Early warning

A slowing economy has aggravated balance-sheet stress for many highly leveraged members of India Inc. An activist RBI and the new Bankruptcy Code are also prompting banks to initiate insolvency proceedings against companies that are tardy in servicing loans. Therefore, news of loan defaults or delays have been a big catalyst to stock prices lately. In the absence of verified reports, the stocks of stressed companies often become a happy hunting ground for punters with retail investors reeled in by rumours of recoveries and turnarounds. Given the circumstances, SEBI’s circular last month requiring all listed companies to treat any default in bank loans, commercial paper, foreign currency convertible bonds or ECBs as material events, and to make immediate disclosures to the stock exchanges, was certainly a very welcome move. But it is SEBI’s definition of what constituted ‘default’ that seems to have set the cat among pigeons. The regulator has now deferred these guidelines, a day before they were to take effect.

There were three contentious aspects to SEBI’s original circular. For one, the regulator seems to have taken a far too stringent view. It required firms to treat as default any non-payment of interest or principal dues on the agreed date, and asked firms to disclose such default to the exchanges within one working day. In the ordinary course of business , even financially sound companies can suffer delays of a few days in servicing loans due to temporary cash flow mismatches. Disclosing such minor delays as defaults to the exchanges may lead to an over-reaction in the stock price and contribute to unnecessary volatility for investors. Two, such public disclosure of ‘default’ would also require rating agencies to take immediate note of the event, and downgrade the outstanding instruments of the issuer. Such downgrades could then materially impact the issuer’s ability to tide over the cash crunch and require lenders to immediately provision for the account. Three, if companies were to implement this rule, the market regulator’s definition of default would be materially different from the RBI’s. At present, Indian banks consider a borrower as a defaulter only if either interest or principal repayments remain unpaid for more than 90 days beyond the due date. This three-month leeway is given mainly to make clear distinctions between a temporary liquidity crunch and deep-rooted solvency problems when branding a firm as a loan defaulter.

As working capital stress, especially for mid-sized companies, has been significantly aggravated by GST implementation, it is good that SEBI decided not to enforce these rules in their current form. A compromise solution now would be for SEBI to harmonise its definition of default with the RBI and make a beginning with the same 90-day standard. However, given the materiality of default-related information to stock investors, it is imperative for SEBI to revert with revised rules at the earliest and not put it on the back-burner.

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