To, Ms. Richa G. Agarwal Date: January 28, 2017 Deputy General Manager Investment Management Department Division of Funds I Securities and Exchange Board of India SEBI Bhavan, Plot No. C4-A, G Block Bandra Kurla Complex, Bandra East Mumbai - 400 051 Re: Public Issuance of Non-Convertible Debentures having credit rating below Investment Grade At the outset, we, at Indian Association of Investment Professionals (IAIP 1 ), a member society of the CFA Institute 2 appreciate the opportunity to submit our response to the consultation paper on Public Issuance of Non-Convertible Debentures having credit rating below Investment Grade. Through our global research and outreach efforts, CFA Societies around the world endeavour to provide resources for policy makers, financial services professionals and their customers in order to align their interests. Our members engage with regulators in all major markets. Through our policy positions and surveys, we have advocated for strengthening fiduciary responsibility of advisers, and improving disclosures of various financial instruments. We have presented our comments in the prescribed format. The response was put together through a rigorous consultative process that involved CFA charter holders. The comments represent the views of members drawn from different categories of practitioners, including investment advisors, asset managers, and academics, and do not represent the views of any one individual or section of the industry. 1 The Indian Association of Investment Professionals ( IAIP ) is an association of over 900 local investment professionals. The Association consists of portfolio managers, security analysts, investment advisors, and other financial professionals, that; promote ethical and professional standards within the investment industry, facilitate the exchange of information and opinions among people within the local investment community and beyond, and work to further the public's understanding of the CFA designation and investment industry. 2 CFA Institute is a global non-profit association of investment professionals with over 130,000 members in over 140 countries. In India, the community of CFA charter holders is represented by the Indian Association of Investment Professionals, registered as a section 25 company under the Companies Act. CFA Institute s mission is to lead the investment profession globally by promoting the highest standards of ethics, education and professional excellence for the ultimate benefit of society.
. Name of Entity / Person : Indian Association of Investment Professionals(IAIP) Sr. No. Pertains to Point No Suggestions Rationale General Suggestions for enhancing the disclosures and advertisement guidelines with regard to the 1 Public Issuance of Non-Convertible Debentures The regulations may be mandatory for both public issues and private placements Paramount to create framework to boost participation in below-investment grade nonconvertible debentures by all investor segments. Implementation of stricter guidelines for below investment grade NCD issuers will also enthuse institutional participation. This will boost primary volumes, support secondary market liquidity, etc. Irrespective of format of issuance public or private retail and high-net worth investors can come to be holders of below investment grade-ncds through secondary market purchases. Hence applicability of guidelines for all formats of issuances. 2 Rating agency fees should be collected upfront for life of the issue. The proportionate amount for periods beyond 1 st year can be kept in an escrow account under SEBI s aegis. SEBI releases fees to rating agency on an annual basis. Investors are primarily driven by ratings of a corporate for their investment decision making process. However, rating agency collect fees for their services from issuer. There is high degree of potential moral hazard. It has been observed that issuers engage in rating shopping ; Several instances that post issuance, issuer gets less responsive to rating agency s queries leading to rating agency unilaterally withdrawing the corporate rating. To avoid such practices and mitigate moral hazard of rating agency dependency of collecting fees from issuer on annual basis, these fees be upfront collected. Should a rating agency be found below standard then SEBI to have power to enforce change of rating agency. 3 There is severe need to build confidence amongst investors. Frequent communication of
Ratings agencies should carry out surveillance on a biannual basis. Also, issuers to carry out semi-annual limited audits. Equally important to ensure its wide-spread circulation among investors: e.g. mandatory for debenture trustee; RTA agent to send emails pertaining to surveillance reports to all below investment grade NCD investors. This is in addition to public disclosures. financial information should be followed through by bi-annual surveillance. Such measure will boost investors confidence to allocate some proportion of their investible corpus for below investment grade NCDs. While the corporate investors have systems to monitor the issue and their ratings and take decision to offload/exit, the retail investors do not have any such means and usually hold the paper till maturity. It would give them signal of risk-migration and then take corrective measures if desired. 4 Issuers be asked to send periodic financial update to its NCD holders as they are warranted to send to their share-holders With reference to all disclosures and information sharing - debt capital providers should be treated akin to equity capital providers. Maybe there is a need to also impose annual debenture-holders meetings wherein issuer provides all attendees an opportunity to engage in Q&A, like a Shareholders Annual General Body Meeting 5 Same disclosure norms as applicable for listed equity securities to be applicable for below investment grade NCDs SEBI disclosure norms and guidelines to be followed without exception. 6 All Below Investment Grade NCDs to be on listed basis. To dilute some of the provisions of deemed listed securities for issuers whose equity is not listed. SEBI to recognize the challenges in listing debt securities by issuers such as private limited companies, subsidiaries / joint ventures of listed companies, subsidiaries / joint ventures of foreign companies, etc. Goal to be stringent with information disclosures at time of issue and periodically
