The Securities and Exchange Board of India ("SEBI") vide press release1 dated June 14, 2013, notified the SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013 ("NCRPS Regulations")2 allowing non-convertible preference shares ("NCRPS") as another instrument for public fundraising for Indian companies. Hitherto, optionally convertible preference shares and optionally convertible debentures could be listed under the provisions of the SEBI (Issue of Capital and Disclosure Requirements") Regulations, 2009 ("ICDR Regulations"), however, there was no regime for listing of NCRPS.

From a foreign investment perspective, only equity shares and instruments fully and mandatorily convertible into equity could be held by a non-resident under the foreign direct investment ("FDI") regime, and since there was no regime for listing of NCRPS, foreign portfolio investment in NCRPS was not possible.

In 2009, SEBI issued the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 ("Debt Regulations") with the objective of simplifying debt issuances by Indian companies. Such issuances permitted simplified listing of non-convertible debentures ("NCDs"). With dormant equity capital markets, issuers turned to raising debt by way of listed NCDs.3 Foreign investors received the instrument with enthusiasm as it allowed them assurance of exit and assurance of return without being qualified as ECB (as in case of FDI) and also allowed collateralization benefits. However, NCDs, even though in many cases linked to cash flows, reflected as debt on the books of the issuer and a need was felt to look for alternative forms of raising 'capital'.

Whilst the Reserve Bank of India ("RBI") has not yet permitted acquisition of listed NCRPS by foreign investors under the portfolio investment regime, it does seem likely that such permission may be introduced shortly to allow for investment through NCRPS as well. This Hotline is based on the premise that foreign portfolio investment in NCRPS may be allowed eventually and examines the benefits of the NCRPS Regulations issued on private placement basis in such light.

BACKGROUND

The NCRPS Regulations are modeled on the lines of the Debt Regulations as recommended by the Corporate Bonds & Securitization Advisory Committee ("COBOSAC"). The COBOSAC recommended that the draft regulations ("Draft Regulations") for issue and listing of NCRPS be drafted in line with Debt Regulations, yet with some key differences, in view of the distinctive nature of the instrument. COBOSAC inter-alia recommended4: (i) stricter eligibility criteria for making public issuances of NCRPS; (ii) relatively liberal framework for private placement of NCRPS, which is proposed to be listed and such private placement be restricted to institutional investors and high net-worth individuals; and (iii) comprehensive disclosure requirements for both public issuances and private placement. The Draft Regulations proposed by COBOSAC, however underwent several changes before SEBI notified the NCRPS Regulations. In this Hotline, we look at some of these changes and the advantages of NCRPS from an issuer and subscriber perspective and how does the NCRPS regime hold up against the NCD regime from foreign portfolio investment perspective.

Salient Features

  • What is the nature of the instrument?
    • While some of the accounting principles may consider NCRPS in the nature of debt, the Indian generally accepted accounting principles ("Indian GAAP") would consider NCRPS to be a part of shareholders' funds.
    • It may add to the net worth of a company as it is part of the paid-up capital as against debt, which is a liability.
  • Who can issue?

The NCRPS Regulations specify that only the following category of companies shall be eligible to issue NCRPS: (i) public company as defined under Section 35 of the Companies Act, 1956 ("Act"); and (ii) public sector undertaking or statutory corporation, which has its securities listed on any stock exchange or which seeks to list its NCRPS on a recognized stock exchange.

It is interesting to note that under the Draft Regulations, COBOSAC had recommended that the term 'issuer' shall include "any company, public sector undertaking or statutory corporation", which proposal was in line with the definition provided in the Debt Regulations.

  • Is there a minimum public float required?

    Regulation 19 of the NCRPS Regulations specifies that Rule 19 (1) and Rule 19 (3) of the Securities Contracts Regulation Rules, 1957 ("SCRR") shall not apply in case of listing of NCRPS by way of public issue or private placement. However, exemption from Rule 19(2)(b) has not been provided for, even though such exemption was provided for in the Draft Regulations.

    Analogous to this, Regulation 22 of the Debt Regulations also grants a relaxation from the strict enforcement of (i) Rule 19(1) and 19(3) of the SCRR; and (ii) Rule 19 (2)(b) of the SCRR6 in respect of listing of debt securities issued by way of private placement and public issue by an infrastructure company, a government company, a statutory authority or corporation or any special purpose vehicle set up by any of them, which is engaged in the infrastructure sector.

    In the absence of a specific exemption granted under the NCRPS Regulations in relation to applicability of Rule 19(2)(b) of the SCRR, it could mean that without a minimum public float of 25% of the issuer's securities, the issuer will not be permitted to list its NCRPS on any stock exchange. Though we understand that SEBI has been steadfast in its stance of enforcing the minimum public shareholding requirement and has already penalized several companies which have been in breach of the norm7, by not providing issuer companies under the NCRPS Regulations an exemption from Rule 19(2) (b) can severely hamper the ability of unlisted issuer companies to issue and list the NCPRS.

