The Securities and Exchange Board of India (“SEBI”) has recently issued the operational guidelines (“Operational Guidelines”) for its circular dated August 13, 2021, on ‘Security and Covenant Monitoring using Distributed Ledger Technology’ (the “DLT Circular”). This article will examine the key highlights of the Operational Guidelines and analyse their impact.
SEBI has introduced significant changes to the process of issuing listed debt securities since 2020. These changes impose additional obligations and compliance requirements on debenture trustees (“DTs”), in addition to those imposed on issuers of non-convertible securities (“Issuers”). As a result, DTs are inter alia required to conduct ‘independent due diligence exercises’ on the assets of Issuers for the purposes of creation of security, as well as periodically monitor the security that is created. This due diligence helps verify whether the assets are free from any existing encumbrances, or, where such assets are encumbered, that the necessary consent letters or pari passu letters have been obtained from the existing charge holders for the creation of fresh security over them. SEBI also constituted a working group to strengthen the processes of security creation, monitoring of security created, monitoring of asset cover and covenants of non-convertible securities. Based on the recommendations of this working group, it was decided that a platform for ‘security and covenant monitoring’ (the “Platform”) will be developed and hosted by the depositories.
The Operational Guidelines apply to all issuances made on or after April 1, 2022. If Issuers are unable to comply with the requirements, they can explain the same to the depositories, however, this is only permitted till July 1, 2022, after which date Issuers will not be allotted ISINs for fresh issuances until they comply with the Operational Guidelines.
1. Distributed Ledger Technology
Distributed ledger technology (“DLT”) will be the backbone of this Platform. DLT is a technology by which a database containing digital data can be replicated, stored, shared, and synchronised across multiple participants, without the need for a central administrator. A typical DLT will have multiple participants store copies of a virtual ‘ledger’ and make updates in accordance with the DLT’s network protocol or consensus mechanism.
DLT is perhaps best known by its most common implementation – the ‘blockchain’. In a blockchain, the ‘ledger’ is made up of “blocks”, which are used to record transactions that are then “chained” together using cryptographic hash functions. In contrast, distributed ledgers do not necessarily require such a chain of “blocks” in order to function.
2. Use of DLT for the Platform
Depending on the use-case, different implementations of DLT are possible. The Platform, as envisaged by SEBI, will use a permissioned type of ledger, i.e., participants will be selectively allowed to join the system, and will only be given limited permissions, in terms of what they can do by way of participation. The Platform will be used to assign assets that are offered as security for non-convertible securities a unique identifier, and the DLT, being a digital database, will be used to ensure that there is no duplication of assets. In the event there are multiple securities created against the same asset, this can be traced back to the particular asset, and DTs can take necessary corrective action.
3. Functions of the Platform
The Platform will be used to capture the process of creation of security (viz. due diligence, charge creation, etc.), provide continuous monitoring of covenants by DTs (as applicable), record interest and redemption payments, and consolidate information on credit rating of non-convertible securities by credit rating agencies, etc.
a. Recording of Assets
The DLT Circular provides that Issuers will be able to record relevant details regarding various kinds of assets proposed as security for non-convertible securities, such as: (i) immovable property; (ii) movable fixed assets; (iii) current assets (viz., receivables, book debts); (iv) intangible assets (viz., IPRs, etc.); (v) securities/ other financial assets; (vi) assignment of rights; and (vii) guarantees (each, an “Asset”) through the Platform.
However, under the Operational Guidelines, it has been provided that only the following assets will be tracked to begin with, and even then, at a portfolio level (with no specific parameters for the underlying assets being captured): (i) movable assets (viz., furniture, equipment, inventory, etc.); (ii) current assets (viz., portfolio of advances/ receivables, etc.); (iii) any other asset of similar nature.
Each Asset shall be recorded on the DLT by the Issuer, subject to validation/ verification by DTs.
b. De-Duplication of Assets
A system-generated 12-digit alphanumeric unique identifier (“Asset Identifier”) will be assigned to each Asset recorded on the Platform. The depositories will be responsible for ensuring that there is only one Asset Identifier assigned to each Asset. This will be done at a portfolio level, as mentioned under the Operational Guidelines.
If there are duplicate/ near duplicate entries detected for an Asset, the Platform will provide alerts to the Issuer and the DT. The Issuer and DT will then be required to cross-check and verify the details entered into the system for Asset creation.
DTs shall annually reconcile the list of Assets recorded in the system in respect of an Issuer, and if a duplicate entry is found for an Asset, they will take the steps necessary to (i) eliminate the duplicate entry (or entries) and verify security cover the entry relates to, and (ii) if required, also take appropriate corrective steps.
Upon the occurrence of an event which reduces the security cover to below the mandated/ stipulated limit, as per regulation 54 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, the Issuer is required to update the details on the Platform immediately. Each such event shall be a ‘trigger event’, and the depositories will be required to send trigger event alerts to all concerned stakeholders.
4. Relevant Considerations
a. The Operational Guidelines currently only provide for the inclusion of records related to movable assets on the DLT. The type of charge that may be created over such assets will typically only be a floating charge.
There is no clarity on how often the details of the assets must be updated and how the assets will be distinguished.
b. Parameters for Recording of Assets
Some of the indicative parameters required to be captured for all asset categories, such as their short descriptions, will require Issuers and DTs to be disciplined, so that these descriptions are consistent and meaningful. For example, in the case of an NBFC issuing debentures against the security of its receivables from its customer loans and advances, describing the pool of loan assets accurately and sufficiently will be challenging. There may be corresponding changes required in the manner of recording such details by the issuer.
c. Tight timelines for verifying existing issuances
Issuers will have until September 30, 2022 to comply with the Operational Guidelines, in respect of their existing outstanding issuances of non-convertible securities. However, DTs will be required to verify all the details pertaining to Assets recorded in respect of such existing outstanding issuances of non-convertible securities by November 30, 2022 – a window of just 2 (two) months. This may possibly be a challenging timeframe.
This is an interesting technology-driven exercise introduced by SEBI, and it recognises the value of applying technology to achieve consistency, transparency, and timely intervention to protect the interests of the investors in relation to the assets of Issuers. This is probably one of the foremost endeavours by a regulator in India to use technology in regulation. Over time, and as the use of the Platform becomes predominant, teething troubles, interpretation, consistency, and the use of appropriate technology will be factors that the market and the regulator will have to address.
 SEBI Circular No. SEBI/ HO/ MIRSD/ CRADT/ CIR/ P/ 2022/ 38 dated March 29, 2022 “Operational Guidelines for ‘Security and Covenant Monitoring’ using Distributed Ledger Technology (DLT)”
 SEBI Circular No. SEBI/HO/MIRSD/MIRSD_CRADT/CIR/P/2021/618 dated August 13, 2021 “‘Security and Covenant Monitoring’ using Distributed Ledger Technology”
 The working group was comprised of officials from SEBI, the Depositories, the Stock Exchanges, and the Trustees Association of India.