Strange requirement for creating funded debenture redemption reserve

The MCA has brought an amendment to Shares and Debentures Rules, vide notification 16th August, 2019. This brings all NBFCs and HFCs under the fold of the requirement for creating funded debenture redemption reserve (DRF), except in case of convertible debentures.

1.     The requirement of creating the DRR itself is unique to India, and there have been opinions expressed time and again that this is one of the factors which is impeding the bond markets in the country. It is with a view to ameliorate the requirement for DRR that the FM made a Budget pronouncement that the govt will be relaxing the DRR requirement.

2.     And what a relaxation – the requirement was reduced from the existing 25% to 10%. However, in a completely unexpected move, the requirement for parking liquid funds, in form of a debenture redemption fund (DRF) has been extended to all bond issuers, irrespective of whether they are covered by the requirement of DRR or not.

3.     Worse still, the Notification fails to clarify whether this is applicable to debentures/bonds already issued, before the date of the notification.

4.     Consider an NBFC or HFC, which relies heavily on bond issuance. Assume that the outstanding bonds issued by an HFC is Rs 100000 crores, of which, say Rs 30000 crores is falling for redemption during the year.

a.     In the plain language of the Notification, at least 15% of this Rs 30000 crores worth of redemption, that is, Rs 4500 crores, has to be parked in liquid funds, being bank FDs or trust securities.

b.     And this money cannot be used for any purpose other than redemption of debentures/bonds

5.     Strangely enough, NBFCs/HFCs are practically exempt from the requirement of DRR itself, except in case of public issues. At the same time, the requirement for parking a part of the funds required for redemption seems completely ununderstandable. If there is no requirement even for annually conserving a part of their profits, the requirement of creating a fund out of the same becomes completely illogical.

6.     One of the modes of investment is trust securities as notified by the CG u/s 20 (f) of the Trusts Act. See notification dated 21st April, 2017 and further amended vide notification dated https://taxguru.in/corporate-law/govt-notifies-securities-in-which-trust-money-can-be-invested.html

a.     One may notice that listed bonds with A rating themselves are eligible for investment.

b.     Assuming that the bonds of the HFC themselves are rated A or above, the bonds of the HFC themselves are trust securities. However, the Notification talks about bonds of “any other company”.

7.     NBFCs and HFCs are passing through one of the worst phases of liquidity crunch. In such a scenario, expecting them to park a part of their funds, meant for business, into liquid funds, will be completely inopportune.

8.     While the requirement is not retrospective, one may take a view that once the notification has come, one should try to create a DRF for the debentures maturing within 31st March, 2020 itself.

Needless to say, the MCA notification requires immediately to be reconsidered.