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Secured debentures: SEBI's fiat
It is just as well that SEBI has mandated that corporates raising money through secured bonds and debentures ensure that the securities issued by them are fully backed by assets. So far the asset back-up has been a fraction of the money raised.

FOR YEARS, corporates have been issuing ‘secured’ debentures wherein the underlying security hardly accounted for a fraction of the amount raised through the issue of debentures. The security could even be a property, much lower in value, compared to the money raised through the issue of debentures. Obviously, it was a misnomer to call them secured debentures. In fact, it is not appropriate to call them even partly secured debentures considering that the value of the underlying security pales into insignificance compared to the money raised through the issue of debentures. Few investors questioned this practice (or should I say malpractice?). Instead, they would look up the rating enjoyed by the issue.

According to a press report, investors have been comfortable with the arrangement in place earlier, the misnomer notwithstanding. Happily, SEBI (the Securities & Exchange Board of India) is not. SEBI insists that there be a cent per cent security creation against an offer of secured debentures.

According to a banker quoted in the report, the recent experience of cash-starved property firms rolling over debts to buy time from investors like mutual funds may have forced SEBI to assume such a rigid stance vis-s-vis secured debentures. Or SEBI may want retail investors to step into the debt market in which case the tightening of the rules governing offer of secured debentures is but natural. Whether the banker’s conjecture is right fully or partly, the SEBI fiat is welcome.

What are the implications of the SEBI move for India Inc? For one, Indian corporates have to follow a different route to raise debt funds from the domestic market. Corporates are also aware that (as the banker rightly pointed out) some property firms rolled over debts to buy time from investors like mutual funds because they faced a cash crunch. Apparently, the excessive faith placed in the rating enjoyed by the issuer had let the investors down. The SEBI stance has already forced two housing finance companies to postpone their bond issues. If they are unable to arrange cent per cent asset back-up for the money being raised by issue of debentures, they cannot use the prefix ‘secured’ anymore and have to issue them as unsecured debentures entailing a higher cost. Unsecured debentures are not patronised by institutional investors like banks and insurance companies.

Thus, for debt-dependent companies, the new bond issue regime will make it difficult to raise funds from the market. Then there are practical difficulties to contend with for the issuers of debentures. Securing every single asset in favour of the investor is practically difficult. For example, for a housing finance company, its receivables are its assets for the most part. Such assets are ‘floating’ in nature and whenever an existing asset is replaced by a new asset (on account of an existing loan being closed and a new loan taking its place), the latter has to be secured in favour of the investor. Additionally, the issuer has to contend with stamp duty which will sharply raise the cost of funds.

While the practical difficulties the issuers face are true, calling a partly secured debenture, a secured debenture, still cannot be justified. If the issuer has to pay a higher rate of interest to the investors, so be it. After all, the issue is rated AAA and post tax, the impact of the higher interest rate allowed to investors should not be significant from the point of view of the issuer.

In India, the stock market and the government securities market have become modern and dynamic. Unfortunately the corporate debt market has remained static. Presently, corporate debentures in India are placed privately, by and large. In 1995, private placement of debentures took off very well, owing to a great degree of deregulation. However, in late 2003, the regulatory framework was fine-tuned significantly. But unfortunately, the fine-tuning exercise did not prohibit the issuers of debentures from calling partly secured debentures as secured debentures.

The potential of the debt market remains unrealised in the country, although the Bombay Stock Exchange put in place a system to make the switchover from the OTC market to an exchange traded market for corporate bonds. For this to happen, stamp duty on transfer should be made uniform across the country; better still, it should be done away with, altogether. The bulk of corporate debt is issued through private placement where the investor base is rather small. No wonder, a secondary market for corporate debt is practically absent. The valuation and pricing of corporate debt is rather vague. The yield curve is conspicuous by its absence, for all practical purposes. As a result, market participants do not know for sure the price at which corporate debt with different ratings and tenors should be traded. Companies with a ‘sub-excellent’ rating cannot raise debt funds from the market.

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