Update. Bond Market in India-An overview. CS Aman Nijhawan Vinod Kothari Consultants Private Limited

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1 Update Bond Market in India-An overview CS Aman Nijhawan Vinod Kothari Consultants Private Limited December 01, 2015 Check at: for more write ups. Copyright: This write up is the property of Vinod Kothari & Company and no part of it can be copied, reproduced or distributed in any manner. Disclaimer: This write up is intended to initiate academic debate on a pertinent question. It is not intended to be a professional advice and should not be relied upon for real life facts.

2 Contents Introduction... 3 Current Scenario... 3 Advantage of Corporate Bond Market... 5 Major Issuers and Investors in Bond Market... 6 Current Issues and Challenges in Indian Bond Market... 7 Policy Initiatives... 9 Types of Bonds... 9 Legal nature of Debentures with comparison to other instruments Regulatory framework Companies Act, 2013(Act, 2013) FEMA RBI provisions for NBFCs Snapshot on Innovative Instruments in the Bond market Municipal Bonds Masala Bonds (Rupee denominated bonds) Covered Bonds Conclusion... 30

3 Introduction A well developed capital market consists of both the equity market and the bond market. Globally, bond market is much more popular than the equity market, but in India situation is totally reversed, i.e. equity market is more vibrant and more developed than the bond market, especially the corporate bond market remains underdeveloped. This is due to dominance of the government securities in the bond market and dependency of corporates on banks and financial institutions loan for their debt funding necessities. Further, issuer profile in India is concentrated among a few categories of market participants dominated by financial sector firms including banks, non-banking financial companies (NBFCs), financial institutions, housing finance companies (HFCs) and primary dealers (PDs) while there is hardly any issuance by non-banking non financial companies (NBNFCs). This is due to the fact that the way legislation is framed it is much easier for NBNFCs to opt for a loan rather than bonds. Globally, bonds are mostly unsecured but in India bonds must be secured as unsecured bonds tantamount to public deposits and under the existing framework, it is difficult and impractical for most issuers to raise money through public deposits. The reason is obvious - if the company has security to offer, they will rather opt for a loan, which is much simpler. When entities exhaust their assets to secure, they opt for the bond issuance. Current Scenario There is no doubt that the Indian corporate debt market has now started taking baby steps and transforming itself into a much more vibrant trading field for debt instruments from the elementary market that it was about a decade ago, but there is still a long way to go. As per the latest data available with SEBI, no. of issues which were at 1414 as at end March, 2008 increased to 2635 by end March, 2015.During the same period, the amount raised increased from billion to billion. The public issuances which were billion in increased to billion in , though it fell back to billion during the year ended March, 2015.The private placements were billion in

4 , billion in , billion in , billion in and billion 1 in the year Value of Corporate Debt Issuance under the two Routes (in billions) April-15July 2015 Source:SEBI Private Placement Public Issue Though the above figures indicate a healthy growth in number and volume of corporate bond market activity, but in comparison with the government bond market, the Indian corporate bond market is dwarfed. Following graph shows a comparative position of the government bonds and corporate bonds issued as of March as a proportion of GDP among the major Asian countries

5 Government and Corporate Bonds as percentage of GDP Peoples Hong Kong Indonesia Republic of Korea Malaysia Philippines Singapore Thailand Vietnam India 5.4 Government bonds Corporate bonds Source :RBI Advantage of Corporate Bond Market A developed corporate bond market serves the needs of an emerging economy in multiple ways: i. It supplements the existing banking system in providing the required funding to enterprises and while doing so reduces the vulnerability of the financial system to external shocks by ensuring diversification of funding sources in the economy. Previous financial crises have shown that systemic problems in the banking sector can interrupt the flow of funds from savers to investors for a significantly long period of time. ii. It enables better pricing of credit risk, dynamic allocation of capital, realistic pricing of government debt and reduction of currency mismatches in the financial system. iii. It provides investment options for institutions such as insurance companies and pension funds which seek high quality long term assets to match their long term liabilities.

