This article is written by Amarnath Simha, pursuing a Diploma in Companies Act, Corporate Governance and SEBI Regulations from LawSikho.com. Here he discusses “Five Interesting Points In Sebi (Issue And Listing Of Debt Securities By Municipalities) Regulations, 2015”.

The Sebi (Issue and Listing of Debt Securities by Municipalities) Regulations, 2015 was amended on 27.09.2019 wherein the Regulations became Securities and Exchange Board of India (Issue and Listing of Municipal Debt Securities) Regulations, 2015 (hereinafter ILMDS Regulations).

Introduction

The SEBI allowed the Municipalities to issue debt bonds to the public for raising funds for meeting the financial requirements of its projects, by virtue of its above regulations.  The Municipality has been defined as the institution of self-government constituted under Article 243Q of the Constitution of India (vide Regulation 2(m)). Under Article 243Q, the institutions are (1) Nagar Panchayat for a transitional area i.e., an area in transition from a rural area to an urban area (2) Municipal Council for a smaller urban area and (3) Municipal Corporation for a larger urban area.   Hence, grama panchayats or village panchayats have been left out. Any of the three bodies can raise money from the public by issuing debt securities.

Amendments on 27.09.2019

The Regulations were extensively amended on 27.09.2019 by SEBI (https://www.sebi.gov.in/legal/regulations/sep-2019/securities-and-exchange-board-of-india-issue-and-listing-of-debt-securities-by-municipalities-amendment-regulations-2019_44519.html).  The need for such amendments was explained in a consultation paper on review of the regulations which were released for public comments on 20.05.2019 by SEBI (https://www.sebi.gov.in/reports/reports/may-2019/consultation-paper-on-review-of-sebi-issue-and-listing-of-debt-securities-by-municipalities-regulations-2015_43039.html).  

Some of the interesting aspects of the regulations are considered herein

Issuer: Meaning

Prior to the 2019 amendment, only Municipality under Article 243Q was allowed to raise funds.  The word ‘issuer’ was expanded vide Regulation 2(l) to include even a statutory body/board/corporation authority/trust/agency established or notified by any Central or State Act or any Special Purpose Vehicle notified by the State Government or Central Government subject to the condition that it undertakes one or more functions that may be entrusted under Article 243W of the Constitution of India.  The issuer may also include any structure set up under the Pooled Finance Development Fund Scheme. It also includes a body corporate to which the corporate act, 2013 applies and set up by the Government for the purpose of raising funds for a person performing one or more functions entrusted under Article 243W.  

Escrow Accounts

The regulations mandate the opening of three different escrow accounts.  They are

1. No lien escrow account: Regulation 2(p): i.e., the account created for the specific purpose of receiving and disbursing funds towards discharge of contractual obligations.
2. Interest payment account: Regulation 2(j) i.e., the account wherein the interest amounts due to be paid by the borrower/issuer is deposited.
3. Sinking fund: Regulation 2(y): the account created specifically for repayment of municipal debt securities.

The need for these accounts can be better understood by looking at the consultation paper.  The unamended regulations contained proposals for maintenance of 100% asset cover at all times by municipality sufficient to discharge the principal amount of the debt securities issued.  It was felt that maintenance of the 100% asset cover could not be effective as the charge on the municipality fixed or immovable assets could not be easily enforced by the creditors and it was going to face legal challenges.  The proposals for the amendment were for the establishment of escrow account wherein the funds owed to investors/creditors are earmarked to such an account which provided protection to the investors regarding payment of their dues by providing charge on receivables of a municipality.

The ‘No lien escrow account’ was recommended to be created wherein all tax revenues, user charges, grants etc., as detailed in the offer document/placement memorandum are deposited. The ‘Interest Payment Account’ was recommended on the basis that throughout the tenure of the debt securities, an amount equivalent to two interest obligations is to be kept in the account vide a transfer from ‘No lien Escrow account’ to this account.  Sinking fund account was recommended so that the principal amount due for repayment is periodically transferred to this account from the ‘No lien escrow account’.

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Regulation 19 states that the issuer should create a structured payment mechanism and maintain specific escrow accounts for the purpose of debt servicing as specified by SEBI from time to time.

Trust Deed and Debenture Trustee

Regulation 20 provides that the issue proceeds should not be utilized until the execution of the Trust Deed.  The Trust deed should be executed for securing the issue of municipal debt securities by the issuer in favour of the debenture trustee.  Such a trust deed must contain details as required under the Schedule IV of the SEBI (Debenture Trustees) Regulations, 1993. The trust deed should not contain any clauses which limits/extinguishes the obligations/liabilities of the debenture trustees or the issuer.  The trust deed should not contain any clauses limiting/restricting/waiving the provisions of the Statute/Regulations/circulars and guidelines by the SEBI. The trust deed should not indemnify the debenture trustees for the damage/loss caused by their acts and omission.  

