Corporate Bond Market Turning Attractive?

Over the last few years, the Indian debt markets have witnessed significant defaults by debt issuers. These defaults have thrown light on the various difficulties faced by debenture trustees in expeditious enforcement of collateral. These issues have arisen due to various factors such as the absence of charge on identified assets, lack of transparency, inadequate disclosures at the time of debt issuances and procedural impediments at the time of enforcement. A need was felt to amend and tighten the regime for issue of listed debentures, specifically secured debentures.

Background

In view of the above, in the last quarter of 2020, the Securities and Exchange Board of India (“SEBI”) introduced  multiple amendments and circulars in respect of listed non-convertible debentures  (“NCDs”). The SEBI (Debenture Trustee) Regulations, 1993, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 and the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 were amended by SEBI, along with several circulars which were issued by SEBI. The following is an overview of the key changes introduced.

Role of debenture trustees

• Obligations of debenture trustees in respect of NCDs have been significantly enhanced, especially in respect of monitoring of asset cover and creation of security. 

• When an NCD issuer (“Issuer”) proposes to create security over its assets, debenture trustees are now duty bound to exercise their independent due diligence in respect of such security creation. By this, it is meant that they shall be required to ascertain that such assets are either free from all encumbrances, or the Issuer has obtained no-objection certificates from all existing charge-holders in respect thereof. This requirement will ensure that the security package for each lender is carved out accurately, and there is no commingling thereof.

• SEBI has prescribed that from 1st April 202 onward, debenture trustees shall be required to issue ‘due diligence certificate’ in the format prescribed by SEBI, and this certificate will need to be submitted to the stock exchanges to get NCDs listed. In this regard, the circular uses the following language:

“12. Before making the application for listing of debt securities, the Issuer shall create charge as specified in the OD or PPM/ IM, in favour of the debenture trustee and also execute debenture trust deed (DTD) with the debenture trustee. 

13. The Stock Exchange(s) shall list the debt securities only upon receipt of a due diligence certificate as per format specified in Annexure B from debenture trustee confirming creation of charge and execution of the DTD.”

• It is unclear whether the intention of the regulator was to ensure that security creation for NCDs is mandatorily done upfront (i.e. as a condition precedent to issuance of the NCDs). This may create practical hurdles for Issuers. This language also leaves a grey area in relation to situations such replenishing/ replacement of security due to a fall in the security cover, etc. and whether such actions can be done post-facto. Further clarity from SEBI may be required in this regard once the circular comes into effect.

• For NCDs secured by receivables/ book debts, debenture trustees will be required to carry out due diligence and monitor the asset cover on a quarterly basis. These changes might have come due to the fact that monitoring of these factors by a DT is of paramount importance given that the Issuer has undertaken an obligation to repay. 

Asset cover maintenance

• SEBI has made the requirements in respect of maintenance of asset cover by Issuers, particularly stringent. This ensures that the rights of the lenders/ debenture holders are protected in case of a default, and that the asset cover of the Issuer is sufficiently high to ensure repayment. 

• As against the earlier requirement of annual basis, Issuers will now  be required to provide the debenture trustee, on a half yearly basis, a certificate from the statutory auditor regarding maintenance of asset cover and compliance with the covenants of the offer document/information memorandum. Prior to the amendment, this certificate could have been obtained from an independent chartered accountant or a practicing company secretary. The amendment thus makes it onerous and important for Issuers to ensure continual maintenance of asset cover.

Modifications to NCD documentation

• SEBI has mandated that debenture trust deeds shall now contain two parts, Part A which shall contain statutory/standard information pertaining to the NCD issue whereas Part B shall contain details specific to the NCD issue. This will make the NCD documentation easier for all stakeholders (including retail investors) to understand.

• The regulatory disclosures in respect of listed NCDs have also been significantly enhanced to include disclosure of conditions for breach of covenants, risk factors pertaining to the NCD issue and all covenants in respect of an issuance, including any side letters, accelerated payment clauses, etc. This ensures that investors fully comprehend the risks at the time of making the investment. It also enables them to be fully aware of important details of the terms of the debentures, duties of debenture trustees and redressal mechanisms (in cases of default). 

Amendments pertaining to a default scenario

Recovery Expense Fund: 

• A new concept of a recovery expense fund (“REF”) has been introduced by SEBI. Issuers will now be required to ensure that 0.01% of the issue size subject to a maximum of INR 25 lakhs is set aside as the REF, to be used by the debenture trustee towards meeting expenses incurred in case of enforcement of security. 

• The Issuer shall contribute to this fund at the time of making the application for listing the NCDs, by depositing cash or cash equivalents with the recognised stock exchange. If an event of default occurs, the debenture trustee would be entitled to utilise such funds after obtaining the consent of the requisite number of debenture holders and release of the funds by the stock exchange. 

• This is a positive move, as previously debenture trustees would face several practical issues in a default scenario. This was because they were unable to recover dues/fees from the Issuer but were still obligated to act for the benefit of the debenture holders, and work towards enforcement of security. If a certain amount of money is specifically set out by the Issuer for such a scenario, filing of recovery proceedings and enforcement of security would be expedited.

Process of acceding to an inter-creditor agreement: 

• This amendment comes specifically in light of the mishaps experienced by the debt market during the default of Dewan Housing Finance Corporation Limited (“DHFL”). After that infamous default, creditors (which inter alios included banks, non-banking financial companies, and debenture trustees) sought to take steps for recovery of money, which included discussions regarding entering into an inter-creditor agreement (“ICA”). 

• The ICA forms part of the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019. DHFL’s NCD holders were approached by other lenders to sign the ICA. However, there was a complete lack of clarity as to rights of debenture trustees vis-à-vis larger creditors such as banks, etc. who were leading the ICA process. There was no well-defined process for debenture trustees to follow in such circumstances, which led to confusion in the debt market. 

• The amendment ensures that such issues are avoided and that actions to be taken by a debenture trustee (upon default, specifically where there is an ICA), are streamlined and standardised. SEBI has therefore prescribed the procedure to be followed by the debenture trustee in case of a default by an Issuer, the procedure for issuance of notices to the debenture holders, calling for a meeting of the debenture holders, ascertaining consent in favour of or against acceding to the ICA and circumstances when the debenture trustee may exit the ICA.

Concluding Remarks

The changes brought by SEBI are aimed at providing for a streamlined and transparent process of issuance of listed NCDs. They will also ensure that debenture trustees are adequately empowered in case of an enforcement scenario, and the rights and interests of the debenture holders are protected. The detailed due diligence process and the requirement of obtaining no-objection certificates from existing lenders may however significantly increase the time frame and costs involved for issuance of listed NCDs. Further clarity may also be required on refinancing transactions where typically security is released only upon repayment being made from the proceeds of the NCDs. Debt market participants will have to wait and watch to see if these amendments will enable a more streamlined approach towards issuance of listed NCDs or lead to unlisted NCDs and traditional bank and financing by non-banking financial companies becoming a more attractive mode of borrowing.