6 iv. It fosters the development of credit derivative products, thereby allowing efficient credit risk transmission. v. Bond financing lowers funding cost for high quality borrowers as intermediation costs are lower for bond financing than for bank financing. vi. A well-developed bond market introduces a healthy competition with the banking sector in providing corporate financing. vii. Bond market helps in spreading the risk among ultimate savers rather than get concentrated in the intermediaries. Major Issuers and Investors in Bond Market Issuers base in Bond Market Corporates Banks and Financial Institutions Public Sector Units Government Issuers Local bodies

7 Investors Base in the Bond Market: Mutual Funds Pension Fund Foreign Institutional Investors Corporate treasuries Insurance Companies Retail investor Banks and Financial Institutions Investors Trusts Current Issues and Challenges in Indian Bond Market Various efforts have been taken by regulatory authorities over the time to boost the market. In the Union Budget it was announced to formulate a High level Expert Committee on Corporate Bonds and Securitization to which Finance minister has formulated R.H. Patil Committee to formulate a road map for development of the market. However, still there are

8 certain factors 3 that impede the growth of corporate bond market and need to be tackled to facilitate improvement and growth of this segment such as: i. Low investor base: The investor base in the corporate debt market is confined to banks, insurance companies, mutual funds, pension funds and primary dealers. Retail participation remains low due to absence of knowledge and understanding of bonds as an asset class. ii. Preference of government debt: The huge supply of government papers in the country is one of the major impediments to the growth of the corporate bond market. To meet the target of the fiscal deficit, every year government issues bonds in huge quantity which ultimately impede the growth of corporate bond market. iii. Limited instruments and products: There is need for a wide array of instruments and products to be available in the market that would meet the diverse needs of its participants. There is lack of innovative instruments in the Indian context which in turn inhibits development of the bond market. Credit Default Swaps ( CDS ) and Interest Rate Futures (IRFs) are some of the instruments that have come in of late and it is expected that these will grow. iv. Market Infrastructure: Absence of infrastructure facilities such as screen based automated order matching, central clearing and settlement, negotiated dealing system, etc. also affect corporate bond market trading. v. Ease of issuances: Bond issuance is viewed as being costly and cumbersome compared with bank lending. For making attractive to the issuers, the ease and cost of issuance have to improve. The listing and disclosure requirements and procedures have to be simple and less complicated. The size, scale and tenure of issues must improve and need to be made more attractive by encouraging public offers instead of the current preference for private placements. vi. Lack of market makers: The growth and development of any market is dependent on market makers who can provide both buy and sell quotes. Although prevalent in the government bond market, they are lacking in the corporate bond segment. vii. Tight liquidity or trading in the secondary market: Absence of a liquid corporate bond market acts as a deterrent to investor participation. viii. Tax deductibility and stamp duty issues. 3

9 ix. Bankruptcy laws need to be streamlined to enable the growth of corporate bond market. x. Bond ratings also deter the growth which cannot be totally done away with. Policy Initiatives Some of the recent initiatives by the Government of India, RBI, SEBI and other regulatory authorities in the direction of developing the corporate debt market are as follows: i. Trade reporting platform: To ensure transparency, reporting platforms for over the counter trades in corporate bonds has been set up. ii. Pooling account: To facilitate DvP-I 4 based settlement of trades in corporate bonds, clearing houses of the stock exchanges have been permitted to have a pooling fund account with RBI. iii. Repo in corporate bond: Repos in corporate bonds had been allowed to regulated and other RBI permitted entities in the year 2010 and in regard to this, the norms were also relaxed to a great extent. iv. Credit Default Swaps (CDS) on corporate bonds: CDS on corporate bonds has been permitted to facilitate hedging of credit risk associated with holding corporate bonds. Short term instruments like CPs, CDs & NCDs and unlisted but rated corporate bonds have also been permitted as eligible reference obligations. v. Credit enhancement by IIFCL: Under the Union Budget , India Infrastructure Finance Company Limited (IIFCL) was allowed to provide partial credit guarantee for enhancing rating of bond and for enabling channelization of long-term funds for infrastructure projects. vi. Introduction of Rupee linked offshore bonds by International Finance Corporation (IFC): With a view to attract foreign inflows into India and to improve the status of Indian market, International Finance Corporation was permitted to float a rupee linked bond overseas amounting to USD 1 billion. Types of Bonds Bonds can be classified as follows: A. On the basis of Security: 4 DvP is the mode of settlement wherein transfer of securities and funds happen simultaneously

