India: Note On Market Linked Debentures

A Market Linked Debenture ("MLD") is basically a non-convertible debenture with a hybrid nature that couples the features of both plain vanilla debt security and exchange traded derivatives. A MLD offers principal protection, which is a predominant characteristic of a debt security, coupled with the feature that the returns arising from such MLD is not fixed but is linked to an underlying market / index, usually to equity markets. For this instant reason, there are various nomenclatures used in the place of MLDs such as equity linked debentures, stock linked debentures, etc.

As noted earlier, the principal component of an MLD falls under the definition of 'debt securities' under regulation 2(k) of the Securities Exchange Board of India ("SEBI") (Issue and Listing of Non-Convertible Securities) Regulations 2021 ("SEBI NCS Regulations") as noted below:

"Debt securities means non-convertible debt securities with a fixed maturity period which create or acknowledge indebtedness and includes debentures, bonds or any other security whether constituting a charge on the assets/ properties or not, but excludes security receipts, securitized debt instruments, money market instruments regulated by the Reserve Bank of India, and bonds issued by the Government or such other bodies as may be specified by the Board";

Regulation 28 of the SEBI NCS Regulations prescribes that an issuer of a debt security while making a public issue of a debt security and seeks listing thereof on a recognised stock exchange, shall make disclosures in a disclosure statement as detailed in Schedule I of SEBI NCS Regulations and disclosures under the Companies Act 2013. The issuer shall ensure that the audited financial statements contained in the draft offer document and the offer document shall not be more than six months old from the date of filing of draft offer document or issue opening date, as applicable. All the disclosures specified above shall also be made available on the websites of stock exchange(s) where such securities are proposed to be issued and listed, issuer and lead manager and shall be available for download in pdf / html formats. The issuer shall also file the offer document with the stock exchange(s) and simultaneously with the Registrar of Companies for dissemination on their respective websites prior to the opening of the issue.

Similarly, Regulation 45 of SEBI NCS Regulations spells out that an issuer of a debt security while making a private placement of a debt security and seeks listing thereof on a recognised stock exchange, shall make disclosures in a disclosure statement as detailed in Schedule II of SEBI NCS Regulations and disclosures under Companies Act 2013. The issuer shall ensure that the audited financial statements contained in the placement memorandum and tranche placement memorandum shall not be more than six months old from the date of filing of placement memorandum or issue opening date, as applicable.

In view of the fact that MLDs are different in their nature and the risk-return relationship, the SEBI had prescribed additional disclosures to MLDs vide its circular "Operational Circular for issue and listing of Non-convertible Securities, Securitised Debt Instruments, Security Receipts, Municipal Debt Securities and Commercial Paper" dated 10 August 2021 and bearing reference no. SEBI/HO/DDHS/P/CIR/2021/613 ("Operational Circular"). The disclosures in the Operational Circular are in addition to the disclosures prescribed under SEBI NCS Regulations. The Operational Circular is largely based on and reiterates the position specified in the earlier SEBI circular on 'Guidelines for Issue and Listing of Structured Products/ Market Linked Debentures' bearing reference no. Cir. /IMD/DF/17/2011 and dated 28 September 2011.

The Operational Circular also clarifies that debt securities which do not promise to return the principal amount in full at the end of the tenor of the instrument, i.e., 'principal non-protected' shall not be considered as 'debt securities' within the purview of SEBI NCS Regulations and therefore will not be eligible for issue and listing under the SEBI NCS Regulations.

2.1. Eligibility of issuer and minimum subscription

The issuer of an MLD must have a minimum net worth of at least INR 100 crores at the time of issue.

2.2. Disclosure requirements:

• Credit rating by any registered credit rating agency shall bear a prefix 'PP-MLD' denoting principal protected market linked debentures followed by the standardized rating symbols.
• A detailed scenario analysis/ valuation matrix showing value of the security under different market conditions such as rising, stable and falling market conditions shall be disclosed in a table along with a suitable graphic representation.
• A risk factor shall be prominently displayed that such securities are subject to model risk, i.e., the securities are created on the basis of complex mathematical models involving multiple derivative exposures which may or may not be hedged and the actual behaviour of the securities selected for hedging may significantly differ from the returns predicted by the mathematical models.
• An additional risk factor shall also be prominently displayed stating that in case of principal/capital protected MLDs, the principal amount is subject to the credit risk of the issuer whereby, the investor may or may not recover all or part of the funds in case of default by the Issuer.
• Where indicative returns/ interest rates are mentioned in the information memorandum in percentage terms, such figures shall be shown only on annualized basis.
• Latest and historical valuation for MLDs shall be disclosed and made available on the websites of the issuer and of the valuer appointed for the purpose.
• All commissions by whatever name called, if any, paid by issuer to distributor for selling/ distribution of such securities to end investors shall be disclosed in the offer document.
• Conditions for premature redemption of such securities, if any, shall also be clearly disclosed in the offer document.

2.3. Appointment of independent valuation agency

• A third-party valuation agency which shall be an Association of Mutual Funds in India ("AMFI") appointed valuation agency, shall be mandatorily appointed by the issuer.
• Such valuation agency shall provide to the issuer, value of the securities at a frequency which is not less than once in a calendar week. The valuation is to be made and published on the website of the valuer as well as that of the issuer. Additionally, the issuer shall arrange to provide to an investor the value whenever the investor demands the same and the costs involved in the valuation is to be specifically disclosed in the offer document and the issuer cannot charge the investors for such services.

2.4. Safeguards for retail investors

The issuer shall ensure that the following safeguards are in place while selling MLDs to retail investors:

• The intermediary who sells the security to the retail investor shall be a SEBI regulated entity.
• The intermediary shall explain to the investor the risks involved in such MLDs, and shall ensure that the investor is capable of taking the risk posed by such securities and shall satisfy itself that the securities are suitable to the risk profile of the investor
• The intermediary shall provide and make available to the investor the offer document.
• The intermediary shall provide investor guidance on obtaining valuation for the securities, i.e., the locations where such information would be available (issuer or the third party).
• Specific guidance shall be provided by the intermediary to the investor on exit loads/ exit options/ liquidity support, if any, etc., being provided by the issuer or through the secondary market.