Provident funds
On 5 June, the Central Board of Trustees of the Employees’ Provident Fund Organisation (EPFO) approved the lowering of the threshold limit for the applicability of establishments covered under the Employees Provident Fund and Miscellaneous Provisions Act, 1952.
As a result, establishments with a minimum of 10 employees will be required to contribute towards the provident fund accounts for its eligible employees, against the existing limit of at least 20 employees.
This threshold limit to cover establishments under the act has been changed for the first time since 1960. In recent times, the most significant amendment to the act with respect to its applicability, was in 2001 when the monthly salary limit of employees for coverage under the Employees’ Provident Fund Scheme, 1952, was raised from Rs5,000 (US$117) to Rs6,500. Unlike recent amendments to other labour laws, the salary threshold under the act remains the same.
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It appears that the intention behind extending the coverage of the act to smaller establishments is to reduce the gap between the number of employees currently covered and the total workforce in the country. At present, approximately 471,678 establishments and around 44.4 million employees are covered under the act, which is in addition to employees covered under private trusts set up by their employers. With this revised applicability, a greater number of organizations will be covered under the act.
The amendment brings the act in line with two other beneficial legislations in India: the Employees’ State Insurance Act, 1948, which is applicable inter alia to factories with a minimum of 10 employees; and the Payment of Gratuity Act, 1972, which is applicable to all establishments with a minimum of 10 employees. This would, to some extent, contribute to unifying the social security efforts of the government.
Debt capital markets
In an effort to give impetus to the primary debt market, the Securities and Exchange Board of India (SEBI) in June issued the SEBI (Issue and Listing of Debt Securities) Regulations, 2008. These regulations govern the issue and listing of non-convertible debt securities, including debentures and bonds, but exclude security receipts, securitized debt instruments and bonds issued by the government. The debt regulations have repealed the provisions of the SEBI (Disclosure and Investor Protection) Guidelines, 2000 (DIP Guidelines), in so far as they relate to the issuance and listing of debt securities.
Prior to these regulations, every public issuance of debt securities had to adhere to extensive disclosure requirements and lengthy timelines as prescribed under the DIP Guidelines. This included the filing of draft offer documents with SEBI at least 30 days before filing with the Registrar of Companies for SEBI’s comments, onerous disclosures and multiple intermediaries and certification. The DIP Guidelines contained no mechanism for listing privately placed debt securities.
The key elements of the notification include a significant dilution of disclosure requirements for the public issue and private placement of debt securities. While offer documents for the public issue of debt securities need to be filed with SEBI for record purposes, there is no requirement for such filing in relation to private placements.
The notification has introduced an enabling mechanism for the listing of privately placed debt securities which applies even in cases where the equity shares of the issuer are not listed on any stock exchanges. The issuer is free to determine the price of the debt securities in consultation with the lead merchant banker and may use a book building process to determine the price in the case of a public issue.
An enabling mechanism is also available for the issuance of debt securities through the online system of stock exchanges, subject to compliance with necessary procedures prescribed by SEBI.
As a result, the intervention of SEBI in the entire offer and listing process has been minimized, with more reliance placed on due diligence and certificates provided by merchant bankers and debenture trustees.
Although the regulations appear comprehensive, a few questions remain unanswered: Can the public trade on debt securities which have been privately placed and listed? In such an event, what if the number of holders of debt securities exceeds 50? What is the basis of allotment in the event of over-subscription of debt securities on a public issue?
While these issues need to be clarified by SEBI, it is nevertheless commendable that much of the framework to bring about a radical transformation in the primary debt market has been laid out. This will not only benefit issuers by making available easier avenues for raising debts as alternatives to traditional borrowing from banks and financial institutions, but will equally assist investors by providing them with access to a vibrant and matured corporate debt market.
