Basics of Factoring in India

Megha Mittal, Associate ( )
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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AIF Second Amendment Regulations, 2021 – Regulated Steps towards Liberalised Investment

-Megha Mittal  (

Amidst the various concerns addressed in the Board Meeting dated 25th March, 2021,[1] the Securities and Exchange of Board of India (‘SEBI’) extensively dealt with several issues identified with respect to Alternative Investment Funds (‘AIFs’), inter-alia a green signal to AIFs for investing in units of other AIFs; ambiguity regarding the scope of the term ‘start-up’; and the need for a code of conduct laying down guiding principles on accountability of AIFs, their managers and personnel, towards the various stakeholders including investors, investee companies and regulators.

Thus, with a view to target the issues in consideration, the Board proposed that the following amendments be introduced in the SEBI (Alternative Investment Funds) Regulation, 2012 (‘AIF Regulations’/ ‘Principal Regulations’)[2]

  • provide a framework for Alternative Investment Funds (AIFs) to invest simultaneously in units of other AIFs and directly in securities of investee companies;
  • provide a definition of ‘start-up’ as provided by Government of India and to clarify the criteria for investment by Angel Funds in start-ups
  • prescribe a Code of Conduct for AIFs, key management personnel of AIFs, trustee, trustee company, directors of the trustee company, designated partners or directors of AIFs, as the case may be, Managers of AIFs and their key management personnel and members of Investment Committees and bring clarity in the responsibilities cast on members of Investment Committees; and
  • remove the negative list from the definition of venture capital undertaking.

 The aforesaid proposals, put to the fore in view of the suggestions and requests received from several stakeholder groups like the domestic AIFs, global investors, and the regulatory bodies, have now been notified vide notification dated 5th May, 2021, via the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021[3] (‘Amendment Regulations’). A key takeaway from the Amendment Regulations is the flexibility granted w.r.t. indirect investments by AIFs for investment in units of another AIF, however with some riders and possible gaps, as discussed below.

Below we summarise and discuss the amendments introduced vide the Amendment Regulations, and analyse its impact

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Social Stock Exchanges – Enabling funding for social enterprises the regulated way

By Sharon Pinto & Sachin Sharma, Corplaw division, Vinod Kothari & Company  ( 


The inception of the idea of Social Stock Exchanges (SSEs) in India can be traced to the mention of the formation of an SSE under the regulatory purview of Securities and Exchange Board of India (SEBI) for listing and raising of capital by social enterprises and voluntary organisations, in the 2019-20 Budget Speech of the Finance Minister. Consequently, SEBI constituted a working group on SSEs under the Chairmanship of Shri Ishaat Hussain on September 19, 2019[1]. The report of the Working Group (WG) set forth the framework on SSEs, shed light on the concept of social enterprises as well as the nature of instruments that can be raised under such framework and uniform reporting procedures. For further deliberations and refining of the process, SEBI set up a Technical Group (TG) under the Chairmanship of Dr. Harsh Kumar Bhanwala (Ex-Chairman, NABARD) on September 21, 2020[2]. The report, made public on May 6, 2021[3], of the TG entails qualifying criteria as well as the exhaustive ecosystem in which such an SSE would function.

In this article we have analysed the framework set forth by the reports of the committees with the globally established practices.

Concept of SSEs

As per the report of the WG dated June 1, 2020[4], SSE is not only a place where securities or other funding structures are “listed” but also a set of procedures that act as a filter, selecting-in only those entities that are creating measurable social impact and reporting such impact. Further the SSE shall be a separate segment under the existing stock exchanges. Thus, an SSE provides the infrastructure for listing and disclosure of information of listed social enterprises.

Such a framework has been implemented in various countries and an analysis of the same can be set forth as follows:

A. United Kingdom

  • The Social Stock Exchange (SSX) was formed in June 2013 on the recommendation of the report of Social Investment Taskforce. The exchange does not yet facilitate share trading, but instead serves as a directory of companies that have passed a ‘social impact test’. It thus provides a detailed database of companies which have social businesses. It facilitates as a research service for potential social impact investors.
  • Further, companies that are trading publically in the main board stock exchange, may list their securities on SSX, thus only for-profit companies can list on the SSX[5] It works with the support of the London Stock Exchange and is a standalone body not regulated by any official entity.
  • Social and environment impact is the core aim of SSX. To satisfy the same, companies are required to submit a Social Impact Report for review by the independent Admissions Panel composed of 11 finance and impact investing experts.
  • The disclosure framework comprises adherence to UK Corporate Governance Guidelines and Filing Annual Social Impact Reports determine the continuation of listing in SSX.

B. Canada

  • Social Venture Connection (SVX)[6] was launched in 2013. Like SSX, SVX is not an actual trading platform but it is a private investment platform built to connect impact ventures, funds, and investors. It is open only for institutional investors[7].
  • The platform facilitates listing of for-profit business, NPO, or cooperatives categorized as, Social Impact Issuers and Environment Impact Issuers. These entities are required to be incorporated in Ontario for at least 2 years and have audited financial statements available.
  • For listing, a for-profit business must obtain satisfactory company ratings through GIIRS, a privately administered rating system.
  • Issuer must conform to the SVX Issuer Manual. In addition to this reporting of expenditure and other financial transactions shall be done once capital is raised. Further the issuers are required to file financial statements annually in accepted accounting methods and shall not have any misleading information. Ratings are required to be obtained, however the provisions are silent on the periodicity of revision of ratings.

C. Singapore

  • Singapore has established Impact Exchange (IX) which is operated by Stock Exchange of Mauritius and regulated by the Financial Service Commission of Mauritius.
  • IX is the only SSE that is an actual public exchange. It is thus a public trading platform dedicated to connecting social enterprise with mission-aligned investment. Social enterprises, both for-profits and non-profits, are permitted to list their project. NGOs are allowed as issuers of debt securities (such as bonds).
  • Listing requirements on the exchange are enumerated into social and financial categories. Following comprise the social criteria for listing:
  1. Specify social or economic impact as the reason for their primary existence.
  2. Articulate the purpose and intent of the company in the form of a theory of change- basis for demonstrating social performance.
  3. Commit to ongoing monitoring and evaluation of impact performance assessment and reporting.
  4. Minimum 1 year of impact reports prepared as per IX reporting principles.
  5. Certification of impact reports by an independent rating body 12 months prior listing.

Further the financial criteria entails the need for a fixed limit of minimum market capitalization, publication of financial statements and use of market-based approach for achieving its purpose.

D. South Africa

  • The ‘South Africa Social Exchange’ or SASIX[8], offers ethical investors a platform to buy shares in social projects according to two classifications: by sector and by province[9]. Guidelines for listing prescribe compliance with SASIX’s good practice norms for each sector.
  • In order to get listed, entities have to achieve a measurable social impact. The platform acts as a tool of research, evaluation and match-making to facilitate investments into social development projects
  • NGOs can also list their social projects on the exchange. Value of the projects is assessed and then divided into shares. Following project implementation, investors are given access to financial and social reports.
  • While social enterprises are required to have a social purpose as their primary aim, they are also expected to have a financially sustainable business model. The SASIX ceased functioning in 2017[10].

Key ingredients for a social enterprise

  • The report of the TG[11] has categorised social enterprises into For Profit Enterprise (FPEs) and Not for Profit Organisation (NPOs). In order to qualify as a social enterprise the entities shall establish primacy of social impact which shall be determined by application of the following 3 filters:

  • On establishment of the primacy of social impact through the three filters as stated above, the entity shall be eligible to qualify for on-boarding the SSE and access to the SSE for fund-raising upon submitting a declaration as prescribed.

Qualifying criteria and process for onboarding

As per TG recommendation, an NPO is required to register on any of the Social Stock Exchange and thereafter, it may choose to list or not. However, an FPE can proceed directly for listing, provided it is a company registered under Companies Act and complies with the requirements in terms of SEBI Regulations for issuance and listing of equity or debt securities.

Further, the TG has recommended a set of mandatory criteria as mentioned below that NPOs shall meet in order to register.

A. Legal Requirements:

  • Entity is legally registered as an NPO (Charitable Trust/ Society/Section-8 Co’s).
  • Shall have governing documents (MoA & AoA/ Trust Deed/ Bye-laws/ Constitution) & Disclose whether owned and/or controlled by government or private.
  • Shall have Registration Certificate under 12A/12AA/12AB under Income Tax.
  • Shall have a valid IT PAN.
  • Shall have a Registration Certificate of minimum 3 years of its existence.
  • Shall have valid 80G registration under Income-Tax.

B. Minimum Fund Flows:

In order to ensure that the NPO wishing to register has an adequate track-record of operations.

  • Receipts or payments from Audited accounts/ Fund Flow Statement in the last financial year must be at least Rs. 50 lakhs.
  • Receipts from Audited accounts/ Fund Flow Statement in the last financial year must be at least Rs. 10 lakhs.

Framework for listing

Post establishment of the eligibility for listing and the additional registration criteria in case of NPOs, the social enterprises may list their securities in the manner discussed further. The listing procedures vary for NPOs and FPEs and is set forth as follows:


  • NPO shall be required to provide audited financial statements for the previous 3 years and social impact statements in the format prescribed. Further the offer document shall comprise of ‘differentiators’ which shall help the potential investors to assess the NPOs being listed and form a sound and well-informed investment decision. A list of 11 such differentiators has been provided in the report of the TG.
  • Further in case of program-specific or project-specific listings, the NPO shall have to provide a greater level of detail in the listing document about its track record and impact created in the program target segment.
  • All the information submitted as part of pre-listing and post-listing requirements, shall be duly displayed on the website of the NPO.


  • In case of an FPE, existing regulatory guidelines under various SEBI Regulations for listing securities such as equity, debt shall be complied with.
  • The differentiators will be in addition to requirements as mandated in SEBI Regulations in respect of raising funds through equity or debt.
  • Further, FPEs have been granted an option to list their securities on the appropriate existing boards. Thus the issuer may at their discretion list their debt securities on the main boards, while equity securities may be listed on the main boards, or on the SME or IGP.

Types of instruments 

Depending on the type of organisation, SSEs shall allow a variety of financing instruments for NPOs and FPEs. As FPEs have already well-established instruments, these securities are permitted to be listed on the Main Board/IGP/SME, however visibility shall be given to such entities by identifying them as For Profit Social Enterprise (FPSE) on the respective stock exchanges.

Modes available for fundraising for NPOs shall be Equity (Section 8 Co’s.), Zero Coupon Zero Principal (ZCZP) bonds [this will have to be notified as a security under Securities Contracts (Regulation) Act, 1956 (SCRA)], Development Impact Bonds (DIB), Social Impact Fund (SIF) (currently known as Social Venture Fund) with 100% grants-in grants out provision and funding by investors through Mutual Funds. On the other hand, FPEs shall be able to raise funds through equity, debt, DIBs and SIFs.

While SVF is an existing model for fund-raising, the TG has proposed various changes in order to incentivise investors and philanthropists to invest in such instruments. In addition to change in nomenclature from SVF to SIF, minimum corpus size is proposed to be reduced from Rs. 20 Cr to Rs. 5 Cr. Further, minimum subscription shall stand at Rs. 2L from the current Rs. 1 Cr. The amendments shall also allow corporates to invest CSR funds into SVFs with a 100% grants-in, grants out model.

Disclosure and Reporting norms

Once the FPE or the NPO (registered/listed) has been demarcated by the exchange to be an SE, it needs to comply with a set of minimum disclosure and reporting requirements to continue to remain listed/registered. The disclosure requirements can be enlisted as follows:

For NPO:

  • NPO’s (either registered or listed) will have to disclose on general, governance and financial aspects on an annual basis.
  • The disclosures will include vision, mission, activities, scale of operations, board and management, related party transactions, remuneration policies, stakeholder redressal, balance sheet, income statement, program-wise fund utilization for the year, auditors report etc.
  • NPO’s will have to report within 7 days any event that might have a material impact on the planned achievement of their outputs or outcomes, to the exchange in which they are registered/listed. This disclosure will include details of the event, the potential impact and what the NPO is doing to overcome the impact.
  • NPO”s that have listed its securities will have to disclose Social Impact Report covering aspects such as strategic intent and planning, approach, impact score card etc. on annual basis.