7 8 9 10 Information disclosure for listed debt securities should be driving criteria and to dilute the need for independent directors, etc. To introduce incremental rating scale opining on lossgiven default (LGD) for below investment grade NCDs Support shortening of issuance timeline for public issues of below investment grade NCDs Exchange-traded CDS to be enabled (either for specific credit or credit index) Enhanced role of debenture trustee (DT). DT to monitor and communicate with NCDholders The suggested visual representation of Risk-ometer, may not be thereafter for benefit of investors. For this aspect to be treated on par with issuers whose equity is listed. However, dilute some of the provisions, like need for independent and women directors on board of directors. Similar to, recently introduced rating scales for infrastructure companies/projects that provides additional opinion on loss-given default, rating agency should additionally provide LGD-based scales for these class of NCDs. It is recognized that this scale may take few years and track-record of Insolvency Courts, for robust statistical / empirical data in arriving at timely recovery rates. However, the incremental opinion should be helpful for more informed investment decision making. Below Investment Grade NCD issuers may be permitted to upload shelf prospectus and then at desired frequency be able to issue NCDs under this omnibus prospectus. E-bidding to also be feasible for this class of issues. Availability of credit hedging tool as well as ability to participate in the risk of below investment grade NCD issuer should be encouraged. This mechanism has ability to feed-back into creating wider investor interest, deepening primary and secondary markets and efficiency in price discovery. DT should be responsible for collecting and reporting various financial data, issuer s certification of adherence to financial covenants, security creation, regular security valuation updates, etc. Also there must be regular regulatory oversight and minimum standards on DT. Visual image of risk-o-meter may suffer from what may be termed as optical paradox.
11 appropriate. For visual representation, it may be correlated with the probability of default of each rating. Further, a table presenting the rating agency s probability of default for each rating category/notch may be clearly specified. To highlight: From the look of the Risk-o-meter picture, it implies that BBB- is just 2-time riskier than D. In other words, for D rating it implies default has taken place while BBB- may be perceived as 50% chance for default, and AAA being near 0% change of default. Such an optical representation may lead to misunderstanding by the potential investors. Ratings are based on probability of default, which is not a linear scale. To add a table that highlights the quantitative probabilities of chance of default for each rating notch / category. This may be better explained using an analogy from the medical field. Any pathology / diagnostic report (e.g. blood report, urine report, etc.) provides the person s actual readings and for comparison also provides expected or normal ranges of a healthy person. 12 Alternate or add-on feature to highlight risk in the Below Investment Grade NCDs Applying the pathological practice in financial credit worthiness, a heathy range against selected financial ratio may be provided. This can help the investor carry out self-analysis of the relative risk in the concerned NCD. The selected ratios for the concerned rating may be compared with higher rated entities in the similar sector/ industry. The applicable ratios may be broadly pre-selected from the below set. 1) Liquidity Measurement Ratios a) Current Ratio b) Quick Ratio c) Cash Ratio d) Cash Conversion Cycle 2) Profitability Indicator Ratios a) Return On Assets b) Return On Equity
c) Return On Capital Employed 3) Debt Ratios a) Overview Of Debt b) Debt Ratio c) Debt-Equity Ratio d) Capitalization Ratio e) Interest Coverage Ratio f) Cash Flow To Debt Ratio 4) Operating Performance Ratios a) Fixed-Asset Turnover b) Sales/Revenue Per Employee c) Operating Cycle 5) Cash Flow Indicator Ratios a) Operating Cash Flow/Sales Ratio b) Free Cash Flow/Operating Cash Ratio c) Cash Flow Coverage Ratio d) Dividend Payout Ratio The regular investor reports should monitor these ratios on an ongoing basis. The actual readings to be shown for previous quarter and previous year in addition to market observed healthy range. In case of new issue, the issuer should disclose past 5 year financial performance of the company and compare the same with issuer within the same sector with ratings like AAA, AA, AA+. 13 Dual rating preferred Strongly propagate dual-rating for below investment grade NCDs to reduce incentives for rating shopping. To permit issuance of both unsecured and secured below investment grade NCDs, Different offerings for secured and unsecured Below Investment Grade NCDs.
