This article has been written by Priya Singh pursuing the Diploma in Global Corporate Practices from LawSikho. This article has been edited by Amitabh Ranjan (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho). 

Introduction

There are numerous requirements for operating a business. Raising capital/funds is one such critical criterion. Among other things, funds are essential to accomplish the day-to-day operations of the company, for large-scale projects – namely business expansion, growth, takeovers, mergers, or product development. To meet such requirements companies are excessively reliant on traditional banking institutions and non-banking finance firms to obtain credit.

Issuing bonds is an alternate option for companies to raise funds apart from resorting to bank loans or the sale of the company’s stocks to investors. The issuance of a bond by a corporation is termed as a “corporate bond”. Debt securities are another name for such bonds.

The Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations, 2008 (ILDS Regulations)  under its regulation 2(1)(e) defines “debt securities” as such non-convertible debt securities which create or acknowledge indebtedness, which includes debenture, bonds and other securities of a body corporate or any statutory body constituted through legislation, whether constituting a charge on the assets of the body corporate or not. The definition excludes bonds issued by the Government or other bodies as the Board specifies, security receipts and securitized debt instruments.

These Debt securities are listed on the stock exchanges in the same way shares are listed. In addition to the Companies Act, 2013, a public corporation must comply with the ILDS  Regulations (Issue and Listing of Debt Securities)  while listing debt securities on stock exchanges. Regulation 3 of ILDS mandates application of the regulation only to debt instruments that are issued publicly and listed on a recognised stock market, whether through a public offering or a private placement.

With the objective of lowering business dependency on banks for funding, diversifying borrowings, and enhancing the Indian corporate bond market, few concerted actions have been taken by the government and authorities. In its Union Budget release on February 1, 2018, the Ministry of Finance stated, “SEBI would also consider mandating, beginning with Large Corporates, to fulfil around one-fourth of their funding needs via the bond market.” As a result, the Securities and Exchange Board of India (SEBI) published a discussion paper titled “Designing a Framework for Enhanced Market Borrowings by Large Corporates” on July 20, 2018. After taking into account the comments received in response to the discussion paper and consulting with market participants, SEBI exercising its power under Section 11(1) of the Securities and  Exchange  Board  of  India  Act,  1992 read  with regulation 101(2) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 issued a circular titled “Fundraising by issuance of debt securities by large entities” dated 26th November 2018. The circular mandates Large Corporates to raise 25% of their incremental borrowings through the issuance of debt securities.

Decoding the circular

Criteria for applicability

• Based on financial year:

1. For Entities that follow April-March as their financial year the framework came into effect on April 1, 2019.
2. Entities following calendar year as their financial year had the framework take effect from January 1, 2020.

• Note: The expression “financial year” (FY) refers to the period from April to March or January to December, as the case may be. As a result, FY 2020 will cover the period from April 1, 2019 to March 31, 2020, or January 1, 2020 to December 31, 2020, whichever is applicable.
• Listed entities

The framework applies to all the listed companies (excluding Scheduled Commercial Banks) as of the end of the financial year (March 31 or December 31).

The listed entities must fulfil the following criteria:

1. As per the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, listed entities should have their specified securities, debt securities, or any non-convertible redeemable preference share listed on a recognised stock exchange(s); and
2. Should have Rs 100 crores as outstanding long-term borrowing.

• Note: Here outstanding long-term borrowings signifies any outstanding borrowing with an original maturity of more than one year, not including external commercial borrowings and inter-corporate borrowings between a parent and its subsidiary(ies);

3. Entities must have a credit rating of “AA and above”,

• Note: These credit ratings should be of the unsupported bank borrowing or plain vanilla bonds of an entity, which have no structuring/support built.
• If an issuer has multiple ratings from different rating agencies, the highest of those ratings will be considered for the framework’s application.

What are large corporations according to the framework?

A listed entity that meets the criteria outlined above is classified as a “Large Corporate” (LC). Under the framework, such a LC must raise at least 25% of its incremental borrowings in the financial year following the financial year in which it is classified as a LC, through the issuance of debt securities, as defined under SEBI (Issue and Listing of Debt Securities) Regulations, 2008.

What is incremental borrowing according to the framework?

For the purpose of the circular, the expression “incremental borrowings” means any borrowing done in a particular financial year, which has an original maturity of more than a year, nevertheless if such borrowing is for refinancing/repayment of existing debt or for any other purpose. However, such borrowings should not include external commercial borrowings and inter-corporate borrowings between a parent and its subsidiary(ies).

Applicable guidelines for large corporates

1. The requirement to achieve the incremental borrowing norms is applied yearly for FY 2020 and 2021.
2. As a result, a listed organisation designated as a LC on the last day of FY 2019 and FY 2020 would have to comply with the condition of raising at least 25% of its incremental borrowings, through the issuance of debt securities by the last day of FY  2020 and FY 2021, respectively.
3. In a situation where a LC is unable to meet the foregoing criterion, it must explain the reason for the shortfall to the Stock Exchanges in the manner as discussed further in the disclosure requirements.
4. The criterion of mandatory incremental borrowing by LC from FY 2022 will have to be met over a contiguous block of two years. This means a listed entity classified as a LC as of the final day of FY”T-1,” must meet the criteria of additional borrowing for FY”T,” over FY”T,” and “T+1.”
5. However, if there is a shortfall in the required borrowing at the end of two years (which means if the actual borrowing through route of debt securities is found to be less than 25% of the incremental borrowings for FY”T”), a monetary penalty/fine of 0.2 percent of the gap in the borrowed amount will be imposed and paid to the Stock Exchange(s).

