[Tanishq Vijay Vargiya and Vaibhav Nishad are 3rd year students at the Gujarat National Law University, Gandhinagar]
The Securities and Exchange Board of India (SEBI) has on 21 September 2023 published the SEBI (Listing Obligations and Disclosure Requirements) (Fourth Amendment) Regulations, 2023 (the ‘Amendment’), by which it introduced regulation 62A of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. (the ‘LODR’) The object is to address concerns surrounding the subsequent issuance of non-convertible debt securities (‘NCDs’) by listed entities. These amendments, framed in the backdrop of SEBI’s consultation paper, aim to foster transparency, rectify information disparities, and enhance market integrity in the realm of NCDs.
The authors in this post delve into the intricacies of regulation 62A, shedding light on its key provisions and the potential implications for Large Corporate Borrowers (‘LCBs’). It also raises concerns pertaining to the impact on the market and investors due to the mandatory listing of entities with low credit ratings.
Deciphering Regulation 62A
In a bid to address mounting concerns over information disparities, market opacity, and investor clarity stemming from the simultaneous issuance of listed and unlisted NCDs by the same entities, SEBI undertook a transformative initiative. The Amendment introduced a pivotal provision within regulation 62A of the LODR framework. This regulation, which takes effect on 1 January 2024, carries profound implications. The intricacies of regulation 62A are as follows:
- Compulsory Listing for NCDs: Subsection 1: This provision mandates that any listed entity planning to issue NCDs after 1 January 2024 must unequivocally list these securities on stock exchanges. The objective here is clear–to subject all future NCDs issuances to the scrutiny of the market, eliminating the shadows of opacity.
- Voluntary Listing for Pre-2024 Unlisted NCDs: Subsection 2: For listed entities with unlisted NCDs issued prior to 31 December 2023, a choice is extended. They may opt to voluntarily list these securities on stock exchanges, an option that facilitates the alignment of existing debt securities with the new regulatory landscape.
- Listing of Outstanding Unlisted NCDs: Subsection 3: Crucially, should a listed entity intend to list NCDs after 1 January 2024, it must also undertake to list all outstanding unlisted NCDs issued on or after that date within a three-month window. This dual-listing requirement is a significant stride toward enhancing transparency, ensuring that all NCDs, irrespective of their issuance date, become part of the public domain.
- Exemptions from Compulsory Listing: Subsection 4: While the rule book stipulates mandatory listing, there are exceptions. Certain categories of NCDs are exempt from this requirement, including bonds issued under section 54EC of the Income Tax Act, 1961, NCDs stemming from agreements with multilateral institutions, and those issued under court orders or regulatory mandates from financial sector regulators such as SEBI, RBI, IRDAI, or PFRDA.
- Imposing Lock-In Period for Exempted NCDs: Subsection 5: To ensure that exempted NCDs serve their intended purpose without undue speculation, investors are bound by a lock-in arrangement until maturity. These securities must remain unencumbered, emphasising their long-term nature.
- Comprehensive Disclosure Mandate: Subsection 6: Lastly, listed entities contemplating the issuance of NCDs under subsection 4 are entrusted with the responsibility of disclosing all vital terms of such securities to the stock exchanges. These disclosures span a gamut of information, encompassing embedded options, security specifics, interest rates, charges, commissions, premium details, maturity periods, and any additional data required by SEBI.
Regulation 62A aims to foster transparency, rectify information disparities, and enhance market integrity in the NCD market by introducing a comprehensive set of rules. However, these rules also raise pertinent questions about their impact on LCBs and the market’s overall volatility.
Implications of Regulation 62A on Large Corporate Borrowers
While implementing regulation 62A, SEBI mandated the listing of unlisted NCDs along with compliance with listing obligations and disclosure requirements similar to those for listed NCDs with the aim that such listings would improve transparency and disclosure of NCDs. However, compliance with regulation 62A could create an additional compliance burden on LCBs, who are already governed by SEBI’s framework for Large Corporate Borrowers.
The LCB framework, at its core, requires LCBs to raise at least 25% of their incremental borrowings through the issuance of debentures. It fosters the corporate bond market’s growth and enhances investor options and protection. However, this framework has a time period of two years, referred to as a block, within which LCBs must fulfil the 25% requirement. Failure to do so incurs a penalty of 0.2% on the shortfall amount, calculated as the difference between actual debenture issuance and the mandated amount. However, several LCBs struggled to fulfil this mandate, due to which SEBI extended the deadline. With regulation 62A coming in, these NCDs issued by LCBs would now have to be listed on stock exchanges if they possess any outstanding listed NCDs. This may increase the administrative and operational burden on the issuer and expose it to greater regulatory risk and liability. The issuer would have to list all NCDs regardless of size, tenure and purpose of issuance, which may limit the flexibility.
