Bond Issuers Facing Disproportional Compliances on Corporate Governance as SEBI Move Nullifies MCA Exemption
Vinod Kothari  and  Vinita Nair 15 September 2021
At one end India is aiming to be included in global bond indices and government is aiming to open the domestic bond market. At the other end, Securities Exchange Board of India (SEBI) is enforcing stricter compliance requirements on the bond issuers and the intermediaries associated with the bond market, like debenture trustees and credit ratings agencies (CRAs).
While, the ministry of corporate affairs (MCA) chose to liberalise debt-listed entities with only privately-placed debt securities from strict corporate governance-related provisions under Companies Act (CA) 2013, SEBI has tightened its strings on such entities by bringing it within the ambit of high-value debt (HVD) entity.
Giving a push to bond markets in the country is an admitted policy objective, so much so that ‘large borrowers’ are mandated to move a part of their incremental funding compulsorily to the bond markets. However, just when privately-placed bond issuance had begun to show promise due to low-interest rates and increasing investor confidence, the move by the SEBI of notifying SEBI (Listing Obligations and Disclosure Requirements) (Fifth Amendment) Regulations, 2021 (2021 Amendment) comes as an enigma. The amendment extends corporate governance requirements, mainly equivalent to those applicable to equity-listed entities, to debt-listed entities. 
These new norms, incorporated in the post-listing corporate governance requirements imbibed in SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations), become effective immediately on a ‘comply or explain’ basis and become binding from 1 April 2023.
What is surprising is that the capital market regulator has thought of equating a debt listed entity with equity listed one, ostensibly disregarding the essential difference between equity listing and bond listing. Equity listing is achieved by a public offer which underlies widely dispersed retail investors’ interest.
To the extent of 98%, a bond listing is a private placement, which definitely means that bonds are placed with knowledgeable, qualified institutional buyers. Also, it is a known fact that many listed bond issuers are private limited companies, which are closed corporations, with a strictly private holding of capital. In the light of these facts, an extension of substantially the same regime for debt-listed entities as that applicable to equity listings creates several irreconcilable compliance requirements, some of which are detailed in this article. 
When the need to push the country’s bond markets to new heights, ahead of potential inclusion of India in global bond indices, is unquestionable, this regulatory move is both surprising and prejudicial. Surprising, because for many of SEBI’s regulatory exercises, there were no public comments for these amendments.
The key to the potential prejudice that the regulatory move may cause to bond markets is the definition of 'high-value debt-listed entities', picking up a threshold of Rs500 crore. Suppose the total value of listed bonds outstanding, purely from the corporate sector, is over Rs36 lakh crore. In that case, the amount of Rs500 crore is infinitesimal, being less than 0.014% of the bond market and, therefore, the basis for taking this value as 'high value' is seriously flawed.
Let us start with some facts. India’s bond market is primarily a private placement one, comprising bespoke bond issues with a limited number of investors, the majority of them being qualified institutional buyers (QIBs).
While technically, these bonds may be sourced through an electronic platform, the avowed fact is that bond issues by even the most frequent bond issuers are negotiated over the counter.
The public issue of bonds is a rare activity. This is evident in the table below for listed debt issuance through private placement vis-à-vis public issuance during the past three years.
Source: (visited on 13 September 2021)
Table 1: Listed debt issuance
Regulatory Regime Earlier
Regulation is always proportional to the regulatory concern, in this case, investor protection. The securities regulator is neither the prudential regulator for the bond issuers nor lays the operational safeguards in companies’ working. The key responsibility of the securities regulator is to ensure that corporate governance does not entail risks to investors’ interests.
Further, the regulatory regime that existed hitherto is as follows. Once the debt securities are listed, companies were required to comply with listing regulations, mainly chapter II (dealing with principles relating to disclosures), chapter III (dealing with common obligations for all listed entities and chapter V (dealing with disclosure requirements on the website, to debenture trustees, stock exchanges, submission of financial results and structure and terms of debt securities). Provisions relating to corporate governance did not apply to debt-listed entities.