For FPE:

FPE’s having listed equity/debt will have to disclose Social Impact Report on annual basis and comply with the disclosure requirements as per the applicable segment such as main board, SME, IGP etc.

Other factors of the SSE ecosystem

a. Capacity Building Fund

As per the recommendation of the WG, constitution of a Capacity Building Fund (CBF) has been proposed. The said fund shall be housed under NABARD and funded by Stock Exchanges, other developmental agencies such as SIDBI, other financial institutions, and donors (CSRs). The fund shall have a corpus of Rs. 100 Cr and shall be an entity registered under 80G, which shall make it eligible for receiving CSR donations pursuant to changes to Section 135/Schedule VII of Companies Act 2013. The role of the fund shall encompass facilitating NPOs for registration and listing procedures as well as proper reporting framework. These functions shall be carried out in the form awareness programs.

b. Social Auditors

Social audit of the enterprises shall compose of two components – financial audit and non-financial audit, which shall be carried out by financial or non-financial auditors. In addition to holding a certificate of practice from the Institute of Chartered Accountants of India (ICAI), the auditors will be required to have attended a course at the National Institute of Securities Markets (NISM) and received a certificate of completion after successfully passing the course examination. The SRO shall prepare the criteria and list of firms/institutions for the first phase soon after the formation of SSEs, and those firms/institutions shall register with the SRO.

c. Information Repositories

The platform shall function as a research tool for the various social enterprises to be listed, thus Information Repository (IR) forms an important component of the framework. It functions as an aggregator of information on NGOs, and provides a searchable electronic database in a comparable form. Thus it shall provide accurate, timely, reliable information required by the potential investors to make well informed decisions.


The social sector in India is getting increasingly powerful – this was evident during Covid-crisis based on the wonderful work done by several NGOs. Of course, all social work requires funding, and being able to crowd source funding in a legitimate and transparent manner is quintessential for the social sector. We find the report of the TG to be raising and addressing relevant issues. We are hoping that SEBI will now find it easy to come out with the needed regulatory platform to allow social enterprises to get funding through SSEs.














Draft Credit Derivatives directions: Will they start a market stuck for 8 years?

Vinod Kothari ( and Abhirup Ghosh (

Credit derivatives, an instrument that emerged around 1993–94 and then took the market by storm with volumes nearly doubling every half year, to fall off the cliff  during the Global Financial Crisis (GFC), have been a widely used instrument for pricing of credit risk of entities, instruments, and countries. Having earned ignoble epithet as “weapons of mass destruction” from Warren Buffet, they were perceived by many to be such. However, the notional outstanding volume of CDS contracts reached a volume of upwards of USD 9 trillion in June, 2020, the latest data currently available from BIS website.

In India, CDS has been talked about almost every committee or policy recommendation that went into promoting bond markets, and yet, CDSs have been a non-starter ever since the CDS guidelines were first issued in 2013. A credit derivative allows a synthetic trade in a credit asset, and is not merely a hedging device. One of the primary limitations with the 2013 guidelines was that the RBI had taken a very conservative stand and would permit CDS trades only for hedging purposes. The 2021 draft Directions seek to open the market up, on the realisation that much of the activity in the CDS market is not a hedge against what is on the balance sheet, but a synthetic trade on the movement in credit spreads, with no underlying position on the reference bonds or loans.

What is a CDS?

Credit derivatives are derivative contracts that seek to transfer defined credit risks in a credit product or bunch of credit products to the counterparty in the derivative contract. The counterparty to the derivative contract could either be a market participant, or could be the capital market through the process of securitization. The credit product might either be exposure inherent in a credit asset such as a loan, or might be generic credit risk such as bankruptcy risk of an entity. As the risks, and rewards commensurate with the risks, are transferred to the counterparty, the counterparty assumes the position of a virtual or synthetic holder of the credit asset.

The counterparty to a credit derivative product that acquires exposure (called the Protection Seller), from the one who passes on such exposure (called the Protection Buyer), is actually going long on the generalised credit risk of the reference entity, that is, the entity whose debt is being synthetically traded between the Protection Seller and Protection Buyer. The compensation (CDS premium) which the Protection Buyer pays and the Protection Seller receives, is based on the underlying probability of default, occurring during the tenure of the contract, and the expected compensation (settlement amount) that the Protection Seller may be called to pay if the underlying default (credit event) occurs. Thus, this derivative product allows the protection buyer to receive . Thus, the credit derivative trade allows the parties to express on view on (a) whether a credit event is likely to occur with reference to the reference entity during the tenure; and if yes, (b) what will be the depth of the insolvency, on which the compensation amount will depend. As a result, the contract allows people to trade in the credit risk of the entity, without having to trade in a credit asset such as a loan or a bond.

Credit default swaps (CDSs) are the major credit derivative product, which itself falls within the bunch of over-the-counter (OTC) derivatives, the others being interest rate derivatives, exchange rate derivatives, equity derivatives, commodity derivatives, etc.  There are, of course, other credit derivative products such as indices trades, basket trades, etc.

Structure of a plain vanilla CDS contract has been illustrated in the following figure:

Fame and shame

Credit derivatives’ claim to fame before the GFC, and shame thereafter, was not merely CDS trading. It was, in fact, synthetic CDOs and their more exotic variations. A synthetic CDO will bunch together several CDS contracts, create layers, and then trade those layers, mostly leaving the manager of the CDO with a fee income and an equity profit. While it could take years to ramp up a book of actual bonds or loans, a synthetic CDS book could be ramped in a matter of hours. In the benign market conditions before the GFC, there were not too many defaults, and therefore, synthetic CDOs and structured finance CDOs would be happily created and sold to investors, with happiness all over. However, since every synthetic CDO would, by definition, be a highly leveraged structure (the lowest tranche bearing the risk of the entire edifice), and multiple sequential layers of such leverage were built by structured finance CDOs, the entire edifice came crumbling during the GFC, as modeling assumptions based on good times of the past were no more true.

RBI hesitatingly allows CDS

The RBI developed cold feet looking at the mess in the global CDS market, and rightly so, and therefore, the RBI has never been bullish on unbridled CDS activity. Hence, the 2013 Guidelines were very guarded and limited permission – only for hedging purposes. Hedging was not something that the Indian bond market needed, as India mostly had highly rated bonds, and the bondholder earning fine spreads will not pay out of these spreads to shell out the risk of a highly rated, mostly held-to-maturity bond investment. Hence, the CDS market never took off.

Nearly every committee that talked about bond markets in India talked about the need to promote CDS. In August 2019[1], the FM announced several reforms that could boost economic growth. One of the proposals was that the MOF, in consultation with the RBI and SEBI will work on the regime for CDS so that it can play an important role in deepening the bond markets in India.

Latest move of the RBI

The Reserve Bank of India (“RBI”) in the Statement of Developmental and Regulatory Policies dated 4th December, 2020[2], expressed its desire to revise the regulatory framework for Credit Default Swaps as a measure to deepen the corporate bonds market, especially the ones issued by the lower rated issuers.

Subsequently, on 16th February, 2021[3], the RBI issued draft Reserve Bank of India (Credit Derivatives) Directions, 2021 (“Draft Directions” or “Proposed Directions”) to replace the Guidelines on Credit Default Swaps (CDS) for Corporate Bonds which was last revised on 7th January, 2013[4] (“2013 Guidelines”).

This write-up attempts to provide a detailed commentary on the Draft Directions, with references to the 2013 Guidelines as and where required, however, before that let us take a note of the key highlights of the proposed revised directions.

Highlights of the Draft Directions

  1. Participants in a CDS transaction:

The major participants in the proposed transactions:

    1. Market-makers: they are financial institutions
    2. Non-retail users: they can be protection buyers as well as protection sellers, and purpose of their engagement could be for hedging their risk or otherwise. An exhaustive list of the institutions has been laid down who can be classified as non-retail users
    3. Retail users: they can be protection buyers as well as protection sellers, however, the purpose of their engaged should be for hedging their risk only. A user who fails to qualify as non-retail user, by default becomes a retail user. Additionally, the Proposed Directions also allow non-retail users to reclassify themselves as retails users.

Persons resident in India are allowed to participate freely, however, persons resident outside India are allowed to participate as per the directions issued by the RBI, which are yet to be issued.

2. Only single-name CDS contracts are permitted:

The Proposed Directions allow single-name CDS contracts only, that is, the CDS contracts should have only one reference entity. Therefore, other forms of the CDS contracts like bucket or portfolio CDS contracts are not allowed.

3. Presence of a reference obligation:

Credit derivatives could either have a reference entity or a reference obligation. The Proposed Directions however envisages the presence of a reference obligation in a CDS contract. This is coming out clearly from the definition of the CDS states that the contract should provide that the protection seller should commit to compensate the other protection buyer for the loss in the value of an underlying debt instrument resulting from a credit event with respect to a reference entity, for a premium.

4. Eligible reference obligations:

The reference obligations include money market instruments like CPs, CDs, and NCDs with maturity upto 1-year, rated rupee denominated (listed and unlisted) corporate bonds, and unrated corporate bonds issued by infrastructure companies. In this regard, it is pertinent to note that the

5. Structured finance transactions:

Neither can credit derivatives be embedded in structured finance transactions like, synthetic securitisations, nor can structured finance instruments like, ABS, MBS, credit enhanced bonds, convertible bonds etc., be reference obligations for CDS contracts.

Commentary on some of the Key Provisions of the Draft Directions


The Proposed Directions will apply on all forms of the credit derivatives transactions irrespective of whether they are undertaken in the OTC markets and or on recognised stock exchanges in India.


5. Cash settlement:

Relevant extracts:

(i) Cash settlement of CDS means a settlement process in which the protection seller pays to the protection buyer, an amount equivalent to the loss in value of the reference obligation.

Our comments:

The Proposed Directions allow cash settlement of the CDS, where the protection seller pays only the actual loss in the reference obligation to the protection buyer. There are usually two ways of computing the settlement amount in case of cash settlement – first, based on the actual value of the loss arising from the reference obligation, and second, based on a fixed default rate which is agreed between the parties to the contract at its very inception.

To understand the second situation, let us take an example of a contract where the protection seller agrees to compensate the losses of the protection buyer arising from a reference obligation. Say, the seller agrees to compensate the buyer assuming a 10% default in the buyer’s exposure in a debt instrument on happening of a credit event. In this case, if the credit event happens, the seller will compensate the buyer assuming a 10% default rate, irrespective of the whether losses are more or less than 10%.

However, in the first case, settlement amount would work out based on the assessment of actual losses arising due to happening of the credit event.

Apparently, the definition of cash settlement seems to include only the first case, as it refers to an amount equivalent to the loss in value of the reference obligation.

6. Credit default swaps

Relevant extracts:

(iii) Credit Default Swap (CDS) means a credit derivative contract in which one counterparty (protection seller) commits to compensate the other counterparty (protection buyer) for the loss in the value of an underlying debt instrument resulting from a credit event with respect to a reference entity and in return, the protection buyer makes periodic payments (premium) to the protection seller until the maturity of the contract or the credit event, whichever is earlier.

Our comments:

CDS contracts can be drawn with reference to a particular entity or to a particular obligation of an entity. In the former case, the reference is on all the obligations of the reference entity, whereas in the latter case, the reference is on a particular debt obligation of the reference entity – which could be a loan or a bond.

However, the definition of CDS in the Proposed Directions states the contract should be structured in a manner where the protection seller commits to compensate the protection buyer for the loss in the value of an underlying debt instrument. Therefore, the exposure has to be taken on a particular debt obligation, and it cannot be generally on the reference entity.

 7. Credit event:

Relevant extracts:

(iv) Credit event means a pre-defined event related to a negative change/ deterioration in the credit worthiness of the reference entity underlying a credit derivative contract, which triggers a settlement under the contract.

