Archive for category: Bond Market

Increased threshold, new incentive-disincentive framework instead of penalty

Sharon Pinto, Senior Manager & Palak Jaiswani, Asst. Manager (corplaw@vindokothari.com)

Updated on October 26, 2023

Background

With an intent to promote the Corporate Bond market, SEBI had introduced the framework for borrowing by Large Corporates (‘LCs’) framework with effect from April 1, 2019 by way of circular issued on November 26, 2018. Under the said framework, certain listed entities^[1] who satisfied the prescribed criteria with respect to their long term borrowings, were mandated to raise 25% of their incremental borrowings by way of issuance of debt securities. Incremental borrowings were defined to include borrowings of original maturity of more than 1 year excluding external commercial borrowings and inter-corporate borrowings between a parent and subsidiary(ies). This portion of incremental borrowings was required to be raised by way of debt securities on an annual basis For FY2020 and FY2021 and over a block of 2 years which was then extended to 3 years from FY 2022 onwards. Failure to meet the same would attract a penalty of 0.2% of the shortfall amount.

Around 1/3rd of the eligible LCs were unable to raise the required amount through debt securities in FY 21-22 on account of:

• raising of debt becoming costlier due to tightening liquidity and hike in the benchmark rate;
• non-availability of interest subsidy benefits from Central and State Governments in case of certain issuers and the resultant impact on viability of the projects undertaken;
• cost of debt resulting in higher tariff rates to the ultimate consumers in case of power sector entities, etc.

On the other hand, the investors like insurers, pension, and provident funds are required to invest a particular percentage of their incremental receipts in corporate bonds and therefore, continuous issuance of debt securities was necessary.

Recently, SEBI amended the SEBI (Issue and Listing of Non-Convertible Debt Securities) Regulations, 2021 (‘NCS Regulations’) introducing Chapter V B effective from July 06, 2023 that provides the requirement for LCs under Reg. 50B to comply with requirements stipulated by SEBI.

While it has been more than 4 years since the introduction of the concept of LCs, issuers are still struggling to comply with the mandatory requirements. Therefore, SEBI decided to review the LCs framework and issued a Consultation Paper dated August 10, 2023, for public comments. Thereafter, basis the comments received from the public and suggestions of the Corporate Bond and Securitisation Advisory Committee (‘CoBoSAC’), SEBI approved the revised framework, as detailed herein in its Board meeting held on September 21, 2023 (‘SEBI BM’).

Revised framework as per the Present Circular

The revised framework has been notified by SEBI vide Circular dated October 19, 2023 (‘Present Circular’) and is applicable w.e.f. April 1, 2024 for LCs (criteria for identification discussed in the latter part) following April-March as their financial year and from January 1, 2024 for entities following January-December as their financial year. Thus, the revised framework is applicable for entities which would be identified as LCs as on March 31, 2024 or December 31, 2023, as the case may be.

Key features of the revised framework are as follows:

Key features of the revised framework^[2]

This article discusses the amendments made in the LCs framework by way of the Present Circular including the rationale provided in the CP, relevant points discussed in the SEBI Board meeting in this regard and transition related requirement for ongoing block of 3 years for existing LCs.

Increase in the threshold of outstanding long-term borrowings

Existing Provisions	Proposed Changes in CP	SEBI’s rationale for proposed change
Outstanding long-term borrowings[3] of Rs. 100 crore or above	Outstanding long-term borrowing of Rs. 500 crore or above.	To align the criteria for LCs with the ‘High Value Debt Listed Entity’ or ‘HVDLEs’ as provided under the Listing Regulations.

Brief of public comments received and SEBI’s response:

While a major portion of public comments were in favour of the increase in the limit to Rs. 500 crore, a common remark raised by the public suggested applying the LC framework based on outstanding listed debt instead of outstanding long-term borrowings. SEBI disagreed as it will increase the burden for entities that have already tapped the debt market and will not help in reducing the burden on the banking system. There were few comments seeking exemption from the applicability in case of loss making companies and NBFCs, which was also dismissed by SEBI indicating that it has no nexus with profit or loss made by an entity and that NBFCs being the largest borrowers cannot be excluded.

SEBI BM decision

Increase the limit from existing Rs. 100 crores to Rs. 1000 crores, basis which, around 170 entities would qualify as LCs (as opposed to 482 entities in case of limit of Rs. 500 crore proposed).