In a related development, SEBI has issued the SEBI (Public Offer and Listing of Securitized Debt Instrument) Regulations, 2008, which lay down the eligibility of an issuer, and other conditions for the listing of securitized debt instruments. The regulations will be applicable to the public offer and listing of securitized debt instruments.
According to the eligibility criteria, the issuer will be in the form of trust, while the originator or its associates will have no control over the issuer or its trustees. The trust deed must contain certain clauses, as stated in Schedule IV of the regulations, however, it should not contain a clause which limits or extinguishes the obligations and liabilities of the trustees or the issuer, or indemnifies those parties for loss or damage caused to the investors by their act of negligence, commission or omission. In addition, all trustees of the issuer are required to register with SEBI, except in the case of debenture trustees who are already registered with a securitization or asset reconstruction company; the National Housing Bank or the National Bank for Agriculture and Rural Development.
The issuer is prohibited from raising money in the form of debt, and cannot issue any debt securities other than securitized debt instruments. Issuers are not permitted to engage in the business of lending or investment, except in accordance with the schemes floated by it, or through the activities of an asset management company, portfolio manager or mutual fund.
The instrument of trust should allow the issuer to launch multiple schemes and terms of issue, relating to the securitized debt instruments proposed to be issued. The issuer should also be allowed to restrict the rights of the investors to the relevant asset pool alone.
The assignment of assets to the issuer will be in the nature of a true sale. The issuer should not acquire debts or receivables from any originator that is a part of the same group or under the same management as that of the trustee. The debt or receivables assigned to the issuer should be expected to generate identifiable cash flows for the purpose of servicing the instrument; and the originator should have valid enforceable interests in the assets and in the cash flow of assets, prior to securitization. The regulations state that the debt or receivables shall be transferred at an arm’s length price, based on commercial considerations.
The schemes formulated by the issuer should follow the regulations, which provide specific requirements for distinct accounts, asset pooling and the realization of a scheme. Subject to adequate disclosures, the terms of issue may result in a clean-up call option by the issue. This refers to an option retained and exercisable by the originator, for the purchase of debt or receivables assigned to a special purpose distinct entity. Such a purchase is, however, only possible if the residual value of the debt or receivables falls below a specified percentage of the price at which it was assigned.
The regulation prescribes that an originator cannot at any time subscribe to or hold more than 20% of the total securitized debt instruments issued by the special purpose distinct entity in a particular scheme. However, this condition is not applicable in the case of holding on account of underwriting or credit enhancement. A scheme can be wound up through an investor vote by a special resolution when the securitized debt instruments have been fully redeemed, or upon legal maturity.
Securitized debt instruments listed or issued to the public will be freely transferable, while the investors holding them will have beneficial interest in the underlying debt or receivables as conferred by the scheme.
If the issuer fails to redeem any securitized debt instrument, investors holding at least 10% in nominal value of such instruments can meet and decide to wind up the scheme, remove the trustee or replace him, the expenses of which shall be reimbursed out of realization from the asset pool. Further, the terms of issue cannot be adversely varied without the consent of investors.
Issuers offering securitized debt instruments to the public for subscription through an offer document must ensure the document contains disclosures as prescribed by the regulations, particularly in terms of the financial information of the issuer and originator, and the quality of the asset pool. Furthermore, an offer of securitized debt instruments made to 50 or more individuals in a financial year will qualify as an offer made to the public. It has also been made mandatory to obtain credit ratings from two credit agencies and disclose them in the offer document.
The regulations have paved the way for the listing and trading of securitized debt instruments. SEBI has also proposed to introduce a simplified and relaxed listing agreement in this regard. It will be interesting to watch the market norms develop with respect to such instruments, as the market has still not matured to facilitate the trading of such debt instruments.
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The legislative and regulatory update is compiled by Nishith Desai Associates, a Mumbai-based law firm that provides legal and tax counselling. The authors can be contacted at nishith@nishithdesai.com. Readers should not act on the basis of this information without seeking professional legal advice.
