SEBI Decides To Go Blockchain On Debenture Issuances. Here's How It Will Work...

SEBI to implement distributed ledger technology for monitoring charge on assets.

<div class="paragraphs"><p>The SEBI logo in Mumbai. (Photograph: BloombergQuint)</p></div>
The SEBI logo in Mumbai. (Photograph: BloombergQuint)

The market regulator has notified the operational guidelines for distributed ledger technology used for blockchains to monitor security and covenants of non-convertible securities.

The Securities and Exchange Board of India put out a broad framework in August last year, and has now spelled out its workings. Under the DLT system, the key participants would be the issuers and intermediaries such as debenture trustees and credit rating agencies.

The new guidelines on the adoption of distributed ledger technology with unique asset IDs will improve transparency around charges created by institutions on assets while issuing securitised debt instruments, Jaikrishnan G, partner at Grant Thornton Bharat, told BloombergQuint.

This move will strengthen the lender/investor confidence as these assets will be continuously monitored with a strong and unalterable transaction audit trail.
Jaikrishnan G, Partner, Grant Thornton Bharat

If the information is in a distributed, permissioned ledger, the advantage is that authorised participants are essentially creating ledger entries and will be involved in adding new blocks to the chain of existing information using cryptography, Swapneil Akut, counsel at S&R Associates, told BloombergQuint.

"The information introduced is set in stone. If any change is proposed to be made by the issuer, it will have to be verified by the relevant debenture trustee. So, issuers of debt securities are constantly being watched—this will bring additional comfort and may be crucial to the growth of bond markets."

Once the ledger is created, it's protected against external interference from unauthorised participants; the aim is to create a decentralised platform where verified information is immutable.
Swapneil Akut, Counsel, S&R Associates

The data asymmetry in lending transactions is addressed via information covenants in the underlying transaction documents. However, this still means that data flow is controlled by the issuer.

SEBI's recent regulations require issuers of listed debt to report security packages and asset valuations prior to listing, each of which has to be verified by the debenture trustee, Shilpa Ahluwalia, partner & head- fintech at Shardul Amarchand Mangaldas & Co., explained. Reporting on subsequent valuations and fluctuations through the life of the bond was not streamlined earlier and the DLT will address this, she said.

All information linked to a particular asset or bond can be reported and tracked on a single blockchain, she said.

SEBI, too, had articulated similar reasons for introducing DLT, saying it will be a more resilient system and offer better protection against cyberattacks because of its distributed nature. It will not allow additional charge on any asset, if already created up to the present value of the asset, the regulator had said last year.

The DLT Structure

According to SEBI's guidelines, an issuer will feed information into the database.

This information is required to be verified, and a process will probably evolve (via smart contracts) where every time an issuer feeds information, an intimation is sent to the relevant intermediary. Only after it is verified, the data will be recorded on the blockchain, Ahluwalia said, adding that this may be subject to change as the system progresses.

A system generated asset ID will be allotted to each asset offered by the issuer as security for the non-convertible securities. To ensure this, the DLT system will provide an alert to the issuer and the debenture trustee for identifying possible duplicate entries by an issuer.

Since the system is at a nascent stage, the regulations add that certain assets will be tracked at a portfolio level and no specific parameters would be captured. This will include movable assets such as furniture and equipment, and current assets like portfolio of advances/receivables, among others.

Because certain information in relation to the collateral/assets will initially be tracked at a portfolio level, specific information as to what comprises charged assets may not be readily available, Akut said.

Thus, if a developer has several NCD programmes running in tandem, tracking the underlying security/asset breakdown may become an issue.
Swapneil Akut, Counsel, S&R Associates

But these complexities will be figured in time, he said, adding that the move is in the right direction.

Ahluwalia pointed out some practical challenges. The DLT will increase the compliance requirement for issuers, she said.

"The DLT framework does not contemplate a one-time data entry by an issuer only at the time of listing," she said. "Throughout the life of the bond, issuers will have to update the database, alert stakeholders in cases of changes such as a downgrade in credit rating or security valuation."

Issuers will have to to provide updates through the life of the bond and monitor how the underlying assets are performing.
Shilpa Ahluwalia, Partner, Shardul Amarchand Mangaldas & Co.

Credit rating agencies and trustees, on the other hand, have been entrusted with the obligation to verify and monitor the integrity of the database, she said.

Those who have issued non-convertible securities prior to April 1, 2022 will have to comply with SEBI's guidelines by September-end to avoid penalties. For future issuances, they will have to register their assets with the DLT system.

(Corrects an earlier version that misstated Swapneil Akut's designation)