Rather than being overly prescriptive, applying an even-handed approach to regulations will better serve the SEBI’s overall goals, write Aditya Bhargava and Sristi Yadav
Traditionally, debt raising in India has been skewed to borrowings from banks. From a macroeconomic perspective, borrowings from banks – particularly the use of relatively low-risk-appetite capital through customer deposits for long-term corporate and project loans – is considered an inefficient form of fundraising. Although not as deep as most OECD (Organisation for Economic Co-operation and Development) jurisdictions, bond offerings are fast gaining momentum and acceptability as a mode of fundraising for corporate entities as well as governmental bodies.
Recognising a need to de-stress the balance sheets of banks, the Ministry of Finance, as well as the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) are encouraging the mobilising of borrowings through debt capital markets. Some national budgets have proposed requirements for large corporate entities to mandatorily raise a significant portion of their debt requirements through debt capital markets. The SEBI has also issued directions requiring large corporate entities fulfilling certain criteria to raise at least 25% of their incremental borrowings in a financial year from debt capital markets.
The Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations, 2008, was the bedrock for the issuance of listed debt instruments until it was recently recast as the Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (NCS regulations). The 2008 regulations prescribed a clear framework for the issuance of listed debt instruments and the listing of privately placed debt instruments, and also prescribed a standardised set of disclosures. The 2008 regulations were supplemented by periodic circulars from the SEBI prescribing operational and procedural requirements for listed debt instruments.
PRESCRIPTIVE AND PROCEDURAL
The SEBI’s rule-making process tends to be very prescriptive and detail-oriented, and often deliberates on mundane issues such as interest calculation methodologies, day count conventions, and even the nitty-gritties of the contents of bond issuance documents. For instance, in 2013, the SEBI prescribed detailed operational instructions on the day count convention to be followed for listed debt instruments as well as the manner of calculation of interest.
This was supplemented by operational instructions, in 2019, on the minimum penal interest rates to be applied in case of defaults and, in 2021, on the minimum face value of privately placed debt instruments. While these instructions would have been well received in the case of debt instruments that were offered to retail customers, in the case of privately placed debt instruments that have institutional investors with risk appetites different from retail investors, these instructions have caused some dismay among stakeholders.
The SEBI’s rule-making process tends to be steadfastly faithful to procedure, even though the ultimate results of such rule-making may not be the most palatable to stakeholders. Changes to most SEBI regulations tend to be preceded by a “consultation paper” for public comment, which provides some indication of the SEBI’s thought process and also some advance warning to stakeholders on what they should expect. Final forms of revised or updated regulations of the SEBI mostly tend to hew to the contents of the consultation papers.
In the context of debt instruments, on 19 May 2021, the SEBI issued a consultation paper on the consolidation of the 2008 regulations, and Securities and Exchange Board of India (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013, into a single set of regulations, with the intent of easing the “compliance burden” on the companies, and harmonising and ensuring consistency with the other regulations issued by the SEBI on listed debt instruments and the Companies Act, 2013.
Following the consultation paper, on 10 August 2021, the SEBI issued the NCS regulations prescribing the framework for issuance of listed non-convertible instruments (including privately placed debt instruments). Simultaneously with the issuance of the NCS regulations, the SEBI also introduced the “Operational Circular for Issue and Listing of Non-convertible Securities, Securitised Debt Instruments, Security Receipts, Municipal Debt Securities and Commercial Paper”, consolidating various operational instructions and circulars on listed non-convertible instruments.
Various changes have been introduced, in the NCS regulations and the operational circular, which appear to align provisions for private placement and public issue of debt instruments. A stock exchange’s “in principle approval” is now mandatorily required for the issue of both privately placed debt instruments and public issuances. A disclosure-heavy offer document or “placement memorandum”, largely akin to that for public issuance of debt instruments, is now required for all issuances of privately placed debt instruments.
The NCS regulations not only prescribe the disclosures required in the placement memorandum, but also the form and manner in which such disclosures are required to be made, including the layout of the cover page, the requirement of using “simple English”, and avoiding a combination of first and third-person sentences in the placement memorandum.
Further, the use of terms such as “market leader” and “leading player” in a placement memorandum now requires independent corroboration. The placement memorandum cannot contain any unsubstantiated forward-looking statements. Specific risk factors are now also required to be incorporated in a placement memorandum, and risk factors also need to be organised on the basis of materiality.
Where an issuer is a financial institution, additional disclosures are required in the placement memorandum, such as the lending policy, classification of loans, aggregated exposure to the top 20 borrowers, details of non-performing assets for the last three financial years (both gross and net exposures), portfolio summary on industries/sectors to which loans have been provided, and quantum and percentage of secured versus unsecured borrowings.
In addition to consolidating existing operational instructions, the operational circular also introduces some sources of friction, such as the mandatory applicability of the electronic book provider (EBP) platform. The EBP platform is a stock-exchange operated electronic platform that applies the concept of price discovery through public bidding for privately placed debt instruments.
The EBP platform is now required to be used for all issuances of privately placed debt instruments of INR1 billion (USD13.7 million) and above, or issuances of privately placed debt instruments that together with previous issuances aggregate to or exceed INR1 billion. Previously, this threshold was INR2 billion.
By opening up already negotiated commercial deals for public bidding, the EBP platform creates a disincentive for institutional investors to invest in listed debt instruments, inadvertently countering one of its aims of deepening India’s corporate bond markets.
The NCS regulations and the operational circular consolidate regulations and disclosure requirements on classification of debt instruments as “green debt”. Legislating on “green debt” appears counterintuitive, as social impact investors generally have their own criteria for disclosures and monitoring of investments, classified as “green issuances” or “social finance (so-fi)”, and these criteria are generally not connected to any regulatory requirements.
Further, considering that the benchmarks for such investments tend to relate to the green bond criteria prescribed by international organisations such as the International Finance Corporation, the approach followed in the NCS regulations appears counterproductive and one which, instead of increasing participation from investors, hinders the flexibility of issuers and investors.
Perhaps it could be said that concerns oriented around secondary market distributions of privately placed listed debt instruments may have led to the NCS regulations aligning the requirements for private placement of debt instruments to those for public issuances, resulting in a cumbersome and compliance-heavy framework.
While such compliance-heavy requirements and additional scrutiny are required for public issuances of debt instruments to retail customers, who may not be as sophisticated as institutional investors, such levels of disclosure and scrutiny would not be required for private placement of debt securities to institutional investors.
If the intention was to ensure that the general public are protected, then regulating secondary market distribution or prescribing higher disclosure requirements would have been sufficient. But if the intent of the issuance of debt instruments is to distribute in the secondary market, then a more nuanced approach should have been considered, which would have also reflected well on the rule-making process.
The SEBI’s approach so far is perhaps laudable for a nascent regulator that would need to show a high degree of involvement to stakeholders. However, with the SEBI now completing 30 years as a regulator, and the evolution of debt capital markets in India, this approach should be tempered into a more principal-based approach so as not to curtail the freedom of contract and deal-making abilities of parties.
The tussle between overly prescriptive regulations and stakeholders bemused by their apparent inability to contractually agree on ordinary commercial matters appears to be the overlying theme of the evolution of debt capital markets in India. A more even-handed approach would dovetail well with the SEBI’s overall goals of deepening the Indian corporate bond market, increasing stakeholder participation, and also protecting investors.
Aditya Bhargava is a partner and Sristi Yadav is a senior associate at Phoenix Legal.
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