Sebi bars Axis Capital from acting as investment banker in debt market until further orders

The interim order was issued on September 19

The market regulator has restrained Axis Capital (ACL) from undertaking any new assignments in the capacity of merchant banker, arranger or underwriter for any issue of securities in the debt segement.

In an interim order issued on September 19, the Securities and Exchange Board of India (Sebi) has also asked ACL to reply within 21 days to the observations made in the order.

The regulator looked into the allegation that ACL extended itself beyond activities permitted to a merchant banker in the issue of listed non-convertible debentures (NCDs) of Sojo Infotel.

According to the interim order passed by Sebi's Whole-time Member (WTM) Ashwani Bhatia, "ACL provided guarantee/indemnity towards redemption of NCDs in the guise of underwriting, which it was not permitted to do under the existing regulatory framework. Such activity poses risk to the financial system as it can potentially disrupt the orderly functioning of the market."

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A merchant banker is allowed to take market risk while underwriting an issue. That is, it is allowed to subscribe or procure subscription for securities, issued or offered for sale, that remain unsubscribed. As the order states, "Very clearly, the intent of the Regulations is to permit a Merchant Banker to take market risk by subscribing to the unsubscribed portion of the securities offered to the investors and to dispose of the securities so procured, by charging a fee."

But, through its arrangement with Sojo, ACL was undertaking a credit risk by providing credit-risk cover to the NCD subscribers, according to the order.

According to the order, ACL's transaction with regard to Sojo's NCDs was not part of issue management but of security enforcement mechanism, which essentially falls under the domain of debenture trustee (which in this case was Axis DT or ACL's sister concern).

As the order said, "The whole transaction was, in substance, a structured secured credit transaction in the cloak of a capital market instrument (bonds) designed to finance an acquisition (of Lava International Ltd or LIL), which had adequate collateral / guarantees in the form of pledge of shares of Sojo and LIL, personal guarantees of promoters of Sojo, lien over escrow account and hypothecation of assets of Sojo. ACL’s credit support or credit enhancement, which was a credit guarantee in the guise of underwriting, was a critical component of the said structured credit transaction. ACL in this case was taking credit risk exposure, rather than market risk."

How did this work?

For the NCD issue, a debenture trustee deed (DTD) was executed between Sojo, Axis Debenture Trustee (ADT) and ACL.

Sojo had pledged the shares of LIL as security cover for the NCD issue. Under the DTD, if there a default, the debenture trustee would invoke a pledge. Then, according to the DTD, if ACL is not able to find buyers for the pledged shares, it would have to fulfil its "underwriting commitment", by having to purchase or fund the purchase of these pledged shares.

As the order noted, "ACL was unconditionally, unequivocally and irrevocably
obligated to purchase or fund the purchase of the Pledged Shares."

The order stated, " The commitment provided by ACL in respect of NCDs of Sojo cannot be termed as an underwriting activity as it was not an agreement to “subscribe to or procure subscription for securities, issued or offered for sale, remaining unsubscribed.” Rather, it was a guarantee to redeem the NCDs of Sojo in the event of default on maturity. It is pertinent was noted that the CRAs (CRISIL / ICRA) had rated and assigned CE ratings to all of the above mentioned issuances on the basis of the guarantee/indemnity provided by ACL which was legally enforceable, irrevocable and unconditional covering the entire amount and full tenure of the rated instrument."

The order taking these and various other facts into consideration stated that " in the instant case, ACL went beyond the mandate of issue management, as the activity undertaken by ACL was in contravention of the definition of underwriting and the role of Merchant Banker as defined in MB Regulations, 1992.