ISSUE VII : Capital markets: Summer innovations

INTRODUCTION

In an endeavor to simplify the regulatory framework, SEBI has issued two notifications for the capital markets on May 26, 2008 and June 6, 2008. The former is covered in SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008 (“SEBI Securitised Debt Instruments Regulations”) and deals with public offer and listing of securitized debt. The latter is SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (“SEBI Listing of Debt Securities Regulations”) and provides for issuance and listing of non-convertible debt securities (excluding Government bonds) issued by any company, public sector undertaking or statutory corporations.

This bulletin highlights the key aspects of these two regulations which have paved trading of simpler debt products in the Indian market.

1. SEBI Securitised Debt Instruments Regulations

Securitization, by its very nature, enables risk-holders to spread the risk over a wide range of investors (especially in the case of public offering of a securitized debt), and this can result in a rapid spread and sharing of the risk amongst a large set of people. In India, the definition of “securities” in the Securities Contracts (Regulation) Act, 1956 (“SCRA”) included corporate instruments, government securities, derivatives and rights or interests in securities. However, securitized instruments (instruments created by securitizing loans) such as mortgage-backed securities and asset-backed securities fell outside the ambit of the definition, and were ineligible for listing and trading on stock exchanges. As a consequence, securitization deals were done principally by means of private placements.

By qualifying such instruments as securities by means of an amendment to the SCRA in 2007, a legal framework was created for public issue and secondary market trading of such instruments. The definition now stipulates that a securitized debt instrument is “any certificate or instrument (by whatever name called), issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging the beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be.”

Prior to the notification of the regulations for listing and trading of securitized debt instruments, only private placement to Qualified Institutional Buyers was permitted for these instruments.

The key highlights of the regulations include:

• It is necessary that the entity making a public offer of securitized debt instruments or seeking listing for securitized debt instruments must be a special purpose distinct entity, and all the trustees are registered with SEBI;
• If a debenture trustee, or a securitization company or an asset reconstruction company are registered with regulators such as Reserve Bank of India, SEBI or National Bank for Agriculture and Rural Development, no separate registration will be required;
• Key permissible structures are provided for special purpose entities;
• The securitized debt instruments issued to public or listed on a recognized stock exchange will be in dematerialized form;
• The instrument will have to acknowledge actual benefit accrued to the investors in underlying debt or receivables;
• There is flexibility in terms of pay-through/pass-through structures;
• The assignment of assets to the issuer must be a true sale which means that, according to SEBI, the “debt or receivables assigned to the issuer should be able to generate identifiable cash flows for the purpose of servicing the instrument and the originator should have valid enforceable interests in the assets and in cash flow of assets prior to securitization;”
• The originator¹ must be an independent entity from the issuer and its trustees should not exercise any control over the issuer;
• The issuer cannot acquire any debt from any originator who is part of the same group or under the same management as the trustee;
• SEBI has put a time limit of 30 days – no public offer of a securitized debt instrument shall remain open beyond thirty days;
• The draft offer document shall be filed with SEBI at least 15 days before opening of the issue;
• In case of public issues, listing will be mandatory;
• The instruments issued on a private placement basis may also be listed subject to the compliance of simplified provisions of the regulations;
• The securitized debt instruments issued to the public or listed on a recognized stock exchange in accordance with the regulations shall be freely transferable;
• The terms of issue of the securitized debt instrument shall not be varied adversely without the consent of the investor;
• Defaults by a trustee who fails to comply with the terms of the certificate, SEBI Act as well as SCRA may lead to cancellation or suspension of the registration.

2. SEBI Listing of Debt Securities Regulations

In order to “facilitate development of a vibrant primary market for corporate bonds in India” these regulations aim to provide a simplified regulatory framework for issuance and listing of non-convertible debt securities issued by any entity, a public-sector undertaking or private corporate bodies. It excludes bonds issued by Governments.

The main features are:

• Issuers have flexibility to structure their instruments and decide on the mode of offering, without diluting the areas of regulatory concern;
• There is no need to file the draft offer documents with SEBI for comments;
• The instrument-related disclosures have to follow Schedule II of the Companies Act, Schedule I of the regulations, and additional disclosures prescribed by SEBI;
• For public issues, in addition to the disclosures specified under Schedule II of the Companies Act, the regulations require additional disclosures about the issuer and the instrument such as nature of instruments, rating rationale, face value, issue size, etc.;
• The three cornerstones of transparency are emphasis is on due diligence, adequate disclosures and credit rating;
• Non-Banking Financial Companies and Public Financial Institutions are exempt from mandatory listing; however, they may list their privately placed debt securities subject to compliance with the simplified requirements and Listing Agreement;
• Facilitating electronic disclosures, the focus is on the role and obligations of the debenture trustees, execution of trust deed, creation of security and creation of debenture redemption reserve in accordance with the Companies Act;
• The draft offer document must be filed with the designated stock exchange through a registered merchant banker who shall be responsible for the due diligence;
• The draft offer document shall be placed on the websites of the stock exchanges for a period of seven working days for comments;
• While listing of securities issued to the public is mandatory, the issuers may also list their debt securities issued on private placement basis subject to credit rating, and compliance with the simplified regulatory requirements provided in the regulations;
• The regulations place significant obligations on the intermediaries and issuers;
• Redemption must be in terms of the offer documents;
• A roll-over of the debt securities requires passing of a special resolution – i.e. consent of at least 75% of the holders of the securities with a prior minimum notice period of 21 days;
• SEBI may, suo moto or based upon information received, appoint people to review and inspect books of accounts and other documents belonging to the issuer, merchant banker or other intermediaries in order to verify non-compliance with various matters including listing conditions, legislations such as the SEBI Act, SCRA and others;
• The provisions of SEBI (Disclosure and Investor Protection) Guidelines relating to issue and listing of debt securities stand rescinded.

According to SEBI, the lack of an active secondary market and limited success of corporate bind offerings are, among others reasons for re-evaluating its policies. The Board also feels that simplifying raising money will assist in meeting the demands of the infrastructure sector. It is premature to speculate about the efficacy of these two regulations. Time will determine that or identify loopholes, and possibly highlight need for amendments in several over-lapping legislations relating to securities and corporate law.

1 Section 2(1)(m) of the SEBI Securitised Debt Instruments Regulations provide that “originator means the assignor of debt or receivables to a special purpose distinct entity for the purpose of securitization.”