stock exchanges under the IFSC region in India. Now, the International Financial Service Centres Authority (Issuance and Listing of Securities) Regulations, 2021 (“IFSC Regulations”) provide a framework for listing of “ESG debt securities”.

In this article, we will discuss the internationally recognised means of raising sustainable finance and the present and potential capacities of India in raising such sustainable finance by means of ESG debt securities.

Meaning and types

As the name suggests, ESG bonds or debt securities are debt instruments that are linked to or contribute to the development of ESG concepts in some way or the other.

The International Capital Market Association (ICMA) recognises 4 types of bonds that are interested in sustainable financing –

Further separate guidelines[3] have been issued by ICMA in respect of each of these bonds. A snapshot showing comparative between these 4 types of bonds is as follows –

A study of these guidelines show that the SLBs are quite different from other sources of sustainable finance, being “general corporate funds” instead of “use of proceeds” funds.

Therefore, the same has been discussed separately in later parts of this article.

Further, the categories of projects in which proceeds of green bonds, social bonds, and sustainable bonds can be used have been listed below (the list is illustrative) –

Similar standards have been issued by the Climate Bonds Standard Board that recognises only green bonds, Association of South East Asian Nations (ASEAN) having set different standards for green bonds, social bonds and sustainable bonds. Similar standards have also been issued by the European Union for green bonds and social bonds. It is noteworthy that all these standards are voluntary in nature and aligned with the ICMA Guidelines with some modifications of their own. The IFSC Regulations also recognise all the 4 types of bonds as ESG debt securities, issued as under any of the aforesaid guidelines.

Sustainability-linked bonds (SLBs) – where lies the uniqueness?

As discussed above, internationally there are four types of recognised ESG bonds, which are also proposed to be imbibed in the legal framework in India. While the first three being in the nature of “use-of-proceeds” bonds, the Sustainability-linked bonds or SLBs have distinguishing features. The SLBs rests on five key pillars, as follows –

The SLBs require companies to frame key performance indicators and Sustainability Performance Targets. To give an example, a company may frame its sustainability performance target to reduce its greenhouse gas (GHG) emissions by 20% compared to that of the year 2018 as baseline. In this case, the key performance indicators can be reduction of CO2 emissions, reduction of carbon footprint etc.

Growth of ESG bonds

The Environmental Finance – Sustainable Bonds Insight, 2021 provides

data analytics in respect of the various types of sustainable bonds issued during the year 2020. The data shows high volume of green and social bonds issued during the year as compared to sustainable bonds and SLBs, which are relatively new and evolving concept. While the figures show a comparative between different types of ESG bonds issuance, it also provides an insight on the increasing volume of the ESG bonds being issued in the Covid era (an increase in the bonds issuance in the months of September, October and November).


Present position v/s potential growth

The Report shows a comparison of the development of sustainable bond market in the recent years and an estimate of what is expected in the current year 2021. It demonstrates clearly that the sustainable bond market is expected to rise further in the upcoming areas.

Growth of ESG bond market in India in recent times

In India, the ESG bonds issuance is witnessing an evident upshot. However, the same has not found much investors’ interest in the country. Nevertheless, the Indian issuer companies have still been able to raise much funds from the issuance of ESG bonds from global investors. The below chart clearly demonstrates the increase in funds raised by way of issue of ESG bonds[4].

Some of the big Indian issuers of ESG focussed bonds include GreenCo, JSW Hydro Energy, Shriram Transport Finance Company, India Green Power Holdings, ReNew Power, Ultratech Cement Ltd etc.

Sustainability linked bonds or SLBs, as discussed, is relatively new and innovative concept in the podium of ESG bonds in the world. India has made a remarkable entry in this field with Ultratech Cement Limited[5], issuing SLBs, thereby, being the first company in India and second in Asia to issue SLBs. The company has raised a total of 400 million USD equivalent to Rs. 2900 crores by way of issuance of such SLBs. The same has been listed in the Singapore Exchange Securities Trading Limited[6].

ESG Bonds – Motivations for the Issuer and Investor

Issuer’s perspective

  • Cost advantage due to yield reduction – The yield payment in respect of ESG bonds are relatively lower than that of other conventional bonds[7]. A reason for such lower yields is increase in demand with limited supply of such bonds. An example may be the issuance of green bonds by Italian Government[8], which was oversubscribed by 10 times.
  • Role as corporate citizens – The ESG bonds contribute to demonstrating the role of issuers as responsible corporate citizens, spending the proceeds generally on sourcing of renewable energy, pollution reduction, climate change initiatives.
  • Attracts responsible investors – The ESG bonds align with social development goals (SDGs) and principles of responsible investing (PRI) thereby attracting socially responsible investors whose investment decisions are more of impact-oriented than yield-based.
  • Seen as ethical companies – The companies issuing ESG bonds are looked upon as ethical companies by the stakeholders thereby helping in demonstrating a good corporate image.

Some additional advantages motivation lies for issuance of SLBs

  • Flexibility of designing structure – The main feature of SLB is that it gives a flexibility to the issuers to design their issued bonds in their own way.
  • Flexibility with regard to use of proceeds – Another flexibility is with regard to the use of issue proceeds which need not necessarily be towards promoting green projects, social projects or the like. Therefore, the companies are free to use the proceeds for their operational activities without giving a second thought on whether the same qualifies as a green project or social project.
  • Motivation for fulfilment of ESG targets – The SLBs put a “step-up” on the coupon rate of the bonds in case the issuer misses its ESG target. Therefore, it gives an additional economic interest for the issuers to fulfil their ESG targets.

