Explained: Why has SEBI suggested that debenture trustees hive off a large part of their business?

When the regulator examined the revenue model of the top five, active DTs, it found that only a third of their revenue was coming from activities that are regulated by Sebi.

The capital markets regulator has suggested that debenture trustees spin out a large chunk of their business that generates significant revenue.

These business verticals--which operate in unregulated segments--earn for debenture trustees nearly as much as their Securities and Exchange Board of India (SEBI)-regulated activities do.

SEBI has proposed that the spinning off be done to avoid a systemic risk in the market.

In a consultation paper issued on November 4, SEBI explained its reasoning.

Here is an easy reckoner.

They are intermediaries between debenture (debt) issuing entities issuing debentures (debt) and the holders of such instruments.

Their chief responsibility is to protect the interests of the debenture holders. For this, they have to, among other things, track the issuing entity's financial health and ability to repay the debt by asking for regular reports; take possession of the property that is held as a security and monitor it on a continuous basis to ensure that it is adequate and available to meet the interest and principal amount; and resolve grievances of the debenture holders.

A bank, a public financial institution, an insurance company or a body corporate qualify. Any such entity has to register with SEBI as a debenture trustee (DT).

When the regulator examined the revenue model of the top five active DTs, it found that only around 30 percent of their revenue was coming from activities that are regulated by SEBI.

Revenue from services that came under the supervision of other regulators, including services such as acting as securitisation trustee and public deposit trustee, came to around 35.85 percent of the total. Revenue from services such as share pledging, escrow agency and acting as a facility agent, which do not come under any regulator, came to 28.51 percent of the total. This unregulated business vertical generates nearly as much as that which falls under SEBI's purview, and this is what seems to be concerning the watchdog.

As the consultation paper noted, "DT activities which are not under the purview of SEBI and any other Financial Sector Regulator/ Authority may pose regulatory and systemic risks in the market."

On the whole, DTs' business model seems heavily dependent on activities outside SEBI's jurisdiction and on other commercial arrangements with the issuer company.

The consultation paper noted, "A significant amount of commercial relationship of the trustees is associated with issuer company in terms of providing other forms of businesses, which are outside the purview of SEBI."

When so much of their services are in the absence of SEBI oversight, the market regulator is unable to deal with grievances that investors/other stakeholders may have from availing these services.

The capital markets regulator has approached this problem from an ease-of-doing business perspective. Therefore, it has suggested that the DT hive off activities that are not regulated by any financial regulator or authority into a separate legal entity.

The entity should not use the brand or the corporate name of the regulated entity beyond a sunset period of one year. The entity may, however, share resources with the registered DT but should segregate legal liability.

On the activities outside SEBI's purview but fall under the ambit of another financial sector regulator, the paper suggests that the DT continue these activities but in line with the guidelines given by that other financial regulator/authority.

Grievances related to these activities that come under the other regulator should also be dealt with by that regulator.

SEBI has proposed that if a trustee is planning to undertake activities not regulated by it, the entity need not seek registration from the capital market regulator. This means that anyone doing activities such as handling issue of unlisted non-convertible debentures or handling share pledges or acting as a monitoring agent need not seek SEBI registration.