Our comments:

In the simplest form of a credit derivative contract, credit event is a contingent event on happening of which the protection buyer could incur a credit loss, and for which it seeks protection from the protection seller. The definition used in the Proposed Directions is a very generalised one. As per ISDA, the three most credit events include –

  1. Filing for bankruptcy of the issuer of the debt instrument;
  2. Default in payment by the issuer;
  3. Restructuring of the terms of the debt instrument with an objective to extend a credit relief to the issuer, who is otherwise under a financial distress.

8.Deliverable obligation

Relevant extracts:

(v) Deliverable obligation means a debt instrument issued by the reference entity that the protection buyer can deliver to the protection seller in a physically settled CDS contract, in case of occurrence of a credit event. The deliverable obligation may or may not be the same as the reference obligation.

Our comments:

Refer discussion on physical settlement below.

In case of physical settlements, the question arises, what is the asset that protection buyers may deliver? As discussed under physical settlement, protection buyers may exactly hold the reference asset. A default on this asset would also imply a default on other parallel obligations of the obligor: therefore, market practices allow parallel assets to be delivered to protection sellers. Essentially, a protection buyer may select out of a range of obligations of the reference entity, and logically, will select the one that is the cheapest to deliver. To ensure that the asset delivered is not completely junk, certain filters are covered in the documents, and the deliverable asset must conform to those filters. In particular, these limitations are quite relevant when the reference entity has not really defaulted on its obligations, but only undergone a restructuring credit event.

9. Physical settlement

Relevant extracts:

(xv) Physical settlement of CDS means a settlement process in which the protection buyer transfers any of the eligible deliverable obligations to the protection seller against the receipt of notional/face value of the deliverable obligation.

Our comments:

We discussed earlier that one of the ways of settling a CDS contract is the cash settlement. The other way of settling a CDS contract is the physical settlement. In case of physical settlement, protection buyers physically deliver; that is, transfer an asset of the reference entity and get paid the par value of the delivered asset, limited, of course, to the notional value of the transaction. The concept of deliverable obligation in a credit derivative is critical, as the derivative is not necessarily connected with a particular loan or bond. Being a transaction linked with generic default risk, protection buyers may deliver any of the defaulted obligations of the reference entity.

In case of physical settlement, there is a transfer of the deliverable reference obligation to protection sellers upon events of default, and thereafter, the recovery of the defaulted asset is done by protection sellers, with the hope that they might be able to cover some of their losses if the recovered amount exceeds the market value as might have been estimated in the case of a cash settlement. This expectation is quite logical since the quotes in case of cash settlement are made by potential buyers of defaulted assets, who also hope to make a profit in buying the defaulted asset. Physical settlement is more common where the counterparty is a bank or financial intermediary who can hold and take the defaulted asset through the bankruptcy process, or resolve the defaulted asset.

10. Reference entity:

Relevant extracts:

(xvi) Reference entity means a legal entity, against whose credit risk, a credit derivative contract is entered into.

Our comments:

As may be noted later on in the writeup, reference entity in the context of the Proposed Directions refers to a legal entity resident in India.

11. Reference obligation

Relevant extracts:

(xvii) Reference obligation means a debt instrument issued by the reference entity and specified in a CDS contract for the purpose of valuation of the contract and for determining the cash settlement value or the deliverable obligation in case of occurrence of a credit event.

Our comments:

Reference obligation is the underlying debt instrument, based on which the contract is drawn. In practice, this obligation could be loan, or a bond of the obligor. However, the Proposed Directions refer to certain money market instruments and corporate bonds. Discussed later.

12. Single-name CDS

Relevant extracts:

(xix) Single-name CDS means a CDS contract in which the underlying is a single reference entity.

Our comments:

Usually, CDS could be created with reference to either a single obligation, or obligations from a single reference entity, or a portfolio of obligations arising from different reference entities. The Proposed Directions completely rules out portfolio derivatives, and allows CDS contracts with reference to a single entity only.

Eligible participants

Relevant extracts:

  1. Eligible participants

The following persons shall be eligible to participate in credit derivatives market:

(i) A person resident in India;

(ii) A non-resident, to the extent specified in these Directions.

Our comments:

Any person resident in India is eligible to participate in the credit derivatives market. Even retail investors have been allowed to be a part of this, however, restrictions have been imposed on specific classes of users concerning the purpose of their participation.

Non-resident users, like FPIs, have also been allowed to participate on a restricted basis, however, specifics of their limitations will come by way of specific directions which will be issued by the RBI in due course.

Permitted products

  1. Permitted products in OTC market

(i) Market-makers and users may undertake transactions in single-name CDS contracts.

(ii) Market-makers and users shall not deal in any structured financial product with a credit derivative as one of the components or as an underlying.

As already discussed earlier, only single-name CDS contracts are allowed, bucket or portfolio CDS contracts are not permitted. One of the reasons for this could be that RBI might like to test the market before allowing the users to write contracts on exposures on multiple obligors.

Clause (ii) prohibits the use of credit derivatives in the structure finance products. Synthetic securitisation is one of the products that use embeds a credit default swap in the securitisation transaction. Presently, the Securitisation Guidelines[5] has put a bar on synthetic securitisation, in fact, the draft Guidelines on Securitisation, issued by the RBI in 2019[6], also retained the bar on synthetic securitisation.

Vinod Kothari, in his article Securitisation – Should  India be moving to the next stage of development?[7], stated:

It is notable that a synthetic securitisation uses CDS to shift a tranched risk of a pool of assets into the capital markets by embedding the same into securities, without giving any funding to the originator. Synthetic structures are intended mainly at capital relief, both economic capital as well as regulatory capital.

Synthetic securitisation may come in handy for Indian banks to gain capital relief. Synthetic securitisation structures are seen by many to have made a comeback after the GFC. In fact, the European Banking Authority has launched a consultation process for laying down a STS framework for synthetic securitisations as well[8]. A Discussion Paper of EBA says: “The 2008 financial crisis marked a crash of the securitisation market, after which, also due to stigma attached to the synthetic segment, the securitisation market has gradually emerged in particular in the traditional (and retained) form. With respect to synthetic securitisation following a few years of subdued issuance, the synthetic market has been recovering in the recent years, with both the number and volume of transactions steadily increasing. Based on the data collection conducted by IACPM, altogether 244 balance sheet synthetic securitisations have been issued since 2008 up until end 2018. In 2018, 49 transactions have been initiated with a total volume of 105 billion EUR.”[9]

In the USA as well, credit risk transfer structure has been used by Freddie Mac and Fannie Mae vide instruments labelled as Structured Agency Credit Risk (STACR) and Connecticut Avenue Securities™ (CAS) bonds. Reportedly, the total volume of risk transferred using these instruments, for traditional single family dwelling units, has crossed USD 2.77 trillion by end of 2018[10].

There may be merit in introducing balance sheet synthetic securitisations by banks and NBFCs. To begin with, high quality portfolios of home loans, consumer loans or other diversified retail pools may be the reference pools for these transactions. Gradually, as the market matures, further asset classes such as corporate loans may be tried.

Synthetic securitisations were frowned upon by financial regulators across the globe after the GFC, however, as may have been noticed in the extracts quoted above, several developed jurisdictions now allow synthetic securitisation, with the required level of precautions added to the regulatory framework dealing with it.

Reference entities and obligations for CDS

Relevant extracts:

  1. Reference Entities and Obligations for CDS

(i) The reference entity in a CDS contract shall be a resident legal entity who is eligible to issue any of the debt instruments mentioned under paragraph 5(ii).

(ii) The following debt instruments shall be eligible to be a reference / deliverable obligation in a CDS contract:

  1. Commercial Papers, Certificates of Deposit and Non-Convertible Debentures of original maturity upto one year;
  2. Rated INR corporate bonds (listed and unlisted); and
  3. Unrated INR bonds issued by the Special Purpose Vehicles set up by infrastructure companies.

(iii) The reference/deliverable obligations shall be in dematerialised form only.

(iv) Asset-backed securities/mortgage-backed securities and structured obligations such as credit enhanced/guaranteed bonds, convertible bonds, bonds with call/put options etc. shall not be permitted as reference and deliverable obligations.

Our comments:

As per Clause 5(i), only resident legal entities can be reference entities for the purpose of CDS contracts, however, the Proposed Directions are silent on the meaning of the term resident legal entity. One could argue that entities which are registered in India should be treated as resident legal entities, however, a clarification in this regard shall remove the ambiguities.

Clause (ii) allows the use of the following instruments as a reference obligations:

  1. Money market instruments like CPs, CDs and short-term NCDs
  2. Rated Rupee-denominated corporate bonds, both listed and unlisted
  3. Unrated rupee-denominated corporated bonds issued by infrastructure companies.

The 2013 Guidelines also provided for similar set of instruments. However, it is pertinent to note that the Proposed Directions provide for an express bar on usage of the following structured products as reference obligations:

  1. Asset backed securities
  2. Mortgage backed securities
  3. Credit enhanced or guranateed bonds
  4. Convertible bonds
  5. Bonds with embedded call/ put options

Loans continue to be ineligible for use as reference obligation.

Market makers and users

Relevant extracts:

6.1 Market-makers

(i) The following entities shall be eligible to act as market-makers in credit derivatives:

  1. Scheduled Commercial Banks (SCBs), except Small Finance Banks, Payment Banks, Local Area Banks and Regional Rural Banks;
  2. Non-Bank Financial Companies (NBFCs), including Housing Finance Companies (HFCs), with a minimum net owned funds of ₹500 crore as per the latest audited balance sheet and subject to specific approval of the Department of Regulation (DoR), Reserve Bank.
  3. Standalone Primary Dealers (SPDs) with a minimum net owned funds of ₹500 crore as per the latest audited balance sheet and subject to specific approval of the Department of Regulation (DoR), Reserve Bank.
  4. Exim Bank, National Bank of Agriculture and Rural Development (NABARD), National Housing Bank (NHB) and Small Industries Development Bank of India (SIDBI).

(ii) In case the net owned funds of an NBFC, an HFC or an SPD as per the latest audited balance sheet fall below the aforesaid threshold subsequent to the receipt of approval for acting as a market-maker, it shall cease to act as a market-maker. The NBFC, HFC or SPD shall continue to meet all its obligations under existing contracts till the maturity of such contracts.

(iii) Market-makers shall be allowed to buy protection without having the underlying debt instrument.

(iv) At least one of the parties to a CDS transaction shall be a market-maker or a central counter party authorised by the Reserve Bank as an approved counterparty for CDS transactions.

Our comments:

When compared to the 2013 Guidelines, the only addition to list of entities that are eligible to act as market makers is housing finance companies. The net-worth requirements for NBFCs and SPDs remain the same as that under 2013 Guidelines. However, here it is pertinent to note that while the banks are not required to obtain any specific approval from the RBI, NBFCs and SPDs will have to obtain specific approval from the Department of Regulation. The RBI may reconsider this position and remove the requirement of obtaining special approval for the NBFCs and SPDs and put them in a level playing field with the banks.

Relevant extracts:

6.2 User Classification Framework

(i) For the purpose of offering credit derivative contracts to a user, market-maker shall classify the user either as a retail user or as a non-retail user.

(ii) The following users shall be eligible to be classified as non-retail users:

  1. Insurance Companies regulated by Insurance Regulatory and Development Authority of India (IRDAI);
  2. Pension Funds regulated by Pension Fund Regulatory and Development Authority (PFRDA);
  3. Mutual Funds regulated by Securities and Exchange Board of India (SEBI);
  4. Alternate Investment Funds regulated by Securities and Exchange Board of India (SEBI);
  5. SPDs with a minimum net owned funds of ₹500 crore as per the latest audited balance sheet;
  6. NBFCs, including HFCs, with a minimum net owned funds of ₹500 crore as per the latest audited balance sheet;
  7. Resident companies with a minimum net worth of ₹500 crore as per the latest audited balance sheet; and
  8. Foreign Portfolio Investors (FPIs) registered with SEBI.

(iii) Any user who is not eligible to be classified as a non-retail user shall be classified as a retail user.

(iv) Any user who is otherwise eligible to be classified as a non-retail user shall have the option to get classified as a retail user.

(v) Retail users shall be allowed to undertake transactions in permitted credit derivatives for hedging their underlying credit risk.