Investor’s perspective

It is said that behind the investors’ growing interest in ESG bonds lies two reasons – (i) values-driven and (ii) value-driven. While the investors, as part of their responsibility towards the society and environment, consider ESG in their investment analysis, that is not the only reason investors are investing in ESG bonds. Another reason that drives the investors in supporting ESG concerns and investing in ESG bonds is the long term perspective and the expectation of deriving great value from their investment portfolio. The investors believe that a company that invests in the ESG concerns and addresses the ESG issues properly, are more likely to earn profits in the long term. Therefore, while the investors are demonstrating their values and responsible behaviour by choosing ESG focussed bonds, they are also booking adequate profits for themselves in the long run.

Now, with the new SLBs coming into picture, the investors are likely to get more benefits out of their investment in the ESG bonds in the form of SLBs. The terms of SLBs are designed as such that the investors get a “step-up” or hike in the coupon rates as and when the issuer misses a pre-defined target (identified as SPTs).

Sustainability-linked bonds (SLBs) – investors always at the winning end

The concept of SLBs comes with a very interesting feature – where investor benefits on the issuer missing its ESG target. Since the investor is making profits on the cost of compromise in ESG responsibilities by issuer, therefore it is controversial that how can an investor show his ESG responsibility at a time when it is making profits on failure to reach ESG targets? However, that is not the case. Another viewpoint towards the case maybe that the investors are motivating their issuers in reaching their ESG targets, and where they fail to do, the investors cast a penalty on the issuer. Whatever the case may be, in both the scenarios, investors are the one who are at the winning side.

A recent interesting case of issue of ESG bonds in the form of SLBs may be discussed here.

A Japanese firm, Nomura Research Institute Ltd, has issued ESG bonds with the “variable bond characteristics” as below –

  1. Where the issuer reaches target – early redemption of debts
  2. Where the issuer misses target – extra yield to investors

In both the cases, the investors will be benefitted. In the first case, the investor will earn return on their investments early, so they will be in possession of their funds again at a shorter span of time. On the contrary, in the second case, though the funds of the investors will be locked for a longer time, the same will bring them higher yield. So, the investors, are very well in a win-win position in all probable cases.

Requirements for listing of ESG debt securities in India

The Ministry of Finance has notified the IFSCA (Issuance and Listing of Securities) Regulations, 2021 or the IFSC Regulations.  It is a unified framework for various kinds of securities and is framed with the main intent of consolidating the regulatory requirements in order to access the global capital with more ease and less complexity. The concept of ESG bonds have been specifically recognized and captured under Chapter X of the said Regulations. However, it has to be noted that these IFSC regulations are applicable only for the IFSC-listed companies. No specific framework is provided for ESG bonds for other domestic companies in India outside the scope of IFSC Regulations. The same can still be taken as a guidance for other domestic issuances.

While the requirements for issuance and listing of ESG bonds are given in Chapter X, the same is in addition to those under Chapter IX of the Regulations. Please note that, Chapter IX lays down the requirements for issuance and listing of debt securities. By “debt securities” is meant the non-convertible debt securities, as is clear from the definition of “debt securities” under Regulation 2(e) of the Regulations.

The additional requirements for the ESG bonds are as follows –

  • An independent external review is required to be obtained in order to satisfy that the issue of ESG bonds are in line with internationally recognised standards set for ESG bonds, the principles of ICMA being one of them.
    • Review may be in the form of verification, certification, second party opinion, or scoring/rating.
  • The most important requirement under ESG investing is disclosure and reporting The same is being discussed here under a separate head.
  • Impact report is important in order to measure the actual impact of the projects in which the ESG funds have been spent.

Disclosure and reporting

As also envisaged by the Sustainability-linked bond principles of ICMA, disclosure is a main pillar of ESG investing. The IFSCA Regulations also focusses on the disclosure requirements.

Under the IFSCA Regulations, the following disclosures are required to be made –

  • The objectives of the issue of debt securities
  • The process followed for selection and evaluation of projects
  • The system employed for tracking deployment of issue proceeds
  • Intended vs actual utilisation of issue proceeds
  • Specific projects to which the issue proceeds have been disbursed/ allocated.

Further, in case of SLBs, the reporting guidance as under the ICMA Guidelines shall apply.

Applicability to other listed entities not covered under IFSC Regulations

The IFSC Regulations are not applicable to companies other than those listed under the jurisdiction of IFSC Authority. However, the IFSC Regulations are in alignment with other internationally-recognised principles in this regard. We have taken examples of some Indian companies like JSW Steel, Ultratech Cement, Adani Energy, Shriram Transport Finance Co. Ltd, Ultratech Cement etc which provides disclosures and follow the requirements of external review in line with the ICMA Guidelines and IFSC Regulations, which re-iterate requirements of ICMA and other internationally recognised guidelines.


As the world has approached the twentieth century, a shift has become apparent towards more grounded aspects of life – rather than just profit earning. Earlier, it was believed that the corporate world has only one motive – the profit earning motive. However, the focus has now been modified to include various other aspects as well. With instruments like ESG bonds, the efforts are being made to include sustainability in the economy, so that both can progress side-by-side. As the statistics above suggest, India is nowhere lagging behind in the ESG investing. This may be seen as one of the probable cause that IFSCA has included ESG bonds as a specified security in its Listing Regulations.  The IFSCA Regulations do not introduce the ESG bonds in India for the first time, rather it just seeks to regulate issuance of the same by means of express regulations in this regard.

