Provisions in India's new Companies Act requiring corporate borrowers to set aside half of bond proceeds have made the sale of such securities costlier and have brought the local market to a halt.
Under Section 71 of the legislation, which took effect this month, corporate bond issuers have to create a debenture redemption reserve equivalent to at least 50% of a planned bond sale before the maturity of the security.
The rule doubles an earlier 25% debenture redemption reserve and expands it to include private bonds, those with 49 or fewer investors.
The previous rule, under the old Companies Act, addressed public bonds only, a much smaller part of the local market.
On top of that, the company has to set aside 15% of its total maturities for the following fiscal year by the end of the current fiscal year.
Among other things, the regulation seeks to address recent defaults plaguing India's retail investors.
However, market participants say the guidelines fail to account for the different credit qualities of borrowers in the Indian market.
"The [debenture redemption reserve] enforcement has its genesis in the notorious bond sales to retail investors of some companies that regulators are probing," said a Delhi-based source at a frequent issuer.
"The lawmakers cannot create specific rules for these defaulters. So, now, everyone has to bear the brunt of their wrongdoing."
One of the bigger defaults came from companies belonging to the Sahara Group, which raised millions of dollars from retail investors.
The Supreme Court of India said recently that the group owes Rs370bn ($6 billion) to small investors. Subrata Roy, the head of the group, has been in jail since early March.
LACK OF CLARITY
In addition to expanding the reserve requirement, the act may also expand the number of securities that the debenture redemption reserve affects.
Market participants have said they are not sure what qualifies as a debenture, because the regulator has expanded that term to include "any other securities" of a company.
"The definition of the debenture is kept open-ended and we don't know if that also now includes commercial paper," said a Mumbai-based official of a non-banking financial corporation.
"If that is the case, then all the rules, including the debenture redemption reserve, will be applicable to comercial paper issuance as well."
Issuers are still waiting for the Ministry of Corporate of Affairs to clarify which securities qualify as debentures.
Setting aside so much capital might put an unnecessary strain on liquidity, especially because the new act may affect several types of debt.
"We can still live with the 15% retention requirement, but extending debenture redemption reserve [to include] sub debt and perpetual bonds is just absurd," said an official at a non banking financial corporation.
Certain procedural changes may also make life harder for issuers.
Under the previous legislation, companies used to get blanket approval from shareholders to issue bonds and such permissions were valid for two to three years.
The new rules require borrowers to get shareholder permission every year.
Issuers are, so far, uncertain how this new procedure will change the way they raise funds.
"We are consulting our legal department and will make a decision on the current year's borrowing plans once these small details are clear," said an official at a state-run non-banking financial corporation.
That is not the only thing that needs clarifying.
The act states that the redemption reserve has to be created out of company profits and the debenture redemption reserve should be in place before the debenture redemption commences.
Yet, it does not provide details on how a loss-making issuer will be able to set aside the funds if there are no profits.
"The government should also clarify the situation when a bond issuer becomes loss-making and this happens before the full debenture redemption reserve requirement comes into force," said an official at a non-banking financial corporation.
"How would this situation be resolved?" he asked.
Some market participants pointed to another troubling detail. The act has different rules for listed and unlisted entities.
An entity used to be considered listed only if its equity was on a stock exchange, but, according to the new act, a company with any securities on an exchange is considered a listed entity.
"Most of my bonds are listed, but my equity is not. So, am I a listed entity from April 1?" asked an executive.
"We can live with any rules and tweak our borrowing plans according, but only when we know what rules will stay and what will change."
It is not clear if the companies will get an answer soon, even though top borrowers have meetings planned with the Ministry of Corporate Affairs in a few days, sources say.
General elections are on in the country until May 12 and any important government decision will be made only after the results are released on May 16.