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Institutional EYE

Commentary on Corporate Governance Issues

Defaulting on debt - and disclosures

The Securities and Exchange Boards (SEBI) circular of August 4 asking companies to disclosure delays/defaults addresses a number of issues simultaneously. But that SEBI needs to ask companies to do so itself speaks about the perfidiousness of companies. If regulators are over-prescriptive or corporates are burdened with excessive disclosure, they only need to look within their own. SEBI, for long, focussed on principles-based regulations. In the same spirit, its Listing Obligations and Disclosure Requirements Regulations of 2016, expected companies to disclose material information and events to the stock exchanges. While not being over prescriptive, this was expected this to mean: (a) The omission of information which is likely to result in discontinuity or alteration of event or information already available publicly; (b) The omission of information which is likely to result in significant market reaction if the said omission came to light at a later date. At the risk of exaggerating, companies have taken ‘material’ to mean being expeditious in reporting purchase-orders won, but dallying reporting a default. Companies tend to follow the lowest common denominator on their approach to disclosures – so while changes in credit ratings were reported, since these are mandatory, defaults were not. Tired of haranguing companies to follow the spirit of the regulation and disclose defaults and delays in a timely manner, SEBI has put aside its principles-based approach and through a series of circulars, moved to rule-based disclosure steadily tightened reporting requirements. In a circular to credit rating agencies last November, it defined default for them and then in June, in a missive to debenture trustees, it asked them to confirm timely payment of interest and keep the rating agencies informed of any default within seven days. And now, in its most prescriptive circular of 4 August 2017, SEBI has asked companies to report delay in payments (‘non-payment’) within one working day - be it bonds, ECB’s, loans, FCCB’s, commercial paper etc.. SEBI has also specified a format, eliminating (- reducing?) the chance of unorthodox interpretation. In one fell swoop the August 4 circular puts an end to what my friend, Sandeep Parekh, calls the bond of Omerta between companies and banks.There was never any incentive for the company to make this disclosure – such an acknowledgement invariably results in immediately restricting access to cash. But, it was also not in the banks interest to report the default, as they will then need to provide a capital charge. The circular, by putting the disclosure of delay/default in the public domain, breaks the unholy nexus. If banks are not happy, there is a number that explains this. The rating downgrades will push up risk weights on these loans to 150%. Credit Suisse estimates that this will exacerbate the capital shortfall for the sector by an additional US$4 bn taking the total requirements to US$ 46 billion by FY19E. On a separate note, given that this additional requirement is on account of a SEBI circular, RBI, has shown maturity as regulator in not pushing back, and needs to be applauded. Rating agencies will now not be able to take cover under the garb that they did not have information about the missed payment – the trustee did not inform them, or the company was in breach of its agreement to them by not telling them, or that the bank was expected to let them know. Genuine all, but these excuses do not cut much ice when a little bit of leg-work could have established the truth. Not just this, SEBI has gone a step further and said that such companies cannot be moved to investment grade within twelve months. The disclosure of delay/default, in the prescribed format, helps serve another function – that of acknowledgement of the debt itself and in doing so expedites the services an information utility will soon provide. This needs elaborating. The Insolvency Code calls for a setting up of an information utility with this very objective. The utility has been tasked with maintaining digital records of loan documents and a database of borrowers, lenders, lending terms, security etc. On references to the insolvency court, this information can be very quickly accessed by resolution professionals and courts like the NCLT. It will help them save time and foster expeditious clearance of cases. Even as the first information utility – National e-governance Services Limited (NESL), is gearing-up to roll-out its services, the SEBI prescribed format, with information on loan amount, loan covenants, number of lenders, total and current outstanding amount etc.. The disclosures by companies will both ease and accelerate the roll-out of NESL’s services. Secondary markets too will benefit. Asymmetric information resulted in those in-the-know selling ahead of the news percolating to the market. When the news did hit the market, the share price plummeted resulting in margin calls – and further disruption. And while the disclosure on delay/default might still cause the share price to plummet, the SEBI circular at the base level ensures that information dissemination is more evenhanded, and to this extent minimises the chance of mischief. The recent instances of rule based regulation – women on corporate boards, tenured auditor rotation, CSR spends have all had a significant and positive impact on corporates. Based on this experience, I expect the delay/default disclosures to have a salutary impact as well. Having said so, to avoid more prescriptive regulation, corporate India must consider changing its focus from placing itself between the fine lines of regulatory requirements, to a more perspective-based disclosure regime. A modified version of this article by Amit Tandon, was published in Business Standard on 15 August 2017. To view the article click on this link or type the following on your url:


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