[1] Our article on the same can be read here

[2] Read our articles on the same here

[3] Green Bond Principles

Social Bond Principles

Sustainability Bond Guidelines

Sustainability-linked Bond Principles

[4] https://www.refinitiv.com/

[5] See Page 4 of the Annual Report here

[6] Listing confirmation can be accessed here

[7] Asian Development Outlook – 2021

[8] Read this here

Our other related resources –

  1. https://vinodkothari.com/2014/03/prospects-green-bonds-rise/
  2. https://vinodkothari.com/2017/05/guidelines-for-issuance-of-green-bonds/
  3. https://vinodkothari.com/wp-content/uploads/2017/03/India_plans_to_tap_Green_Bonds-1.pdf
  4. http://vinodkothari.com/2020/08/cartload-of-details-in-brsr-a-challenge-ahead-for-elaborate-reporting/
  5. http://vinodkothari.com/2020/08/brr-in-process-to-become-a-fully-loaded-electronic-form/
  6. http://vinodkothari.com/2021/03/esg-concerns-on-corporate-governance-in-india/
  7. https://vinodkothari.com/2021/07/corporate-responsibility-towards-climate-change-uk-leads-regulatory-measures/

Proxy advisors and their role in corporate decision making on questions of law

Sharon Pinto, Manager, corplaw@vinodkothari.com

Concept of proxy advisors

Proxy advisors are research based entities that formulate recommendations on the decisions of companies which require shareholder approval. SEBI (Research Analysts) Regulations, 2014 (‘SEBI Regulations’), defines proxy advisors “as any  person  who  provides  advice,  through  any  means,  to institutional investor or shareholder of a company, in relation to exercise of their rights in the company including recommendations on public offer or voting recommendation on agenda items”. Thus, these advisory firms guide shareholders to make sound investment decisions and exercise their voting rights effectively. Matters that require shareholder approval under the Companies Act, 2013, are of significant importance and include decisions pertaining to appointment of directors (including managing director, whole-time directors, independent directors), manager, approval of their remuneration, alteration of Articles or Memorandum of Association of the company, etc. The clientele of the proxy advisory firms includes institutional investors, who are usually not privy to the affairs of the company. Thus, they may rely on the recommendations issued by the said entities. As in case of certain companies the shareholding/voting rights of such investors may be considerably large, the recommendations of a proxy advisory firm may substantially affect the decision-making by the investor, and in turn, the affairs of the company.

As per Regulation 2 (1) (m) of SEBI (Investment Advisors) Regulations, 2013, ‘investment advisor’ means a person who is engaged in the business of providing investment advice for a consideration. However, a proxy advisor is into recommending voting decisions to shareholders, and are not into recommending whether an investor or a potential investor should or should not make/keep an investment.

Investment advisors are entities that specifically provide financial advice. They undertake research in order to provide advice relating to investment decisions of their clients, separating them from proxy advisors, who provide voting recommendations on agenda items, which may also include approval of public offer by the shareholders. Thus, the role of proxy advisors does not entail provision of financial advice.

In this article, the author deliberates on the role of proxy advisors and the issues concerning their functioning, the enforceability of the recommendations, while perusing the position of applicable laws in India as well as in the global context.

Effect of proxy advisor recommendation on corporate decisions

The role of proxy advisors is of a benign nature. They perform the function of educating investors of the right corporate governance practices on the basis of the research undertaken by them. Thus, they may act as catalysts in strengthening corporate governance. However, the downside to the process is the possibility of concentration of power with the proxy advisors and lack of regulatory overview or safeguards w.r.t. their opinions. Since the guidelines are based on best governance practices, they may go beyond the provisions of law. Further, the recommendations and guidelines thus issued are not subject to regulatory overview or approval. They are solely the views of the advisory entities and may thus differ on the grounds of interpretation or factual information. Thus, the said recommendations and guidelines must be used as a tool for further analysis by the investor and thereafter making independent decisions and not as views of the regulator, on account of the proxy advisors being licensed market intermediaries. The below figure shows an analysis of the effect of negative voting recommendations of the proxy advisor on the resolutions pertaining to related party transactions, appointment of non-executive directors, independent directors and other significant corporate decisions:

The current provisions applicable to proxy advisory entities in India do not prescribe for prior interaction of the firms with the company. While the same may act as a safeguard for the freedom of proxy advisory entities to express their opinions, the recommendations of the advisory entities may lack the consideration of necessary facts or information in order to give a comprehensive picture of the proposed decision of the company.

Concerns stemming from voting guidelines and recommendations of proxy advisors and existing regulatory framework

As the regulatory framework governing proxy advisors is still evolving, certain issues relating to the functioning of the proxy advisors and the guidelines and recommendations issued by them require further regulatory oversight. The existing regulatory framework and safeguards in place have been discussed below with respect to the said concerns.


Proxy advisory firms operating in India are required to obtain a license under the afore-mentioned SEBI Regulations. They are also required to mandatorily adopt a code of conduct as prescribed under the SEBI Regulations. The SEBI Regulations have set forth provisions relating to registration, eligibility criteria, management of conflict of interest, adoption of code of conduct among other matters. 

  • Conflict of interest

Conflict of interest is a major concern in case of proxy advisory firms providing other services like consultancy services to the company in addition to being advisors to its investors. Thus, it may give rise to biased opinions which are reflected in the recommendations of the advisory entity, resulting in negative impact on the shareholder interest. Chapter III of the SEBI Regulations deals with management of conflict of interest and disclosure requirements which mutatis mutandis applies to proxy advisors.