Regulation 26 provides for the obligations of the Debenture Trustee.  The Debenture Trustee is vested with the requisite powers for protecting the security holders.  He is expected to carry out the functions with due care, diligence and loyalty in accordance with the regulations, trust deed, the offer document/placement memorandum.  But most importantly, he is needed to monitor the separate escrow accounts maintained in respect of the earmarked revenue and shall ensure disclosure on an ongoing basis at all material events.  He should supervise the implementation of the obligations cast on the issuer.  

In the unamended regulations, provisions were made for the appointment of a monitoring agency such as a scheduled commercial activity or public financial institution to monitor the earmarked revenue in the escrow account.  It also provided for obtaining a viability certificate or detailed project appraisal report from a public financial institution or a scheduled commercial bank. Even in respect of the project, a separate project implementation cell to monitor the progress of the project was provided.  All these regulations were felt to be putting additional burden on the municipality without commensurate protection to the security holders and hence those mechanisms were withdrawn and the entire responsibility of carrying out the monitoring functions was to cast on the Debenture Trustee itself.  Hence, the role of the Debenture Trustee has enlarged under the amended regulations.

Disclosures

The issuer is mandated to disclose the details as per Schedule I to the Regulations under Regulations 6 and 27.  These disclosures are to be made in the offer document and placement memorandum. Regulation 27 states that all material facts shall be disclosed by the issuer in the offer documents issued/distributed to the public and the issuer shall ensure that such disclosures are true, fair and adequate with no misstatements or misleading statements.  Regulation 6 states that the issuer and the lead manager shall ensure the draft offer document contains the details as required by Schedule 1 and Schedule 1A of the regulations and other SEBI mandated disclosures. The lead manager is mandated to exercise due diligence and satisfy himself about the veracity and adequacy of such disclosures.  

The disclosures at Schedule 1 include among others, 

1. General Information about all the persons involved in the issue
2. Details about the issuer and its capital structure
3. Objects of the issue
4. Tax Benefits
5. Issue specific information
6. Financial information
7. Legal and other information
8. Government Approvals
9. Undertaking by the Issuer
10. Documents to be submitted
11. Risk factors
12. Such other details felt necessary.

Looking at the role of the lead manager and the issuer, the municipality, a constitutionally recognized body, is made to undergo the same strenuous process of obtaining the SEBI approvals and other SEBI mandated norms which a public or private limited company has to undergo.

A Conspectus of a few other significant aspects

The issuer cannot issue debt securities if it has defaulted in repayment of debt securities or loans obtained from banks or financial institutions during the preceding 365 days (Regulation 4©.  The issuer must obtain a credit rating from a registered credit rating agency and that credit rating must be disclosed in the offer document. (Regulation 4B). The debt securities must be issued in Demat form.  (Regulation 4C) and the debt securities must be listed on a recognized stock exchange (Regulation 4E).  

The issuer has to have a surplus income in any of the immediately preceding three financial years as per its Income and Expenditure Statement (Regulation 5(a).  The issuer has to ensure that every application form issued by the Issuer is accompanied by a copy of the term sheet containing various disclosures as detailed in Schedule 1A of the Regulations (Regulation 10). 

Private placement of up to 200 persons excluding the institutional investors is allowed by the Regulations (Regulation 14-15).  The minimum subscription amount per investor in private placement is Rs.10 lakhs (Regulation 15).  

The issuer has the option of buy-back (Regulation 17).  The issuer has the option of recall (call) or can provide for redemption prior to maturity date (put).

The issuer has to utilize the funds only for the purposes indicated therein under the objects (Regulation 18A (1)) and shall disclose the schedule of project implementation (Regulation 18(4)).  The issuer has to contribute 20% of the project cost from its own resources (Regulation 18B). Provision of rollover is also provided under certain circumstances (Regulation 21). The issuer has to comply with continuous listing conditions as specified in Schedule V including continuous disclosures.

Conclusion

The consultation paper reveals that as on 20.5.2019, only seven municipalities had raised Rs.1,389 crores through the issuance of debt securities.  Hence, the amendment was carried out to make the right to issue debt securities available to more entities as well as make the process smoother and at the same time providing for investor protection.  The effect of the amendment will have to see in the coming days.

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