Securities market regulator Sebi last week asked listed companies to publicly disclose any default in repayment of principal or interest on loans from banks and financial institutions beyond 30 days. “Such disclosure shall be made promptly, but not later than 24 hours from the 30th day of such default,” Sebi said in its circular of November 21.
On August 4, 2017, Sebi had issued a similar circular, requiring all listed entities to make such “disclosures within one working day from the date of default at the first instance of default”, but had deferred the implementation of that rule hours before it was to kick in on October 1 of that year.
The new default rule will come into force on January 1, 2020.
Why the new rule
Sebi says the change was necessary to address information asymmetry — or a gap in the availability of information to different classes of investors — on defaults on loans by listed companies. Investors come to know of such defaults much later — whereas a similar default on repayment of a bond or a similar instrument issued by a company has to be disclosed immediately, in line with Sebi’s regulations.
An early disclosure can act as an early warning system, which can help investors make considered decisions on whether to stay on or sell the stock and exit, cutting their losses. In the current scenario, a meltdown such as those at IL&FS, DHFL, or PMC Bank, can leave many investors flatfooted. It is also expected that the move will lead to greater credit discipline in the banking industry.
How change came
The mountain of bad loans especially with state-owned banks, and their non-disclosure, nudged regulators towards addressing the root cause rather than merely the symptom. In July 2015, the Reserve Bank of India launched Asset Quality Review (AQR) to assess the true state of bank loans. Many lenders — including large private banks — were in the habit of “evergreening” loans, i.e., providing fresh funds to borrowers just before the repayment date in order to ensure that loans were not classified as bad.
For Sebi, the concern was the grant of frequent waivers on its own rules to government-owned banks when they raised money from institutional investors through Qualified Institutional Placements or QIPs. These weren’t genuine placements of securities to investors — rather, it was the LIC or the government putting in money, as many investors remained unaware of the real state of the banks. And there was little incentive for the banks or the government to correct this.
From a day to 30 days
Sebi’s August 4, 2017 circular made it mandatory for listed corporates to disclose default within a day of the event. It can be argued that had the circular been implemented, investors would have been made aware of the troubled state of some of India’s top corporate groups and firms, which were referred to the insolvency court in 2018. The pushback by powerful groups led to the regulator jettisoning the rule without giving reasons. In internal discussions before the original circular was issued, some Sebi officials had pointed out that 30 days was the norm for corporate bonds.
The other argument in favour of 30 days could be uniformity in regulatory rules. In its famous circular of February 12, 2018, the RBI had directed banks to start the process of resolution or restructuring of a loan even if the default was for only a day. After the April 2, 2019 ruling of the Supreme Court striking down the circular, the RBI revised its rule in June — offering a 30-day window to classify an account as a Non Performing Account.
Sebi’s November 21 circular could be seen either as a sign of regulatory synergy with the RBI, or as a nod to a more pragmatic approach.
The challenge now
In 2017, Sebi backed off at the last minute on implementing the disclosure norms on default. However, 2018 and 2019 have seen the collapse of several storied corporates. Much of what was known before they went into bankruptcy was based on anecdotal evidence with credit rating agencies way behind the curve.
The erosion of faith could be detrimental to fuelling fresh investment. In India, the tightening of rules often happens in the aftermath of a scam or under public pressure, after investors have been short-changed. Last time, the regulator blinked; this time the challenge for both Sebi and the government is to hold firm. If they do that, they will at least be able to tell investors and other stakeholders from January next year that they had been forewarned.
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