The outbreak of the corona virus (“COVID-19”) has created an unprecedented impact on the economy, causing the financial markets to suffer significant losses in a very short period of time. The COVID-19 crisis is an extraordinary supply and demand shock with far reaching and uncertain ramifications. While developed economies are experiencing a slowdown, emerging markets and developing economies are highly exposed. The global capital markets are one of the main transmission channels of this on-going and systemic shock. Overall, regulators have had to be vigilant and take proactive and transparent measures to ensure that they can react quickly and adapt to the changing circumstances.
The uncertainty from COVID-19 on the financial markets will remain for the foreseeable future. It is inescapable that in such a volatile market, companies would face liquidity stress and have limited access to credit. This would consequentially increase the probability of companies defaulting on their debt financing. In order to deal with such a financial crisis, the Indian capital markets regulator, the Securities and Exchange Board of India (“SEBI”), has created alternative fundraising opportunities. SEBI has permitted trading in defaulted debt securities. While there was always a market for distressed loans, there was no real market for distressed bonds. In the distressed loan market, stressed asset funds and asset reconstruction companies played a pivotal role. They acquired distressed loans in accordance with the guidelines issued by the Reserve Bank of India. With bond issuers facing difficulties to meet their debt financing obligations, a need for an equivalent legal framework for trading in distressed bonds was felt.
In order to permit trading in defaulted debt securities, SEBI on 23rd June 2020 issued a circular titled “Operational framework for transactions in defaulted debt securities post maturity date/redemption date under provisions of SEBI (Issue and Listing of Debt Securities) Regulations, 2008” (“Circular”). The Circular has come into effect from 1st July 2020. Prior to the Circular, stock exchange(s) would suspend trading/reporting on debt securities before the date of redemption. Also, depositories would impose restrictions on off-market transfers on the date of redemption which restricted transfers on and after the date of redemption. This resulted in the bond becoming illiquid and impacted both issuers as well as investors. While issuers struggled with lower credit rating and impact to their overall credit worthiness, investors would struggle with getting an exit.
The Circular while permitting trading in defaulted debt securities, has stipulated stringent obligations on the issuers, debenture trustee, depositories and stock exchange(s). Issuers are required to intimate the debt securities payment status within 1 (one) day of the redemption/payment period and within 5 (five) days for existing transactions. Further, information on the updated status of payment of the debt securities is required to be provided on a yearly basis. Additionally, bank details of the issuer (from where redemption payments will be made) and a pre-authorization to the debenture trustee to seek debt redemption payment related information from the Issuer’s bank is required to be provided while executing the debenture trust deed. For existing transactions, the pre-authorization is required to be provided within 60 (sixty) days from the date of the Circular. In case of any failure in providing the necessary information, the debenture trustee is required to obtain the same by seeking information from the issuer or carrying out an independent assessment. Needless to mention, trading in the debt securities until such information is provided shall remain suspended.
To ensure transparency in trading and enable investors to take a well-informed decision, depositories in co-ordination with stock exchanges are required to update the International Securities Identification Number (“ISIN”) master file. The updated ISIN shall mandatorily reflect in its description that there was a default in payment of the redemption amount of the concerned debt securities. Once the ISIN is updated, information regarding the resumption of transactions shall be disseminated immediately on the websites of both depositories and stock exchanges. Further, depositories are required to intimate both parties to the transaction that it is “Transaction in ISIN-defaulted in redemption”. This is to ensure that only experienced investors and investors that have a risk appetite participate in the trading of such bonds. Additionally, to enable transparency on an ongoing basis, depositories are required to highlight in the periodic account statement to the dematerialised account holders, including the consolidated account statement that the bond is an "ISIN defaulted in redemption”.
The process relating to continuous assessment of default status and payment of debt securities will be followed until either the issuer has been liquidated and money has been realised after completion of recovery proceedings or full payment is made by the issuer on those securities. Trading in debt securities shall be permitted to continue and will be restricted by the depositories only in case of repayment or any development that impacts the status of default such as initiating of insolvency proceedings against the issuer or restructuring of the bonds.
The Circular is a welcome move to create a market for distressed bonds and can be said to be “the need of the hour”. Typically, in a default scenario, the remedies available to the investor include initiation of recovery/insolvency proceedings or restructuring the bonds. Each of the remedies are a time-consuming process. Also, in times of a global pandemic, it may not be the most feasible option available to investors. Trading in such distressed bonds may enable investors to find a time bound exit without undergoing long drawn restructuring negotiations with the issuers or resorting to court proceedings.
The Circular is expected to mitigate the economic distress faced by bond issuers. On the investor side, it is expected that amongst other classes of investors mutual funds may largely benefit. An investment gone sour, impacts the net asset value (“NAV”) of the mutual fund and an early exit from a distressed bond may save mutual funds from their NAV getting affected. Further, the Circular may create new investment avenues for global distressed funds. Global funds that have been looking at the distressed loan market till now may now explore investment opportunities in the distressed Indian bonds as well