10 i. Unsecured Bonds: These bonds do not carry any charge on the assets of the company. The holders of such bonds do not have the right to attach particular property by way of security as to repayment of principal and interest. Unsecured bonds are treated as public deposits under the Companies (Acceptance of Deposit) Rules, 2014.Hence, it is impractical for NBNFCs to issue unsecured bonds while NBFCs are allowed to issue unsecured bonds with a minimum subscription of 1 Crore and above vide notification dated February 20, ii. Secured Bonds: Bonds that are secured by a mortgage of the whole or part of the assets of the company are called secured bonds. As per Section 71 of the Act, 2013 every Company has to issue bonds secured by a first charge or a charge ranking pari passu with the first charge on any assets specified in Schedule III of the Act excluding intangible assets. B. On the basis of Convertibility: i. Compulsorily Convertible Bonds Compulsorily convertible bonds are mandatorily converted into equity shares of the company as per the terms specified in the issue on the expiry of specified period. Hence, in view of mandatory conversion feature, compulsorily convertible bonds are treated as deferred equity instrument. As per Section 73 read with Rule 2(c) of Companies (Acceptance of deposit) Rules, 2014 if the bonds are convertible into equity shares within a period of 5 years, deposit rules will not attract. ii. Non Convertible Bonds These bonds do not carry the option of conversion into equity shares and are therefore redeemed on the expiry of certain specified period. Such bonds shall be secured as per Section 71 read with Rule 18 of the Companies (Share Capital and Debentures) Rules, iii. Partly Convertible Bonds These bonds may consist of two types namely -convertible and non-convertible bonds. The convertible portion is to be converted into equity shares at the expiry of specified period. However, the non convertible portion is redeemed on the expiry of the stipulated period. iv. Contingently Convertible Bonds

11 Contingently convertible bonds are debt instruments which get converted into equity if a pre-specified trigger event occurs. Globally these bonds are called COCO bonds. v. Optionally Convertible Bonds Optionally convertible bonds are debt instruments in which bond holder has an option to convert into shares at the pre-determined price and time. Globally, these bonds are well accepted and prevalent as an interesting hybrid between equity and debt, but in India such bonds are ruled out by regulators due to massive misuse of this instrument by Sahara. C. On the basis of tenure: i. Perpetual Bonds If the bonds are issued subject to redemption on the happening of specified events which may not happen for an indefinite period e.g. winding up, they are called perpetual bonds. These bonds are basically issued by financial sector entities for the purpose of giving permanent support to the capital requirement. Since the debt is not having redemption period, these bonds form part of Tier I capital up to 15 per cent of the Tier I capital and amount in excess of amount admissible as Tier I shall qualify as Tier II capital. Fixed Tenure Bonds The bonds which are issued for a fixed period of term and are redeemable at the end of term are said to be fixed tenure bonds. These bonds may be of long term and short term. Long term bonds are issued for a term of more than 12 months, whereas short term bonds are issued for a term up to 12 months. D. On the basis of Coupon rate i. Coupon Bonds Coupon bonds typically pay interest periodically at the pre-specified rate of interest. The annual rate at which the interest is paid is known as the coupon rate. ii. Zero Coupon Bonds Zero coupon bonds are issued at a discount to its face value, fetches no periodic interest and are redeemed at the face value at maturity. E. On the basis of Rate of return

12 i. Fixed Rate bonds Fixed rate bonds are issued with a fixed coupon (interest) rate, as opposed to a floating rate note. These bonds have a pre-determined interest rate, which is paid over a period of time. ii. Inflation Index linked bonds A bond is considered indexed for inflation if the payments on the instrument are indexed by reference to the change in the value of a general price or wage index over the term of the instrument. F. On the Basis of Redeem-ability i. Redeemable Bonds Bonds that are redeemable on expiry or before the maturity date are called redeemable bonds. Such bonds are issued in accordance with Section 71(8) of the Act, As per Rule 18(1) (a) of the Companies (Share Capital and Debentures) Rules, 2014 secured debentures are to be redeemed within 10 years from date of issue. However, Companies engaged in setting up infrastructure projects may issue for a term exceeding 10 years but not exceeding 30 years. ii. Irredeemable Bonds The bonds which lack a call feature or right of redemption are called irredeemable bonds. Such bonds are also called as perpetual bonds or non-callable bonds. G. On the basis of Seniority i. Subordinated Bonds Subordinated bonds, as evident from the meaning, are subordinated to other debt of the Company. Subordinated debt has been defined under Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015 means an instrument, which is fully paid up, is unsecured and is subordinated to the claims of other creditors and is free from restrictive clauses and is not redeemable at the instance of the holder or without the consent of the supervisory authority of the non-banking financial company.

13 These bonds are issued for a minimum term of 5 years. Subordinated bonds are primarily included in Tier II capital and provide support to capital and are utilized by Companies for paying senior debt. ii. Senior Bonds Senior bonds as the name suggests senior to other debt holders. The holder of these instruments gets a higher priority claim than another bond's to the same class of assets in case of default or bankruptcy. Legal nature of Debentures with comparison to other instruments The word Debenture literally, means an indenture, that is, a legal instrument. Historically, debentures were devised as acknowledgement of floating charge. However, as the practice has evolved over time, debentures are taken to be marketable debt instruments. Companies Act, 2013( Act, 2013 ) defines debenture to include debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not. A. Bonds and Debentures The distinction between the bonds and debentures seems largely of usage-the term bonds has been more prevalent in US parlance while debentures in UK parlance typically referring to a secured instrument.however, over the time, the distinction has been blurred. Technically, the legal structure of a bond is different from that of debenture. Under the Indian Stamp Act, Section 5 defines bond to include the following: a) any instrument whereby a person obliges himself to pay money to another, on condition that the obligation shall be void if a specified act is performed, or is not performed, as the case may be; b) any instrument attested by a witness and not payable to order or bearer, whereby a person obliges himself to pay money to another; and c) any instrument so attested, whereby a person obliges himself to deliver grain or other agricultural produce to another.