Provisions under the Present Circular

The threshold limit of outstanding long term borrowings has been increased to Rs. 1000 crores.

Our Remarks

Classification as an HVDLE is on account of outstanding listed debt securities. On the contrary, an entity may not have any of its debt securities listed but may still be classified as an LC if it has its equity listed and borrowing from banks/ financial institutions exceeding the prescribed threshold. Increase of limit to Rs. 1000 crore is a welcome change.

Scope of outstanding long-term borrowings and incremental borrowings

Existing Provisions	Proposed Changes in CP	SEBI’s rationale for proposed change
Includes: any outstanding borrowing with an original maturity of more than 1 year   Excludes: (i) External Commercial Borrowings (ii) Inter-corporate borrowings between a holding and subsidiary	Term ‘incremental borrowings’ to be replaced with  ‘qualified borrowings’.   Includes: any outstanding borrowing with an original maturity of more than 1 year   Excludes: (i) External Commercial Borrowings (ii) Inter-Corporate Borrowings between its holding and/or subsidiary and /or associate companies; (iii) Grants, deposits, or any other funds received as per the guidelines or directions of the Government of India (‘GOI’); (iv) Borrowings arising on account of interest capitalization	To cover associate companies, on which the holding company has significant influenceThe end use of grants received from the Government is restricted to the purposes specified by Government and cannot be deviated fromInterest capitalized on the loan amount cannot be considered as borrowings.

Brief of public comments received and SEBI’s response:

All the public comments were in favor of the proposal. Few comments were received to additionally exclude borrowings for the purpose of refinancing which was not accepted by SEBI as it would defeat the intent of the framework. The suggestion to exclude borrowings made for mergers, acquisitions and takeovers was accepted by SEBI given those are not routine occurrences in the life-cycle of an entity.

SEBI BM decision

Incremental borrowings to be termed as qualified borrowings. Borrowings for mergers, acquisitions and takeovers to be further excluded from the scope of qualified borrowings.

Provisions under the Present Circular

The nomenclature ‘incremental borrowings’ has been revised to ‘qualified borrowings’ and the exclusions proposed in the CP i.e. inter-corporate borrowings involving associate companies, any funding received from the GOI, borrowings on account of interest capitalisation have been given effect to. Additionally, as per the public comments received, borrowings for the purpose of scheme of arrangement as stated above have also been excluded.

Retention of credit rating requirement as a criterion for LC identification

Existing Provisions	Proposed Changes in CP	SEBI’s rationale for proposed change
Have a credit rating of “AA and above”	Remove the requirement.	Entities with long-term outstanding borrowings of Rs. 500 Cr or above would generally fall under the bracket of credit rating of ‘AA and above’

Brief of public comments received and SEBI’s response:

Most of the public comments were against the proposal as entities with low rated debt may not find investors at all, which was accepted by SEBI.

SEBI BM decision

The criteria of a minimum credit rating to be retained as per existing norm.

Provisions under the Present Circular

SEBI has retained the existing requirement prescribing a minimum credit rating of “AA”/“AA+”/AAA under the revised framework.

Our Remarks

The proposal in the CP to drop the requirement altogether was inappropriate. An outstanding borrowing of Rs. 500 crore may not be necessarily indicative of the credit quality of the borrower. While regulations may force or incentivize the issuers to come up with debt issuance pursuant to this framework, however, it cannot force the investors to invest. An investor in debt security will rely on the credit quality which is fairly indicated through the credit rating of the debt security. The requirement of having a credit rating is one of the prerequisites for listing a debt security under NCS Regulations (Reg. 10). Even for determining the list of eligible issuers of debt securities for the purpose of contribution to Core Settlement Guarantee Fund (‘Core SGF’),  the issuer should have long term debt rating of the eligible securities of AAA, AA+, AA and AA- (excluding AA- with negative outlook). Decision to retain the erstwhile requirement is a welcome move.

Retention of block period of three years

Existing Provisions	Proposed Changes in CP	SEBI’s rationale for proposed change
FY 2020 & FY 2021 – On an annual basis FY 2022 onwards – On a block of 3 years	On an annual basis	To simplify the process of raising debt securities and to eliminate the complex process of tracking all the issuances during the block years.

Brief of public comments received and SEBI’s response:

Most of the public comments were against the proposal, which was accepted by SEBI.

