[Ganesh BL is an Advocate practising in Mumbai.]
The Securities and Exchange Board of India (SEBI) on 19 October 2023 introduced certain modifications (Amendments) to the SEBI (Issue and Listing of Non-Convertible Securities) 2021 (NCS Regulations) read together with the SEBI master circular on ‘fund raising by issuance of debt securities by large entities’ (Master Circular). This comes at a time where the central government is encouraging the availing of debt through the issuance of non – convertible securities and other securitized debt instruments (collectively, Debt Securities) in comparison to vanilla term loans (for reference see here and here). Hence, in 2018, SEBI vide the Master Circular had mandated certain companies to raise not less than 25% of their incremental borrowings in a financial year by way of issuance of Debt Securities. Such companies had to: (a) have their previously issued Debt Securities and/or equity listed on a recognized stock exchange; (b) have outstanding long term borrowings of INR 100 crores or more (long term borrowing is any debt with an original maturity of more than one year and excludes external commercial borrowings and inter corporate borrowings between a parent and subsidiary); and (c) have a credit rating of ‘AA and above'.
The Amendments have inter alia introduced 2 primary modifications to the Master Circular:
(a) the types of debt that have now been excluded as long term borrowings are:
(i) grants, deposits or any other funds received as per the directions of the government;
(ii) borrowings arising from interest capitalization;
(iii) borrowings for the purpose of schemes of arrangement involving mergers, acquisitions and takeovers; and
(iv) borrowings between companies and their associate entities;
(b) a minimum credit rating requirement of ‘AA/AA+AAA’, to be considered a large corporate (LC).
The rationale behind the Amendments introduced by the SEBI was to ensure investor protection, to make the issuance of Debt Securities cost effective and to also ensure adequate protection to companies belonging to certain sectors. In light of the same, the article seeks to analyze the efficacy of the Amendments introduced by the SEBI.
Increased Thresholds
Prior to the introduction of the Amendments, the SEBI had released a consultation paper (CP) for the proposed modifications to the Master Circular. The CP had recommended increasing the threshold of long term borrowings from INR 100 crores to INR 500 crores. The rationale behind the recommendation was to align the definition of LCs with that of a ‘high value debt listed entity’ as identified under the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015. While majority of the public comments received by the SEBI, were in favour of the increase in the stipulated threshold, applying the thresholds based on outstanding listed debt rather than outstanding long-term borrowings was recommended by stakeholders. The SEBI rejected the suggestion as it would lead to a strain on entities that have already issued Debt Securities. Be that as it may, the increased threshold is welcome as it provides a ‘breather’ and eliminates the obligation of certain entities not meeting the aforesaid qualifications to issue Debt Securities (170 entities would qualify as LCs as opposed to 482 entities under the extant regulations).
Further Exclusions
Under the extant Master Circular, LCs were to raise 25% of their incremental borrowing in a financial year from the bond market. ‘Incremental borrowings’ inter alia included borrowings which had an original maturity of more than one year and excluded inter corporate deposits between parent and subsidiaries. The Amendments have now further excluded borrowings between parent and associate companies as well, given that associate companies have a significant influence on a company. This is a welcome amendment by the SEBI as it not only ensures transparency but also discourages mala fide corporate structures that may be developed to circumvent the Master Circular.
The Amendments also excluded borrowings for the purpose of mergers, acquisitions and takeovers. The latter was not provided in the CP, but were received as suggestions from stakeholders. The rationale behind the same was to ensure that the obligations of LCs were not extinguished by virtue of a merger, acquisition or a takeover. While, the exclusion is prima facie a positive amendment, it may lead to a burden on bona fide mergers / takeovers / acquisitions where companies are constrained to avail additional debt from the bond market. The SEBI has also been silent with respect to the treatment of a LC post a merger / takeover / acquisition on whether the existing debt of the entities prior to such merger merger / takeover / acquisition is considered for assessing the compliance with the Amendments.
Increased Credit Rating
The CP had also recommended the omission of having a minimum credit rating for corporates to be considered as LCs. However, the Amendments did not omit the requirement but rather elaborated the same, requiring LCs to have a long term debt rating of of ‘AAA, AA+, AA and AA-'. The rejection of the proposal is a welcome change as the reduced credit rating would include several entities as LCs. Furthermore, merely an outstanding borrowing of INR 1,000 crores is not necessarily indicative of credit quality. The omission would not only lead to investor risk but also burden certain debt ridden entities with a low credit rating to avail further debt to comply with the Master Circular. An investor in Debt Securities will rely on the credit quality of the scrip prior to subscribing to the same, which is fairly indicated through the credit rating of the issuer. Furthermore, the requirement of having a credit rating of not less than AA- is a pre requisite for issuing listed debt securities under the NCS Regulations. Therefore, having a position that seemingly conflicts with the NCS Regulations was inappropriate.
Conclusion
With India’s bond market rapidly growing, the need for further regulation to ensure transparency and to safeguard the interests of prospective investors is pertinent. Thus, the modifications introduced in the Amendments are welcome, as it would not only further the growth of the bond market by mandating that LCs avail debt by way of issuance of Debt Securities but also ensure that the interest of LCs and investors are protected. Furthermore, the SEBI also plans to incentivise LCs who meet their targets for a particular FY. While the incentives as stipulated by the SEBI are not released, it sure is to positively impact the bond market.
While the SEBI intends to increase investor participation in the bond market, it has in the recent past issued circulars related to the mandatory listing of debt securities, processes of voluntary delisting, etc. The said circulars may reduce the inclination of a company to approach the debt market and may also reduce investor participation. While the Amendments and the Master Circular are beneficial for those entities that have already issued listed debt securities, it may act as a deterrent for companies that have not and which propose to enter the debt market. Hence, regulation by the SEBI, while pertinent, must also be holistic and exhaustive to ensure that investors as well as prospective issuers are not caught in a web of entangled laws, further hampering the progression of the Indian bond market.