It is also notable that debt-listed entities were earlier only required to prepare half-yearly financial statements instead of quarterly financial statements applicable to equity listed entities. 
The rest of the labyrinth of corporate governance provisions, dealing with the composition of the board of directors, non-executive chairperson, independent directors, the constitution of the several board committees, and shareholders’ approval for related party transactions, did not apply to debt-listed entities.
Present Amendment
SEBI, in its board meeting held on 6 August 2021, approved amendments to the listing regulations and notified the 2021 amendment with effect from 8 September 2021. The amendments may be classed into (i) those applicable to a 'high value' debt-listed entity and (ii) those applicable to every entity having its non-convertible securities listed.
The 2021 Amendment has made corporate governance-related provisions applicable to a listed entity that has listed its non-convertible debt securities and has an outstanding value of listed non-convertible debt securities of Rs500 crore and above as of 31 March  2021 (HVD entity). Further, once the provisions become applicable, they will continue to apply even if the outstanding value falls below the threshold.
Given the details of bonds issuance and the present outstanding indicated above, several entities would be regarded as HVD entities. Given SEBI’s requirements under the large corporate borrower framework, entities with any of its securities listed, having an outstanding long-term borrowing of Rs100 crore or above and with a credit rating of ‘AA and above’, will have to mandatorily raise 25% of its incremental borrowing by ways of issuance of debt securities or pay monetary penalty/fine of 0.2% of the shortfall in the borrowed amount at the end of the second year of applicability.
Suppose one were to argue that the mere size of debt funding brings in corporate governance requirements. In that case, even a company that borrows from banks and financial institutions to the extent of Rs500 crore should, a priori, have been subjected to similar requirements. If moving from loans to bonds attracts severe corporate governance requirements, not applicable otherwise, there is a clear disincentive to moving bond markets, which is conflicting directly with SEBI’s own provision of a 'arge borrower framework.'
We discuss some of the new requirements imposed on HVD entities and demonstrate how some of these are entirely non-reconciling with the type of entities they would apply.
Complete Overhaul of Board Composition
The board of an HVD entity should comprise the prescribed number of independent directors (IDs) depending on the nature of the office of the chairperson. Appointment of IDs in the case of private companies and wholly-owned public limited companies will require inducing the requisite number of external persons on its board. In the case of a promoter chairperson, half of its board should comprise IDs. 
A private company is a private matter in terms of its shareholding. It cannot have an 'independent' shareholder. Hence, boards of private companies, as per law, may only have two directors. 
SEBI, on the contrary, mandates six directors. Regrettably, a private company’s very 'privacy' is compromised by independent directors’ mandated presence. Indeed, some external investors contributed to the entity’s debt, but they did so with the explicit understanding that the corporate governance of a private company is remarkably different from that of a widely-held company. If a private company has to behave and be governed almost like a widely-held public company, there may be a strong disincentive for such companies to access bond markets.
The requirement of IDs is not merely getting some guests into the boardroom. IDs are required to be independent of the management, meet the eligibility criteria and are responsible for protecting the interest of the minority shareholders. In the case of several HVD entities, there would be no minority shareholders whatsoever. Therefore, the IDs would be left wondering how the IDs would discharge the same obligations as applicable to an entity with a few lakh shareholders.
The procedure to be followed by a listed entity to appoint an ID under listing regulations is also very elaborate. The nomination and remuneration committee (NRC) is required to prepare a description of the needed capabilities and skillsets after doing a gap analysis, identify candidates based on the prepared description, and justify to the board and shareholders how the proposed incumbent meets the criteria and then recommend their appointment. 
The listed entities are required to obtain declaration of independence from the IDs and assess their integrity. Further, the provisions stipulate conducting a familiarisation programme periodically, obtaining the directors’ and officer’s insurance for the IDs (otherwise applicable only to top-500 equity-listed entities effective 1 January 2022), and ensuring that a separate meeting of IDs is carried out.
Need To Constitute Four Committees
The HVD entity, irrespective of whether a private company or a closely-held company, is required to have an audit committee, NRC, risk management committee (otherwise applicable only to top-1,000 listed entities based on market-capitalisation, but strangely applicable to the entire population of HVD entities) and even a stakeholder’s relationship committee (SRC).
