[Ganesh BL and Shubhalakshmi Bhattacharya are Associates at a law firm in Mumbai]
On 21 July, 2022, the Securities and Exchange Board of India (“SEBI”) issued a consultation paper (“Consultation Paper”) proposing a regulatory framework to govern online bond trading platforms (“Bond Platforms”). This comes at a time when India has witnessed a transformation in the number of retail investors participating in the bond market. The financial years 2020 and 2021 saw an addition of approximately sixty million retail investors within the economy. According to SEBI, the surge is primarily linked to the ease with which retail investors can now subscribe to securities through the platform markets. The Bond Platform marketplace has been recently developed to provide retail investors opportunities to invest in listed and/or unlisted debt securities of companies bearing fixed rates of return within fixed time periods (“Bonds“) without approaching a broker and engaging in what may seem an arduous process of registration or subscription.
At present, under the Companies Act, 2013, bonds are primarily issued through a public issuance or on a private placement basis. Public issues are made through the online mechanism of the relevant stock exchange and depository. Privately placed dematerialized issuances are mandatorily made through the Electronic Book Provider Platform (“EBP Platform”) of either the National Stock Exchange or the Bombay Stock Exchange, if (a) the issuer is in existence for three years or more and where the issue size is of Rs.100 crore or more; and (b) the issuer is in existence for less than three years, irrespective of the issue size.
Furthermore, under the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021, only Qualified Institutional Buyers (“QIBs”) and Non-QIBs, including arrangers who the relevant issuer has authorized, are permitted to invest in debt securities issued on the EBP Platform. In contrast, Bond Platforms provide an avenue for most issuers, irrespective of their period of incorporation and issue size, to offer retail investors the opportunity to subscribe to debt securities issued by them. SEBI notes that the ease of the process of investment in bonds through such platforms led to an increase in the participation in the bond market from several non-institutional investors. However, these Bond Platforms are currently unregulated; hence, the Consultation Paper makes a case for its regulation.
In light of the same, this post seeks to analyze the Consultation Paper and the proposed regulatory framework of the SEBI.
Recommendations and Analysis
The primary rationale behind SEBI’s proposal for the regulation of online bond platforms is inter alia four-fold: (a) absence of standard requirements on know your client Know Your Customer (“KYC”) norms; (b) ambiguity in redressing investor grievances; (c) conflict of interest, product offerings, information availability and possible mis-selling of issuers; and (d) concerns regarding deemed public issuances.
SEBI states that while these Bond Platforms operate similarly to organized avenues for trading, which bring together buyers (particularly non-institutional investors) and sellers (which most often are the platform providers themselves), they do not come under any regulatory purview. However, the applicability of existing regulations such as the SEBI (Merchant Banker) Regulations, 1992 (“Merchant Banker Regulations”), SEBI (Investment Advisers) Regulations, 2013 (“Investment Advisers Regulations”), and the SEBI (Research Analysts) Regulations, 2014 (“Research Analysts Regulations”) are not discussed in the Consultation Paper. This becomes important to note, as these regulations also mandate that the service provider would have to obtain registration; depending on the applicability of the regulations based on the services provided, it is possible that the services provided by the Bond Platforms could also be brought under the purview of these regulations.
SEBI has proposed alternatives to the current scenario in the Consultation Paper, one of them being that it would be mandatory for Bond Platforms to register themselves as stock-brokers with SEBI under the SEBI (Stock Broker) Regulations, 1992 (“Stock Broker Regulations”) or is run by SEBI registered brokers (debt segment). The rationale is based on the view that these Bond Platforms primarily act as facilitators, as they are used to facilitate transactions by investors registered on their websites. Further, by ensuring that SEBI regulates these Bond Platforms, the non-institutional investor confidence would be enhanced. By mandating that these Bond Platforms are registered are stock-brokers, and thereby having the transactions routed through the trading platform of the exchanges, among other benefits, it provides (i) an exit opportunity for investors, (ii) a risk management and surveillance mechanism, and (iii) investors with a well-defined framework for addressing their grievances. These streamlined processes, which would be implemented as a result of the registration, are particularly important for investors, as they would prevent the ambiguity arising from a multitude of Bond Platforms having their own policies and grievance mechanisms in place. Further, the net worth and deposit requirements prescribed for stock-brokers would ensure that the Bond Platforms are stable and would provide for the implementation of standard KYC requirements for registering investors and issuers on the Bond Platforms.
However, proposing such an alternative without simultaneously amending other existing regulations which may apply to Bond Platforms may lead to issues in the interpretation and applicability of the law. By ascertaining that the Bond Platform would require to be registered as stock-brokers, one of the possible implications is that regulations such as the merchant Banker Regulations, Investment Advisers Regulations, and the Research Analyst Regulations (depending on the services provided by the relevant Bond Platform) are not applicable to them. This could lead to a scenario whereby, although the Bond Platforms engage in a multitude of services, they would still not come under the relevant regulatory purview, as their registration as a stock-broker would be considered compliance with the law. Such a scenario would then frustrate the purpose of proposing this alternative framework.
SEBI further proposes that only listed debt would be eligible to be subscribed through a Bond Platform. This is a welcome recommendation as it resolves the conundrum of deemed public issuances. Currently, under the Companies Act, a private placement of Bonds can only be made to two hundred prospective allottees. A breach of this threshold would make the private placement a deemed public issuance (“DPI”), thereby triggering other provisions within the Companies Act and rules thereunder that govern DPIs. SEBI noted that by virtue of offering unlisted Bonds issued on a private placement basis for investment on the Bond Platforms, it automatically resulted in a DPI as several Bonds were down sold to more than two hundred investors, thereby violating norms of a DPI. In order to mitigate the risk of a DPI, especially in cases where Bonds are sold to more than two hundred investors, SEBI recommends that Bond Platforms must offer only listed debt securities for purchase/sale to their registered users. This recommendation not only curtails the possible contravention of the Act but also ensures that issuers mandatorily comply with the pre-requisites of a public issue of securities, thereby eliminating the risk of an ex-post contravention of the Act. Be that as it may, several commentators believe that the ban on unlisted debt securities could stifle the market’s growth as trades would need to be settled via routes that today are not commonly used (for further reference, see here and here).
With India being at the epicentre of transformative cyberspace usage, the development of Bond Platforms is likely to witness exponential growth in the coming years, as was witnessed with the growth of platform markets in several other sectors (for further reference, see here and here). Hence, the need for regulation by the SEBI, while pertinent, must also be holistic and exhaustive to include the operation and application of different legislations as aforementioned in order to prevent a situation where Bond Platform developers are caught in a web of entangled legislations, further hampering their development. A legislation in light of the same will not only ensure that the development of Bond Platforms and retail investor participation is encouraged but will also strike a balance between the protection of prospective consumers and growth of the debt market on par with the digital economy.
– Ganesh BL & Shubhalakshmi Bhattacharya