14 B. Loan and Debenture A loan is a bilateral instrument, and is therefore a contract. A debenture is a loan intrumentalised and is backed by a certificate. It becomes marketable. The contract between a debenture holder and debenture issuer is inherent in the terms of issue of a debenture. A loan is represented by an agreement while a debenture is represented by an instrument. Loans are not transferable while debentures are Transferable. In loan, security interest is created in favor of lender while in debenture, security interest created in favor of debenture trustee. C. Debenture and Commercial paper Commercial paper is issued in the form of a promissory note so, it is a negotiable instrument while debenture on the other hand is a marketable instrument. For transfer, negotiable instrument merely requires negotiation while debenture on the other hand, require compliance of the transfer procedure. Regulatory framework For issuing debentures, Company has to comply with the following provisions of laws:

15 Private Placement / Public issue Companies Act, 2013 Preferential issue OCD/ CCD Debenture provisions Deposit provisions ICDR Regulations, 2009 ILDS Regulations, 2008 SEBI Listing Agreement Debentures/Bonds Debenture Trustee Regulations, 1993 SEBI(LODR) Regulations,2015 (effective from Decmber 01,2015) RBI NCD Directions, 2010 NBFC Private Placement guidelines NHB HFC Issuance of NCD on Private Placements (NHB) Directions, 2014 FDI Regulations FEMA ECB Regulations

16 Listed Companies Unlisted companies Private Companies Privately placed NCDs Sections 42, 71 CA, 2013 and allied Rules and provisions of s of Association of the company. Convertible debentures In case of equity listed company SEBI (ICDR) Regulations, Section 42, 62(1)(c), allied Rules and Part I of Chapter III of CA, Short term NCDs Issuance of Non- Convertible Debentures (Reserve Bank) Directions, 2010 Section 42 along with allied rules Long-term NCDs Public issue of debentures: SEBI (Issue and Listing of Debt Securities) Regulations, 2008, Part I of Chapter III of CA, 2013 Listing of privately placed debentures SEBI (Issue and Listing of Debt Securities) Regulations, 2008 Companies (Acceptance of Deposit) Rules, 2014 Privately placed NCDs Sections 42, 71 CA, 2013 and allied Rules and provisions of s of Association of the company. Convertible debentures. Section 42, 62(1)(c), allied Rules and Part I of Chapter III of CA, Short term NCDs Issuance of Non- Convertible Debentures (Reserve Bank) Directions, 2010 Section 42 along with allied rules Long-term NCDs Public issue of debentures: SEBI (Issue and Listing of Debt Securities) Regulations, 2008, Part I of Chapter III of CA, 2013 Listing of privately placed or public issued debentures SEBI (Issue and Listing of Debt Securities) Regulations, 2008 Companies (Acceptance of Deposit) Rules, 2014 Privately placed debentures Sections 42, 62(1)(c) (in case of convertible debentures), 71 of CA, 2013 and allied Rules and provisions of s of Association of the company. Listing of privately placed debentures SEBI (Issue and Listing of Debt Securities) Regulations, 2008 Companies (Acceptance of Deposit Rules), 2014 applicability must be evaluated.

17 Companies Act, 2013(Act, 2013) Where a company issues secured debentures, it is governed by the provisions of Section 71 of the Act, As per Rule 18 of Companies (Share Capital and debenture) Rules, 2014 every issue of secured debentures shall be secured by creation of a charge on the properties or assets of the company, having a value which is sufficient for due repayment of amount of debentures and interest thereon. Further, the security has to be by way of specific assets. The word specific asset implies the creation of a fixed charge on debentures to be secured by way of a charge or mortgage created in favor of the debenture trustee on: any specific movable property of the company; or any specific immovable property wherever situate, or any interest therein. However by virtue of Companies (Share Capital and Debentures) Amendment Rules, 2015 NBFCs are allowed to create charge or mortgage on any movable property of the Company. Unsecured debentures attract public deposit rules under Section 73 as the definition of deposit excludes only those debentures which are secured by first charge or a charge ranking pari passu with the first charge on any assets referred to in Schedule III of the Act, 2013 excluding intangible assets of the company or debentures compulsorily convertible into shares of the company within five years. Hence, there is no doubt that the rules under Section 71(3) pertaining to secured debentures and Section 73 pertaining to deposits have tried to supress the bond market. Debenture Redemption Reserve (DRR) Section 71(4) of Act, 2013 read along with rule 18(7) of Companies (Share Capital and Debentures) Rules, 2014 requires creation of DRR by every company issuing redeemable debentures. For this, an adequate amount of profit is required to be transferred till the debentures are redeemed and/or cancelled. The DRR is to be created only out of the profits of the company which are available for payment of dividend. Further, the rules state that certain percentage of profits has to be transferred to DRR and the same is reproduced below:

18 AIFI and Banking Companies Not required Public issue 25% Registered Privately placed Listed issue Privately placed Unlisted issue Not required Not required NBFCs Unregistered or Exempted At par with NBNC DRR requirements Public Issue 25% HFCs Privately Placed Listed Issue Not required FII including IFCs At par with regd NBFCs Privately placed UnlistedIssue Not required Public Issue 25% Listed Private Listed Issue 25% NBNFCs Private Unlisted Issue 25% Unlisted Private Unlisted Issue Private Listed Issue 25% 25%

19 Further, the Company which is required to maintain DRR shall park, on or before the 30 th day of April each year, a sum of at least 15% of the amount of its debentures, maturing during the year ending on the 31 st day of March next following year, in any one or more of the following: in deposits with any scheduled bank, free from charge or lien; in unencumbered securities of the Central Government or of any State Government; in unencumbered securities mentioned in clauses (a) to (d) & (ee) of Section 20 of the Indian Trusts Act, 1882; in unencumbered bonds issued by any other company which is notified under clause (f) of Section 20 of the Indian Trusts Act, 1882; The money so parked can be utilized only for the purpose of repayment of debentures maturing during the year. The amount remaining deposited /invested shall not at any time fall below 15% of the amount of debentures maturing during that year ending 31 st March. Debenture trustee Though being a creditor of the company debenture-holders have no power in their hands to enforce their rights or security interest against the company in case of default. Hence, here comes the role of debenture trustee who act as bridge between the company and debenture-holders and protect the interest of debenture holders by serving as a liaison between both of them. Regulations which govern debenture trustees In India, debenture trustees are regulated by SEBI. SEBI (Debenture Trustees) Regulations, 1993 govern the debenture trustees and provide eligibility criteria for registration of debenture trustees, code of conduct, monitoring and review, procedure of action in case of defaults, avoidance of conflict of interest and inspection by SEBI. As per the aforesaid regulations Debenture trustee means a trustee of a trust deed for securing any issue of debentures of a body corporate. Companies Act, 2013( Act, 2013 ) & SEBI (Issue and listing of debt securities) Regulations, 2008 As per Section 71(5) of Act, 2013 read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 appointment of debenture trustee is mandatory in case of issuance of debentures to the public or to the members where the number exceeds 500 while as per SEBI (Issue and listing of debt securities) Regulations, 2008 appointment of debenture trustee is mandatory where the debentures are proposed to be listed, issued whether on private placement basis or public issue. What is a debenture trustee? When is a debenture trustee needed?

20 Creation of security in case of debentures means creating security interest on any property for the benefit of debenture holders. As debentures are a transferable instrument, it is logistically difficult to create security in favour of debenture holders. As a matter of transactional convenience, security is created in favour of debenture trustee, who holds it for the benefit of debenture holders. This view has also been collaborated in the FAQs 5 issued by SEBI. The debenture trustee holds the secured property on behalf of issuer of security and for the benefit of debenture holders. In the event of default by the issuer of security, the debenture trustee will have the power and authority to bring the secured property to sale following the procedure in the Transfer of Property Act, 1882 and the proceeds of sale will have to be applied to redeem the debentures. Statutory requirement for appointment of debenture trustee is only if the issue is made to persons exceeding 500, however, logistically, debenture trustees will be needed for every issue of secured debentures. Who can be appointed as debenture trustee? SEBI (Issue and Listing of Debt Securities) Regulations, 2008 requires only a debenture trustee to be appointed in compliance with the Securities and Exchange Board of India (Debenture Trustees) Regulations, The Regulations, 2008 are applicable only to listing of debt securities issued through public issue or on private placement on a recognized stock exchange. Further, Rule 18(2)(c) of Debenture Rules, 2014 also states that the following person shall not be appointed as debenture trustee, if the debenture trustee: (a) beneficially holds shares in the company; (b) is a promoter, director or key managerial personnel or any other officer or an employee of the company or its holding, subsidiary or associate company; (c) is beneficially entitled to moneys which are to be paid by the company otherwise than as remuneration payable to the debenture trustee; (d) is indebted to the company, or its subsidiary or its holding or associate company or a subsidiary of such holding company; (e) has furnished any guarantee in respect of the principal debts secured by the debentures or interest thereon; (f) has any pecuniary relationship with the company amounting to two per cent. or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year; (g) is relative of any promoter or any person who is in the employment of the company as a director or key managerial personnel 5 5