(vi) Non-retail users shall be allowed to undertake transactions in credit derivatives for both hedging and other purposes.

Our comments:

As brought out earlier under the highlights section, there can be two types of users – non retail and retail users. Financial institutions, resident corporates with networth of Rs. 500 crores or above, and FPIs can become non-retail users. The non-retail users can participate in these contracts either for hedging their credit risk or any other purposes.

On the other hand, anyone who is not eligible to become a non-retail user, by default becomes a retail user. Additionally, non-retail users have been given an option to reclassify themselves as retail issuers should they want. Retail users are allowed to undertake these transactions only for the hedging their credit risk.

The provisions under the Proposed Directions differ significantly from that under the 2013 Guidelines which allowed only financial institutions and FIIs to participate as users. Further, neither did the Guidelines differentiate between retail and non-retail users, nor did it allow the use of CDS for other than hedging purposes.

The classification between retail and non retail users is welcome move where they have not put any restriction on the more serious non-retail users, who can use these even for speculative purposes, apart from hedging. This could increase the liquidity of the instruments, therefore, deepening the market.

Operations and standardisations

Relevant extracts:

7.1 Buying, Unwinding and Settlement

(i) Market-makers and users shall not enter into CDS transactions if the counterparty is a related party or where the reference entity is a related party to either of the contracting parties.

(ii) Market-makers and users shall not buy/sell protection on reference entities if there are regulatory restrictions on assuming similar exposures in the cash market or in violation of any other regulatory restriction, as may be applicable.

(iii) Market-makers shall ensure that all CDS transactions by retail users are undertaken for the purpose of hedging i.e. the retail users buying protection:

  1. shall have exposure to any of the debt instruments mentioned under paragraph 5(ii) and issued by the reference entity;
  2. shall not buy CDS for amounts higher than the face value of the underlying debt instrument held by them; and
  3. shall not buy CDS with tenor later than the maturity of the underlying debt instrument held by them or the standard CDS maturity date immediately after the maturity of the underlying debt instrument.

To ensure this, market-makers may call for any relevant information/documents from the retail user, who, in turn, shall be obliged to provide such information.

(iv) Retail users shall exit their CDS position within one month from the date they cease to have underlying exposure.

(v) Market participants can exit their CDS contract by unwinding the contract with the original counterparty or assigning the contract to any other eligible market participant.

(vi) Market participants shall settle CDS contracts bilaterally or through any clearing arrangement approved by the Reserve Bank.

(vii) CDS contracts shall be denominated and settled in Indian Rupees.

(viii) CDS contracts can be cash settled or physically settled. However, CDS contracts involving retail users shall be mandatorily physically settled.

(ix) The reference price for cash settlement shall be determined in accordance with the procedure determined by the Credit Derivatives Determinations Committee or auction conducted by the Credit Derivatives Determinations Committee, as specified under paragraph 8 of these Directions.

Our comments:

The Proposed Directions imposes restrictions on the users to enter into contracts involving their related parties.

Further, as noted earlier, contracts entered into by the retail users must be for the purpose of the hedging credit risks only, in addition to it there are some other restrictions with respect to the tenor and amount of the protection. However, the onus to ensure that these conditions are met with have been imposed on the market makers. This leads to an additional compliance on the part of the market makers.

In terms of settlement, the Proposed Directions allow both cash and physical settlement, however, for retail users only physical settlement is allowed.

Further, the Proposed Directions also provide for the manner of exiting a CDS contract. In practice, there are three ways of settling a credit derivative contract – first, by settlement in cash or physically, second, by entering into a matching contract with a third party, therefore knocking off the contract in the hands of the protection buyer, and third, by assigning the contract to third parties. The Proposed Directions allow all of these.

Relevant extracts:

7.2 Standardisation

(i) Fixed Income Money Market and Derivatives Association of India (FIMMDA), in consultation with market participants and based on international best practices, shall devise standard master agreement/s for the Indian CDS market which shall, inter-alia, include credit event definitions and settlement procedures.

(ii) FIMMDA shall, at the minimum, publish the following trading conventions for CDS contracts:

  1. Standard maturity and premium payment dates;
  2. Standard premiums;
  3. Upfront fee calculation methodology;
  4. Accrual payment for full first premium;
  5. Quoting conventions; and
  6. Lookback period for credit events.

Our comments:

FIMMDA has been authorised to standardise the documents, and conventions for CDS contracts. World-over standard CDS products are prevalent with standard maturity dates, coupon payments, rates. Standardisation of key terms of a credit derivative contract transform the product from bespoke bilateral transactions to standard marketable products.

Some of the prevalent conventions used internationally are the Standard North Amercian Corporate Convention (SNAC) or the Standard European Corporate (SEC) Convention. The aim of both these conventions is to standardize the trading mechanics of credit default swaps (the SNAC for North American corporate names and the SEC for European corporate names) and facilitate trading through a central clearing counterparty, as well as to reduce uncertainty associated with credit events. This is because in order to make trades completely fungible (i.e., so they have the quality of being capable of exchange or interchange), all trading conventions have to be fully standardized.

Both the conventions have the following trading mechanics:

  1. They have a fixed coupon and an upfront fee.
  2. The first coupon of a CDS accumulates from the date of the last coupon, regardless of the trade date.
  3. The quoted spread for a given maturity is assumed to be a flat spread, rather than representing a point in the term structure.

References from the aforesaid conventions could be drawn while standardisation of the CDS conventions for the Indian market.

Prudential norms, accounting and capital requirements

Relevant extracts:

  1. Prudential norms, accounting and capital requirements

Market participants shall follow the applicable prudential norms and capital adequacy requirements for credit derivatives issued by their respective regulators. Credit derivative transactions shall be accounted for as per the applicable accounting standards prescribed by The Institute of Chartered Accountants of India (ICAI) or other standard setting organisations or as specified by the respective regulators of participants.

Our comments:

The market participants shall have to follow prudential norms and capital adequacy requirements for credit derivatives issued by the sectoral regulators. For NBFCs, for credit protection purchased, for corporate bonds held in current category – capital charge has to be maintained on 20% of the exposure, whereas for corporate bonds held in permanent category, and where there is no mismatch between the hedged bond and the CDS, full capital protection is allowed. The exposure shall stand replaced by exposure on the protection seller, and attract risk weights at 100%.

Similar provisions apply for banks, however, for bonds held in the permanent category, where there is no mismatch between the hedged bonds and CDS, the capital charge on the corporate bonds is nil, whereas, the capital charge on the exposure on protection sellers is maintained at 20% risk weight.

In terms of accounting, for NBFCs and HFCs, Ind AS 109 will have to be followed. Banks however will have to rely on ICAI’s Guidance Notes, if any, to do the accounting.

Our other resources on the topic:

  1. Our dedicated page on Credit Derivatives:
  2. Our articles on Credit Derivatives:
  3. Our book, Credit Derivatives & Structured Credit Trading, by Vinod Kothari –










[10] Based on

Investment window for FPIs widened

Permitting FPIs to invest in defaulted debt securities


-Aanchal Kaur Nagpal (


While the Indian equity market has consistently shown a rigorous growth, the bond market in India has mostly been relatively lagging behind. The size and performance of the Indian bond market has been quite inappreciable as compared to the developed economies in the world. The COVID-19 pandemic further caused a turmoil in the market. Among the investor class, Foreign Portfolio Investors (FPI) are a major participant in the debt market contributing to approximately 10% of the total debt investment.

Source: CRISIL Yearbook on Indian Debt Market, 2018

Further, as depicted below, the investments by FPIs in debt market has not been a consistent or a straight line and has seen more downward trend than upward.

Source: NSDL

As on February 5, 2021, foreign investment in corporate bonds has only reached 25% of the total available limit[1]. Further, the proportion of FPI investment as a part of the total foreign investment in India, is constrained by various investment limits and regulatory requirements.

FPIs are allowed to invest in eligible government securities and eligible corporate bonds. In case of corporate bonds, the following restrictions are imposed –

  • Restriction on short term investment in corporate bonds

FPIs are not permitted to make short term investments of more than 20% of their total investment in corporate bonds. The above cap was increased from 20% to 30% of the total investment of the FPI providing more flexibility to FPIs in making investment decisions.

  • Issue limit

Investment by any FPI, including related FPIs, cannot exceed 50% of any issue of a corporate bond. In case an FPI, including related FPIs breaches the same and invests in more than 50% of any single issue, it cannot make further investments in that issue until the condition is met.

  • Minimum residual maturity

FPIs can only invest in corporate bonds with a minimum residual maturity of 1 years, subject to the condition that short-term investments limit in corporate bonds.

Exempted Securities –

However, there are certain securities that are exempt from the above restrictions –

  • Debt instruments issued by ARCs; and
  • Debt instruments issued by an entity under the CIRP as per the resolution plan approved by the NCLT under the Insolvency and Bankruptcy Code, 2016.

The aforesaid exemption was introduced with the intent to further widen the scope of investment by FPIs. It not only allowed FPIs to make short term investments in the above debt instruments without any limit but also bring in more options for FPIs to invest without having to consider the single/group investor-wise limits

FPIs are allowed to invest in security receipts issued by ARCs to address the NPA issue of financial institutions. Further, debt instruments issued by a corporate debtor under CIRP have also been made eligible for FPI investment. This was done with the intent to revive corporate debtors under a resolution plan. Thus, RBI has allowed FPIs to invest in such securities that are in dire need of investment, while granting various exemptions to make them more attractive.

Power of RBI to permit debt instruments or securities for FPI investment

As per SEBI (Foreign Portfolio Investors) Regulations, 2019, amongst other eligible debt instruments, FPIs are allowed to invest in any debt securities or other instruments as permitted by RBI [Regulation 20(1) (g)].

Thus, RBI has the power to prescribe eligible debt securities for FPI investment.

Foreign Portfolio Investors (FPIs) Investment in Defaulted Bonds

As discussed, investment by FPIs in debt instruments issued by ARCs or an entity under the CIRP, are exempted from the short-term limit and minimum residual maturity requirement. In order to further promote investment by FPIs in corporate bonds, RBI, in its Statement on Developmental and Regulatory Policies dated 5th February, 2021[2], has proposed to extend similar exemptions to defaulted corporate bonds. Accordingly, FPI investment in defaulted corporate bonds are proposed to be exempted from the short-term limit and the minimum residual maturity requirement. For this purpose, detailed guidelines will be issued separately by RBI.

Defaulted debt securities refer to ‘non-payment of interest or principal amount in full on the pre-agreed date and shall be recognized at the first instance of delay in servicing of any interest or principal on such debt.

At present, FPIs are permitted to invest in defaulted debt securities only against repayment of amortising bonds. Now, RBI is intending to permit FPIs to invest in defaulted corporate bonds as fresh issues as well and in all other cases as well.

Existing provision on FPI investment in corporate bonds under default –

Investments by FPIs in corporate bonds under default [Para 15 of Operating Guidelines for FPIs[3]]

  1. FPIs are permitted to acquire NCDs/bonds, which are under default, either fully or partly, in the repayment of principal on maturity or principal instalment in the case of an amortising bond.
  2. FPIs will be guided by RBI’s definition of an amortising bond in this regard.
  • The revised maturity period for such NCDs/bonds restructured based on negotiations with the issuing Indian company, should be as per the norms prescribed by RBI from time to time, for FPI investments in Corporate Debt.
  1. The FPIs shall disclose to the Debenture Trustees, the terms of their offer to the existing debenture holders/beneficial owners of such NCDs/bonds under default, from whom they propose to acquire.
  2. All investments by FPIs in such bonds shall be reckoned against the prevalent corporate debt limit. All other terms and conditions pertaining to FPI investments in corporate debt securities shall continue to apply.

SEBI also issued an operational framework[4] for transactions in defaulted debt securities post redemption date along with obligations of Issuers, Debenture Trustees, Depositories and Stock Exchanges while permitting such transaction

However, the motive for FPIs for investing in such defaulted corporate bonds is still to be understood. Since defaulted debt securities refer to securities even with one-time defaults, corporate bonds with favourable future prospects or where the security against such bonds is sufficient and promising, may attract FPI investments. RBI’s intent behind this move is to deepen the financial market, bring better liquidity in defaulted debt securities and also provide an additional investment opportunity to FPIs. The detailed guidelines are awaited to be issued by RBI.


