What does SEBI's attempt at restructuring corporate debt mean for bond market?

In an attempt to lighten the burden of bad loans on the banking sector, market regulator Securities and Exchange Board of India (SEBI) on July 20, proposed that companies with borrowings exceeding Rs 100 crore should meet 25 percent of their loan requirement through the bond market. The new framework could come into force from April 1, 2019. Market participants have been given time until August 13 to send a feedback to improve the fine print of the document.

The regulator’s move to give a fillip to India’s nascent corporate bonds market stems from a Budget proposal earlier this year. By operationalising the Budget announcement, the quantum of future borrowings by large corporates from the banking sector will gradually wean off.

According to the proposed framework, a company will be classified as a “large corporate” if its total outstanding credit exceeds Rs 100 crore and has a credit rating of AA and above.

So, what does the change in borrowing norms mean for large companies?

If a company wants to borrow Rs 1,000 crore to fund infrastructure development in 2019-20, it will have to mandatorily raise Rs 250 crore by issuing bonds, while the remaining capital can be raised from other sources. Under the proposed framework, the definition of a large corporate is based on its outstanding long-term borrowings that is exclusive of inter-corporate deposits and external commercial borrowings (ECBs).

Inter-corporate deposits include money that is kept in one company by another for a term of six months. An ECB is a financial instrument used by entities to borrow from foreign sources, such as multinational banks or non-resident Indians (NRIs), for commercial activities in India.

The blueprint of SEBI’s lending norms also categorically state that the aggregate long-term debt threshold for "large corporates" includes not just the money owed to banks, as was the case with RBI's earlier norms to protect lenders. The central bank's large exposure framework (LFE) merely stated that a bank’s total advances to a company should not be more than 20 percent of its capital base.

SEBI’s consultation paper proposes a "comply or explain" approach that includes a provision to fine large companies for not meeting the bond-borrowing requirement. This will be applicable for the first two years after its implementation in April 2019. From the third year, this requirement will be tested by considering two years as a single block.

If large corporates do not meet 25 percent of their aggregate borrowing for FY22 and FY23 from the bond market, they will have to explain reasons for non-compliance, and subsequently pay a penalty between 0.2 percent and 0.3 percent of the shortfall in borrowing.

It remains to be seen whether levying a monetary penalty will be a deterrent to non-compliance. For example, if a company issued bonds to raise only 15 percent of its aggregate long-term borrowing of Rs 100 crore, it will have to pay 0.2 percent of Rs 10 crore, which amounts to Rs 2 lakh.

As on March 31, 2017, 43 percent of total outstanding long-term borrowings of large corporates was in bonds. In comparison, capital sourced from traditional banking channels amounted to 36 percent. However, 55 percent of the 1,427 large companies surveyed by CARE Ratings had not entered the bond market, highlighting SEBI’s push for diversifying the channels of credit.

Capital-intensive sectors such as real estate and infrastructure development have higher long-term funding requirement, and are unsurprisingly, active in the bond market. Moreover, as the quantum of borrowings increases, so does the share of debt from bonds.

For companies with aggregate borrowings exceeding Rs 10,000 crore, more than half the long-term debt is from bonds. There is an inverse relationship between the size of the debt and the share of credit from banks. Companies whose debt is only marginally greater than the minimum requirement for classification as a large corporate, borrow more from banks. Around 25 percent of the debt portfolio of companies with borrowings upwards of Rs 300 crore is from bonds.

In addition to the minimum debt requirement, the SEBI consultation paper says the new rules will be applicable to those companies with a credit score of AA or upwards. By maintaining a high credit score, the regulator is effectively narrowing down the pool of borrowers by a wide margin. Only 376 out of the pool of large corporates have a credit score of AA and above.

Among the 376 companies that meet the criteria mentioned in SEBI’s consultation paper, 109 have not entered the bond market. Large corporates abstaining from floating bonds are mostly from the power and automobile sectors.

However, companies with debt over Rs 2,500 crore are more involved in the bond market to fuel their appetite for long-term debt. Data compiled by ACE Equity shows that companies with aggregate debt between Rs 300 crore and Rs 1,000 crore raised almost half their total funding from bonds.

Over the years, bonds have made a resurgence in the debt market. According to SEBI’s consultation paper, the share of bonds in the total borrowing by corporates has increased from 37 percent in 2012-13 to 51 percent in 2016-17. However, 90 per of such debt instruments are issued by companies with AA and AAA categories. By forcibly making all companies rated AA and above, raise 25 percent of their aggregate borrowings from the bond market, the stress on banks looks set to ease.