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NBFCs May Now Issue Unsecured Debentures!

Published on Tue, Feb 24,2015 | 11:41, Updated at Tue, Feb 24 at 13:41Source : 

A New Chapter For Bond Markets In India!
By: Vinod Kothari & Nidhi Bothra, Vinod Kothari & Co.
NBFCS May Now Issue Unsecured Debentures
A notification dated February 20, 2015[1] from the Reserve Bank of India (RBI) marks the opening of a completely new chapter in the history of bond markets in India. By this notification, the RBI has permitted NBFCs to issue unsecured bonds. Thereby, the issuer may decide, based on investor perception, rating considerations and availability of cover assets, whether to issue secured bonds, or unsecured bonds, or partly secured bonds. NBFCs will certainly seize this opportunity as the rules pertaining to secured debentures under sec 71 of the Companies Act are causing tremendous difficulty for NBFCs.

Demand For Permitting Unsecured Bonds
All over the world, loans may be secured or unsecured, but bonds are mostly unsecured bonds[2]. The reasons is obvious - if issuers have collateral to offer, they will rather opt for a loan, which is much simpler. When entities exhaust their assets to secure, they move to the bond markets.

However, in India, the operation of the rules pertaining to pubic deposits has, for years now, constrained companies to issue secured bonds only, as unsecured bonds tantamount to public deposits.
This is constraining the bond markets. The authors and their colleagues, have been voicing concern over this by way of articles[3] on the state of bond market and need for its development. Representations have also been consistently made to the Finance Ministry[4], RBI and other regulators where we have been emphasising on permitting issuance of unsecured debentures to qualified institutional buyers (QIBs) and that there is minimal amendment required to the deposit rules to carve out an exemption for unsecured debentures from the definition of deposits. The need for permitting unsecured debentures arises from the following issues:
a.  In the existing regulatory regime, unsecured debentures are treated as public deposits and under the existing framework it is difficult and impractical for most issuers to raise money through public deposits. Hence debentures necessarily have to be secured.
b.  If companies had security to offer, it would have been easier to access bank loans. It is when companies exhaust their security interests that they opt for bonds. Bonds are an incremental, additional source of funding, and not the first source of borrowing for most companies.
c.  There is no reason to restrict the bond markets to secured bonds, as long as the investor is a qualified institutional buyer (QIB) and/or the bond issuance is rated. As QIBs can easily take a credit call on the issuer, the security offered is of no relevance. In any case, the security feature may be a question of pricing/rating of the bond, and the regulation does not have to impose any fetters in this regard.

Problems Of Secured Bonds
We need to realise that bonds issuer profile in India is concentrated among a few categories of market participants dominated by financial sector including banks, Non-Banking Financial Companies (NBFCs), financial institutions, housing finance companies (HFCs) and Primary Dealers (PDs) while other non-financial entities hardly account for total issuances made in 2013-14. [5] Given the legislative framework there is no scope for non-financial corporate to issue bonds.

Where a company issues secured bonds, the company is covered by the provisions of sec 71 of the Companies Act, 2013. As per rules under this section, effective 1st April 2014, every issue of secured bonds has to have “tangible” securities – that is, the security cannot be in form of a pledge. Also the security has to be by way of “specific” assets. The word specific assets implies the creation of a fixed charge.
In case of financial sector entities, who anyway occupy a predominant share of the bond markets, the only practical security to offer is loans/receivables. This is in the form of a dynamic pool of current assets. Creating a specific charge on a portfolio of loan receivables leads to perfunctory exercise of identifying loans, topping up the pool once loans amortise or prepay, etc.  Unfortunately, after the enactment of the new rule under the Companies Act, NBFCs have been engaged in this perfunctory exercise.

Commercial Considerations In Issue Of Unsecured Bonds
Commercially, creating a floating charge over a pool of receivables is essentially the same as setting a leverage trigger. For example, if a bond issuance is backed by a security of car loans with an asset cover of 1.25 times, the purpose is satisfied by setting a covenant whereby the issuer shall at all times ensure that it has performing car loans on its balance sheet at least equal to 125% of the outstanding bond balance. If the covenant is breached, the issuer may be penalised by way of a penal rate. If the breach continues, the covenant may force the bonds to be pre-redeemed.