[1] Source: NSDL-




Our articles on related topics-

Law relating to collective investment schemes on shared ownership of real assets

-Vinod Kothari (

The law relating to collective investment schemes has always been, and perhaps will remain, enigmatic, because these provisions were designed to ensure that enthusiastic operators do not source investors’ money with tall promises of profits or returns, and start running what is loosely referred to as Ponzi schemes of various shades. De facto collective investment schemes or schemes for raising money from investors may be run in elusive forms as well – as multi-level marketing schemes, schemes for shared ownership of property or resources, or in form of cancellable contracts for purchase of goods or services on a future date.

While regulations will always need to chase clever financial fraudsters, who are always a day ahead of the regulator, this article is focused on schemes of shared ownership of properties. Shared economy is the cult of the day; from houses to cars to other indivisible resources, the internet economy is making it possible for users to focus on experience and use rather than ownership and pride of possession. Our colleagues have written on the schemes for shared property ownership[1]. Our colleagues have also written about the law of collective investment schemes in relation to real estate financing[2]. Also, this author, along with a colleague, has written how the confusion among regulators continues to put investors in such schemes to prejudice and allows operators to make a fast buck[3].

This article focuses on the shared property devices and the sweep of the law relating to collective investment schemes in relation thereto.

Basis of the law relating to collective investment schemes

The legislative basis for collective investment scheme regulations is sec. 11AA (2) of the SEBI Act. The said section provides:

Any scheme or arrangement made or offered by any company under which,

  • the contributions, or payments made by the investors, by whatever name called, are pooled and utilized solely for the purposes of the scheme or arrangement;
  • the contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable from such scheme or arrangement;
  • the property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors;
  • the investors do not have day to day control over the management and operation of the scheme or arrangement.

The major features of a CIS may be visible from the definition. These are:

  1. A schematic for the operator to collect investors’ money: There must be a scheme or an arrangement. A scheme implies a well-structured arrangement whereby money is collected under the scheme. Usually, every such scheme provides for the entry as well as exit, and the scheme typically offers some rate of return or profit. Whether the profit is guaranteed or not, does not matter, at least looking at the definition. Since there is a scheme, there must be some operator of the scheme, and there must be some persons who put in their money into the scheme. These are called “investors”.
  2. Pooling of contributions: The next important part of a CIS is the pooling of contributions. Pooling implies the contributions losing their individuality and becoming part of a single fungible hotchpot. If each investor’s money, and the investments therefrom, are identifiable and severable, there is no pooling. The whole stance of CIS is collective investment. If the investment is severable, then the scheme is no more a collective scheme.
  3. Intent of receiving profits, produce, income or property: The intent of the investors contributing money is to receive results of the collective investment. The results may be in form of profits, produce, income or property. The usual feature of CIS is the operator tempting investors with guaranteed rate of return; however, that is not an essential feature of CISs.
  4. Separation of management and investment: The management of the money is in the hands of a person, say, investment manager. If the investors manage their own investments, there is no question of a CIS. Typically, investor is someone who becomes a passive investor and does not have first level control (see next bullet). It does not matter whether the so-called manager is an investor himself, or may be the operator of the scheme as well. However, the essential feature is there being multiple “investors”, and one or some “manager”.
  5. Investors not having regular control over the investments: As discussed above, the hiving off of the ownership and management of funds is the very genesis of the regulatory concern in a CIS, and therefore, that is a key feature.

The definition may be compared with section 235 of the UK Financial Services and Markets Act, which provides as follows:

  • In this Part “collective investment scheme” means any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.
  • The arrangements must be such that the persons who are to participate (“participants”) do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions.
  • The arrangements must also have either or both of the following characteristics—
  • the contributions of the participants and the profits or income out of which payments are to be made to them are pooled;
  • the property is managed as a whole by or on behalf of the operator of the scheme.
    • If arrangements provide for such pooling as is mentioned in subsection (3)(a) in relation to separate parts of the property, the arrangements are not to be regarded as constituting a single collective investment scheme unless the participants are entitled to exchange rights in one part for rights in another.

It is conspicuous that all the features of the definition in the Indian law are present in the UK law as well.

Hong Kong Securities and Futures Ordinance [Schedule 1] defines a collective investment scheme as follows:

collective investment scheme means—

  • arrangements in respect of any property—
  • under which the participating persons do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions in respect of such management;
  • under which—
  • the property is managed as a whole by or on behalf of the person operating the arrangements;
  • the contributions of the participating persons and the profits or income from which payments are made to them are pooled; or
  • the property is managed as a whole by or on behalf of the person operating the arrangements, and the contributions of the participating persons and the profits or income from which payments are made to them are pooled; and
  • the purpose or effect, or pretended purpose or effect, of which is to enable the participating persons, whether by acquiring any right, interest, title or benefit in the property or any part of the property or otherwise, to participate in or receive—
  • profits, income or other returns represented to arise or to be likely to arise from the acquisition, holding, management or disposal of the property or any part of the property, or sums represented to be paid or to be likely to be paid out of any such profits, income or other returns; or
  • a payment or other returns arising from the acquisition, holding or disposal of, the exercise of any right in, the redemption of, or the expiry of, any right, interest, title or benefit in the property or any part of the property; or
  • arrangements which are arrangements, or are of a class or description of arrangements, prescribed by notice under section 393 of this Ordinance as being regarded as collective investment schemes in accordance with the terms of the notice.

One may notice that this definition as well has substantially the same features as the definition in the UK law.

Judicial analysis of the definition

Part (iii) of the definition in Indian law refers to management of the contribution, property or investment on behalf of the investors, and part (iv) lays down that the investors do not have day to day control over the operation or management. The same features, in UK law, are stated in sec. 235 (2) and (3), emphasizing on the management of the contributions as a whole, on behalf of the investors, and investors not doing individual management of their own money or property. The question has been discussed in multiple UK rulings. In Financial Conduct Authority vs Capital Alternatives and others,  [2015] EWCA Civ 284, [2015] 2 BCLC 502[4], UK Court of Appeal, on the issue whether any extent of individual management by investors will take the scheme of the definition of CIS, held as follows:  “The phrase “the property is managed as a whole” uses words of ordinary language. I do not regard it as appropriate to attach to the words some form of exclusionary test based on whether the elements of individual management were “substantial” – an adjective of some elasticity. The critical question is whether a characteristic feature of the arrangements under the scheme is that the property to which those arrangements relate is managed as a whole. Whether that condition is satisfied requires an overall assessment and evaluation of the relevant facts. For that purpose it is necessary to identify (i) what is “the property”, and (ii) what is the management thereof which is directed towards achieving the contemplated income or profit. It is not necessary that there should be no individual management activity – only that the nature of the scheme is that, in essence, the property is managed as a whole, to which question the amount of individual management of the property will plainly be relevant”.

UK Supreme Court considered a common collective land-related venture, viz., land bank structure, in Asset Land Investment Plc vs Financial Conduct Authority, [2016] UKSC 17[5]. Once again, on the issue of whether the property is collective managed, or managed by respective investors, the following paras from UK Financial Conduct Authority were cited with approval:

The purpose of the ‘day-to-day control’ test is to try to draw an important distinction about the nature of the investment that each investor is making. If the substance is that each investor is investing in a property whose management will be under his control, the arrangements should not be regarded as a collective investment scheme. On the other hand, if the substance is that each investor is getting rights under a scheme that provides for someone else to manage the property, the arrangements would be regarded as a collective investment scheme.

Day-to-day control is not defined and so must be given its ordinary meaning. In our view, this means you have the power, from day-to-day, to decide how the property is managed. You can delegate actual management so long as you still have day-to-day control over it.[6]

The distancing of control over a real asset, even though owned by the investor, may put him in the position of a financial investor. This is a classic test used by US courts, in a test called Howey Test, coming from a 1946 ruling in SEC vs. Howey[7]. If an investment opportunity is open to many people, and if investors have little to no control or management of investment money or assets, then that investment is probably a security. If, on the other hand, an investment is made available only to a few close friends or associates, and if these investors have significant influence over how the investment is managed, then it is probably not a security.

The financial world and the real world

As is apparent, the definition in sec. 235 of the UK legislation has inspired the draft of the Indian law. It is intriguing to seek as to how the collective ownership or management of real properties has come within the sweep of the law. Evidently, CIS regulation is a part of regulation of financial services, whereas collective ownership or management of real assets is a part of the real world. There are myriad situations in real life where collective business pursuits,  or collective ownership or management of properties is done. A condominium is one of the commonest examples of shared residential space and services. People join together to own land, or build houses. In the good old traditional world, one would have expected people to come together based on some sort of “relationship” – families, friends, communities, joint venturers, or so on. In the interweb world, these relationships may be between people who are invisibly connected by technology. So the issue, why would a collective ownership or management of real assets be regarded as a financial instrument, to attract what is admittedly a  piece of financial law.

The origins of this lie in a 1984 Report[8] and a 1985 White Paper[9], by Prof LCB Gower, which eventually led to the enactment of the 1986 UK Financial Markets law. Gower has discussed the background as to why contracts for real assets may, in certain circumstances, be regarded as financial contracts. According to Gower, all forms of investment should be regulated “other than those in physical objects over which the investor will have exclusive control. That is to say, if there was investment in physical objects over which the investor had no exclusive control, it would be in the nature of an investment, and hence, ought to be regulated. However, the basis of regulating investment in real assets is the resemblance the same has with a financial instrument, as noted by UK Supreme Court in the Asset Land ruling: “..the draftsman resolved to deal with the regulation of collective investment schemes comprising physical assets as part of the broader system of statutory regulation governing unit trusts and open-ended investment companies, which they largely resembled.”

The wide sweep of the regulatory definition is obviously intended so as not to leave gaps open for hucksters to make the most. However, as the UK Supreme Court in Asset Land remarked: “The consequences of operating a collective investment scheme without authority are sufficiently grave to warrant a cautious approach to the construction of the extraordinarily vague concepts deployed in section 235.”

The intent of CIS regulation is to capture such real property ownership devices which are the functional equivalents of alternative investment funds or mutual funds. In essence, the scheme should be operating as a pooling of money, rather than pooling of physical assets. The following remarks in UK Asset Land ruling aptly capture the intent of CIS regulation: “The fundamental distinction which underlies the whole of section 235 is between (i) cases where the investor retains entire control of the property and simply employs the services of an investment professional (who may or may not be the person from whom he acquired it) to enhance value; and (ii) cases where he and other investors surrender control over their property to the operator of a scheme so that it can be either pooled or managed in common, in return for a share of the profits generated by the collective fund.”


While the intent and purport of CIS regulation world over is quite clear, but the provisions  have been described as “extraordinarily vague”. In the shared economy, there are numerous examples of ownership of property being given up for the right of enjoyment. As long as the intent is to enjoy the usufructs of a real property, there is evidently a pooling of resources, but the pooling is not to generate financial returns, but real returns. If the intent is not to create a functional equivalent of an investment fund, normally lure of a financial rate of return, the transaction should not be construed as a collective investment scheme.


[1] Vishes Kothari: Property Share Business Models in India,

[2] Nidhi Jain, Collective Investment Schemes for Real Estate Investments in India, at

[3] Vinod Kothari and Nidhi Jain article at:




[7] 328 U.S. 293 (1946), at

[8] Review of Investor Protection, Part I, Cmnd 9215 (1984)

[9] Financial Services in the United Kingdom: A New Framework for Investor Protection (Cmnd 9432) 1985


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Market-Linked Debentures – Real or Illusory?

Aanchal Kaur Nagpal and Shreya Masalia

Vinod Kothari and Company |  


Market linked debentures (MLDs) are a type of debt security that provides returns based on the performance of an underlying index/security. When the underlying security does well, the return on MLDs will be high and vice-versa. While the underlying security to which the MLDs are linked is at the discretion of the issuer, the same, however, needs to be related to the market, e.g. indices such as Nifty 50, SENSEX etc., or securities like equity, debt securities, government securities etc. For an in-depth understanding of the concept and the regulatory framework of MLDs, read our article here.

