India: ISINs Capped & Default Monitoring By Intermediaries Tightened – A Game Changer For The Bond Market?

In order to provide a liquid corporate bond market and better price discovery and pursuant to recommendations by the HR Khan Committee on the 'Development of the Corporate Bond Market in India' (Committee Report) (refer to newsflash dated 3 May 2017) as well as the SEBI Consultation Paper on 'Consolidation and Re-Issuance of Debt Securities under the SEBI (Issue and Listing of Debt Securities) Regulations, 2008' dated 2 February 2017 (Consultation Paper), the securities regulator has issued various circular's on 30 June 2017 (which are effective immediately) covering:

  1. Consolidation and re-issuance of International Securities Identification Number (ISIN) for debt securities issued under the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (ILDS Regulations) which will apply for all listed private placements of debt securities;
  2. Sharing of information in relation to defaults in payments on debt securities with Credit Rating Agencies (CRAs) by debenture trustees; and
  3. Monitoring and review of ratings by CRAs.

These measures are in furtherance of the regulators' aim of ensuring transparency in debt security issuances as well as investor protection by addressing information asymmetry prevalent in the current framework for debt security issuances.

Circular on Consolidation and Re-issuance of ISINs for Privately Placed Debt Securities – Key Features

Number of ISINs that may be allotted in a FY

  • The SEBI circular allows a maximum number of 17 ISINs maturing in any financial year for an issuer entity, out of which a maximum of 12 ISINs shall be allowed for plain vanilla debt securities (both secured and unsecured debt securities) and a maximum of 5 ISINs shall be allowed for structured products (such as debentures with options attached) or market linked debt securities issued under the Guidelines for Issue and Listing of Structured Products or Market Linked Debentures dated 28 September 2011.
  • An issuer may utilise all 12 ISINs allowed for structured or market linked debt securities in one financial year. However, if all 12 ISINs are utilised, then the 5 ISINs cannot be utilised by the issuer, either for plain vanilla or structured debt securities.
  • In case of put or call options embedded debt securities, the maturity of the ISIN is then calculated based on the original maturity date of the debt security. For instance, if a debt security has a maturity of 5 years, but may be callable after 3 years, the debt security will be grouped in the 5 year maturity period.
  • 12 ISINs over and above the 17 ISINs will also be available for issue of capital gains tax debt securities under Section 54EC of the Income Tax Act, 1961.
  • The circular will not apply in case of ISINs maturing in respect of debt securities issued prior to FY 2017-18.
  • The table below gives a scenario analysis for multiple issuances in a financial year:


Debt securities

Plain vanilla

structured

total ISINs*

In any Financial Year

12 ISINs

5 ISINs

17

0

12 ISINs

12

2 ISINs

10 ISINs

12

6 ISINs

5 ISINs

11

 

6 ISINs

6 ISINs

12

*12 additional ISINs available for S/ 54EC debentures An issuer may honour its debt obligations arising out of ISINs by staggered payments or bullet maturity re-payments. An issuer will have the flexibility to offer different payment options (i.e. staggered redemption to insurance companies or bullet payment to mutual funds) to different category of investors subject to disclosures in the information memorandum. Any modifications to an existing terms or structure of an issue is to be done in accordance with Regulation 59 of the ILDS Regulations. In the event of multiple record dates arise on account of staggered payments or change in frequency of payment, the issuer is permitted to have multiple record dated provided disclosure of the basis of payment (i.e. pro rata or first cum basis) is made to the investors and stock exchanges.

Exemptions from the applicability of ISINs rule

The following debt securities shall be exempt from the application of regulations relating to ISINs:

  • Tier-II bonds issued by Housing Finance Companies (HFCs) having a maturity period of less than 5 years,
  • Tier-II bonds issued by primary dealers with minimum maturity of 5 years,
  • Additional Tier-1 bonds (which are perpetual) and Tier-II bonds having a minimum maturity of 5 years,
  • Subordinated debt issued by insurance companies, which is either perpetual or having a maturity period of not less than 10 years to life, and 7 years for health insurance companies,
  • Bonds issued for the purpose of lending to long-term infrastructure sub-sectors and affordable housing with a maximum maturity of 7 years,
  • Perpetual debt instrument and Tier-II bonds issued by NBFC-ND-SIs,

Transition Provisions & Continuous Monitoring Requirements – Applicable to All Issuers With Listed Debentures

Submission of Information on outstanding debt issuances immediately: All Issuers who have issued listed debt securities under the ILDS Regulations are required to submit details of debt securities issued providing the ISIN number, issuance date, maturity date, coupon, payment frequency as well as amount outstanding in the format prescribed within 15 working days i.e. by July 20, 2017.

Amendment to Constitutional Documents: Issuers have a time period of 6 months from June 30, 2017 to insert enabling provisions in their constitutional documents to allow for consolidation and re-issuance of debt securities so as to be compliant with clause (a) of Regulation 20A of the Regulations. A confirmation certificate is required to be submitted in this regard by issuers to the stock exchange within 30 working days from the end of six months from June 30, 2017.