As per Regulation 15 (1) of SEBI Regulations, the entities are required to maintain internal policies and procedures governing the dealing and trading by any research analyst for addressing actual or potential conflict of interest arising from such dealings or trading of securities of the subject company. The said Regulations further prescribe restrictions on the dealings by employees of the advisory firms. Regulation 17 provides for the conditions on the compensation received by research analysts, wherein the compensation is required to be reviewed by the board of the research entity and is to be independent of the brokerage services division. Further, the SEBI Regulations prescribe for restriction on publication and distribution of reports of a subject company in which the research analyst has acted as a manager or co-manager.

In addition to other disclosures, following w.r.t. whether the research analyst or research entity or his associate or his relative has any, will form part of the research report:         


As per SEBI procedural guidelines for proxy advisors issued on August 3, 2020, proxy advisors are required to disclose conflict of interest on every specific document where they are giving their advice. Further, the disclosures should especially address possible areas of potential conflict and the safeguards that have been put in place to mitigate possible conflicts of interest. They are also required to establish clear procedures to disclose, manage and/or mitigate any potential conflicts of interest resulting from other business activities including consulting services, if any, undertaken by them and disclose the same to clients.


  • Material misstatements and factual errors


Proxy advisors are required to additionally disclose in their reports the  extent  of  research  involved  in  a  particular  recommendation  and  the  extent  and/or effectiveness of its controls and procedures in ensuring the accuracy of issuer data in accordance with Regulation 23 of the SEBI Regulations. Further, the above-mentioned procedural guidelines issued by SEBI state that proxy advisors shall ensure that the recommendation policies are reviewed at least once annually. They shall further disclose the methodologies and processes followed in the development of their research and corresponding recommendations to their clients.

Regulation 20 of the SEBI Regulations, has prescribed the following with regard to contents of the Report:

  1. Research analyst or research entity shall take steps to ensure that facts in its research reports are based on reliable information and shall define the terms used in making recommendations, and these terms shall be consistently used.
  1. Research  analyst or  research  entity that  employs  a  rating  system  must  clearly  define the meaning  of  each  such  rating  including  the  time  horizon  and   benchmarks  on  which  a  rating  is based.
    1. If a research report contains either a rating or price target for subject company’s securities and the research analyst or research entity has assigned a rating or price target to the securities for at least  one  year,  such  research  report  shall  also  provide  the  graph  of  daily  closing  price  of  such securities for the period assigned or for a three-year period, whichever is shorter.


  • Interaction with the subject company


Regulation 23 of the SEBI Regulations, stipulates a proxy advisor to disclose the policies and procedures for interacting with issuers, informing issuers about the recommendation and review of recommendations. The afore-mentioned SEBI procedural guidelines for proxy advisors state that the proxy advisor shall have a stated process to communicate with its clients and the company. Further, proxy advisors shall share their report with their clients and the company at the same time. The said ‘sharing policy’ is required to be disclosed by proxy advisors on their website. Timeline to receive comments from company may be defined by proxy advisors and all comments/clarifications received from the company, within the said timeline, shall be included as an addendum to the report. If the company has a different viewpoint on the recommendations stated in the report of the proxy advisors, then proxy advisors, after taking into account the said viewpoint, may either revise the recommendation in the addendum report or issue an addendum to the report with its remarks, as considered appropriate.

  • Difference of opinion

The views of proxy advisors as discussed herein are solely based on their research and interpretation not subject to the approval of any regulator. Further, the benchmarks set by the entities are based on highest corporate governance principles, hence they may surpass the requirement of law.

The procedural guidelines issued by SEBI state that they shall clearly disclose in their recommendations the legal requirement vis-a-vis higher standard they are suggesting if any, and the rationale behind the recommendation of higher standards.

The Report of the Working Group dated July 29, 2019, formulated by SEBI on issues concerning proxy advisors has proposed for proxy advisors to send an unedited response of the company to all its subscribers. In case a company is not satisfied with the response, it may write again to proxy advisors and in case the response is still not acceptable, the Company concerned may approach SEBI under the SEBI Regulations seeking SEBI’s intervention. However, mere differences based on opinion, which are backed with authentic public data and analysis, cannot be the basis of any complaint or litigation. Litigation should not be initiated merely because an opinion is not favourable to the management of a company, especially if opportunity had been given by proxy advisors to the company and the same has been duly addressed. Thus, an objection may only be raised by companies in case of abuse of power by the proxy advisors by violating the Code of Conduct as mandatorily prescribed under SEBI Regulations. A mere case of difference of opinion basis different interpretations, which is not on account of factual misstatement or lack of material facts, cannot be the basis of contention.

United States of America

Under the Securities Exchange Act of 1934 (‘Exchange Act’), Securities and Exchange Commission (‘SEC’) regulates the proxy solicitation process for publicly traded equity securities. SEC also regulates the activities of proxy advisory firms that are registered with SEC as investment advisers under the Investment Advisers Act of 1940 (Advisers Act). As per the SEC’s Interpretation and Guidance on Applicability of Proxy Rules on Proxy Voting Advice, it has stated that proxy voting advice should be considered a solicitation, subject to the federal proxy rules because it is “a communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.”

