Examining the Legal Nature of Commercial Papers: Securities or Money Market Instruments?

[Priyanka Sunjay is an associate at L&L Partners Law Offices. The author thanks Jay Parikh and Varun Kumar for their inputs]

On 22 October 2019, the Securities Exchange Board of India (“SEBI”) issued a circular titled ‘Framework for Listing of Commercial Paper’ (“SEBI Circular”) in order to enable listing and trading of commercial papers on stock exchanges. This poses certain important questions like (i) the applicability of the provisions of the Companies Act, 2013 that are specific to issuance of ‘securities’ for issuance of listed commercial papers, and (ii) SEBI’s power to regulate commercial papers.

Regulation of Commercial Papers

The Reserve Bank Commercial Paper Directions, 2017 (“Commercial Paper Directions”) issued by the Reserve Bank of India (“RBI”), along with the operational guidelines on commercial papers (“Operational Guidelines”) issued by the Fixed Income Money Market and Derivatives Association of India (“FIMMDA”) collectively govern the issuance and trading of commercial paper.

SEBI Circular and the Checklists Issued by the Stock Exchanges

In essence, the SEBI Circular specifies that an issuer who desires to list its commercial papers should forward an application for listing along with the required disclosures to the concerned stock exchange. On approval of the listing application by the concerned stock exchanges, the disclosures should be made available on the concerned stock exchanges.   

Following the SEBI Circular, the BSE and the NSE issued checklists for listing of commercial papers, wherein certain information and documents were required to be submitted along with an application for listing of commercial papers on the BSE and the NSE. According to the checklists, applicants that are new issuers must submit the uniform listing agreement, and all such issuers who have listed other securities and who wish to list commercial papers for the first time on the BSE or the NSE are required to include commercial papers in ‘Securities Applied for Listing’ under the ‘Information about the Company and Securities’ of the uniform listing agreement. Additionally, the annexures to the application for listing of commercial papers in the BSE and the NSE appear to include commercial papers as “securities” to be issued on the debt market segment and note that the application has been made for listing of commercial papers issued on a “private placement basis.” Further, the checklists also require a confirmation to be provided of, among other things, compliance with provisions of the Companies Act.

Thus, confusion has arisen due to the BSE and NSE checklists that use the term ‘securities’ in relation to commercial papers and require a listing agreement, which is required under regulation 109 of the SEBI (Listing    Obligations    and    Disclosure    Requirements) (“SEBI LODR Regulations”) by an issuer desirous of listing its securities on a recognized stock exchange, to be filed for listing of commercial papers.

Provisions of the Companies Act and Rules thereto

Section 42 of the Companies Act, 2013 read with rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 (“Prospectus Rules”) and section 62 of the Companies Act read with rule 13 of the Companies (Share Capital and Debentures) Rules, 2014 (“Share Capital Rules”) govern the procedure for allotment of securities by private placement. Section 2(81) of the Companies Act defines securities as having the same definition given under section 2(h) of the Securities Contract (Regulation) Act, 1956 (“SCRA”).

Under section 2(h) of the SCRA the following are included in the definition of securities: (i) shares, scrips stocks, bonds, debentures, debenture stock or other marketable securities of a like nature; (ii) derivatives; (iii) units or any other instrument issued to the investors under any mutual fund scheme, or by any collective investment scheme; (iv) security receipts; (v) any certificate or instrument acknowledging beneficial instrument of an investor in a debt or receivable held by a special purpose distinct entity; (vi) government securities; and, (vii) rights or interests in securities.

Analysis

It is necessary to consider whether commercial papers, upon being listed, especially in light of the recent developments, fall within the definition of ‘security’ under the SCRA and, therefore, invite the applicability of section 42 and other provisions of the Companies Act, 2013.

There are two important points to be noted with respect to regulation of commercial papers by the RBI. First, the power of the RBI to regulate commercial papers comes from section 45W of the Reserve Bank of India Act, 1934 that empowers the RBI to regulate transactions in, inter alia, securities, and money market instruments. The Commercial Paper Directions define commercial paper as an unsecured money market instrument issued in the form of a promissory note, and the term ‘money market instrument’ is defined to include commercial paper and such other debt instrument of original or initial maturity up to one year as specified by the RBI.