 SEBI BM decision

SEBI to retain the requirement of the continuous block of 3 years in the framework.

Provisions under the Present Circular

It has been prescribed that atleast 25% of the qualified borrowings will be required to be raised by way of issuance of debt securities over a continuous block of 3 years.

Since, the framework is applicable w.e.f. FY 2025, entities identified as LCs as on the last day of ‘T-1’ [i.e. March 31, 2024 / December 31, 2023, as the case may be], will be required to raise the requisite quantum of qualified borrowings of FY ‘T’ [FY 2025] through issuance of debt over a block of 3 years i.e. over ‘T’ [FY 2025], ‘T+1’ [FY 2026]  and ‘T+2’ [FY 2027].

Our Remarks

The proposal in the CP to make it an annual requirement was inappropriate. For the purpose of this framework, the interest of such issuers who do not issue debt securities frequently is also to be kept in mind. While frequent issuers of debt securities may not find it difficult to borrow funds by issuance of further debt securities, it may not be feasible for non-frequent issuers to raise the entire quantum of prescribed incremental borrowings within a period of 1 year. Issuers are to be given certain flexibility and the timelines need not be made more stringent. Decision to retain the erstwhile requirement is a welcome move.

Incentive for exceeding the mandatory limit

Existing Provisions	Proposed Changes	SEBI’s rationale for proposed change
–	In case of a surplus, a certain quantum of the annual listing fees to be reduced; Reduction in the contribution to be made to the core SGF.	To promote ease of doing business and to encourage LCs to raise funds by incentivizing them.

Brief of public comments received and SEBI’s response:

All public comments were in favour of the proposal. One of the recommendations was to provide incentive in the form of reduction in the contribution to be made to the Recovery Expense Fund^[4], which was not approved by SEBI given it is a refundable deposit and meant to meet recovery expenses in case of any default.

SEBI BM decision

SEBI decided to introduce the incentive structure. With respect to the proposal for reduced contribution to Core SGF, SEBI approved to permit carry forward of incentive  till utilisation or set off within 6 years of obtaining the incentive.

Provisions under the Present Circular

The incentive scheme proposed has been notified. A benefit of reduction in the annual listing fees pertaining to listed debt securities or non-convertible redeemable preference shares ranging between 2% to 10% computed in the following manner would be available in case of surplus borrowings raised through issuance of debt:

Sr. No.	% of surplus borrowing as on last day of FY “T+2” for the block starting FY “T”	% of reduction in annual listing fees payable to the Stock Exchanges by the LCs for FY “T+2”
1	0-15%	2% of annual listing fees
2	15.01% – 30%	4% of annual listing fees
3	30.01% – 50%	6% of annual listing fees
4	50.01% – 75%	8% of annual listing fees
5	Above 75%	10% of annual listing fees

Further, a credit in the form of reduction in the contribution to be made to the Core SGF of LPCC would also be available in the following manner:

Sr. No.	% of surplus borrowing for the block starting FY “T” as on last day of FY “T+2”	Quantum of Credit
1	0-15%	0.01%
2	15.01% – 30%	0.02%
3	30.01% – 50%	0.03%
4	50.01% – 75%	0.04%
5	Above 75%	0.05%

The Present Circular further mentions that in case of entities classified as ‘eligible issuers’ by the LPCC, the incentive would be permissible to be carried forward for a period of 6 years of obtaining the same as approved in the SEBI BM. Further, in case of an entity which is not an eligible issuer, the incentive may be carried forward until it is classified as an eligible issuer. Thereafter, the incentive would be available for the purpose of utilisation for a period of 6 years from year of such classification.

Manner of computation

Let us consider the following example to understand the computation of credit:

Company ‘X’ is identified as an eligible issuer requiring to contribute Rs. 2 crores to the Core SGF. It has complied with the requirements of raising the requisite qualified borrowings in the following manner:

Sr. No.	Particulars	Amount (in Rs. Cr)
1	Borrowings that should have been made from the debt market by the LC for FY “T” (A)	200
2	Actual borrowings in “Block of three years” (B)	250
3	Surplus borrowings (B-A) (C)	50
4	% of surplus borrowing (C/A*100)	25%
5	Quantum of credit (% of quantum of credit as per the table above*C)	0.01 (i.e. 50*0.02%)
6	Actual contribution required to be made to the SGF [Actual contribution required to be made – Quantum of credit]	1.99 (i.e. 2-0.01)