  • Conflict of interest

SEC in its Guidance on Investment Advisor’s use of Proxy Advisors states that an investment adviser’s decision regarding whether to retain a proxy advisory firm should also include a reasonable review of the proxy advisory firm’s policies and procedures regarding how it identifies and addresses conflicts of interest. Since proxy voting advice has been considered as solicitation, relevant federal proxy rules shall apply. Solicitations that are exempt from the federal proxy rules’ information and filing requirements remain subject to Rule 14a-9 of General Rules and Regulations of Exchange Act. Accordingly, the provider of the proxy voting advice should consider whether, depending on the particular statement, it may need to disclose about material conflicts of interest that arise in connection with providing the proxy voting advice in reasonably sufficient detail so that the client can assess the relevance of those conflicts in order to avoid a potential violation of the aforesaid rule.

SEC has proposed amendments to regulate proxy advisors which shall be mandatory from December 1, 2021. As per the said amendments, any person providing proxy voting advice within the scope of proposed rules, who wishes to utilize the exemption in either Rule 14a–2(b)(1) or (b)(3) must include in their voting advice (or in any electronic medium used to deliver the advice) prominent disclosure of: 

  1. Any information regarding an interest, transaction, or relationship of the proxy voting advice business (or its affiliates) that is material to assessing the objectivity of the proxy voting advice in light of the circumstances of the particular interest, transaction, or relationship; and 
  2. Any policies and procedures used to identify, as well as the steps taken to address, any such material conflicts of interest arising from such interest, transaction, or relationship


  • Material misstatements and factual errors


Rule 14a–9 prohibits any proxy solicitation from containing false or misleading statements with respect to any material fact at the time and in light of the circumstances under which the statements are made. In addition, such solicitation must not omit to state any material fact necessary in order to make the statements therein not false or misleading. As per the SEC amendments mentioned above, entities providing proxy voting advice, in case of failure to disclose material information regarding proxy voting advice, ‘‘such as the proxy voting advice business’s methodology, sources of information, or conflicts of interest’’ could, depending upon particular facts and circumstances, be misleading within the meaning of the rule. It has been further stated that, the amendment does not make mere differences of opinion actionable under Rule 14a–9.


  • Interaction with the subject company


SEC amendments in Rule 14a of the Exchange Act, 1934, provide certain exemptions with respect to filing requirements of the proxy rules subject to the condition that registrants that are the subject of proxy voting advice have such advice made available to them at or prior to the time when such advice is disseminated to the proxy voting advice business’s clients

The amendments also provide for safe harbour rules specifying policies and procedures of the proxy advisors may include conditions requiring registrants to –

  1. file their definitive proxy statement at least 40 calendar days before the security holder meeting 
  2. expressly acknowledge that they will only use the proxy voting advice for their internal purposes and/or in connection with the solicitation and will not publish or otherwise share the proxy voting advice except with the registrant’s employees or advisers.


  • Difference of opinion


While Rule 14a-9 of Exchange Act, 1934 states that no solicitation subject to this regulation shall be made by means of any proxy statement or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, the same is not applicable in case of difference of opinion. However, since as per the proposed SEC amendments, entities will be required to make their proxy voting advice available to the registrants at or prior to the time when such advice is disseminated to the proxy voting advice business’s clients, the same shall provide a fair opportunity for representation to the registrant companies.

United Kingdom

As per the Directive (EU) 2017/828, a proxy advisor is a legal person that analyses, on a professional and commercial basis, the corporate disclosure and, where relevant, other information of listed companies with a view to informing investors’ voting decisions by providing research, advice or voting recommendations that relate to the exercise of voting rights. The Proxy Advisors (Shareholders’ Rights) Regulations 2019, came into force on 10th June, 2019. The Proxy Advisors (Shareholders’ Rights) Regulations in part implement the revised Shareholders Rights Directive (Shareholder Rights Directive II).

  • Conflict of interest

The Proxy Advisors (Shareholders’ Rights) Regulations, 2019, under Regulation 5, state that the proxy advisor must take all appropriate steps to ensure that it identifies any actual or potential conflict of interest or any business relationship that may influence the advisor in the preparation of research, advice or voting recommendations. Further, such a conflict of interest or business relationship is required to be identified without delay after the time at which it arises. In case of identification of an actual or potential conflict of interest, the proxy advisor must disclose the fact to its clients together with particulars of the conflict of interest or business relationship concerned, in addition to a statement of the action it has undertaken to eliminate, mitigate or manage the conflict of interest or business relationship concerned.


  • Material misstatements and factual errors


Regulation 4 of the Proxy Advisors (Shareholders’ Rights) Regulations, 2019, prescribes minimum information to be disclosed relating to preparation of research, advice and voting recommendations, as given below:

Similar to the legislation in India, the policies and procedures are required to be reviewed at intervals of no more than twelve months beginning with the date on which it was last updated.


  • Difference of opinion


Adoption of Code of Conduct is not mandatory under the Proxy Advisors (Shareholders’ Rights), 2019, provided the proxy advisors provide a clear and reasoned explanation of reasons for not doing so. The provisions prescribe a person may submit a complaint to the Financial Conduct Authority (FCA), in case of contravention of any requirement. Further, the Code of Conduct is required to be updated at an interval of not more than twelve months.


Under the Australian regime, only the proxy advisors providing financial services are required to obtain a license referred to as Australian Financial Services (AFS) license, under the Australian Corporations Act, 2001. Thus, the obligations set forth under the said Act are not applicable to proxy advisors that undertake research and provide voting recommendations.

  • Conflict of interest

In case of proxy advisory firms providing financial services pursuant to Australian financial services (AFS) license, one of the obligations under Section 912A of the Corporations Act stipulates that the proxy advisors are to have adequate arrangements in place for the management of conflicts of interest that may arise wholly, or partially, in relation to activities undertaken in the provision of financial services.