Second, (i) a board resolution authorizing a company to borrow through issuance of commercial papers, and (ii) a shareholders’ consent to borrow commercial papers by a special resolution in term of section 180(1)(c) of the 2013 Act is required where the money to be borrowed, together with the money already borrowed by the company, will exceed aggregate of its paid-up share capital and free reserves are required under the Commercial Paper Directions and the Operational Guidelines.

Similarly, coming to the SEBI Circular and the checklists issued by the BSE and the NSE, it is important to note that the SEBI Circular, in relation to disclosures to be provided along with the application for listing of commercial papers, specifically provides for issuers who were in the first instancealready under the purview of the SEBI LODR Regulations to make disclosures in relation to their financial information for listing of commercial papers. But it does not make the SEBI LODR Regulations applicable on issuers of commercial papers.

Similarly, it is to be noted that the BSE and NSE checklists do not make the process and other legal requirements as applicable to ‘securities’ under the SEBI LODR Regulations apply to commercial papers. In fact, the NSE in the ‘FAQs for Listing of Commercial Papers’ that is available on their website, has clarified that the SEBI LODR Regulations are not applicable for exclusively listed commercial papers, but it has noted that issuers must comply with the SEBI Circular.

Additionally, under regulation 3 of the SEBI LODR Regulations, the applicability of the SEBI LODR Regulations is restricted to designated securities that are listed on recognized stock exchanges, as specified therein. Thus, in the absence of any such specification of SEBI, commercial papers cannot clearly be included in the list of applicable designated securities under regulation 3 of the SEBI LODR Regulations.

Importantly, Annexure 1 of the SEBI Circular requires the list of top 10 ‘debt securities holders’ and top 10 ‘CP holders’, thereby clearly distinguishing between debt securities and commercial paper. Similarly, the circular issued by SEBI on ‘Electronic Book Mechanism for Issuance of Securities on Private Placement Basis’ includes commercial papers as securities only for the purpose of the circular, and compliance with the electronic book mechanism is optional for issuers of commercial papers on a private placement basis under the said circular.

The above position is supported by the decision rendered by the Gujarat High Court in Essar Steel Limited v. Gramercy Emerging Market Fund, wherein the Gujarat High Court considered whether global notes issued by a company qualified as ‘securities.’ The Court adopted the raising of finance and investment test to determine if the notes qualified as securities under section 2(h) of the SCRA and observed that where the seller’s purpose behind issuing an instrument is to raise money for the general use of a business enterprise or to finance substantial investments, and the buyer is primarily interested in the profit the note is expected to generate, the instrument is likely to be qualified as a ‘security’ as opposed to issuance of the instruments in a consumer context (such as a commercial paper) when such instruments cannot be classified as a ‘security’.

Conclusion

On taking a view that commercial papers do not qualify as ‘securities’ under section 2(h) of the SCRA, the power of SEBI to issue the SEBI Circular in exercise of its powers under section 11(1) of the SEBI Act, 1992 becomes unclear, for under the aforesaid provision, SEBI is authorized to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit. The preamble to the SEBI Act, 1992 envisages the establishment of a board to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto. Similarly, section 2(j) of the SCRA defines stock exchange as an entity concerned with assisting, regulating or controlling the business of buying, selling or dealing in securities.

Yet, this is not the first time that SEBI has issued circulars in relation to commercial papers. In its circular issued on 1 October 2019 in order to enhance transparency and disclosure for investment by mutual funds, SEBI has not categorized commercial papers as ‘securities’, but rather categorized them as ‘unlisted debt instruments.’ In a similar vein, all SEBI regulated entities were required to report their over-the-counter transactions in certificates of deposits and commercial papers on the FIMMDA reporting platform within 15 minutes of the trade for online dissemination of market information under a SEBI circular. Notably, section 11(1) of the SEBI Act, 1992 was cited as the provision authorizing SEBI to issue the circulars. Thereby, it appears that the above circulars along with the SEBI Circular pertaining to commercial papers qualify as ‘matters connected therewith or incidental thereto’ under the preamble to the SEBI Act, 1992, thus giving SEBI the authority to issue circulars.

On the basis of the above analysis, it may be concluded that the SEBI Circular is only intended to create a framework for listing of commercial papers and does not intend to render it as “securities” under section 2(h) of the SCRA. Evidently, the BSE and the NSE cannot ‘expand’ the definition of securities to include commercial papers or ‘legislate’ or create a ‘legal or regulatory framework’ separate and distinct from what is envisaged under the SEBI Circular or under the Commercial Paper Directions / Operational Guidelines.    

Priyanka Sunjay

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