The previous article touched upon the concern of MLDs being used for the purpose of regulatory arbitrage, without being truly market-linked. The regulatory arbitrage may come in the form of additional ISINs, exemption from EBP mechanism, etc. The same has been discussed in detail in the previous article.

In this article, we shall examine various case studies (picked from various information memorandum available on the stock exchange and websites of companies) to prove the point.

The case studies are tabulated below:

S. No. Underlying The basis for coupon payoff Likely/unlikely conditions
1. NIFTY 50 If final fixing level > 25% of initial level, coupon – 8.1767% (XIRR 8.000%)

Initial level (NIFTY 50) index = 11400
25% of initial level (NIFTY 50) = 2850

So, if the final fixing level is above a value of 2850, then coupon pay off will be 8%.
If the final fixing level is below 2850, the coupon will be 0%.

Conclusion –

This condition is highly unlikely to happen. Looking at past trends, the probability that NIFTY 50 would fall below the level of 2850 is very low.

2. NIFTY 50 If Final >= Initial, Principal Amount * 20.50%
If Final < Initial, Principal Amount * 19.65%
This is a likely condition. However, in all cases, the investor is going to receive coupon payoff, even if the underlying performs negatively, there is a payoff.The level of rise in Nifty is not related to the return that the investor will receive. i.e. if the initial level is 10,000 and nifty either rises to 20,000 or 10, 200, the return will be the same.

Difference between coupon payoffs in both the scenarios i.e. whether the underlying performs or not is less than 1%.

3. G-sec The initial fixing level is 105.94 (which is the price of G-sec on the initial fixing date)

If the final fixing level is >=79.455 – then the coupon will be 8%
If the final fixing level is <79.455 but >= 26.485 then the coupon will be 7.95%
If the final fixing level is <26.485 then the coupon will be 0%.


Conclusion –

The downside condition is highly unlikely to happen. The probability that the price of the G-sec on the final fixing date will fall below 26.485 from a level of 105.94 is very low. In fact, on the final fixing date, the price of the G-sec was 108.17 which is higher than the initial fixing level.

4. NIFTY 50 Initial level – an average of 6 observations
Final level – an average of 6 observations
Nifty performance- final level/initial level – 1
Fixed coupon- 26.70%
Participation rate (variable component)- 85%Coupon payoff –
If Final Level >= Initial Level, Principal + Max Fixed-Coupon, Participation rate * Nifty Performance)
Else, If Final Level < Initial Level; Principal + Fixed-Coupon.
Conclusion –

This is a likely condition. Here the coupon payoff is a combination of the fixed and variable part (Directly depending on the performance of nifty)
Even if the underlying performs negatively, the investor will still earn the fixed component along with the principal.

5. NIFTY 50 If Final Fixing Level <= 25% of Initial Fixing Level: 0.000%
If Final Fixing Level > 25% of Initial Fixing Level: 7.4273% p.a.
(XIRR 6.95% p.a.)Suppose,
Initial level (NIFTY 50) index = 9106.25
25% of initial level (NIFTY 50) = 2276.56

So, if the final fixing level is above a value of 2276.56, then coupon pay off will be 6.95%.
If the final fixing level is below 2276.56, the coupon will be 0%.

Conclusion –

This condition is highly unlikely to happen. Looking at past trends, the probability that NIFTY 50 would fall below the level of 2376.56 is very low.

6. G-sec If Final Fixing Level >=25% of the Initial Fixing level, then coupon+ principal
If Final Fixing Level < 25% of the Initial Fixing level, then only principal.
Conclusion –

This condition is highly unlikely to happen. Looking at past trends, the probability that G-sec would fall below 25% of the initial level is low.

7. 10-year G-sec Underlying performance- Final level/ Initial level * 100
Coupon payoff-
If UP >= 75% of initial level- 8.45%
If UP < 75% but >= 25% of initial level, then 8.40%
If UP < 25%, then 0.
This condition is highly unlikely to happen. Looking at past trends, the probability that G-sec would fall below 25% of the initial level is low.
Also, the difference between the two coupon rates is 0.5%
8. NIFTY 50 Reference Index-Linked Return=
Debenture Face Value* Reference Index Return FactorFactor = Max [0%, 115%* {(Observation Value of the Reference Index / Start Reference Index Value) – 100%}]

115% is the participation rate

Observation Value of the Reference Index shall Mean Closing Value of CNX Nifty on the scheduled valuation date for redemption.

This condition is likely to happen- since the return is directly dependent on the performance of the index.Here, the value of Nifty for example is 5700, if nifty falls below 5700, there will be 0% pay off, if nifty rises above 5700, then the payoff would be 115% of the performance of NIFTY,

For example, if Nifty is 5700 and it rises to 6000- rise is 5%- coupon payoff shall be 115% of 5% = 6.05%.

9. G-sec If the performance of underlying final fixing date –

greater than 50% of digital level : Coupon= 8.6819 p.a.
less than or equal to 50% of digital level: Coupon = 0%

*Digital level: 100% of the Closing price of the reference security, of 7.17 G-Sec 2028 as on Initial Fixing Date.

The condition is unlikely to happen.
E.g. The Value of G-sec on the initial date is 97. 72- The chances that the same will fall below 48.86 is very low.
10. NIFTY 50 If Final Fixing Level <= 25% of Initial Fixing Level: 0.000%
If Final Fixing Level > 25% of Initial Fixing Level: 8.70% p.a. (XIRR 8.35% p.a.)Suppose,
Initial level (NIFTY 50) index = 9106.25
25% of initial level (NIFTY 50) = 2276.56

So, if the final fixing level is above a value of 2276.56, then coupon pay off will be 6.95%.
If the final fixing level is below 2276.56, the coupon will be 0%.

Conclusion –

This condition is highly unlikely to happen. Looking at past trends, the probability that Nifty 50 would fall below the level of 2376.56 is very low.

Further, put option is given- participation rate is lower i.e. 65%.

11. NIFTY 50 Coupon amount –

A) If Final > 140% of Initial, then coupon rate =Performance% of the initial principal amount
B) If Final <= 140% of Initial, then coupon rate = 40% of the initial principal amount.

Conclusion –

This condition is highly unlikely to happen as the possibility of Nifty falling to 40% is rare.

12. NIFTY 50 Coupon = Max(Underlying Performance, Min(48.85%,Max(4.885*Underlying
Performance,0)))Underlying performance – (Final Fixing Level / Initial Fixing Level) – 1
Conclusion –

The condition is likely to happen.
Here, if the initial level is 11404.80 and Nifty is below 11404.80 (negative or 0% performance), then the coupon rate is 0%.
Here, if the Nifty rises above 11404.80 till 12431.23 (up to 9% rise), then the coupon rate shall be as per the formula.
If Nifty rises above 12545.28 till 16977.19 (above 9% up to 48.86% rise), then coupon shall be 48.86%)
If Nifty rises above 16993.15 (above 48.86% rise), then the coupon shall be equal to the underlying performance.

13. G-sec If Final Fixing Level <= 25% of Initial Fixing Level: 0.000%
If Final Fixing Level > 25% of Initial Fixing Level: 6.80% p.a.Suppose,
The initial level of g-sec is 100
25% of initial level (G Sec) = 25
So, if the final fixing level is above a value of 25 then the coupon payoff will be 6.80%.
If the final fixing level is below 25, the coupon will be 0%.
Conclusion –

The condition is highly unlikely. Looking at past trends, the probability that g-sec will fall to 25% is very low.

14. Nifty 10 YR Benchmark G-Sec (Clean Price) index 100% of Principal Amount * (Coupon A + Coupon B) Where,

“Coupon A” shall mean:
A) If Final Level >= 30% of Initial Level (i.e. 0.30 * Initial Level),
Coupon shall mean Rebate i.e. 21%


B) If Final Level < 30% of Initial Level (i.e. 0.30 * Initial Level),
Coupon shall be Nil

“Coupon B” shall mean:

(1 + Coupon A) * 10.50% * (Day-Count/365)

The initial level of g-sec is 925
30% of initial level (G Sec) = 277.5

So, if the final fixing level is above a value of 277.5 then coupon pay off will be 21%.
If the final fixing level is below 25, the coupon will be 0%.

Conclusion –

The condition is highly unlikely. Looking at past trends, the probability that g-sec will fall to 30% is very low.

15. NIFTY 50 If Final Fixing Level >=25% of the Initial Fixing level = 36.405%
If Final Fixing Level < 25% of the Initial Fixing level = 0%Suppose,
Initial level 10710.45
final below 2677.61 only then will the coupon be 0%.
Conclusion –

The condition is highly unlikely. Looking at past trends, the probability that Nifty 50 will fall to 25% is very low.

16. CNX Nifty Here, the entry NIFTY is calculated as average for 3 dates in 3 months.

For the final level- NIFTY on 11 observation dates is calculated.

Increases have been divided into levels – and for each level, there is a percentage for coupon rate.

The highest coupon rate out of all the 11 levels will be taken for the final coupon rate.

The minimum level is 115% of the entry Nifty.

Below that- no level and no coupon.

Conclusion –
The coupon is based on the performance of Nifty and hence is likely to happen.
17. 10 year Government security price (a) if IGB 5.79 05/11/30 Corp Price => 75% of *Digital Level the Coupon rate shall be at 11% p.a. (Maximum)

b) if IGB 5.79 05/11/30 Corp Price is less than 75% but equal to or greater than 25% of *Digital Level the Coupon rate shall be at 10.95% p.a. (Minimum)

(c) if IGB 5.79 05/11/30 Corp Price < 25% of *Digital Level then no Coupon shall be

*Digital Level – 100% of IGB 5.79 11/05/2020 Corp price at Initial Observation Date.

Conclusion –

As such it’s highly unlikely to receive no coupon at all as the probability of the g-sec falling to 75% is negligible looking at the past trends. Even the probability of the G-sec value falling between 25 – 75 % is unusual, but even if it does, the difference is the coupon rate is merely that of .05% which is negligible.

18. CNX Nifty If Final Fixing Level >=25% of the Initial Fixing level = 32.143%
If Final Fixing Level < 25% of the Initial Fixing level = 0%Suppose,
The initial level is 10252.10
If the final level falls below 2563.03 then the coupon rate will 0 and above that coupon rate will be 9.25%.
Conclusion –

The condition is highly unlikely. Looking at past trends, the probability that Nifty 50 will fall to 25% is very low.

Analysis of the MLD market in India

On an analysis of the cases given above, one can clearly observe that the conditions on which the performance of the underlying is based, are highly unrealistic. An instance where the value of Nifty or a G-sec would fall by 50-75% seems quite impossible where even ‘The Great Depression of 2008’ caused a fall of only 40% in stock indices. Hence in almost all conditions, the investor will always be receiving a coupon and thus the hedging shown is more of a hoax. The MLDs are, thus, not market-linked at all thereby defeating the purpose of introducing MLDs. On lifting the veil of the underlying condition used, it reveals that the MLDs are in fact equivalent to plain vanilla debentures.


The true intent and spirit of introducing the concept of MLDs can be seen missing from a lot of the issuances by the companies. Instead, MLDs, are being issued, rather in some of the most farcical avatars, to gain regulatory arbitrage otherwise not available to plain vanilla debentures. This is indicative of what the market perceives as a bottleneck or a disadvantage, and what the market desires.

This, in itself, may call for a relook at the extant regulatory framework. Relaxations or exemptions should be considered where laws are not meeting the requisite purpose or are harsher than required, except where such relaxations become unconscionable or go against the basic tenets of policy-making.





2020 – Year of changes for AIFs

Timothy Lopes – Senior Executive                                                                             CS Harshil Matalia – Assistant Manager

The year 2020 – ‘Year of pandemic’, rather we can say the year of astonishing events for everyone over the globe. Without any doubt, this year has also been a roller coaster ride for Alternative Investment Funds (‘AIFs’) with several changes in the regulatory framework governing AIFs in India.