Floating charges do not have much security value, except in the event of bankruptcy, when they crystalize. Floating charges, a concept of UK law dating back to the 19th century, are currently replaced by contractual covenants of leverage, margin, etc which are monitored by trustees.
Thus, the issuer may decide to issue secured or unsecured bonds solely on commercial considerations. The relevant considerations may be rating, pricing of the bonds, and the availability of assets to create a security interest.
From a rating agency perspective, typically, the rating of bonds is always capped at the rating of the issuer. Even if the bonds are secured, there is no upliftment beyond the rating of the issuer, since despite the security interest, there may be default on payment of principal and interest in the event of bankruptcy.
Investors will, however, differentiate between secured bonds, senior unsecured bonds, and subordinated bonds. Therefore, the issuer may take the call of going for secured or unsecured bonds purely on commercial considerations.

RBI’s Amendment To Private Placement Guidelines
The notifications amends RBI’s guidelines for private placement of NCDs to say the following:

Now under private placement guidelines there can be two types of NCDs issuances:
a.  Category I -- Issuance of NCDs to investors with minimum subscription amount of Rs. 20,000 to maximum subscription of less than Rs. 1 crore (Issue to Small Investors)
b.  Category II -- Issuance of NCDs to investors with minimum subscription of Rs. 1 crore (Issue to QIBs)
The table below enumerates the distinctive characteristics of both categories of NCDs:



Category I

Category II





Necessarily will have to be secured

Issuer has option to create security in favour of the subscribers


Limit on number of subscribers

Issuance can be made to 200 subscribers in a financial year.


There is no limit on the number of subscribers.

Treated as public deposit


Secured NCDs are not treated as public deposit


As per the revised guidelines, issuance of unsecured NCDs to this investor class will not be treated as public deposits.













Apart from the revised guidelines for private placement of NCDs, NBFCs have an option of issuing convertible debentures that must be compulsorily convertible into equity within a stipulated period of time and subordinated bonds with a minimum maturity of not less than sixty months provided there is no option for recall by the issuer within that period[6].

SEBI’s regulations for listing of NCDs:

SEBI (Issue and Listing of Debt Securities) Regulations, 2008[7] already facilitate for listing of debt securities issued on private placement basis whether such debt securities are secured by charge over the assets or not. Section 2 (1)(e) of the Regulations define debt securities to mean – 
      (e) “debt securities” means a non-convertible debt securities which create or acknowledge indebtedness, and include debenture, bonds and such other securities of a body corporate or any statutory body constituted by virtue of a legislation, whether constituting a charge on the assets of the body corporate or not, but excludes bonds issued by Government or such other bodies as may be specified by the Board, security receipts and securitized debt instruments;  

Listing of the debentures facilitates the issuers to be able to tap foreign portfolio investors (FPIs) as well as they are permitted to invest in listed securities issued by companies.
However under debt listing agreement[8], para 16 (a) states that listed debt securities need to maintain a 100% asset cover and an exemption is created for such unsecured debt instruments which are issued by regulated financial sector entities eligible for meeting capital requirements for instance subordinated debt instruments.
In the past there were no issuances of unsecured debt. While the SEBI regulations on listing facilitate the issuance of unsecured debt securities, the debt listing agreement needs to be amended to bring it in line with the abovementioned RBI’s amended guidelines.

The need for a strong bond market in India is almost unarguable and has been discussed by market issuers and the regulators alike. The development of the corporate bond market has been an important area and has received greater policy attention. Worldwide, bond financing is more popular than bank financing, but India has seen the reverse. It can be said that the impeding growth of the corporate bond market is due to overhang of government bond market because of high fiscal deficit.

A well-developed corporate bond market is much desired in any economy to supplement bank credit and the equity market and to facilitate the long-term funding requirement of corporate sector as well as infrastructure development in the country.
Permissibility of issuance of unsecured NCDs and facilitating regulations on listing of such securities by SEBI is likely to open the floodgates for bond issuances in the times to come.

[3] Death Knell for the Bond Market,
RBI takes the wind out of NBFCs’ sail,
Other articles discussing need for impetus to bond markets can be viewed here -
[4] Vide representation made to Mr. Anupam Mishra, Director (SM), RBI dated 27th November, 2014,


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