Section 178 of Companies Act (CA) 2013 also mandates constituting SRC only where there are 1,000 shareholders, debenture-holders, deposit-holders and any other security-holders at any time during a financial year. And there are quite a few debts-listed entities that have not triggered this requirement even after eight years of enforcement of CA 2013.
Under listing regulations as well, the role of SRC is mainly to resolve investor grievances, oversee steps taken by the listed entity to reduce the quantum of unclaimed dividend, the effective exercise of voting rights, monitoring adherence to service standards by the registrar and transfer agent (RTA), which may not be even relevant to HVD entities that are private companies or closely held public companies. Strangely, the requirement of having an SRC will apply to debt listed entities having a handful of debt investors and purely in-house shareholders.
Remuneration-related Approvals
The requirement to seek shareholders’ approval by way of special resolution is applicable in case of continuing with the directorship of a non-executive director (NED) of 75 years and above, or remunerating one NED to the extent of more than 50% of annual remuneration of all NEDs in a financial year, or paying of remuneration to the promoter directors serving in an executive capacity in case (i) the annual remuneration payable to such executive director exceeds Rs5 crore or 2.5% of the net profits of the listed entity, whichever is higher; or (ii) where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5% of the net profits of the listed entity.
And it will not be a case of broad shareholder participation with institutional shareholders exercising voting rights based on the guidance from proxy advisors as several HVD entities could be private companies or closely-held public limited companies.
Further, prior approval of public shareholders is required in case any employee, including key managerial personnel or director or promoter of a listed entity, enters into any agreement for himself or herself or on behalf of any other person, with any shareholder or any other third party concerning compensation or profit-sharing in connection with dealings in the securities of such listed entity. 
Formulation of Codes and Policies
Code of conduct for the board and senior management personnel, policy for determination of material subsidiary, policy for determination of materiality of and dealing with related-party transactions, archival policy for the website are some of the additional codes and policies that HVD entities will have to frame.
Paradoxical Regulation: Related-party Transactions (RPTs) To Require Minority Shareholders' Approvals
While framing a policy for the determination of materiality of and dealing with RPTs and half-yearly disclosure of RPTs to stock exchange might seem feasible, the 2021 amendment also stipulates only IDs in the audit committee to approve RPTs. Further, in the case of material RPTs, at the time of seeking shareholders’ approval, all related parties are prohibited from voting to approve the RPT, i.e., either they may vote against or abstain from voting altogether.
This is entirely paradoxical. A debt-listed entity may be a subsidiary of a holding company. The holding company, being a ‘related party’, will be excluded from voting. If the related parties are to be excluded from voting at the general meeting of a private company, it is quite likely that there will be no shareholders whose votes may be counted!
Subsidiary Related Governance
An HVD entity will be required to ascertain material subsidiary, induct an ID on the board of super material subsidiary (that contribute 20% of the consolidated income or net worth), place details of significant transactions undertaken by unlisted subsidiary before its board, place the financials of unlisted subsidiaries before its audit committee and seek prior approval of shareholders in case of disposal of shares resulting in loss of control over the entity by the HVD entity or selling, leasing or disposing 20% of the assets of such material subsidiary in a financial year.
Group governance may be more relevant for entities where the listed entity is answerable to create shareholder value. In the case of a debt-listed entity, the investors’ expectation is not creating shareholder value but the ability to timely service the debt and redeem the principal.
Will this be a deterrent for new issuers or small players from opting for the listed debenture route? Do these enhanced corporate governance norms provide greater comfort and assurance to the investors in securing timely repayment of their monies? Will it increase trading in debt securities in the secondary market? It is assumed that SEBI must have considered these before enforcing the 2021 amendment and only time could reveal the effectiveness of these provisions.
(Vinod Kothari is a chartered accountant, trainer, and author. Mr Kothari, through his firm, Vinod Kothari & Co, is also engaged in the practice of corporate law for over 25 years. CS Vinita Nair is Partner at Vinod Kothari & Co)
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