21 Duties of Debenture Trustee: Under the Act Rule 18(3) of Companies (Share Capital and Debenture) Rules, 2014 lays down the duties of debenture Trustee. It shall be the duty of every debenture trustee to- satisfy himself that the letter of offer does not contain any matter which is inconsistent with the terms of the issue of debentures or with the trust deed; satisfy himself that the covenants in the trust deed are not prejudicial to the interest of the debenture holders; call for periodical status or performance reports from the company communicate promptly to the debenture holders defaults, if any, with regard to payment of interest or redemption of debentures and action taken by the trustee therefor; appoint a nominee director on the Board of the company in the event of- (i) two consecutive defaults in payment of interest to the debenture holders; or (ii) default in creation of security for debentures; or not delay. (iii) default in redemption of debentures. ensure that the company does not commit any breach of the terms of issue of debentures or covenants of the trust deed and take such reasonable steps as may be necessary to remedy any such breach; inform the debenture holders immediately of any breach of the terms of issue of debentures or covenants of the trust deed; ensure the implementation of the conditions regarding creation of security for the debentures, if any, and debenture redemption reserve; ensure that the assets of the company issuing debentures and of the guarantors, if any, are sufficient to discharge the interest and principal amount at all times and that such assets are free from any other encumbrances except those which are specifically agreed to by the debenture holders; do such acts as are necessary in the event the security becomes enforceable; call for reports on the utilization of funds raised by the issue of debentures- take steps to convene a meeting of the holders of debentures as and when such meeting is required to be held; ensure that the debentures have been converted or redeemed in accordance with the terms of the issue of debentures; Additionally, Regulation 15 of the SEBI (Debenture Trustees) Regulations, 1993 prescribes such duty as to: Take possession of trust property in accordance with the provisions of the trust deed. Exercise due diligence to ensure compliance by the body corporate with the provisions of the Companies Act, the listing agreement of the stock exchange or the trust deed.

22 . To take appropriate measures for protecting the interest of the debenture holders as soon as any breach of the trust deed or law comes to his notice. Trust deed and event of default Company has to execute a trust deed in favor of the debenture trustee in Form SH-12 within 3 months of the closure of issue or offer. The debenture trust deed list down the events which shall tantamount to events of default for the trustee to take appropriate actions to protect the interest of the debenture holders such as: (a) Default in repayment of sums on redemption of the debentures: Default has occurred in the repayment of sums of the debentures on the redemption date. (b) Default in repayment of interest: Default has been committed by the issuer in payment of two consecutive installments of interest on the Debentures. (c) Default in performance of covenants and conditions: Except for the events contained in paragraphs (a) (b) above, default has occurred in the performance of any other covenants, conditions or agreement on the part of the Issuer under these presents and such default has continued for a period of thirty days or as may be specified in the Debenture Trust Deed. (d) Supply of misleading information: Any information given by the issuer under the disclosure document, in the reports and other information furnished by the issuer including the warranties given/deemed to have been given by the issuer to the debenture holders/ debenture trustees is misleading or incorrect in any material respect. (e) Proceedings against company: The issuer has voluntarily or involuntarily become the subject of proceedings under any bankruptcy or insolvency law and such proceedings have been admitted by a competent court or the issuer is voluntarily or involuntarily dissolved. (f) Appointment of receiver: A receiver or a liquidator has been appointed or allowed to be appointed of all or any part of the properties of the issuer. (g) Inability to pay debts on maturity: The issuer has admitted in writing that the issuer is unable to pay its debts as they fall due.