  • Interaction with the subject company


On the same lines as the amendments proposed by SEC, in the consultation paper issued by the Treasury of Australian Government in April 2021, it is proposed that proxy advisers will be required to provide their report containing the research and voting recommendations for resolutions at a company’s meeting, to the relevant company before distributing the final report to subscribing investors. It has also been proposed that the advisory entities will be required to notify their clients on how to access the company’s response to the report, by providing a website link or instructions on how to access the response elsewhere. Thus, at present there is no requirement of prior engagement with the subject company.


  • Difference of opinion


Section 912D of the Corporations Act of Australia states that a licensed financial advisor is obligated to lodge a written report with the ASIC in case of a breach of the obligation prescribed under the Act, as soon as practicable but not later than 10 business days after becoming aware of the breach.  However, as proxy advisory entities are currently not required to obtain a license under the Corporations Act, the said provisions are not applicable to them.

ASIC in its review of proxy advisor engagement practices dated June 2018, recommended that if a subject company discovers a matter that is materially false or misleading in a proxy adviser report, the company should:

  • notify the proxy adviser of the matter promptly and seek a correction
  • consider whether it would be appropriate to respond to the matter by way of an ASX announcement or other communication to investors.  

Closing thoughts with respect to tightening of norms relating to proxy advisors

Fair disclosure of information: Proxy advisory entities have garnered more attention in recent years. They have an increased influence over institutional investors and thus have the power to affect the functioning of companies on the basis of the voting recommendations they provide. It is thus necessary that fair and complete disclosure relating to the facts and interpretation of the proxy advisor entity be stated. While certain advisory firms state a disclaimer in their reports, mentioning the fact that the views of the report are not approved by the regulatory authorities, but based on their own benchmarks, the same is not a requirement specified under the regulations governing the entities.

Regulatory oversight of adherence of code of conduct: While it is mandatory for the proxy advisory entities to adopt a code of conduct under the SEBI Regulations, there should be a regulatory oversight on the adherence of the said Code. Further, there is a requirement of placing a fiduciary responsibility on the proxy advisory entities as the guidelines and recommendations published by them are available in the public domain and may affect the opinions of the shareholders of the company. Therefore, the same is required to be unbiased and must state a fair representation of the facts involved. Further, it may be stipulated that, in cases where the proxy advisor is taking a view based on an interpretation of law, which might differ across market participants, the proxy advisor shall specifically state so, and advise the client to take an independent view.

Representation of the subject company: Currently, SEBI procedural guidelines require that the proxy advisors share the report with their clients and the subject company at the same time.  However, as per the amendments proposed in the US and Australian regulatory framework, proxy advisors would be required to provide their report to the subject company prior to the issue of the same to its clients. The same may fill the gap arising out of incomplete or obsolete information. Hence, it may be more relevant if the draft report is shared with the subject company before the same is shared with the client/investors; such that a consolidated report, including the views and interpretations of the subject company, may be issued to the shareholders/clients. This would ensure – (i) a fair opportunity to the subject company to rebut the views/interpretations taken by the proxy advisor, (ii) that the shareholder’s views are not pre-conditioned by the sole views of proxy-advisors, as they do not get the views of the subject company at the first instance. As a matter of reasonable checks, the shareholders may be given the right to seek for the draft report shared by the proxy-advisor with the subject company.

Responsibility of institutional investors – The institutional investors should appropriately weigh on the views of the proxy advisors and the subject company, and ultimately make their own independent analysis of the facts in hand to decide on the issue. 

Other articles on proxy advisors:

  1. Dance of Corporate Democracy: The rise of proxy advisors


  1. SEBI prescribes stricter regimes for Proxy Advisors; Issues procedural guidelines to be followed in addition to Code of Conduct


  1. SEBI revisits regulatory framework for Proxy Advisors


  1. Scope of Proxy Advisors to issue general voting guidelines


Covered Bonds in India: creating a desi version of a European dish

Abhirup Ghosh | abhirup@vinodkothari.com

It is not uncommon to have Indianised version of global dishes when introduced in India, and we are very good in creating fusion food. We have a paneer pizza, and we have a Chinese bhel. As covered bonds, the European financial instrument with over 250 years of history were introduced in India, its look and taste may be quite different from how it is in European market, but that is how we introduce things in India.

It is also interesting to note that regulatory attempts to introduce covered bonds in India did not quite succeed – the National Housing Bank constituted Working Group on Securitisation and Covered Bonds in the Indian Housing Finance Sector, suggested some structures that could work in the Indian market[1]  and thereafter, the SEBI COBOSAC also had a separate agenda item on covered bonds. Several multilateral bodies have also put their reports on covered bonds[2].

However, the market did not wait for regulators’ intervention, and in the peak of the liquidity crisis of the NBFCs, covered bonds got uncovered – first slowly, and now, there seems to be a blizzard of covered bond issuances. Of course, there is no legislative bankruptcy remoteness for these covered bonds.

There are two types of covered bonds, first, the legislative covered bonds, and second, the contractual covered bonds. While the former enjoys a legislative support that makes the instrument bankruptcy remote, the latter achieves bankruptcy remoteness through contractual features.

To give a brief understanding of the instrument, a standard covered bond issuance would reflect the following:

  1. On balance sheet – In case of covered bonds, both the cover pool and the liability towards the investor remains on the balance sheet of the issuer. The investor has a recourse on the issuer. However, the cover pool remains ring fenced, and is protected even if the issuer faces bankruptcy.
  2. Dual recourse – The investor shall have two recourses – first, on the issuer, and second, on the cover pool.
  3. Dynamic or static pool – The cover pool may be dynamic or static, depending on the structure.
  4. Prepayment risk – Since, the primary exposure is on the issuer, any prepayment risk is absorbed by the issuer.
  5. Rating arbitrage – Covered bonds ratings are usually higher than the rating of the issuer. Internationally, covered bonds enjoy upto a maximum of 6-notch better rating than the rating of the issuer.

