Market-linked debentures: Are they real or illusory?

For instance, let’s assume that a company issues MLDs for a tenure of 36 months. The coupon rate is based on Nifty movement i.e. if the Nifty at the end of the 36 months is more than 125% of that at the time of issuance, then the holder will get a coupon of 15%; if it is between 100% and 125%, the holder will get a coupon of 12%; and if it is below 100%, then there will be no coupon paid to the investor. Therefore, here, the coupon rate of the MLDs will be directly linked to the movement of the Nifty.

MLDs are tax-efficient, usually listed, and the capital gains from such listed debentures are taxed at 10% (exclusive of surcharge and cess) after a holding period of more than a year. Such tax efficiency does not apply to unlisted MLDs. MLDs do not fetch any regular and fixed coupon payoff, and investors are directly paid at the time of redemption as one single bullet payment.

State of MLDs

On an analysis of the various issuances in the market (we examined various case studies picked from several information memorandums available on the stock exchange and websites of companies to prove the point.), what was observed was that most of the MLDs in the market are laden with downsides that are highly unlikely to take place. This actually makes the returns fixed and not truly market-linked.

We examined 18 issuances out of which only five had underlying conditions that were likely to occur, while the rest 13 had conditions that were highly impossible to happen. Unlikely conditions included Nifty falling to 2,850 points, in which case the holder would get no coupon rate, while anything above 2,850 would badge the holder with the specified coupon rate. An instance where the value of Nifty or a G-sec would fall by 50-75% seems quite impossible where even ‘The Great Depression of 2008’ caused a fall of only 40% in stock indices. Hence in almost all conditions, the investor will always be receiving a coupon and thus the hedging shown is more of a hoax. The MLDs were, thus, not market-linked, thereby defeating their very purpose. On lifting the veil of the underlying conditions used, it reveals that the MLDs are equivalent to plain vanilla debentures.

However, some entities actually pegged different coupon rates to different levels of Nifty which seemed like an actual linkage of the income of the holder with the market performance of the underlying.

Conclusion

The true intent and spirit of introducing MLDs can be seen missing from a lot of the issuances by companies. Instead, MLDs are issued to gain regulatory arbitrage otherwise not available to plain vanilla debentures. No fixed regular payment of coupons during the tenure of MLDs and exemption from electronic book mechanism (an electronic platform for the private placement of securities) for issuance of securities on a private placement basis are some of the major benefits issuers get by launching MLDs.

This is indicative of what the market perceives as a bottleneck or a disadvantage, and what the market desires. This, in itself, may call for a relook at the extant regulatory framework. Relaxations or exemptions should be considered where laws are not meeting the requisite purpose or are harsher than required, except where such relaxations become unconscionable or go against the basic tenets of policy-making.

Aanchal Kaur Nagpal looks after non-banking regulations and corporate laws at Vinod Kothari Consultants.