Furthermore, this listing requirement triggers another framework—the High-Value Debt Listed Entities (‘HVDLE’) framework as defined in Chapter IV of SEBI (LODR) Regulations, 2015. It applies to entities with outstanding listed debt exceeding Rs. 500 crore in a financial year. The HVDLE framework necessitates adherence to corporate governance norms akin to those for equity-listed entities, which would create an additional compliance burden on issuers with unlisted entities.
In essence, while these frameworks offer potential long-term benefits for LCBs and investors, they also present immediate and substantial compliance burdens for issuers. Navigating the complexities of these regulations, coupled with heightened market risk and volatility, calls for strategic planning and robust governance on the part of the LCBs.
Demystifying the Impact of Low Creditworthiness of Unlisted NCDs
SEBIs recent amendment to mandate all the listed entities with outstanding listed NCDs to list their unlisted NCDs can prove to be a double-edged sword. Even though it aims to enhance the transparency and accountability of all these listed entities, it may have some unintended impact on the volatility and liquidity of the market, with increased risk for investors due to the listing of NCDs by issuers with low credit ratings.
In the consultation paper by SEBI on the mandatory listing of these debt securities, when these issuers with unlisted NCDs were analysed, it was found that out of 177 issuers, 45 of them had a credit rating of BB+ and below (around 32%). These are non-investment grade entities and, when they are forced to list their NCDs regardless of their credit rating and issue size, then it could have some negative consequences like:
- Market Volatility: Issuers with such a low credit rating are likely to default on their debt. They are more volatile than other listed NCDs and less liquid. When a large number of these unlisted NCDs are exposed to price fluctuation and trading activities, and if some of these default on their debt, then it would affect the overall NCD market. Investors will become more risk-averse and start selling off their assets, which would drive down the prices of these NCDs.
- Increased Risk for Investors: Investment in NCDs with such a low credit rating would be very risky for investors. These NCDs are prone to default, meaning investors face a significant prospect of losing money. It is important to note that NCDs cannot be converted to equity in the event of an issuer default, diminishing the prospects of recovering investments. The current regulation does not adequately protect investors from such risky investments.
- Increased Volatility and Reduced Liquidity in Bond Yields: Bond yields are interest rates that investors receive on their bonds. Issuers with such low credit ratings would have very low creditworthiness, due to which bond yields would be very volatile. This would eventually make it difficult for investors to price bonds and could lead to risk in the bond market. Additionally, with such low creditworthiness, the investors would be less willing to buy such bonds, reducing the bond market’s liquidity.
By way of an adjudication order in the matter of Franklin Templeton Mutual Fund, SEBI restricted the trading of unlisted debt instruments with low credit ratings and allowed the mutual fund to hold the securities till maturity. It described such investments as illiquid securities. This shows that listing NCDs with such a low credit rating could have disastrous effects on the market. These NCDs are better traded with a commercial understanding between the issuer and the investor, as they can potentially disrupt the market. Listing of low credit-rated debt securities might improve transparency in the market, but they may have a spillover effect of increasing market volatility and risk for investors; hence, such entities should only list their NCDs with proper monitoring from SEBI.
Regulation 62A signifies a vital stride in elevating transparency and accountability in India’s NCD market. Its core objective of bridging information gaps and reinforcing investor trust through mandatory NCD listing by listed entities holds immense potential for long-term benefits.
However, this regulation introduces immediate compliance challenges, significantly impacting LCBs. As they are already subject to SEBI’s existing framework, LCBs must now navigate the additional intricacies of NCD listing, potentially increasing administrative and operational burdens. Furthermore, concerns arise regarding the regulation’s impact on low-credit-rating issuers. Mandating NCD listing for such entities may inadvertently escalate market volatility, reduce liquidity, and pose significant investor risks, impacting market stability and confidence.
Therefore, striking a balance between market integrity and the burdens placed on issuers, particularly those with low creditworthiness, will ensure that the regulation achieves its intended objectives without causing unintended consequences in India’s financial markets.
– Tanishq Vijay Vargiya & Vaibhav Nishad