Our Remarks

Contribution to Core SGF:

The benefit of reduced listing fee can be availed by the listed entity for listed debt securities or non-convertible redeemable preference shares. However, the relaxation in the form of reduced contribution to Core SGF will be an incentive only to an ‘eligible issuer’ as per the list rolled out annually by AMC Repo Clearing Limited (‘ARCL’), recognised as Limited Purpose Clearing Corporation (‘LPCC’) by SEBI, on the basis of prescribed parameters. In case of an LC which has not been identified as an ‘eligible issuer’, the credit in contribution to the Core SGF would not serve as an incentive and may get lapsed. It may even be the case for an issuer identified as ‘eligible issuer’ in year 1 however, not identified in the subsequent year. ARCL vide Circular dated September 29, 2023 rolled out a list of 125 eligible issuers who will be required to contribute to Core SGF for the eligible issuance as per the eligible list issued on or after 01st October 2023 till 30th September, 2024. In the light of this, SEBI’s decision to allow carrying it forward till 6 years is a welcome change.

Mandatory Listing:

In case an LC which is a debt listed entity and raises further debt pursuant to the LC framework post January 1, 2024, it will be mandatorily required to list every such issuance pursuant to Reg. 62A of the SEBI Listing Regulations, inserted vide the SEBI (Listing Obligations and Disclosure Requirements) (Fourth Amendment) Regulations, 2023. On the other hand, in case an LC is not a debt listed entity, however, lists any particular issuance of debt securities issued pursuant to the LCB framework any time post January 1, 2024, as per the afore-mentioned provision, it will be mandatorily required to list all issuances done post January 1, 2024 within a period of 3 months from the date of listing.

As a result of such mandatory listing, the LCs may cross the threshold of having outstanding listed debt securities amounting to Rs. 500 crores, thereby classifying the entities as a ‘High Value Debt Listed Entity’ or an ‘HVDLE’. Consequently, the entity will be required to comply with the corporate governance provisions stipulated under Reg. 16 to Reg. 27 of the SEBI Listing Regulations. We have further analysed the same in our article which can be accessed here.

Disincentive for not meeting the mandatory limit

Existing Provisions	Nature of amendment proposed	Proposed Changes	SEBI’s rationale for the proposed change
Monetary penalty/ fine of 0.2% of the shortfall in the borrowed amount is levied in case of shortfall	Doing away with the penalty and introducing an incentive/ disincentive structure	In case of a shortfall, an amount equivalent to 0.5 basis points of such shortfall shall be made by the LC to the core Settlement Guarantee Fund (‘SGF’) as set up by the Limited Purpose Clearing Corporation (LPCC).	To promote ease of doing business and to encourage LCs to raise funds by incentivizing them.

Brief of public comments received and SEBI’s response:

While majority of the comments were in favour of the proposal, it was recommended that:

(a) the disincentive should be applicable if there is a non-compliance for a continuous block of 2/3 years;

(b) further reduction in the quantum; and

(c) applicability only to entities required to contribute to Core SGF.

 SEBI BM decision

SEBI confirmed (a) and disagreed for (b). In case of (c). SEBI clarified that Core SGF requirement will be made applicable to all issuers to ensure uniformity.

Provisions under the Present Circular

SEBI has done away with the penalty provision and notified the disincentive structure. The said structure will apply in case of shortfall in raising the requisite quantum at the end of the block of 3 years, i.e. as on the last day of ‘T+2’. The disincentive scheme is in the form of additional contribution to be made to the Core SGF in the following manner:

Sr. No.	% of surplus borrowing for the block starting FY “T” as on last day of FY “T+2”	Quantum of additional contribution
1	0-15%	0.015%
2	15.01% – 30%	0.025%
3	30.01% – 50%	0.035%
4	50.01% – 75%	0.045%
5	Above 75%	0.055%

Manner of computation

Let us consider the following example to understand the computation of disincentive:

Company ‘X’ is identified as an eligible issuer requiring to contribute Rs. 2 crores to the Core SGF. It has complied with the requirements of raising the requisite qualified borrowings in the following manner:

Sr. No.	Particulars	Amount (in Rs. Cr)
1	Borrowings that should have been made from the debt market by the LC for FY “T” (A)	200
2	Actual borrowings in “Block of three years” (B)	150
3	Shortfall in borrowings (X-Y) (C)	50
4	% of shortfall in borrowing (C/A*100)	25%
5	Quantum of additional borrowing (% of quantum of additional borrowing as per the table above*C)	0.0125 (i.e. 50*0.025%)
6	Actual contribution required to be made to the SGF [Actual contribution required to be made +  Quantum of additional borrowing]	2.0125 (i.e. 2+0.0125)

 Dispensation for LCs identified basis erstwhile criteria

The entities which have been identified as LCs under the erstwhile LC framework are required to comply with the requirement over a block of 3 years in the following manner:

FY in which the entity was identified as LC i.e. ‘T-1’	Block of 3 years over which the LC was required to raise the requisite quantum of long term borrowings i.e. ‘T’, ‘T+1’, ‘T+2’	Remaining period of the block as on March 31, 2023 prior to Present Circular	Remaining period as per the Present Circular
FY 2021	FY 2022, FY 2023, FY 2024	1 year i.e. FY 2024	1 year i.e. FY 2024
FY 2022	FY 2023, FY 2024, FY 2025	2 years i.e. FY 2024 & FY 2025	1 year i.e. FY 2024
FY 2023	FY 2024, FY 2025, FY 2026	3 years from FY 2024 to FY 2026	1 year i.e. FY 2024

The erstwhile LCs are required to endeavour to comply with the requirement of raising 25% of their incremental borrowings done during FY 2022, FY 2023 and FY 2024 respectively by way of issuance of debt securities till March 31, 2024, failing which, such LCs are required to provide a one-time explanation in their Annual Report for FY 2024.

The Present Circular additionally amends the Chapter XII of NCS Master Circular to the following effect:

1. Deletion of penalty related provision in Clause 2.2(d) of Chapter XII; and
2. Deletion of format of annual disclosure to be submitted within 45 days from end of the financial year by an identified LC providing details of incremental borrowing and mandatory borrowing, as provided in Clause 3.1 (b) of Chapter XII.

Conclusion

The changes in the framework vide the Present Circular attempt to tackle the hindrances which are being faced by entities classified as LCs, including removal of the penal provisions on shortfall, etc. Thus, these changes seem positive and would help LCs in complying with the LCs framework. However, while the framework aims to deepen the bond market by mandating debt issuance, one cannot disregard the other recent amendments in the legal framework governing debt securities, which seem to be a deterrent for companies from approaching the capital markets, for instance, provisions relating to mandatory listing of debt securities, requirement to obtain approval of all holders in case of voluntary delisting, etc. While the framework would be relevant for entities who have already tested the equity markets and wish to enter the debt market, the recent amendments relating to mandatory listing, no selective delisting etc. would impact issuers who intend to list their debt securities.

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^[1] Criteria under the erstwhile framework was as follows and was applicable to all listed entities except Scheduled Commercial Banks:

1. having listed specified securities or debt or non-convertible redeemable preference shares on a recognised stock exchange; and
2. having outstanding long term borrowing of Rs. 100 crore or above; and
3. having a credit rating of ‘AA and above’.

^[2] About Core SGF:  In terms of SEBI Circular SEBI/HO/DDHS/DDHS-RACPOD1/CIR/P/2023/56 dated April 13, 2023, eligible issuers are required to contribute 0.5 basis points (0.005%) of the issuance value of debt securities per annum based on the maturity of debt securities. The issuers need to make full contribution upfront prior to the listing of debt securities.The Core SGF contribution is applicable for all public issue or private placement of debt securities under the SEBI (Issue and Listing of Non-convertible Securities) Regulations, 2021 of eligible issuer except for a) Tier I & Tier II bonds issued by Banks, NBFCs & other institutions; b) Perpetual Debt; c) Floating rate bonds; d) Market linked bonds; e) Convertible bonds (Optional or Compulsorily); f) Securities other than long term debt rating of the eligible securities shall be AAA, AA+, AA and AA- (excluding AA- with negative outlook).

^[3] Outstanding long term borrowings indicate borrowings which have original maturity of more than 1 year with certain exclusions as detailed further herein.

^[4] Recovery Expense Fund is a refundable fund to be deposited with the stock exchanges at the time of listing. The purpose of the fund is recovery in case of default.