What are the disclosure requirements for large entities?

As provided under the framework a listed entity, identified as a Large Corporate, must make the following mandatory disclosures to the stock exchanges, where its security(ies) are listed:

1. Large Corporates must disclose their status as a LC within 30 days of the commencement of the FY, using the format provided in Annexure A of the circular. The Company Secretary and the Chief Financial Officer of the LC must both certify such disclosures.
2. These disclosures must be included in the entity’s audited annual financial reports.
3. All details related to the incremental borrowings done during the FY, are to be provided in the format as provided in Annexure B1 and B2 under 45 days of the end of the FY.
4. The illustration of the framework and disclosure requirements are provided in Annexure C.

Here is a link to the disclosure by WIPRO Limited confirming that it does not fall under the category of a LC.

Here is a link to the annual disclosure applicable for FY 2021 by Tata Steel Limited, an entity identified as a LC.

What is the responsibility of the stock exchanges in such conditions?

• The Stock Exchange(s) is required to consolidate the information about the LC disclosed on their respective platform and submit the compiled information to SEBI within 14 days of the last date of submission of the annual financial reports.
• In case of a shortfall in the required borrowing, the Stock Exchanges must collect the mandated fine and remit the same to the SEBI IPEF (Investor Protection and Education Fund) within 10 days of the same month in which the fine was collected.

Current scenario

As banks and NBFCs have been hesitant to issue large loans to corporates on account of rising NPAs (non-performing assets), companies have been choosing the route of fundraising through means of debt securities due to relatively low interest cost on bond issuance, emerging demand from institutional investors and capital expansion plans of many companies.

Scheduled Commercial Banks (SCBs) like ICICI Bank and Yes Bank [Note: SCBs are exempt from the 25% norm as given in the circular] and major corporations like Tata Steel Limited and Hindustan Copper Limited (HCL) are increasingly opting for debt securities to raise funds.

According to data available with markets regulator SEBI, companies listed on BSE and NSE Listed firms raised Rs 7.72 lakh crore through issuance of bonds on a private placement basis in 2020-21, an increase of 14 percent from the preceding fiscal, owing to low interest rate and surplus liquidity in the system. This also marks the highest level of fund raising through such a route in a financial year.

Advantages of raising finance through debt securities

1. It can help strengthen the company’s finances by enabling them to take on large loans at a set interest rate. This provides some protection against fluctuations in interest rates or the economy.
2. Because the redemption period for bonds might be several years after the issue date, more cash can be kept in the business.
3. When bonds are sold in the public market, they can be traded – similar to shares. Some corporate bonds are structured to be convertible, which means they can be exchanged for shares in the future.
4. It provides opportunities to investors to diversify their investments.

Disadvantage of issuing debt securities concerning the circular

1. Companies have to comply with various listing rules in order to increase the tradability of the bonds listed on an exchange.
2. Companies are to have a credit rating of “AA and above” which is a mandatory requirement. Having a good credit rating can help in a successful launch of a bond issue but receiving a credit rating is time consuming and will be an added cost to issuing the bonds.
3. Lower-rated corporates have been exempted from the framework for the time being due to the limited demand for such securities.
4. The “Comply or Explain” framework of SEBI would require companies to disclose non-compliance as part of “continuous disclosure requirements”.
5. In case of any shortfall in the requisite bond borrowing, a monetary penalty of 0.2% of the shortfall can be levied.

Conclusion

Bonds are an excellent approach to fund certain types of capital intensive businesses such as Oil & Gas, Automobiles, Manufacturing Firms, Real Estate, Metals & Mining, Infrastructure projects. Few projects take a long time to complete. Building dams, toll roads, flyovers, and huge power plants all require years to develop and install. The project developer will not have enough cash flow to service debt until the project is up and operating. Resorting to the bond market could be a viable option for such companies. A healthy corporate bond market is also thought to relieve a lot of strain on banks that are struggling with bad debts.

As corporates with a ‘AA and above’ rating have been given preference by SEBI this helps to ensure investor confidence in the company as corporates with such a high rating are less likely to default on their obligations to investors.

If the entry barrier for lower-rated corporate bonds is removed, the pool of investment-grade issuers will grow. A Debt fund would also enable retail investors to invest in such initiatives and expand the investor base. Small borrowers have traditionally relied on institutional finance and inter-corporate deposits. They might be able to use the bond market as a way to raise funds at a reasonable cost. Further, it also opens up avenues for greater development and deepening of the fledgling corporate bond market in India. Going forward, it would be crucial to observe the growing trend and sustainability of such a move while also keeping the necessary dispute resolution mechanism in place.

The circular can be accessed on the SEBI website at www.sebi.gov.in under the headings “Legal Framework” and “Corp Debt Market.”

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