Therefore, covered bond is a half-way house, and lies mid-way between a secured corporate bond and the securitized paper. The table below gives comparison of the three instruments:

  Covered bonds Securitization Corporate Bonds
Purpose Essentially, to raise liquidity Liquidity, off balance sheet, risk management,

Monetization of excess profits, etc.

To raise liquidity
Risk transfer The borrower continues to absorb default risk as well as prepayment risk of the pool The originator does not absorb default risk above the credit support agreed; prepayment risk is usually transferred entirely to investors. The borrower continues to absorb default risk as well as prepayment risk of the pool
Legal structure A direct and unconditional obligation of the issuer, backed by creation of security interest. Assets may or may not be parked with a distinct entity; bankruptcy remoteness is achieved either due to specific law or by common law principles True sale of assets to a distinct entity; bankruptcy remoteness is achieved by isolation of assets A direct and unconditional obligation of the issuer, backed by creation of security interest. No bankruptcy remoteness is achieved.
Type of pool of assets Mostly dynamic. Borrower is allowed to manage the pool as long as the required “covers” are ensured. From a common pool of cover assets, there may be multiple issuances. Mostly static. Except in case of master trusts, the investors make investment in an identifiable pool of assets. Generally, from a single pool of assets, there is only issuance. Dynamic.
Maturity matching From out of a dynamic pool, securities may be issued over a period of time Typically, securities are matched with the cashflows from the pool. When the static pool is paid off, the securities are redeemed. From out of a dynamic pool, securities may be issued over a period of time.
Payment of interest and principal to investors Interest and principal are paid from the general cashflows of the issuer Interest and principal are paid from the asset pool Interest and principal are paid from the general cashflows of the issuer.
Prepayment risk In view of the managed nature of the pool, prepayment of loans does not affect investors Prepayment of underlying loans is passed on to investors; hence investors take prepayment risk Prepayment risk of the pool does not affect the investors, as the same is absorbed by the issuer.
Nature of credit enhancement The cover, that is, excess of the cover assets over the outstanding funding. Different forms of credit enhancement are used, such as excess spread, subordination, over-collateralization, etc. No credit enhancement. Usually, the cover is 100% of the pool principal and interest payable.
Classes of securities Usually, a single class of bonds are issued Most transactions come up with different classes of securities, with different risk and returns Single class of bonds are issued.
Independence of the ratings from the rating of the issuer Theoretically, the securities are those of the issuer, but in view of bankruptcy-proofing and the value of “cover assets”, usually AAA ratings are given AAA ratings are given usually to senior-most classes, based on adequacy of credit enhancement from the lower classes. There is no question of independent rating.
Off balance sheet treatment Not off the balance sheet Usually off the balance sheet Not applicable.
Capital relief Under standardized approaches, will be treated as on-balance sheet retail portfolio, appropriately risk weighted. Calls for regulatory capital Calls for regulatory capital only upto the retained risks of the seller Not applicable


This article would briefly talk about the issuance of Covered bonds world-wide and in India, and what are the distinctive features of the issuances in India.

Global volume of Covered Bonds

Since most volumes for covered bonds came from Europe, there has been a decline due to supply side issues. This is evident from the latest data on Euro-Denominated Covered bonds Volume. The performance in FY 2020 and FY 2021 has been subdued mainly due to COVID-19. Though, the volumes suffered significantly in the Q3 and Q4 of FY 20, but returned to moderate levels by the beginning of FY 2021.

The figure below shows Euro-Denominated Covered bond Issuances until Q2 2021.

Source: Dealogic[3]

Countries like Denmark, Germany, Sweden continues to be dominant markets for covered bond issuances. The countries in the Asia-Pacific region like Japan, Singapore, and Australia continues to report moderate level of activities. In North America, Canada represents all the whole of the issuance, with no issuances in the USA.

The tables below would show the trend of issuances in different jurisdictions in 2019 (latest available data):

Source: ECBC Factbook 2020[4]

Covered Bonds in India

In India, the struggle to introduce covered bonds started way back in 2012, when the National Housing Bank formed a working group[5] to promote RMBS and covered bonds in the Indian housing finance market. Though the outcome of the working group resulted in some securitisation activity, however, nothing was seen on covered bonds.[6]

Some leading financial institutions attempted to issue covered bonds in the Indian market, but they failed. Lastly, FY 2019 witnessed the first instance of covered bonds, which was backed by vehicle loans.

In India, issuance of covered bonds witnessed a sharp growth in FY 2021, as the numbers increased to INR 22 Bn, as against INR 4 Bn in FY 2020. Even though the volume of issuances grew, the number of issuers failed to touch the two-digit mark. The issuances in FY 2021 came from 9 issuers, whereas, the issuances in FY 2020 were from only 2 issuers. Interestingly, all were non-banking financial companies, which is a stark contrast to the situation outside India.

The figure below shows the growth trajectory of covered bonds in India:

Source: ICRA, VKC Analysis

The growth in the FY 2021 was catapulted by the improved acceptance in Indian market in the second half of the year, given the uncertainty on the collections due to the pandemic, and the additional recourse on the issuer that the instrument offers, when compared to a traditional securitisation transaction.

