Benefits that SEBI and RBI tried to offer to small and medium sized private companies are largely offset by the countermeasures of Companies Act, 2013

From the recommendations of the RH Patil Committee, emphasising on the importance of the deep and liquid corporate bond market to the constant on-going efforts of Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI), to catalyse the corporate bond market in India there has been limited success at the fore. The corporate bond market in India, which stands below 5% of GDP at present, has the potential to reach to a level of 15% of GDP during the 12^th Five Year Plan (2012-17) on back of policy and regulatory reforms, according to a survey conducted by the Confederation of Indian Industry (CII). A robust corporate bond market is imperative to meet the funding needs of the emerging Indian economy considering the limitations of bank financing and government funding. If there were not enough regulatory bottlenecks before India Inc on raising funds via corporate bonds, the requirements of Companies Act, 2013 (CA, 2013) makes the process even more treacherous and do not seem to be in tandem with the counterpart regulators’ reform targets.
 

SEBI and RBI’s efforts catalysing corporate bond market
 

The public issue requirements are already onerous and stringent. More than 90% of the debt raised is privately placed and the secondary market for corporate bonds is severely constrained by the lack of liquidity, transparency and the price discovery process is not satisfactory. To top it all the investor base remains limited to long term investors. SEBI’s efforts over the years has made several efforts to address these challenges, some which include:

1. The requirement for corporate houses to obtain credit ratings from two agencies was relaxed to one credit agency. This relaxation was made to reduce the cost of issuance of debt instruments;
2. While there may be no takers, but SEBI also decided to allow issue of bonds even which are below the investment grade;
3. In 2013, SEBI took a bold step to mobilise the bond markets by establishing a platform of stock exchanges called ITP for Small and Medium Enterprises (SMEs). The aim was to aid such enterprises in getting access to capital as well as gain wider visibility. Prior to this, listing was possible only after an initial public offer was made and subscribed to. With this move, SEBI made it possible for SMEs to raise capital without going through the expensive IPO (initial public offer) route also enabling the angel investors exit such companies easily.

To improve liquidity and give the corporate bond market a boost, the RBI has also been taking various initiatives. Some of these are recounted below:

1. To promote transparency in corporate debt market, a reporting platform was developed by FIMMDA (Fixed Income Money Market and Derivatives Association of India) and it was mandated that all RBI-regulated entities should report the OTC (over the counter) trades in corporate bonds on this platform. Other regulators have also prescribed such reporting requirement in respect of their regulated entities. This has resulted in building a credible database of all the trades in corporate bond market providing useful information for regulators and market participants;
2. Clearing houses of the exchanges have been permitted to have a pooling fund account with RBI to facilitate DvP-I based settlement of trades in corporate bonds;
3. Repo in corporate bonds was permitted under a comprehensive regulatory framework.
4. Banks were permitted to classify their investments in non-SLR bonds issued by companies engaged in infrastructure activities and having a minimum residual maturity of seven years under the Held-to-Maturity (HTM) category;
5. The provisioning norms for banks for infrastructure loan accounts have been relaxed.

Companies Act, 2013 whammy

Despite these measures, the sea of amendments in the corporate laws may bring some high tides for the bond market. Under Companies Act, 2013 (CA, 2013), any company that lists any of its securities on a recognised stock exchange shall be called a listed company. Section 2 (52) of the CA, 2013 defines listed company as:

(52) “listed company” means a company which has any of its securities listed on any recognised stock exchange;

This would mean any company including a private company which has any security, which includes debt instruments listed on a recognised stock exchange shall be called a listed company for the purpose of this Act and all the provisions of the listed company shall be applicable to such companies as well. Compare this with the erstwhile Companies Act 1956, where the definition of listed companies excluded private companies, even if such private companies had listed debt or structured debt securities. Simply put, private companies which have not yet gone public through an IPO but have listed debt securities with a stock exchange are covered in the new regime under the definition of listed companies.

As a listed company, these companies will have to comply with the following provisions of the CA, 2013:

1. Audit committee requirement -- The listed company shall be required to have an audit committee and such audit committee shall consist of minimum three directors with independent directors forming a majority. While section 149 (4) of the CA, 2013 does not prescribe for a need for an independent director but pursuant to this section will require independent directors (Section 177). In the Companies Act, 1956 only public companies public companies, but not private companies, were required to have an Audit Committee;
2. Nomination and remuneration committee requirement -- Listed companies will be required to have a nomination and remuneration committee as well comprising of three or more non-executive directors out of which not less than one-half have to be independent (Section 178);
3. Secretarial audit -- Though the section says secretarial audit for bigger companies, all listed company be required to provide for a secretarial audit report along with the board’s report which shall be duly signed by company secretary in practice (Section 204). The PCS has to confirm that the company has complied with the provisions of several regulations which include RBI, SEBI, SCRA, listing agreement, depositories, FEMA, competition, there is a long list;
4. Vigil mechanism -- Listed company to establish a vigil mechanism for directors and employees to report genuine concerns in such matters as may be prescribed (Section 177 (9));
5. Appointment of auditors -- Listed company cannot appoint an individual as an auditor for more than one term of five consecutive years and an audit firm as auditor for more than two terms of five consecutive years. There shall be a cooling off period for the individual auditor and the audit company for a period of five years after their expiry of term mentioned above. Then you cannot appoint an audit firm whose partner or partners are common to other audit firm whose tenure expired (section 139(2));
6. Other compliances –
   1. The annual return of the listed company will have to be certified by a company secretary in practice (Section 92(2)).
   2. Listed company to file with RoC changes in the no. of shares held by the promoters and top 10 shareholders of the company within 15 days from such change (Section 93).
   3. Listed companies to have its website and place the financial statement of the company on its website (Section 136).

If the draft rules were to be implemented as is, listed companies will be required to appoint internal auditor (u/s 138), appoint a woman director on board (u/s 149(1)) and also appoint key managerial personnel (u/s 203) which shall include a managing director, company secretary and a chief financial officer.
 

While some of these disclosure requirements could be called to be well placed for listed public companies but the current provisions seem more mindless in their approach. Also the fine imposed for contravention of the provisions of some of the sections may result call for an imprisonment of a term which may extend upto one year or fine which may extend to Rs5 lakh or both.
 

Conclusion
 

For a MSME to get its debt securities listed the regulatory compliance burden may out weigh the benefits of price discovery, liquidity and transparency and the repercussion may be such companies may not be able to attract angel investors either. While funding is critical for the growth of these companies and the development of the economy, the burden of compliance is so huge that it surely comes in the way of becoming a listed company.
 

Such extensive compliance requirements are onerous for private and small companies, for they entail extra regulatory costs and burden. Most SMEs would be doing these for the first time. These will act as a disincentive for SMEs to get securities listed. Hence the benefits that SEBI and RBI tried to offer to small and medium sized private companies are largely offset by the countermeasures of CA, 2013. It seems that until the market regulator and the central bank succeeds in convincing the Ministry of Corporate Affairs to relax the norms for SMEs, the regulatory quagmire may just put the bond market in a worse of position than it already was.
 

(Nidhi Bothra is executive vice president while Shambo Dey is a Research Assistant at Vinod Kothari & Company)