SEBI (Security and Exchange Board of India) recently issued Operational Guidelines for its circular dated August 13th, 2021, on “Security and Covenant Monitoring using Distributed Ledger Technology”. This article examines the main highlights of the Operational Guidelines and their impact.
SEBI has introduced notable changes to issuing listed debt securities since 2020. These changes impose compliance requirements and extra obligations on debenture trustees (“DTs”) and those imposed on issuers of non-convertible securities. Hence, DTs are, among other things, responsible to conduct (“independent due diligence exercises”) on the issuers’ assets, for the purposes of security creation, as well as monitor the security created, periodically. This due diligence helps in verifying whether the assets are free from existing encumbrances, or, where such assets are encumbered, that the necessary consent letters have been obtained from the existing charge holders for creating fresh security over them. A working group was substituted with SEBI, to strengthen the processes of creation of security, monitoring of created security, monitoring of cover of assets and covenants of non-convertible securities. It was decided, based on the recommendations of this working group, that a platform for ‘security and covenant monitoring’ (the “Platform”) will be hosted and developed by the depositories.
The Operational Guidelines are applied to all issuances made on or after April 1, 2022. If the Issuers are unable to fulfil the requirements, they can explain the same to the depositories, however, this is only permitted till July 1, 2022, after which date the Issuers will not be allotted ISINs for fresh issuances until they fulfil the Operational Guidelines.
- Distributed Ledger Technology (DLT)
DLT will be the backbone of this platform. It is a technology using which a database containing digital data can be replicated, shared, stored and synchronized across multiple participants, without the requirement of a central administrator. A normal DLT will have multiple participants store copies of a virtual ‘ledger’ and make updates according to the DLT’s network protocol.
DLT is most widely known for its most common implementation – the ‘blockchain’. In a blockchain, the ‘ledger’ is made up of “blocks”, which are used to record transactions that are then “chained” together with the help of cryptographic hash functions. Whereas distributed ledgers do not necessarily require such a chain of “blocks” in order to function.
- Use of DLT for the Platform
Different implementations of DLT are possible depending on the use case. The Platform, as foreseen by SEBI, will be using a permission type of ledger, i.e., participants will be selectively allowed to join the system, and will be given limited permissions only, in terms of what they can do by participation. The Platform will be used to assign assets that are offered as security for non-convertible securities a unique identifier, and the DLT, being a digital database, will ensure that there is no duplication of assets. If multiple securities are created against the same asset, it can be traced back to the particular asset, and DTs’ necessary corrective action can be taken by the DTs.
- Functions of the Platform
The Platform will be used to capture the process of security creation, provide continuous monitoring of covenants by DTs, record redemption and interest payments, and consolidate information on the credit rating of non-convertible securities.
- Recording of Assets
The DLT Circular bestows that Issuers will be able to record relevant details regarding different kinds of proposed assets as securities for non-convertible securities, such as:
- immovable property.
- intangible assets.
- movable fixed assets.
- securities/ other financial assets.
- current assets.
- assignment of rights, and,
- guarantees through the Platform.
Under the Operational Guidelines, however, it has been bestowed that only the following assets will be tracked, and even then, at a portfolio level:
- movable assets.
- any other asset of similar nature.
- current assets.
The Issuer shall record each asset on the DLT, subject to validation by DTs.
- De-Duplication of Assets
A system-generated 12-digit alphanumeric unique “Asset Identifier” will be assigned to each Asset on the Platform. It will be the responsibility of the depositories to ensure that there is only one Asset Identifier assigned to each asset. This will be done at a portfolio level, according to the Operational Guidelines.
If there are even near-duplicate entries detected for an Asset, alerts will be provided by the Platform to the Issuer and the DT. The Issuer and DT will then be required to cross-check and verify the details entered into the system to create the Asset.
The list of Assets recorded in the system shall be reconciled annually by the DT, in respect of an Issuer, and if a duplicate entry is found for an Asset, necessary steps will be taken to
- eliminate the duplicate entry and verify the security cover to which the entry relates, and
- also, take required corrective steps.
On the occurrence of an event that reduces the security cover to below the stipulated limit, as per regulation 54 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, the Issuer is mandated to update the details on the Platform immediately. Each such event will be a ‘trigger event’, and the depositories will be mandated to send trigger event alerts to all concerned stakeholders.
4. Relevant Considerations
- The Operational Guidelines as of now only provide for the inclusion of records related to movable assets on the DLT. The type of charge that may be created over such assets will generally be a floating charge.
How often the details of the assets must be updated and how the assets will be distinguished do not have any clarification as yet.
- Parameters for Recording of Assets
Some of the indicative parameters mandated to be captured for all asset categories will require disciplined Issuers and DTs so that the descriptions are meaningful and consistent.
- Tight timelines for verifying existing issuances
Issuers will have until September 30th, 2022, to oblige with the Operational Guidelines, with respect to their existing issuances of non-convertible securities. DTs will, however, be required to verify all the details pertaining to recorded Assets in respect of such existing outstanding issuances of non-convertible securities by November 30, 2022 – a window of only 2 months. This timeframe may be challenging.
DLT is an interesting technology-driven exercise, and it recognises the value of applying technology to achieve transparency, consistency, and timely intervention to protect the investors’ interest in relation to the Issuers’ Assets. This might be one of the foremost endeavours by an Indian regulator to use technology in regulation. Over time, and as the use of the Platform becomes predominant, interpretation, teething troubles, consistency, and the use of appropriate technology will be factors that will have to be addressed by the Regulator and the Market.
By Anoushka Amar