Sebi's action on Axis Capital: Research Analyst's article tipped off the regulator about "high-risk transaction"

So far this year, shares of IIFL Finance tumbled over 17 percent

A registered research analyst's article had flagged the irregularity in Axis Capital's (ACL's) handling of a non-convertible debenture issue to the market regulator.

It was an article by Hemindra Kishen Hazari, titled "Is Axis Capital an Investment Bank or a Hedge Fund" and dated January 16, 2024, that brought the regulator's attention to the NCD issue.

On September 19, the Securities and Exchange Board of India (Sebi) passed an interim order restraining ACL from taking any new assignments in the capacity of a merchant banker, arranger or underwriter for any issue or offer for sale of securities in the debt segment until further orders.

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

The order passed by Sebi's Whole-time Member (WTM) Ashwani Bhatia stated that Hazari's article highlighted certain concerns regarding a high-risk transaction undertaken by ACL, a Sebi-registered merchant banker and a wholly owned subsidiary of the Axis Bank. Following the reading of this article, the regulator's officials conducted an inspection of ACL.

The inspection examined whether the transaction undertaken by ACL in respect of listed Non-Convertible Debentures (“NCDs”) of Sojo Infotel Pvt. Ltd.

The regulator passed an interim order stating that ACL provided guarantee for the NCD issue in the guise of underwriting, which is not permitted under the existing regulatory framework. The regulator even found such an arrangement posing a risk to the financial system as "it can potentially disrupt the orderly functioning of the market".

In an interaction with Moneycontrol, Hazari explained what had caught his attention and the risk factors he thought were involved. The RA, according to his website, is a commentator with over 25 years of experience in the Indian capital markets and is specialised in research on banking and the macro-economy.

Hazari told Moneycontrol, "ACL had done such a poor quality deal."

He added, "There were several risk factors, one, Sojo the issuer had nil sales and was loss-making with marginal assets and had a negative net worth in FY2022 and issuer lacked the financial ability to service the bond. Two, the security of Lava shares was illiquid, the company had a single digit EBITDA margin and negative cash flow from operations. Hence, it required a guarantee from ACL. The 'guarantee' was 50 percent of ACL's equity at the time the deal was done which is very high."

What was the arrangement ACL came to?
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."

The order noted that, with this arrangement, ACL went beyond the mandate of issue management and its activity was in contravention of the definition of underwriting and the role of Merchant Banker as defined in MB Regulations, 1992.