[Pammy Jaiswal is a Partner at Vinod Kothari and Company and can be reached at corplaw@vinodkothari.com]
Background
The untiring efforts of the Securities and Exchange Board of India (SEBI) as well as the Government in uplifting the bond market is quite commendable. SEBI has started taking major steps towards the accomplishment of the budget announcement by the Government for the year 2018-19. These include the introduction of an electronic bidding platform for privately placed debt securities, consolidation of ISIN of debt instruments and introduction of a secondary market for debt instruments. Accordingly, India’s bond market is almost at par with the banking loans to stand at 422 billion dollars as compared to 561 billion dollars as on 31 March 2018.
However, a majority of bonds issued in the country are on a private placement basis. Despite gaining prominence, bonds issued in India currently lack an active secondary market. In its continued effort in deepening the bond market, SEBI issued a circular dated 26 November 2018 where it has mandated certain listed entities to borrow a certain percentage of its borrowings through the issuance of debt securities.
While it is true that SEBI does not want to leave any stone unturned in strengthening the Indian bond market, there certain grey areas in the framework, which need further clarification. This post intends to highlight these grey areas and potential answers to the problems. A summarised write-up on the said framework can be viewed here.
FAQ Section
- When will the framework under the circular be applicable?
The framework under the circular is applicable with effect from the financial year (FY) 2019-20 (where the FY is from April to March) or FY 2020 (where FY is from January to December).
- What is the meaning of the term ‘large corporate’?
The entities that fulfil all the three conditions provided below based on the financials of the previous year are termed as large corporates (LCs):
- listed companies (specified securities, debt securities, non-convertible redeemable preference shares);
- having long term (maturity of more than 1 year) outstanding borrowings excluding external commercial borrowings (ECBs) and borrowings between parent and subsidiary of Rs. 100 crore and above; and
- carry a credit rating of AA and above of unsupported bank borrowings or plain vanilla bonds (highest rating to be considered in case of multiple ratings).
- Whether the applicability of the said circular has to be examined every year?
LCs are required to check the applicability of the aforesaid circular every year and accordingly be termed as such.
- What is the meaning of unsupported borrowings?
The circular speaks about the credit rating of unsupported borrowings or plain vanilla bonds. Clause (iii) of para 2.2 states:
have a credit rating of “AA and above”, where credit rating shall be of the unsupported bank borrowing or plain vanilla bonds of an entity, which have no structuring/ support built in; and in case, where an issuer has multiple ratings from multiple rating agencies, highest of such rating shall be considered for the purpose of applicability of this framework.
A supported borrowing may referred to as a borrowing backed by a collateral or some sort of a guarantee for ensuring its repayment. Therefore, an unsupported borrowing is nothing but an unsecured loan. The reason behind maintaining the requirement of credit rating of AA and above for unsupported borrowing is to mandate entities having good creditworthiness for not only secured but also unsecured borrowings to issue a specified percentage of their debt securities in accordance with this circular. Further, only such highly rated entities shall encourage an investor to invest.
- What are the various stipulations with respect to bond issuances imposed by this circular?
There are basically two stipulations imposed under this circular:
(a) Initial requirement:
For the first two years in which the framework becomes applicable (i.e. FY 2020 and 2021), the LC is required to raise a minimum of 25% of the long term borrowings (maturity of more than 1 year) in each of the FY (for which the entity becomes an LC) excluding ECBs and borrowings between parent and subsidiary (incremental borrowings) by way of issuance of debt securities.
(b) Continuous requirement:
From the third year of the applicability (i.e. FY 2022 onwards), the LC is required to mandatorily raise a minimum of 25% of its increased borrowing in such year from the issuance of debt securities over a period of one block of two years.
Further, in case of any shortfall of borrowing in any year, such shortfall is required to be carried forward to the next year in the block.
- What is the manner of adjusting the shortfall in any FY?
As one reviews the illustration provided in Annexure C of the circular, it becomes clear that for the first year of implementation there is no concept of carrying forward the shortfall to the second year, since the LC is required to explain the reason for not being able to comply with the borrowing requirements.
Further, the shortfall for the second year onwards is required to be carried forward to the next year. It would be useful to elaborate on the manner of adjustment by way of an illustration:
X Ltd is an LC as on the last day of the previous year being 31 March 2019.
[Rs. in crores]
| 2020 | 2021 | 2022 | 2023 |
2024 |
2025 [Not an LC] |
|
| Increased Borrowing [IB] | 200 | 500 | 700 | 600 | 650 | 100 |
| Mandatory borrowing from debt securities of 25% of the IB [MB] | 50 | 125 | 175 | 150 | 162.5 | NIL |
| Actual Borrowing from debt securities [AB] | 40 | 100 | 75 | 200 | 100 | 5 |
| Adjustment of the shortfall of the previous year | NIL | NIL | NIL | 100 | 50 | 12.5 |
| Shortfall to carry forward | NIL | NIL | 100 | 50 | 12.5 | 7.5 |
| Penalty | NIL | NIL | NIL | NIL | NIL |
7.5* 0.2% = 0.015 |
Basically, the LC shall first adjust the AB towards the shortfall of the previous year of the current block and then ascertain whether it has complied with the MB requirements. Further, the penalty shall be levied if there is a shortfall of the previous year in the current block that could not adjusted with the AB of the second year of the current block.
