The Axis Capital Dilemma: A Case of Underwriting or Guarantee?

In a rapidly evolving financial world, merchant bankers often walk a fine line between risk management and regulatory compliance. A recent case involving Axis Capital Limited (ACL), a wholly-owned subsidiary of Axis Bank, has highlighted the need for a clearer distinction between underwriting and credit guarantees. The interim order issued by SEBI against ACL brings to light a structured transaction with wide-reaching implications for the integrity of the securities market. At the center of this revelation is the pivotal role played by Mr. Hemindra Kishen Hazari, a SEBI-registered research analyst whose investigation sparked a closer look at Axis Capital’s activities.

The Case Unfolds

On January 16, 2024, Mr. Hazari published a report titled “Is Axis Capital an Investment Bank or a Hedge Fund?”, raising significant concerns about a high-risk transaction facilitated by ACL. The transaction in question involved Non-Convertible Debentures (NCDs) worth ?260 crore issued by Sojo Infotel Pvt. Ltd., a company whose promoters held major stakes in Lava International Limited (LIL), a leading player in the electronics and telecom sector. The funds raised through the NCDs were partly used by Sojo to invest in LIL, making Sojo a shareholder in the company.

However, it wasn’t just the NCD issuance that caught Hazari’s attention. His report emphasized that ACL's role in this transaction went beyond that of a traditional merchant banker. Rather than merely arranging and underwriting the issuance, ACL provided a binding "underwriting commitment," which effectively acted as a guarantee for the repayment of the NCDs. This guarantee was pivotal in securing a top-notch credit rating for the NCDs from CRISIL, and it exposed ACL to significant financial risk.

The Regulatory Response

Following Hazari’s report, SEBI initiated an inspection of ACL’s role in the issuance of NCDs by Sojo Infotel. The findings of the inspection revealed that ACL had not just underwritten the issuance but had also provided credit enhancement that could be likened to a guarantee for the repayment of the NCDs. In the event that the pledged shares of LIL failed to secure sufficient funds for repayment, ACL was unconditionally bound to cover the shortfall, a commitment it ultimately had to fulfill in March 2024, depositing ?166.84 crore into Sojo’s NCD escrow account.

This move by ACL raised several regulatory concerns. As per SEBI’s Merchant Bankers Regulations, underwriting refers to an agreement to subscribe to or procure subscription for securities that remain unsubscribed in an issue. However, in ACL’s case, the underwriting was more akin to a credit guarantee, which falls under the realm of banking and credit risk management—activities not permitted under SEBI’s regulatory framework for merchant bankers. The transaction, in essence, blurred the lines between merchant banking and banking.

Mr. Hemindra Kishen Hazari: The Whistleblower

Mr. Hemindra Kishen Hazari’s report was instrumental in bringing this case to light. His work as a SEBI-registered research analyst has always focused on probing deeper into financial transactions and holding institutions accountable. In this case, his investigative acumen raised the red flags that led SEBI to uncover ACL’s regulatory violations.

Hazari’s findings underscored the need for greater transparency and adherence to regulatory frameworks in the financial sector, especially when it comes to the issuance of complex financial instruments like NCDs. His work serves as a reminder that vigilant oversight and independent research play a critical role in maintaining the integrity of financial markets.

The Broader Implications

SEBI’s interim order against ACL restrains the company from taking on new assignments related to the debt segment until further notice. This action serves as a stark warning to merchant bankers and financial institutions alike: the line between underwriting and providing guarantees must not be crossed. The regulatory framework exists for a reason, and stepping outside it can expose institutions to significant financial and reputational risks.

This case also underscores the role of research analysts like Mr. Hazari, whose work provides the much-needed scrutiny that can protect market integrity. By raising critical questions, Hazari’s report paved the way for SEBI to take corrective action, safeguarding the interests of investors and ensuring that merchant bankers operate within the boundaries set by regulators.

Conclusion

The Axis Capital case serves as a timely reminder of the importance of adhering to regulatory norms in the financial markets. It also highlights the invaluable role played by independent analysts like Mr. Hemindra Kishen Hazari in holding institutions accountable. As financial instruments become more complex, the need for clear regulatory oversight and vigilant market participants becomes ever more critical.

In a world where the lines between banking and merchant banking can sometimes blur, this case is a wake-up call for institutions to prioritize compliance and transparency above all else.

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