Recent Regulatory Changes for AIFs

In continuation to the stream of changes, Securities Exchange Board of India (‘SEBI’), in its board meeting dated September 29, 2020, has approved certain amendments to the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’). The said amendments have been notified by the SEBI vide notification dated October 19, 2020. The following article throws some light on SEBI (AIFs) Amendment Regulations, 2020 (‘Amendment Regulations’) and tries to analyse its impact on AIFs.

Clarification on Eligibility Criteria

Regulation 4 of AIF Regulations prescribes eligibility criteria for obtaining registration as AIF with SEBI. Prior to the amendment,  Regulation 4(g), provided as follows:

“4 (g) the key investment team of the Manager of Alternative Investment Fund has adequate experience, with at least one key personnel having not less than five years experience in advising or managing pools of capital or in fund or asset or wealth or portfolio management or in the business of buying, selling and dealing of securities or other financial assets and has relevant professional qualification;”

The amended provision to 4 (g) extends the meaning of relevant professional qualification, the effect of which seems to add more qualitative criteria to the management team of the AIF, to be evaluated  at the time of grant of certification. The newly amended section 4(g) of the AIF Regulations reads as follow:

“(g) The key investment team of the Manager of Alternative Investment Fund has –

  • adequate experience, with at least one key personnel having not less than five years of experience in advising or managing pools of capital or in fund or asset or wealth or portfolio management or in the business of buying, selling and dealing of securities or other financial assets; and
  • at least one key personnel with professional qualification in finance, accountancy, business management, commerce, economics, capital market or banking from a university or an institution recognized by the Central Government or any State Government or a foreign university, or a CFA charter from the CFA institute or any other qualification as may be specified by the Board:

Provided that the requirements of experience and professional qualification as specified in regulation 4(g)(i) and 4(g)(ii) may also be fulfilled by the same key personnel.”

It is apparent from the prima facie comparison of language that the key investment team of the Manager may have one key person with five years of experience (quantitative) as well as a personnel holding professional qualification (qualitative) from institutions recognised under the regulation. Further, clarity has been appended in form of proviso to the section that quantitative and qualitative requirements could be met by either one person, or it could be achieved collectively by more than one person in the fund.

With this elaboration, SEBI has harmonized the qualification requirements as that with the requirement specified for other intermediaries such as Investment Advisers, Research Analysts etc. in their respective regulations. Detailed prescription on degrees and qualifications for AIF registration by SEBI is a conferring move and is expected to aid as a clear pre-requisite on expectations of SEBI from prospective applications for registration of the fund.

Formation of Investment Committee

Regulation 20 of AIF Regulations specifies general obligations of AIFs. Erstwhile, the responsibility of making investment decisions was upon the manager of AIFs. It has been noticed by the SEBI from the disclosures made in draft Private Placement Memorandums (‘PPMs’) filed by AIFs for launch of new schemes, that generally Managers prefer to constitute an Investment Committee to be involved in the process of taking investment decisions for the AIF. However, there was no corresponding obligation in the AIF Regulations explicitly recognizing the ‘Investment Committee’ to take investment decisions for AIFs. Such Investment Committees may comprise of internal or external members such as employees/directors/partners of the Manager, nominees of the Sponsor, employees of Group Companies of the Sponsor/ Manager, domain experts, investors or their nominees etc.

These  amendments are based on the recommendations to SEBI to recognize the practice followed by AIFs to delegate decision making to the Investment Committee.[1] The rationale behind amendments to AIF Regulations is based on the following merits as proposed in the recommendations::

  1. Presence of investors or Sponsors or their nominees in an Investment Committee which may serve to improve the due diligence carried out by the Manager, as they are stakeholders in the AIF’s investments.
  2. Presence of functional resources from affiliate/group companies of the Manager (legal advisor, compliance advisor, financial advisor etc.) in the Investment Committee may be useful to ensure compliance with all applicable laws.
  3. Presence of domain experts in the committee may provide comfort to the investors regarding suitability of the investment decisions, as the investment team of the Manager may not have domain expertise in all industries/ sectors where the fund proposes to invest.

Thus, the insertion was made, giving the option to the Manager to constitute an investment committee subject to the following conditions laid down in the newly inserted sub-regulation, i.e. Regulation 20(6) of the AIF Regulations given below –

  1. The members of the Investment Committee shall be equally responsible as the Manager for investment decisions of the AIF.
  2. The Manager and members of the Investment Committee shall jointly and severally ensure that the investments of the AIF comply with the provisions of AIF Regulations, the terms of the placement memorandum, agreement made with the investor, any other fund documents and any other applicable law.
  3. External members whose names are not disclosed in the placement memorandum or agreement made with the investor or any other fund documents at the time of on-boarding investors shall be appointed to the Investment Committee only with the consent of at least seventy five percent of the investors by value of their investment in the Alternative Investment Fund or scheme.
  4. Any other conditions as specified by the SEBI from time to time.

The constitution of investment committee is a global standard practice followed by the Funds. However, funds structure in India might be altered with the new defining role of investment committee under the AIF Regulations. The investment committee generally comprises of nominees of large investors in the fund and at times other external independent professional bodies that act as a consenting body towards prospective deals of the fund. The amendment will alter the role of investors holding positions at investment committee as the new defining role might deter them from taking underlying obligations. From the funds perspective seeking external independent professionals might get costly as there is an obligation introduced by way of this amendment regulation. Further, it casts an onus on the investment committee to be involved in day to day functioning of the fund, which used to be otherwise (where members were usually involved in mere finalising the deals).  Lateral entry of the members to investment committee post placement of memorandum with the consent of investors is aimed at greater transparency in funds functioning.

Test for indirect foreign investment by an AIF

As per Clause 4 of Schedule VIII of FEMA (Non-Debt Instrument) Rules, 2019 (‘NDI Rules’) any investment made by an Investment Vehicle into an Indian entity shall be reckoned as indirect foreign investment for the investee Indian entity if the Sponsor or the Manager or the Investment Manager –

(i) is not owned and not controlled by resident Indian citizens or;

(ii) is owned or controlled by persons resident outside India.

Therefore, in order to determine whether the investment made by AIFs in Indian entity is indirect foreign investment, it is essential to identify the nature of the Manager/Sponsor/investment manager, whether he is owned or controlled by a resident Indian citizen or person resident outside India.

RBI in its reply to SEBI’s query on downstream investment had clarified that since investment decisions of an AIF are taken by its Manager or Sponsor, the downstream investment guidelines for AIFs were focused on ownership and control of Manager or Sponsor. Thus, if the Manager or Sponsor is owned or controlled by a non-resident Indian citizen or by person resident outside India then investment made by such AIF shall be considered as indirect foreign investment.

Whether an investment decision made by the Investment Committee of AIF consisting of external members who are not Indian resident citizens would amount to indirect foreign investment?

In light of the above provisions of the NDI Rules and with the introduction of the concept of an “Investment Committee”, SEBI has sought clarification from the Government and RBI vide its letter dated September 07, 2020[2].


With the enhancement in eligibility criteria, SEBI has ensured that the investment management team of the AIF would have relevant expertise and required skill sets.

Further, giving recognition to the concept of an investment committee will cast an obligation on investment committee fiduciary like obligations towards all the investors in the fund. . However, there exists certain ambiguity under the NDI Rules, for applications wherein external members of investment committee who are not ‘resident Indian citizens’,   which is currently on hold and pending receipt of clarification.



SEBI’s stringent norms for secured debentures

Will it lead to a paradigm shift to unsecured debentures?

Shaifali Sharma | Vinod Kothari and Company


The debt market in India has seen significant growth over the years. Amongst the various debt instruments, debentures are one of the most widely used instruments for raising funds. In India, the regulatory framework for debt instruments is governed by multiple regulators through multiple regulations. As far as secured debentures are concerned, more stringent provisions have been prescribed by the respective regulators to protect the interest of investors. In theory, it seems that hard earned money invested by the investors in secured debentures are safe and secured against the assets of the company. However, some major defaults witnessed by debt market in the recent years depict a different reality.

Absence of identified security, delay in payment due to debenture holders and other increased events of defaults witnessed in recent years, has encouraged SEBI to revise the regulatory framework in relation to secured debentures and Debenture Trustees and thereby SEBI vide its circular[1] dated November 03, 2020 (‘November 03 Circular’), has issued norms with respect to the security creation and due diligence of asset cover in furtherance to the recent amendment made in ILDS Regulations[2] and DT Regulations[3] w.e.f. October 8, 2020. Subsequently, on November 13, 2020, SEBI issued circular on Monitoring and Disclosures by Debenture Trustee[4], effective from quarter ended on December 31, 2020 for listed debt securities dealing with various issues namely monitoring of ‘security created’ / ‘assets on which charge is created’, action to be taken in case of breach of covenants or terms of issue, disclosure on website by Debenture Trustee and reporting of regulatory compliance.

The revised framework may pose challenges for corporates to raise fund through secured debentures and may leave them relying on unsecured debentures. In this article we shall discuss and analyse the impact and consequences of these stricter norms on companies and the way forward.

Current Scenario of Corporate Bond Market in India

The RBI Bulletin January, 2019[5] provides that the “total resource mobilisation by Indian corporates through public/private/rights issues is dominated by debt while equity accounts for close to 38%”.

In India, the corporate bond market is dominated by private placements, a graphical trend comparing corporate debt issuance under two routes i.e. public issue and private placement has been given below (‘table 1’). As per the latest data available with SEBI, the total amount raised through corporate bonds by way of private placement has increased from 4,58,073 crores to 6,74,702 crores in the last 5 years.

Table on amount raised through public and private placement issuances of Corporate Bonds in Indian Debt Market (Listed Securities)

Financial Year No. of Public Issues Total amount raised through Public Issue (in crores) No. of Private Placement (in crores) Total amount raised through Private Placement (in crores)
2015-16 20 33811.92 2975 458073.48
2016-17 16 29547.15 3377 640715.51
2017-18 7 4953.05 2706 599147.08
2018-19 25 36679.36 2358 610317.61
2019-20 34 14984.02 1787 674702.88
2020-21 (till Oct) 5 881.82 1157 442526


Source: Compiled from data available at SEBI’s website[6]

Table 1: Corporate Debt Issuance under Private Placement and Public Issue

As regards the concentration of secured borrowing in comparison to the unsecured borrowing in private placement market, the RBI Bulletin January 2019 further provides that ‘secured lending accounted for close to half of the total amount raised even in the private placement market of corporate debt’. The same may be understood from a graphical presentation below:

Source: RBI Bulletin January 2019

This includes secured and unsecured borrowing raised in the private placement market of corporate debt

As also noted by SEBI in its consolidation paper[7] dated February 25, 2020, in last 5 Financial Years the bond issuances were largely secured (approximately 76%).

Therefore, the above figures indicate that the volume of corporate bonds, particularly in private placement market, is higher in secured borrowings.

Regulatory Framework for issuing Secured Debentures

SEBI’s stringent norms for issuance of secured debentures

A company may issue secured debentures after complying with the extensive provisions as prescribed under the Companies Act, 2013 and SEBI Regulations. Further SEBI, in view of the increased events of defaults, challenges in relation to creation of charge, enforcement of security, Inter-Creditor Agreement process and other related issues, has reviewed the regulatory framework for Corporate Bond and Debenture Trustee and revisited the manner of issue of secured debentures by introducing amendments in DT Regulations[8], ILDS Regulations[9] and Listing Regulations[10] w.e.f October 08, 2020.

In furtherance to the above amendments made in ILDS Regulations and DT Regulations, SEBI vide November 03 Circular issued norms applicable to secured debentures intended to be issued and listed on or after January 01, 2021.

While the amended provisions aim to secure the interest of debenture holders, the same has raised compliance burden on issuer of secured debentures and thereby corporates may be inclined towards unsecured borrowing facilities due to following reasons:

  1. Creation of Recovery Expense Fund (REF)

Issuers shall create a Recovery Expense Fund (‘REF’) towards the recovery of proceeding expenses in case of default. The manner of creation, operation and utilization of Fund is prescribed by SEBI vide circular[11] dated October 22, 2020. It requires the Issuer to deposit 0.1% of the issue subject to a maximum of 25 lakhs per issuer. This means that all issuers with an issue size above of 250 crores will be required to deposit 25 lakhs to the REF irrespective of the amount.

