Friday, September 30, 2011

Revised Draft Guidelines on Securitisation

The Reserve Bank of India has issued a revised draft of its guidelines on securitisation transactions. This takes into account reform efforts internationally to deal with distorted incentives of originators in downselling financial assets soon after their creation.
The preamble to the revised draft sets forth the rationale:
1.1 Securitisation involves the pooling of assets and the subsequent sale of the cash flows from these asset pools to investors. The securitization market is primarily intended to redistribute the credit risk away from the originators to a wide spectrum of investors who can bear the risk, thus aiding financial stability and to provide an additional source of funding. The recent crisis in the credit markets has called into question the desirability of certain aspects of securitization activity as well as of many elements of the ‘originate to distribute’ business model, because of their possible influence on originators’ incentives and the potential misalignment of interests of the originators and investors. While the securitization framework in India has been reasonably prudent, certain imprudent practices have reportedly developed like origination of loans with the sole intention of immediate securitization and securitization of tranches of project loans even before the total disbursement is complete, thereby passing on the project implementation risk to investors.
1.2 With a view to developing an orderly and healthy securitization market, to ensure greater alignment of the interests of the originators and the investors, as also to encourage the development of the securitization activity in a manner consistent with the aforesaid objectives, several proposals for post-crisis reform are being considered internationally. Central to this is the idea that originators should retain a portion of each securitization originated, as a mechanism to better align incentives and ensure more effective screening of loans. In addition, a minimum period of retention of loans prior to securitization is also considered desirable, to give comfort to the investors regarding the due diligence exercised by the originators. Keeping in view the above objectives and the international work on these accounts, guidelines have been formulated regarding the Minimum Holding Period (MHP) and Minimum Retention Requirement (MRR).
The draft contains all the detailed operational guidelines that are to be complied with to achieve the above policy objectives.

Further Liberalisation of ECB Policy

In the last few days, the Reserve Bank of India (RBI) has issued a string of circulars to liberalise the policy on external commercial borrowings (ECB). The include the following:
- utilisation of 25 per cent of the fresh ECB raised by a company in the infrastructure sector towards refinancing of the Rupee loan/s availed by it from the domestic banking system, under the approval route;
- import of capital goods by companies in the infrastructure sector by availing of short-term credit (including buyers’ / suppliers’ credit) in the nature of 'bridge finance', under the approval route;
- general rationalisation and liberalisation, such as (i) enhancement of ECB limits under the automatic route for borrowers in the real sector-industrial sector-infrastructure sector, and in specified service sectors viz. hotel, hospital and software, (ii) designation of certain ECBs under Indian rupees, and (iii) the permissibility of using ECBs for meeting interest during construction (IDC) in the infrastructure sector;
- provision of credit enhancement by certain foreign equity holders to the Indian companies in the infrastructure sector; and
- clarification regarding ECBs by foreign equity holders.
These measures not only seek to encourage greater foreign lending to the infrastructure sector, which generates a great demand for financing, but it also helps Indian corporates borrow internationally on more favourable commercial terms given the constant enhancement of interest rates by the RBI that makes domestic borrowings quite expensive. At the same time, there are concerns that these changes may only cause minimal impact, and that more needs to be done, as discussed here and here.

Thursday, September 29, 2011

Berle Symposium – Corporations, Law & Society

The Seattle University Law Review recently published in a special issue works that were presented at this year’s annual symposium of the Adolf A. Berle, Jr. Center on Corporations, Law & Society at Seattle University.

The articles are now available online at, and include an article “Directors as Trustees of the Nation?  India’s Corporate Governance and Corporate Social Responsibility Reform Efforts,” by Professor Afra Afsharipour, which can be found here:

Issue of GDRs and Market Manipulation

Last week, SEBI issued an order relating to a specific transaction structure that involved the use of global depository receipts (GDRs) to allegedly manipulate the stock price of several companies.
The modus operandi was as follows. The companies issued GDRs, which were acquired by various foreign institutional investors (FIIs) or their sub-accounts. The GDRs were all soon thereafter converted into underlying equity shares of the issuing company, which were then sold in large (synchronized) deals to several buyers, such as stock brokers. The stock brokers would in turn sell the shares to other investors. After investigation, SEBI found that the companies, the lead manager to the GDRs, the FIIs/sub-accounts and the stock-brokers were all acting in common as a group. They were able to maintain the stock price of the company through these transactions without symmetry of information to outside investors who may have paid a high price given the issuance of GDRs by the companies and large holdings maintained in them by FIIs. SEBI found this to be an instance of market manipulation and passed an order restraining the relevant companies and investors from participating in the capital markets.
Mobis Phillipose has a detailed analysis in the Mint. He argues that the light regulation of GDR issuances by Indian companies may have contributed to this instance as it allowed parties to take advantage of that route. He notes:
The outcome of all this from the GDR issuing company’s perspective is that they can completely avoid the regulatory process and due diligence that is required while raising funds in the Indian market. Issuing GDRs are a much simpler process, especially when they are listed in exchanges such as London Stock Exchange’s Alternative Investment Market. Indian regulators have allowed this since it pertains to securities that are listed in markets outside their jurisdiction and are bought by investors who are not regulated by them.
But as the recent investigations show, some market participants are using this as a loophole. And ironically, it’s Indian investors who end up with the short end of the stick, when these GDRs are quickly converted into Indian shares. In sum, while it’s made to look like an issue of GDRs, in essence it’s an issuance of Indian stock, given the fact that most GDRs are cancelled and converted into shares.
The last point above is noteworthy as loose regulation of GDRs may lead listed companies to undertake large securities issuances without following either the norms for qualified institutional placements or follow-on public offerings. One solution may lie in tightening the GDR regulations, as Mobis suggests:
Needless to say, Sebi and the central bank will need to look at plugging these loopholes. As a Mint report in July pointed out, regulators are looking at imposing stringent conditions on Indian companies issuing GDRs. But while doing so, policymakers should be careful that genuine users of overseas equity and equity-linked instruments aren’t turned away. Some of the above-mentioned loopholes can be fixed with just better reporting standards, rather than having to get involved in extensive screening.
In any event, the regulations governing market manipulation are quite wide to deal with abuse of otherwise genuine financial instruments such as GDRs, which SEBI has readily invoked in this case.

Saturday, September 24, 2011

New Takeover Regulations Notified

In July this year, SEBI accepted most of the recommendations of the Takeover Regulations Advisory Committee (TRAC). The key changes have been listed here. Yesterday, SEBI formally notified the new version in the form of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 that will come into effect on the 30th day from its publication in the Official Gazette. SEBI has also prescribed consequential amendments to the listing agreement and the formats for disclosure and reporting under the Takeover Regulations.

Among the various changes to the Regulations, the key ones are the increase in the initial mandatory public offer trigger from 15% to 25% and the increase in the minimum offer size from 20% to 26%. The increase in the initial trigger for mandatory public offer would mean that persons holding below 15% can now shore up their holdings up to below 25% without obligations to make an offer. The increase in the minimum offer size might mean that acquirers must commit additional financial resources for acquiring a higher number of shares, but it is not certain if this will make any impact in practice because the track record of acceptances in mandatory public offers has not been substantial, as we have seen here. If that trend were to continue, this change in the Regulations is unlikely to impose additional financial burden on acquirers in practice given that response sizes in offer may be quite low.

A quick look at the new Regulations also indicates a reorganization of its provisions and their ordering that will require its users to familiarize themselves with the new structure.

Wednesday, September 21, 2011

In Memoriam: C. Achuthan

Mr. C. Achuthan, the former presiding officer of the Securities Appellate Tribunal and chairperson of Takeover Regulations Advisory Committee passed away this week. Somasekhar Sundaresan and Sandeep Parekh pay tribute to the individual who played an instrumental role in the evolution of securities regulation in India over the last decade.

Tuesday, September 20, 2011

Relaxation on Foreign Fund Flows

Last week, the Government and the Reserve Bank of India (RBI) have announced decisions that relax erstwhile policy on external commercial borrowings (ECB) as well as foreign investment in limited ways.
First, the Government has decided to relax the ECB policy to recognise the Chinese yuan as one of the permitted currencies. The overall limit under the automatic route has been increased from US$ 500 million to US$ 750 million, apart from other forms of relaxation as reported here. This move appears to permit Indian companies to place greater reliance on foreign borrowings in view of increasing domestic interest rates. It is also expected to ease the pressure on financing for sectors such as infrastructure.
Second, the Government has issued a press release allowing foreign institutional investors (FIIs) greater participation long-term corporate bonds in the infra-structure sector.
Third, the Reserve Bank of India (RBI) has allowed gifts of securities by persons resident in India to non-residents up to a limit of US$ 50,000 (enhanced from US$ 25,000), although such gifts can be made only under the approval route.