14 however not to be clubbed in the same issue. As mentioned above, introducing additional loss-given default based rating scales will further help in bringing out the difference between secured and unsecured NCDs. 15 Issuers should mandatorily disclose credit rating history for period of five years before the issuance period of NCD. Disclosing past credit rating would assist an investor in making investment decision as it would convey about the ability and willingness of the issuer to meet its debt obligations as well as financial performance over a reasonable time frame.
Response to Specific Questions mentioned in Paper - Public Issuance of Non-Convertible Debentures. 16 2.7.1 Risk-o-meter is a more appropriate name. Further to prefix the scale as <name of rating agency s> risko-meter. The name directly relates to the risk associated with the debt papers. However this be suffixed by name of rating agency. I.e. <name of rating agency s> risk-o-meter This is to differentiate that it is rating agency s opinion regarding credit worthiness of the issuer and not an absolute, quantitative measure of risk. Introducing a Risk-o-meter for all the issuers can help in: 1. To bring about uniformity 2. Standardizing the process of assigning the risk 17 2.7.2 Risk-o-meter should be introduced for all the issues, irrespective of the rating 3. Covering the entire spectrum of risk from AAA to D 4. Comparing the issues/issuers by checking the modified visual depiction on the Risk-o-meter Easily identified by investor community. 18 3.1.1 Advertisement should also contain the Risk-o-meter Normally, the retail investors do not get to see the prospectus, they are simply given the forms by the intermediaries with verbal recommendations. But the investors do come across the advertisements. A pictorial representation of a Risk-o-meter can be an intuitive design for the inherent risk of the issue. Making it mandatory can help in standardizing the process and work in the favor of investor empowerment. 4.3.1, 4.3.2 & 4.3.3 There should be minimum amount for subscription in any issue. This may be suggested at INR 10 lakh. It recognizes the stage of evolution of Indian corporate bond markets and the very nascent stage of below investment grade bond market. A high minimum amount and high face value will mitigate the risk of mis-selling by
19 intermediaries/ issuers to naïve retail investors (below INR 10 lakh ticket size). Higher quantum as minimum threshold will keep persons having capability and ability of taking higher risk interested in investment in below investment grade NCDs. The stipulation may be reviewed as the market develops and sufficient understanding of the nuances are widespread among small investors. Retail investors may still participate indirectly through collective investment schemes like Mutual Funds. Tendency of bad-accidents, i.e. defaults being faced by retail investors will kill the market even before it has a chance to evolve. Response to Specific Questions mentioned in Paper - Public Issuance of Non Convertible Redeemable Preference Shares and Debt Securities by Municipalities. Similar to other public issues of debt the The minimum credit rating minimum rating requirement should be requirement should be 20 6.1.1 removed. However, it should follow the same removed for public issuance of strict requirement of various disclosures during NCRPS and Municipal Bonds. the time of issue and post issue. Our members will be happy to work with industry participants and SEBI for supporting its initiatives in increasing disclosures in various financial instruments. We would be grateful to visit your office and explain the contents and details of this response letter. If you or your staff have questions or seek further clarification, please do not hesitate to contact Vinay Bagri, CFA @ +91 98361 88553 or at advocacy@iaipirc.org Sincerely yours, Vinay Bagri, CFA Chair Advocacy Committee Indian Association of Investment Professionals, Member Society of CFA Institute