Defaulting on debt and disclosures

Sebi circular of August 4 asking corporations to disclose delays/defaults addresses number of issues

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 to mean:
 

• The omission of information which is likely to result in discontinuity or alteration of event or information already available publicly;
• 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 and 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 August 4, 2017, Sebi has asked companies to report delay in payments (“non-payment”) within one working day — be it bonds, external commercial borrowings, loans, foreign currency convertible bonds, commercial paper etc. Sebi has also specified a format, eliminating (reducing?) the chance of unorthodox interpretation.
 

Illustration: Ajaya Mohanty

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 per cent. Credit Suisse estimates that this will “exacerbate the capital shortfall for the sector by US $40 bn until FY19E”. On a separate note, given that this additional requirement is on account of a Sebi circular, the Reserve Bank of India has shown maturity as a regulator in not pushing back, and it 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 12 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 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 National Company Law Tribunal. 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, 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 even-handed, 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. The author is founder and managing director, Institutional Investor Advisory Service India Limited. Twitter: @amittandon_in