SEBI enables new framework to allow trading of defaulted debt

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Market regulator SEBI (Securities and Exchange Board of India) recommended a new framework that enables trading in defaulted debt. Industry experts said that this is likely to create a distressed bond market in India, potentially allowing asset management companies among others to return money to investors faster. Even though there is a market for stressed bank loans in India, where Asset Reconstruction Companies (ARCs) and several large global distressed funds are active, industry experts believe that the move to allow trading of default category debt papers and bonds will allow sellers like mutual funds to exit exposures faster to return money to investors.

Ajay Shaw, Partner, DSK Legal said that this is an attempt to create liquidity for securities that at present would be rendered illiquid in case of a default. In an overall view, it seems that this new framework will give rise to a distressed bond market in India, where more experienced hands could come and buy these bonds. SEBI is trying to create new avenues to deal with emerging issues in debt, distressed assets, and ensure that they do not face legal impediments. A senior executive at a distressed asset fund said that this will be beneficial as it will lead to the development of the stressed debt market in India.

It will allow the secondary sale for trapped debt investors like mutual funds and retail investors to recover whatever they can. It is necessary to operationalize the framework for foreign investors to directly buy non-performing assets. Ruchir Sinha, co-head, private equity and M&A at law firm Nishith Desai Associates said that despite opportunities and interests, foreign investors find it difficult to participate due to regulatory issues. This framework by SEBI will help bondholders such as mutual funds which usually have lesser legal remedies for recovering assets that have gone bad. As many issuers are struggling to honor their debt obligations because of the COVID-19 related financial hardships, the permission to trade in defaulted debt bonds would be immensely helpful for them.

The facility for trading in stressed bonds is already available in other countries and buyers like asset reconstruction companies (ARCs), debt funds, hedge funds, and distressed asset funds are already showing interest in these bonds. 

It is a foundation for a new market. However, it will take some time to develop. As per the new norms effective from July 1st, within 2 working days from the date of intimation of default on payment obligations of debt, the depositories in co-ordination with stock exchanges will update the ISIN (code for stocks and debt securities) master file and lift restrictions on transactions in such debt securities.