  • Issue and Listing of PNCPS and PDIs by banks

In order to enable the banks to meet the capital adequacy norms as prescribed under the Basel III8 norms, SEBI has extended the applicability of the NCRPS Regulations to the issue and listing of perpetual non-cumulative preference shares ("PNCPS") and perpetual debt instruments ("PDIs") by banks. The Basel III norms which aim to improve the quality, quantity and transparency of regulatory capital issued by banks, requires all classes of instruments, especially the non-equity regulatory capital instruments of a bank (in Tier I Capital) should be capable of fully absorbing loss either by capable of being written off or be converted into common equity at the point of non-viability of the bank.

Some of the specific criteria for inclusion of PNCPS and PDIs in Tier I Capital are as follows:

  1. PNCPS and PDI shall be perpetual, i.e. there is no maturity date and there are no step-ups or other incentives to redeem;
  2. PNCPS and PDI shall be issued by banks only and not by any SPV etc. set up by the bank and shall be fully paid-up;
  3. While complying with minimum Tier 1 of 7% of risk weighted assets, a bank cannot admit PNCPS together with PDI in Additional Tier 1 Capital, more than 1.5% of risk weighted assets;
  4. PNCPS and PDIs shall not be issued with a 'put option', but banks may issue the instruments with a call option at a particular date subject to prescribed conditions;
  5. The bank must have full discretion at all times to cancel distributions/payments of dividends.
  6. The dividend shall not be cumulative.

Further in case of PNCPS, claims of the investors shall be:

  1. Superior to the claims of investors in equity shares;
  2. Subordinated to the claims of PDIs, all Tier 2 regulatory capital instruments, depositors and general creditors of the bank; and
  3. Neither secured nor covered by a guarantee of the issuer nor related entity or other arrangement that legally or economically enhances the seniority of the claim vis-Ã -vis bank creditors.

In case of PDIs, the claims of the investors in instruments shall be:

  1. Superior to the claims of investors in equity shares and PNCPS;
  2. Subordinated to the claims of depositors, general creditors and subordinated debt of the bank;
  3. Neither secured nor covered by a guarantee of the issuer nor related entity or other arrangement that legally or economically enhances the seniority of the claim vis-Ã -vis bank creditors
  • Issue of NCRPS by non-banking financial companies ("NBFCs")

    As per the provisions of the Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 ("Prudential Norms"), every non-banking financial company is required to maintain a capital adequacy ratio consisting of Tier I9 and Tier II10 capital which shall not be less than 15% of its aggregate risk weighted assets on the balance sheet and of risk adjusted value of off-balance sheet items.

    NCRPS does not fall into the category of Tier I Capital because the definition of 'owned funds'11 as prescribed thereunder includes only equity shares and compulsorily convertible preference shares ("CCPS"). However the definition of Tier II capital includes inter alia preference shares other than those which are compulsorily convertible into equity and hybrid debt instruments.

    With the inclusion of NCRPS in the Tier II capital, non-banking finance companies may find it relatively easier to comply with the capital adequacy ratio as prescribed under the Prudential Norms. However, it needs to be ensured that Tier II capital does not exceed Tier I capital. This is applicable only to systemically important NBFCs.

  • End-use restriction

    Similar to the restriction contained under the Debt Regulations, SEBI has vide Regulation 4(4) of the NCRPS Regulations mandated a significant end-use restriction by specifying that NCRPS shall not be issued for the purpose of providing loan to or acquisition of shares of any person who is part of the same group or who is under the same management, other than to subsidiaries of the issuer. Unlike in the case of privately placed NCDs, SEBI has placed this end-use restriction on privately placed NCRPS also.

    This provision seeks to impair the ability of issuer companies to use the funds raised through NCRPS for lending it to promoters/ promoter group companies unless such borrower entities are subsidiaries of the issuer.

  • Listing of NCRPS

    The listing of NCRPS, issued on a private placement basis on a recognized stock exchange has to adhere to certain prescribed conditions, some of which are as follows: (i) compliance with the provisions of the Act; (ii) credit rating for the NCRPS proposed to be listed, from at least one credit rating agency registered with SEBI and all ratings, including the unaccepted ratings to be disclosed in the offer document; (iii) prescribed set of disclosures to be made appropriately; (iv) minimum application size for each investor in a private placement shall be at least INR 10,00,000; (v) creation of a capital redemption reserve in accordance with the provisions of Section 77A of the Act.

    The NCRPS Regulations have prescribed a detailed set of disclosures to be made by the issuer companies seeking listing of NCRPS which inter-alia include: (i) summary of business activities of the issuer in a particular prescribed format; (ii) details regarding shareholding, directors, promoters and borrowings of the issuer; (iii) any material event/ development or change having implications on the financials/credit quality which may affect the issue or the investor's decision to invest / continue to invest in the NCRPS.

ANALYSIS

As indicated earlier, NCRPS serves as an alternative mode of investment besides equity, debt, and compulsorily convertible instruments such as CCPS. Since NCRPS Regulations are largely modeled around the Debt Regulations, table below comparing NCRPS with NCDs issued on private placement basis may be helpful to evaluate on the choice of fundraising instrument.

Click here to see table.