- What are the penal consequence for non- compliance?
- For FY 19-20 and 20- 21, no penalty but explanation will be required;
- From FY 21-22 onwards, the minimum funding requirement has to be met over a block of two years;
- In case any shortfall of the first year of the block is not met as on the last day of the next FY of the block, a monetary penalty of 0.2% of the shortfall amount shall be levied and paid to the stock exchanges;
- The manner of payment of the penalty has not been provided in the circular but stock exchanges are expected to provide for the same.
- What are the disclosure requirements?
- The fact that the entity has fulfilled the criteria of being an LC based on the financials of previous year has to be disclosed to stock exchange within 30 days of the beginning of the FY. The format is provided in Annexure A to SEBI’s circular.
- The details of incremental borrowings made in the FY have to be disclosed to stock exchange within 45 days of the end of the FY. The format is provided in Annexures B1 [(applicable for FY 19-20 & 20-21) and B2 (applicable for FY 21-22 onwards)] to the circular.
- The aforesaid disclosures shall be certified both by the company secretary and chief financial officers.
- The aforesaid disclosures shall also form part of the annual audited financial results.
- Any other specific requirements?
- The entity will need to choose any one of the stock exchanges (where the securities are listed) for payment of the penalty.
- The entity being an LC for the previous year and carrying a shortfall for that year in the current year for which the entity is not an LC shall also be required to make the requisite disclosures within 45 days of the end of the current year.
- Whether the requirements of the circular are relevant for all the LCs?
While the ambit of the circular is broad enough to cover both non-banking financial companies (‘NBFCs’) and non-banking non-financial Companies (‘NBNFCs’), the circular is more relevant for NBNFCs.
NBFCs are financial institutions and are engaged in lending and investing activities in their day to day operations and, therefore, the major chunk of the working capital and long term funding requirements anyway arises from issuance of debt securities considering the leverage issues.
Therefore, one may construe that the circular is more relevant for NBNFCs since they are not mandated to borrow from the issue of debt securities as the funding requirements of these entities can also be fulfilled by banks. Further, the circular should have laid down a specified threshold on the increased borrowing which, if met, should be required to constitute debt securities also to the tune of 25%.
- Whether relaxation is for any first two year of implementation or the year mentioned in the circular?
This circular was led by a consultation paper issued by SEBI on 20 July 2018 which clearly stated that “[a] “comply or explain” approach would be applicable for the initial two years of implementation. Thus, in case of non-fulfilment of the requirement of market borrowing, reasons for the same shall be disclosed as part of the “continuous disclosure requirements”
However, the circular is clear on the initiation point of the said framework i.e. April, 2019; accordingly, one may take a view that FY 2020 and 2021 shall mandatorily be the first two years in which the relaxation of the “comply or explain” approach can be taken. Any entity that is covered by the aforesaid circular at a later date shall have to mandatorily comply with the borrowing requirements and be liable to penalty in case of non-compliance.
- Whether the term ‘increased borrowings’ shall also cover Pass Through Certificates (‘PTCs’)?
According to the circular, “incremental borrowings” have been defined to include borrowings during a particular financial year with original maturity of more than one year, excluding ECBs and intercorporate debts between a parent and its subsidiaries. Further, IND AS 109 treats PTCs as collateralized borrowings. Here it is pertinent to note that the question of showing the investor’s share in PTC as financial liability arises only because the securitised pool of assets fails the de-recognition test.
The originator has no obligation towards the investors of the PTC. The investors are exposed to the securitised pool of assets and not to the originator. Therefore, merely because the investor’s share appears on the balance sheet of the originator as financial liability, according to Ind AS 109 it does not mean they are debt obligations of the originator. Accordingly, incremental borrowings shall not include PTCs.
- In cases where an entity ceases to be an LC in one year and again gets covered by the circular in subsequent years, whether the initial disclosure to the stock exchange shall be required to be given again?
In our view, such entity should provide the exchange with the initial disclosure for the purpose and to enable the stock exchange to continuously monitor the compliance of the framework.
- How will the stock exchange be apprised that an entity is not an LC anymore?
Ideally there should be an intimation to the exchange stating that the entity is not an LC anymore and accordingly the mandatory borrowing requirements should not be made applicable for such FYs in which it is not an LC. Further, this intimation may also indicate that the entity shall inform the exchange in terms of para 4.1 once it qualifies to be an LC.
- What is the role of the stock exchange in terms of para 5 of the circular?
- The exchange shall collate the information about the LC and submit the same to the Board within 14 days of the last day of the annual financial results;
- The exchange shall collect the fine as mentioned under para 3.2(ii); and
- The said fine shall be remitted by the exchange to the SEBI Investor Protection and Education Fund within 10 days of the end of the month in which the fine was collected.
Conclusion
SEBI has laid down penal provisions for not complying with the circular. However, if the issue size of mandatory borrowing is too small, then there may be a possibility that LCs may considering carrying out a cost-benefit analysis between the issue cost and the penalty amount. Therefore, SEBI should set a minimum threshold for increased borrowings and cover only those LCs to raise funds through bond market who exceed such threshold.
– Pammy Jaiswal