With a view to regulating short-term debentures, the Reserve Bank of India (RBI) placed on its website on 3 November 2009 draft guidelines on issuing non-convertible debentures (NCDs) of maturity less than one year. These guidelines will complement the Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations, 2008 (which regulate long-term listed debt) and enable further development of an active corporate bond market in India.
The High Level Co-ordination Committee on Financial Markets has stated that these instruments need to be regulated as they have systemic implications. While the objective behind the draft guidelines is noteworthy, certain provisions may hinder the development of the bond market. This article lists some of the provisions in the draft guidelines that ought to be reconsidered and also evaluates the legal regime for NCDs vis-à-vis commercial papers (CPs).
Although the draft guidelines define NCDs as “negotiable money market instruments”, it would be prudent to define NCDs only as “debt instruments”. Negotiable by its very meaning implies transferability, whereas NCDs may be non marketable depending on their terms and conditions.
The draft guidelines also cover NCDs with original maturity of more than one year “with optionality attached to it which can be exercised within a year from the date of issue”. Therefore any event occurring within a year of the issue of the NCDs that triggers acceleration (e.g. bankruptcy, breach of contract, etc.) will potentially make a long-term debenture fall within the ambit of the draft guidelines. Interestingly, the draft guidelines specify that NCDs with maturity of less than 90 days cannot be issued. Therefore, arguably in case of default by an issuer within 90 days of issue of the NCDs, the debenture holders or the debenture trustee may not be able to seek acceleration.
Issuers may find the eligibility criteria (as regards net worth and working capital requirements) set out in the draft guidelines onerous, as most financial institutions issuing short-term debentures do not require working capital loans. Therefore the question of “sanctioned working capital limits” does not arise. Many issuers may not even be eligible (as per the RBI norms) to have working capital facilities extended to them by banks.
Further, an issuer’s obligations are required to be classified as a performing asset. However, appropriate carve-outs are required to be made. These include those covered either under a corporate debt restructuring scheme or any other duly approved scheme of arrangement, or under an investigation by the Board for Industrial and Financial Reconstruction (BIFR) or subject to a scheme prepared by BIFR.
The requirement of minimum denomination of Rs500,000 (US$11,000) may hinder participation by small to medium-sized entities. The objective may be simply achieved by specifying a minimum investment required from a single investor, while providing flexibility in the denomination of the NCDs.
The draft guidelines list the acceptable credit rating agencies and states that only commercial banks can be valid debenture trustees for NCDs. They would instead do well to allow participation by all credit rating agencies and all debenture trustees duly registered with SEBI.
Further, the draft guidelines allows NCDs to be issued only at face value, it appears that NCDs with zero-coupon are not proposed to be allowed. This is contrary to market practice and in any event, the Companies Act, 1956, which continues to be applicable to NCDs under the draft guidelines, also permits issuance of debentures at a discount.
The draft guidelines allow non-resident Indians (NRIs) to subscribe to NCDs. However, it appears that NRIs are not allowed to subscribe to NCDs according to the Foreign Exchange Management Act, 1999, and the guidelines and notifications issued under it.
It is relevant to note that the regulatory regime for CPs is similar to NCDs in certain aspects such as eligibility criteria, minimum denominations and investment limits, appointment of rating agencies, etc. However, a key difference under the draft guidelines would be the ability to issue CPs at a discount.
Further, NCDs as envisaged under the draft guidelines cannot be unsecured as opposed to CPs that are by their very nature unsecured. Creation of security is perhaps the comforting factor taken into account by the regulator at the time of making available instruments with similar features especially to retail investors. Although CPs are unsecured, credit enhancement in the form of guarantee is permitted. In such cases, the ratings of the guarantor have to be a notch higher than the issuer, which is difficult. The draft guidelines do not prescribe a similar stipulation.
The key determining factor in establishing long-term liquidity in the market for NCDs is stamp duty. Presently the stamp duty for CPs is a minor issue, whereas the stamp duty for NCDs is prohibitively high unless the same are secured by a registered mortgage deed for the full value of the NCDs.
Prachi Loona and Suprio Bose are associates at Juris Corp, a Mumbai-based firm that specializes in banking and finance, foreign investments, private equity, direct tax, bankruptcy and restructuring, M&A, insurance, energy and infrastructure, dispute resolution and international arbitration.
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