Almost 75% of the issuances were done by issuers have ‘A’ rating, the following could be the reasons for such:

  1. Enhanced credit rating – In the scale of credit ratings, ‘A’ stands just above the investment grade rating of ‘BBB’. Therefore, it signifies adequate degree of safety. With an earmarked cover pool, with certain degree of credit enhancements and, covered bonds issued by these entities fetched a much better credit rating, going up to AA or even AAA.
  2. AUM – FY 2021 was a year of low level of originations due to the pandemic. As a result, most of the financial sector entities stayed away from sell downs, which is evident from the low of level of activity in the securitisation market, as they did not want their AUM to drop significantly. In covered bonds, the cover pool stays on the books, hence, allowing the issuer to maintain the AUM.
  3. Better coupon rate – Improved credit ratings mean better rates. It was noticed that the covered bonds were issued 50 bps – 125 bps cheaper than normal secured bonds.

The Indian covered bonds market is however, significantly different from other jurisdictions. Traditionally, covered bonds are meant to be long term papers, however, in India, these are short to medium term papers. Traditionally covered bonds are backed by residential mortgage loans, however, in India the receivables mostly non-mortgages, gold loans and vehicle loans being the most popular asset classes.

In terms of investors too, the Indian market has shown differences. Globally, long term investors like pension funds and insurance companies are the most popular investor classes, however, in India, so far only Family Wealth Offices and High Net-worth Individuals have invested in covered bonds so far.

Another distinct feature of the Indian market is that a significant share of issuances carry market linked features, that is, the coupon rate varies with the market conditions and the issuers’ ability to meet the security cover requirements.

But the most important to note here is that unlike any other jurisdiction, covered bonds don’t have a legislative support in India. In Europe, the hotspot for covered bonds, most of the countries have legislations declaring covered bonds as a bankruptcy-remote instruments. In India, however, the bankruptcy-remoteness is achieved through product engineering by doing a legal sale of the cover pool to a separate trust, yet retaining the economic control in the hands of the issuer until happening of some pre-decided trigger events, and not with the help of any legislative support. In some cases, the legal sale is done upfront too.

Considering the importance and market acceptability of the instrument, rating agencies in India have laid down detailed rating methodologies for covered bonds[7].


Covered Bonds issued in India will not match most of the features of a traditional covered bond issued in Europe, however, the fact that finally the investors community in India has started recognizing it as an investment opportunity is very encouraging.

The real economics of covered bonds will come to the fore only when the market grows with different classes of investors, like the mutual funds, pension funds, insurance companies etc. in the demand side, which seems a bit far-fetched for now.



[1] A working group was constituted by the National Housing Bank to promote RMBS and Covered Bonds, the report of the working group can be viewed here: https://www.nhb.org.in/Whats_new/NHB%20Covered%20Bond%20Report.pdf

[2] In 2014-15, the Asian Development Bank appointed Vinod Kothari Consultants to conduct a Study on Covered Bonds and Alternate Financing Instruments for the Indian Housing Finance Segment

[3] https://www.icmagroup.org/resources/market-data/Market-Data-Dealogic/#14

[4] https://hypo.org/app/uploads/sites/3/2020/10/ECBC-Fact-Book-2020.pdf

[5] A working group was constituted by the National Housing Bank to promote RMBS and Covered Bonds, the report of the working group can be viewed here: https://www.nhb.org.in/Whats_new/NHB%20Covered%20Bond%20Report.pdf

[6] Vinod Kothari Consultants has been a strong advocate for a legal recognition of Covered Bonds in India. They were involved in the initiatives taken by the NHB to recognize Covered Bonds as a bankruptcy remote instrument in India.

[7] The rating methodology adopted by ICRA Ratings can be viewed here: https://www.icra.in/Rating/ShowMethodologyReport/?id=709

The rating methodology adopted by CRISIL can be viewed here: https://www.crisil.com/mnt/winshare/Ratings/SectorMethodology/MethodologyDocs/criteria/crisils%20criteria%20for%20rating%20covered%20bonds.pdf

Our Video on Covered Bonds can be viewed here <https://www.youtube.com/watch?v=XyoPcuzbys4>

Some resources on Covered Bonds can be accessed here –

Introduction to Covered Bonds by Vinod Kothari: http://vinodkothari.com/2015/01/introduction-to-covered-bonds-by-vinod-kothari/

The Name is Bond. Covered Bond. By Vinod Kothari: http://www.vinodkothari.com/wp-content/uploads/covered-bonds-article-by-vinod-kothari.pdf

NHB’s Working Paper on Covered Bonds: https://www.nhb.org.in/Whats_new/NHB%20Covered%20Bond%20Report.pdf



Basics of Factoring in India

Megha Mittal, Associate ( mittal@vinodkothari.com )
Factoring as an age-old concept has stood the test of time as it enabled businesses to resolve the cash flow issues, rendered liquidity, facilitated uninterrupted services and cushioned businesses against the lag in the billing cycles. Also the merit of the product lies in the simplicity of the concept which is well understood and accepted. 
The principles of factoring work broadly on the seller selling the receivables of a debtor to a specialised financial intermediary called a factor. The sale of the receivables happens at a discount and transfers the ownership of the receivables to the factor who shall on purchase of receivables, collect the dues from the debtor instead of the seller doing so, enabling the seller to receive upfront funds from the factor. This allows companies to cash in on their sales without having to wait for payments to come in from customers in due course. With the purchase of the receivables the factor enters the shoes of the seller and takes on the liability under the contract.

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