All the applications for listing of debt securities made on or after January 01, 2021 shall comply with the condition of creation of REF and the existing issuers whose debt securities are already listed on Stock Exchange(s) shall be given additional time period of 90 days to comply with creation of REF.

This fund is in addition to the requirement of creation of Debenture Redemption Reserve and Debenture Redemption Fund and therefore would entails additional compliance cost to the issuer.

  1. Due diligence by Debenture Trustee for creation of security

The Debenture Trustee is required to assess that the assets for creation of security are adequate for the proposed issue of debt securities. However, there is no clarity on who is to bear the cost of due diligence. In case the same is to be borne by the issuer, the issue expense will unnecessarily increase.

In case of creation of further charge on assets, the Debenture Trustee shall intimate the existing charge holders via email about the proposal to create further charge on assets by issuer seeking their comments/ objections, if any, to be communicated to the Debenture Trustee within next 5 working days.

In cases where issuers have common Debenture Trustee for all issuances and the charge is created in favour of Debenture Trustee, the requirement seems impracticable.

  1. Creation of security and strict time frame of listing debentures through private placement

The November 03 Circular mandates creation of charge and execution of Debenture Trust Deed with the Debenture Trustee before making the application for listing of debentures.

SEBI vide its circular[12] dated October 5, 2020, effective for issuance made on or after December 1, 2020, requires the listing of private placement to be completed within 4 trading days from the closure of the issue. Where the issuer fails to do so, he will not be able to utilize issue proceeds of its subsequent two privately placed issuance until final listing approval is received from stock exchanges and will also be liable to penalty as may be prescribed.

In such scenario, it would be arduous for issuers and Debenture Trustee to comply with the procedural requirements in such stringent timelines.

  1. Entering into Inter-Creditor Agreement (ICA)

An ICA is an agreement between all lenders of a borrower through which lenders collectively initiate the process of implementing a Resolution Plan as per RBI guidelines in case of default. These provisions are applicable to Scheduled Commercial Banks, All India Term Financial Institutions like NABARD, SIDBI etc., small finance banks and NBFC-D. Trustees may join the ICA subject to the approval of debenture holders and conditions prescribed. Debenture Trustee may subject to the approval of debenture holders enter into ICA as per the RBI framework.

  • While the ICA is entered with the approval of debenture holders, however, the debenture holders may not be familiar of the concept of ICA and consequences, positive / negative, of joining ICA resulting into uninformed decision.
  • RBI guidelines on ICA applies to institutional entities and it does not provide any rights for debenture holders.
  • While the Debenture Trustee is free to exit the ICA, it will be challenging to exit ICA and enforce security in case of pari-passu charge.

In addition to the reasons stated above, other stringent compliances as introduced by the SEBI may impose burden and encourage corporates to give a second thought on shifting to unsecured debentures.

Should issuers move towards unsecured debt raising?

While the amendments focus on secured debentures, yet one of the major points in the SEBI Consultation Paper was creation of an ‘identified charge’ on assets. The proposal was in the light of the fact that in case of issuers like NBFCs, the debentures are secured by way of floating charge on receivables. Now, as is known, floating charges are enterprise-wide charges hovering on general assets of the company, unlike fixed charges. Floating charges are subservient to fixed charges. Further, the extant provisions of the Insolvency and Bankruptcy Code are not clear on the treatment of floating charges vis-à-vis unsecured debt. Hence, the prevalence of floating charges on receivables is not of much relevance in the case of issuers like NBFCs. Therefore, ‘secured’ debentures, might actually be an illusion and may have no concrete effect. Hence, with more stringent conditions coming in, it might actually be a motivation to the issuers to move to unsecured debentures.

Fund raising via unsecured debentures and applicability of Deposit Rules

Given the stringent regulatory framework for issuance and listing of secured debentures as discussed above, corporates may start looking for other sources of raising funds, including unsecured debt issuances. In case of issue of unsecured debentures, one has to see the applicability of the Companies (Acceptance of Deposits) Rules, 2014 (‘Deposits Rules’) or Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016[13] (‘NBFC Deposit Directions’), in case of NBFCs, in this regard.

Applicability of Deposit Rules / NBFC Deposit Directions for issuance of unsecured debentures

Applicability Whether deposits?
Secured debentures Unsecured debentures


For Companies


(on which Deposits Rules apply)

Secured debentures shall not be considered as deposits


Definition of ‘deposit’ under Rule 2 (1)(c)(ix) of the Companies (Acceptance of Deposits) Rules, 2014 excludes debentures which are secured by first charge or a charge ranking pari passu with the first charge on any assets referred to in Schedule III of the Companies Act, 2013 excluding intangible assets of the company or bonds or debentures compulsorily convertible into shares of the company within ten years.

Further, if such bonds or debentures are secured by the charge of any assets referred to in Schedule III of the Act, excluding intangible assets, the amount of such bonds or debentures cannot exceed the market value of such assets as assessed by a registered valuer.

Unsecured debentures shall be considered as deposits, unless listed on any recognized Stock Exchange.


Amount raised by issue of unsecured non-convertible debentures listed on a recognised stock exchange as per applicable regulations made by SEBI shall not be considered as deposits since exempted under Rule 2(1)(c)(ixa) of the Companies (Acceptance of Deposits) Rules, 2014.



(on which NBFC Deposits Directions apply)

Secured debentures shall not be considered as public deposits


As per the definition of ‘public deposit’ under para 3(xiii)(f)  of the Master Direction – Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016, any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable property of the company; or by any other asset or which would be compulsorily convertible into equity in the company provided that in the case of such bonds or debentures secured by the mortgage of any immovable property or secured by other assets, the amount of such bonds or debentures shall not exceed the market value of such immovable property/other assets;

Unsecured debentures shall be considered as public deposits, except in case of issuance of non-convertible debentures with a maturity more than one year and having the minimum subscription per investor at Rs.1 crore and above


As per para 3(xiii)(fa) of said Master Directions, any amount raised by issuance of non-convertible debentures with a maturity more than one year and having the minimum subscription per investor at Rs.1 crore and above, provided that such debentures have been issued in accordance with the guidelines issued by the Bank as in force from time to time in respect of such non-convertible debentures shall not be treated as public deposits.

Thus, the debentures will either have to be secured, or will have to be listed in order to avail exemption from the Deposit Rules/ NBFC Deposit Directions.

Compliance Corner: How different is unsecured from secured debentures?

A brief comparison of the requirements of issuance of secured and unsecured debentures is summarized below:

Sr. No. Basis of Comparison Section/ Rule Secured Debentures Unsecured Debentures
1. Creation of security Section 71(3) of the Companies Act, 2013 read with Rule 18 of Companies (Share Capital and Debentures) Rules, 2014 (‘Debenture Rules, 2014’) Secured by the creation of a charge on the properties or assets of the company or its subsidiaries or its holding company or its associates companies, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon.


Charge or mortgage shall be created in favour of the debenture trustee on:

  • any specific movable property of the company or its holding company or subsidiaries or associate companies or otherwise;
  • or any specific immovable property wherever situate, or any interest therein;
  • in case of a NBFCs, the charge or mortgage may be created on any movable property
No security created.
2. Registration of charge Section 77 of the Companies Act, 2013 Issuer shall register the charge within 30 days of its creation/ modification or such additional period as may be prescribed. Not Applicable
3. Redemption Period Rule 18(1)(a) of Debentures Rules, 2014 To be redeem within 10 years from the date of issue

Companies engaged in setting up infrastructure projects, infrastructure finance companies, infrastructure debt fund NBFCs and companies permitted by the CG, RBI or any other statutory authority may issue for a period exceeding 10 years but not exceeding 30 years.

No redemption time frame prescribed for unsecured debentures.
4. Voting Rights Section 71(2) the Companies Act, 2013 Does not carry voting rights Does not carry voting rights
5. Creation of Debenture Redemption Reserve (DRR) Section 71(4) read with Rule 18(7) of Debentures Rules, 2014 DRR/DRF requirement does not depend whether debentures are secured or unsecured, rather it depends on the type of company and the mode of issue i.e. public issue or private placement. Subject to same provisions


6. Appointment of Debenture Trustee Section 71(5) read with Rule 18(1)(c), (2) of Debenture Rules, 2014 Required in case the offer or invitation is made to the public or if the total number of members exceeds 500 for the subscription of debentures [Section 71(5)].

ILDS requires appointment of DT in case of every listed debentures.

Subject to same provisions
7. Duties of Debenture Trustee Section 71(6) read with Rule 18(3) & (4) of the Debenture Rules, 2014, SEBI (ILDS) Regulations, 2008 and SEBI (DT) Regulations, 1993 In accordance with provisions of Section 71(6) read with Rule 18(3) & (4) of the Debenture Rules, 2014

Other obligations as prescribed under SEBI (ILDS) Regulations, 2008 and SEBI (DT) Regulations, 1993

Subject to same provisions
8. Failure to redeem or pay interest on debentures Section 71(10), 164(2) of the Companies Act, 2013
  • In case of failure by the company to redeem the debentures on the date of their maturity or pay interest on the debentures when it is due, an application may be made by any or all of the debenture-holders, or debenture trustee to the Tribunal. The Tribunal can direct the company to redeem the debentures forthwith on payment of principal and interest due thereon.
  • If a company fails to pay interest on debentures, or redeem the same, and the failure continues for one year or more, all the directors of such delinquent company become disqualified.
Subject to same provisions
9. Listing of Debentures SEBI (ILDS) Regulations, 2008, SEBI (LODR) Regulations, 2015 Issuer to comply with the provisions of SEBI (ILDS) Regulations, 2008. Post listing, the issuer, in addition to SEBI (ILDS) Regulations, 2008, shall also comply with provisions of SEBI (LODR) Regulations, 2015 and SEBI (Prohibition of Insider Trading) Regulations, 2015. Subject to same provisions

Neither the Companies Act, 2013 nor the Debenture Rules, 2014 elaborate the manner of issue of unsecured debentures. However, the provisions for issue of unsecured debentures are almost the same as that for secured debentures except certain conditions such as redemption period, requirement of creation of charge on the assets of the issuer and filing charge with the Registrar of Companies.

Investors perspective may also prove the same stand –the unsecured debentures don’t carry securities against any assets of the company unlike in case of secured debenture, however the debenture-holder(s) or the Debenture Trustee may approach the Tribunal which may then direct the company to honour its debt obligations.

Concluding Remarks

From the issuer’s perspective, the debentures have to be secured so as to escape from the Deposit Rules. This is one of the main reasons why companies issue secured debentures.  While the issuer may be able to avoid the rigorous compliances of Deposits Rules, issuing secured debentures have apparently become very stringent.

From investor’s viewpoint, it may seem that the investment in secured debentures is safe as company has created charge on its assets sufficient to discharge the principle and interest amount. Yet some major defaults in past have made the investors more hesitant to invest in the secured debentures.

While at this stage it was important for SEBI to make the norms more stringent to safeguard the interest of the debenture holders, however, it will be challenging for the issuers to comply with such norms, failing which they may be inclined towards issuance of unsecured debt issuances.

Although unsecured debentures do not provide any security against investment, issuer may still rewards investors with higher yields which is a pay-off for increased risk taken by the investor.

Given the new compliance burden and their stringencies for issuance and listing of secured debentures, it will be interesting to see how the ratio of secured and unsecured borrowings changes in the coming years. For the sake of it, the upcoming trends, preferences and acceptability of stringencies by the corporates will be very vital for observation.

Other reading materials on the similar topic:

  1. ‘This New Year brings more complexity to bond issuance as SEBI makes it cumbersome’ can be viewed here
  2. ‘SEBI responds to payment defaults by empowering Debenture Trustees’ can be read here
  3. Our other articles on various topics can be read at:

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[2] SEBI (Issue and Listing of Debt Securities) Regulations, 2008

[3] SEBI (Debenture Trustees) Regulations, 1993







[10] SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015