23 (h) Material adverse effect: If there is an event of a material adverse nature which has or is likely to have, in the reasonable view of the debenture holder(s)/ debenture trustees, a material adverse effect on the Issuer s business, financials and operations. (i) (j) Winding up petition: If an order has been made by the tribunal or a special resolution has been passed by the members of the issuer for winding up of the company. Rights of debenture holders in jeopardy: If in the opinion of the trustees the security of debenture holders is in jeopardy. Failure to redeem debentures or pay interest As per section 71(8) of Act, 2013 Company shall pay interest and redeem the debentures in accordance with the terms and conditions of their issue. In case of violation, general penalty under section 450 of Act, 2013 will be applicable as Section 71 of Act, 2013 does not prescribe any specific penalty. Further, if failure to pay interest on debentures continues for 1 year or more, then the directors of the defaulting company will be disqualified for reappointment or appointment for a period of 5 years in that company or other company under section 164(2)(b).The provisions of section 71(10) of Act, 2013 will also be applicable. If debenture holders are banks and financial institutions, relief under SARAFESI Act shall also be available to them. Additionally, the company cannot issue bonus shares under Section 63 (2) (c) of CA, 2013.Obligations on the company for payment of interest/redemption is summarized below:

24 Whether interest and redemption of debenture is in accordance with Section 71(8) of Act, 2013 Yes No Section 71(8) is complied Violation of setion 71(8) of Act, 2013 Debenture trustee /any debenture holder filed petition to NCLT? No Yes General penalty as per section 450 of Act, 2013 NCLT will pass order Order of NCLT complied? Yes Redemption of debenture with interest No Every officer in default imprisonment upto 3 years or fine of atleast two lakhs but upto five lakhs or both FEMA Where foreign investors invest in debentures, a question arises as to whether the amount will be considered as ECB or FDI. Hence, in case of mandatorily and fully convertible debentures, FDI norms are applicable. Any other class of debentures treated at par with ECBs and ECB Guidelines will be applicable. Such issue shall be governed by Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000 and Investments in fully

25 convertible debentures shall be subject to the limits prescribed under the Consolidated FDI policy issued by DIPP from time to time Investment by Foreign Portfolio Investors (FPIs) SEBI(Foreign Portfolio Investors)Regulations, 2014 govern the FPIs and provide eligibility criteria for registration of FPIs, code of conduct, obligations, investment restrictions etc.under the aforesaid regulations, FPIs are allowed to invest in the following debt securities Perpetual debt instruments and debt capital instruments, as specified by the RBI from time to time; Listed and unlisted non convertible debentures/bonds issued by an Indian company in the infrastructure sector, where infrastructure is defined in terms of the ECB guidelines; Non convertible debentures or bonds issued by NBFCs categorized as Infrastructure Finance Companies (IFCs) by the RBI; Rupee denominated bonds or units issued by infrastructure debt funds. RBI provisions for NBFCs Apart from compliance with applicable regulations as described above, Guidelines on Private Placement of Debentures by NBFCs issued by RBI on February 20, regulate issue of NCDs. The present applicable regulations can be explained by way of following graph: 6

26 By Equity Listed NBFC ICDR, 2009 & ILDS, 2008 CCDs Debt listed or Unlisted NBFC Preferential allotment rules Not privately placed >12 months maturity ILDS, 2008 NBFCs NCDs < 12 months maturity RBI Directions OCDs Privately placed Public Deposit Directions, 1998 RBI Guidelines for private placement of NCDs of more than 1 year & ILDS, 2008 in case taken for listing. RBI vide notification 7 dated February 20, 2015 amended the Guidelines on Private Placement of NCDs (maturity more than 1 year) by NBFCs. The guidelines are not applicable in case of tax exempt bonds. The guidelines have split the NCDs into two categories: 1. with a maximum subscription of below Rs. 1 crore and 2. with minimum subscription of Rs. 1 crore. The provisions are explained in the following chart: 7

27 Category A Maximum subscription below Rs. 1 crore Minimum subscription Rs. 20,000 Can be issued to maximum 200 subscribers NCDs to be fully secured Category B Minimum subscription of Rs. 1 crore per investor No limit on number of subscribers Option to create security lies with the issuer Structuring a bond issue Devising an optimal approach to structuring and sizing a bond issue can enhance an issuer s ability to maximize the amount of bond proceeds. Following elements should be kept in mind while structuring a bond issue: Purpose of utilization

28 The offer document shall contain the purpose for which the bond proceeds will be utilized which can be either general or specific. The most common purpose stated in the offer document, i.e. the money will be utilized for general corporate purpose which implies there is no purpose at all. It is advisable that the purpose shall be specifically stated so that the board of directors can monitor whether the money is utilized for that specific purpose. Security Features The offer document shall state the security which is offered, nature of security interest i.e. senior or subordinated, asset cover, maintenance of asset cover, debt service coverage ratio etc. Manner of repayment The manner of repayment may be bullet i.e. entire amount to be paid at maturity or amortized i.e. amount paid at fixed interval of time or balloon repayments. Coupon rate The offer document shall state whether debentures are issued at a discount or redeemable at premium.further the interest payable on the debentures shall be mentioned. Debenture trustee The name along with the address of the debenture trustee shall be mentioned in the offer document Rating The offer document shall contain the minimum credit rating received from the agency for the proposed issue. Listing The offer document shall contain the name of the Stock Exchange, where the bonds are proposed to be listed. Events of default The offer document may contain the events which shall tantamount to events of default for the trustee to take appropriate actions to protect the interest of the debenture holders. This has been discussed above in detail. Consequences of event of default This may include consequences such as powers to accelerate the payment and if the payment not made within the time prescribed than the debenture trustee may enforce security interest. Snapshot on Innovative Instruments in the Bond market In India, though the bond market is at its infancy stage, but globally there are various kinds of instruments which are prevalent and are untouched or explored very less in India. Some of them are discussed below:

29 Municipal Bonds Municipal Bonds are debt securities issued by state, municipality or country to finance its capital expenditures. The term municipal bond is commonly used in the United States, which has the largest market of such trade-able securities in the world. Globally, these bonds are also recognized as muni bond. The first recorded municipal bond was issued by the City of New York in 1812, which was general obligation bond of the municipal body. In India, the concept was discussed for first time in 1995; thereafter in 1997 Ahmedabad Municipal Corporation raised Rs. 100 crores, by issuing municipal bonds, which was used to finance water and sewerage projects. Structure of the Bonds Typically the municipal bonds are in the nature of debt obligations for the issuers. These are issued for a pre-determined period with a pre-determined coupon rate and require credit rating. The income generated from these instruments are either taxable or are exempted in the hands of the subscriber, subject to tax provisions specific to the country. Regulations in India The Model Municipal Laws issued by the Ministry of Urban Developments and Poverty Alleviation, which was introduced in the year 2003 in order to guide the urban local bodies to structure their law properly, deals with municipal bonds in the paragraphs 122 to 127. The highlights drawn from the same have been discussed below: The municipal bodies can issue bonds to raise funds for the development of the urban infrastructure. The bonds issued by municipal bodies are tax-free in nature, i.e. the income earned from such bonds will be exempt from income tax in the hands of the subscriber. Credit Rating The municipal bodies will have to get the bonds rated by a recognized credit rating agency before offering the same for subscription. Security The municipalities are required to pledge its movable and immovable assets including lands, buildings and tax revenues as a security for issuing bonds. End Use of the issue proceeds The issue proceeds are to be for the purpose of capital investments to develop urban infrastructure like water-supply, sewerage, drainage, solid waste management, markets, roads, bridges and urban transport. The same can be utilized for the purpose of repayment of loans raised through bonds or otherwise for development of the urban infrastructure. Masala Bonds (Rupee denominated bonds)

30 Masala bonds are Indian rupee denominated bonds issued to offshore investors settled in dollars and, therefore, the currency risk resides with investors. IFC has issued a 10-year, 10 billion Indian rupee bonds in November 2014 to increase foreign investment in India and mobilize international capital markets to support infrastructure development in the country. These bonds were offered and settled in US dollars to raise Indian rupees from international investors for infrastructure development in India. Masala bonds marked the first rupee bonds listed on the London Stock Exchange. RBI vide notification 8 dated September 29, 2015 came up with final guidelines for issuance of rupee denominated bonds by Indian companies to overseas investors. As per the guidelines the bonds shall be of minimum maturity of 5 years and can be secured or unsecured, or listed or unlisted, rated or unrated. Covered Bonds Covered bond is a debt instrument that is secured by a pledge of a segregated pool of assets (called cover pool ) which are on the balance sheet of the issuer. The bond is paid back from the issuer s cash flow rather than from the cash flow of the assets in the cover pool themselves. The assets in cover pool only act as additional security cover. Investors have recourse to the assets in the cover pool that secures or "covers" the bond if the issuer/originator becomes insolvent. Globally Covered bonds have been in existence for almost 200 years with zero default history. These are dual recourse instruments as an investor has recourse against both the issuer and the cover pool. These are similar to asset-backed securities created in securitization, but covered bond assets remain on the issuer s consolidated balance sheet. The bond instrument requires maintenance of a particular cover, mostly containing an element of over-collateralisation, at all times. The ratings of covered bonds are typically higher than corporate bonds, and lower than mortgage backed securities. Conclusion A vibrant corporate bond market is undoubtedly a very essential segment of the financial market since it not only support the banking system in meeting the long term funding of the corporates but also a reliable source of finance in situations when the equity market is unstable. Though the Indian bond market is dominated by the government bonds, but there is necessity to put impetus to corporate bond market by adequate changes in regulations, 8

31 allowing some tax benefits, liberalizing its financial market and making the bond market more liquid. However, development of the market is not a one-off affair,there are issues that need continued coordination and cooperation between the market participants and the regulators to develop India s bond market as truly global debt market.