Ongoing Half Yearly Reporting and Monitoring Mechanisms: Issuers are required to submit a statement with details of outstanding debt securities on an ongoing basis in the prescribed format to the stock exchange and the depositories on which its securities are listed within 15 working days from the end of every half year.

In cases of modification of terms of the issue, the issuer is required to inform the depository. Upon receipt of information, the stock exchanges shall upload the same on its website.

On receipt of this information from issuers the stock exchange will upload the same on its website and on the Integrated trade repository (ITR) for corporate bonds and the depositories will upload the same on the centralised database for corporate bonds. The depositories will reconcile the reports received from the stock exchanges and within 5 working days of receipt of report send a status report regarding utilisation of the ISINs by the issuers to the exchanges. Within 30 working days from the end of every half year, the stock exchanges shall submit a report to the SEBI detailing violations of the circular by issuers (if any).

Circular on Monitoring of Interest/ Principal Repayment and sharing of such information with CRAs - Increased monitoring by DTs

The Debenture Trustees (DTs) are obligated to monitor timely repayment of debenture proceeds by the issuers on their due dates and also to share information available with them regarding the issuer, status of payment of interest or principal by the issuer with the registered CRAs.

The circular re-iterates and mandates the DTs to have adequate systems in place to ascertain the status of payments on debt securities by the issuers and efficiently share such information with the CRAs. DTs are required to obtain ISIN-wise information from issuer 7 days prior to the any due date of payment and share this information with the CRAs within a day of the due date. The circular also mandates that the DTs are required to keep track of status of payments from independent sources as well. The DT is required to make necessary disclosures regarding status of payment to debenture holders as part of investor protection measures and enable them to make informed decisions. In the event of non-receipt of information from the issuer the DTs will make a reference to SEBI and also disclose the non-availability of such information on their website. The DT is also require to issue a press release in case of default by the issuer in timely payments, default in security creation and revision in ratings and the DT, issuer and stock exchanges are required to place such information on their website immediately.

Periodical status/ performance reports are to be submitted by the issuers to the DTs within 7 days from the relevant board meeting or within 45 days from the quarter end, whichever is earlier and the DT is required to call for such reports from the issuer.

The circular makes any suppression of material information or non-disclosure of information with respect to timely payment by the DT or/ and the issuer company an unfair trade practice within the meaning of Section 12A of the SEBI Act, 1992 and the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.

Circular on monitoring and review of rating by CRAs – Pro-active Tracking of debt servicing by issuers mandated for CRAs

The circular mandates that CRAs are required to get actively involved in detection of defaults or delays in payments on debt securities and are required to track servicing of debt obligations. CRAs are required to also look for potential deterioration of financials which might lead to defaults i.e. insufficient EBITDA indicators, deterioration in liquidity conditions, abnormal increase in borrowing cost etc. The CRAs are to independently monitor disclosures made by issuer companies on the relevant stock exchanges. In case of receipt of information from the DT, the CRA is required to follow up with the issuer and in case of no response from them it is required to issue a press release and disseminate it on the website of the stock exchange.

Further, the CRA is required to make references to SEBI in case it finds any suppression of information by the issuer or any non-cooperation by the issuer. A failure to provide such references would assume the CRA is abetting with the issuer company and would be construed as an unfair trade practice within the meaning of Section 12A of the SEBI Act, 1992 and the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.

CRAs are mandatorily required to carry out a rating review on the happening of announcement/ occurrence or new of a material event (i.e. announcement of results (quarterly/ half-yearly/ annual), change in corporate structure (merger/ demerger/ amalgamation/ acquisition), corporate debt restructuring or significant decline in share or bond prices, substantial increase in debt levels, losses or suspension of licenses or regulatory approvals etc.). CRAs are required to seek monthly no-default statements from the issuers in the prescribed format.

In addition, the circular also lays down disclosure norms (that include press releases of key financial indicators and disclosures in case of delay in provision of information by the issuer company) and tightens the language of the rating agreement to be signed between the issuer and the CRAs and specifies norms regulating internal audits of CRAs.

Comment

While the circular on capping of ISINs has largely brought in reform relating to consolidation of debt securities, it does not address the stamp duty implications which were observed in the committee reports as well which was one of the primary hindrances from issuers opting for re-issuances under the same ISINs. Fixing stamp duty based on the tenor and issuance value of the debt security and capping of stamp duty in cases of a single issue, and treating re-issuances as part of the same issue for the purposes of stamp duty would give an effective solution to this issue. However, this cannot be addressed by regulator alone, and requires cooperation from the Union and State Governments.

The crux of the issue has always been of whether DTs and CRAs are proactively monitoring and remaining vigilant on behalf of the investors who they are appointed for or does the issuer choosing the DT and CRA essentially vitiate their role significantly?  The circulars tightening monitoring norms for DTs and CRAs, address the issue of "information asymmetry" for secondary market investors especially for lower rated instruments and "rating shopping" to an extent and provides for proactive monitoring by intermediaries and effective information sharing. The creation of a central depository for data relating to all primary issuances and secondary trading of bonds would also assist investors in bridging the information gap which is the main hindrance for development of a secondary market in corporate bonds.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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