India Inc wakes up to stern default rule

Mumbai: A top-rated, solvent corporate can be caught in a nasty surprise of a downgrade to 'D' or 'Default' category, even if for a few hours, if a demanding rule laid down by the capital market regulator is not followed to the T.

The rule is simple: if a rupee of interest or principal payment to a single investor is delayed by a day, credit rating agencies will have to put a default stamp on a company-even if the failure to pay is not attributed to financial woes of the borrower. Stemming from a November 18 circular by the Securities & Exchange Board of India, financial markets are now waking up to the impact of the rule.

On Monday, bank loans of Axis Finance, a subsidiary of Axis Bank, were downgraded to D, before being restored to 'AAA/Stable' rating. Reason: while the company had sufficient funds and instructed its banker to pay on December 30, the bank processed the payment on December 31, causing a one-day delay on the commitment.

Such technical defaults, caused by a cavalier approach to a rigorous regulation by any of the parties connected to fund mobilisation, broadens the scope of default to non-credit problems that have to be addressed now.

According to sources in the financial markets, recently one of the country's largest public sector banks faced a technical default on its tier-1 bonds. "However, no rating action was taken, probably because the problem was quickly fixed, or perhaps also due to the size and importance of the institution," said a person aware of the development. The Axis Finance rating was reassigned to triple-A after the reasons for the delay were addressed and the company took "measures to ensure non-recurrence" of such instances.

While the impact of a momentary downgrade to D would not last, it can nonetheless cause a sudden volatility, and even affect the stock price of the company in question.

In fact, instances of non-payment of debt (principal or interest or both) may arise for reasons beyond the control of a company: inaccurate bank details shared by the investor, dormant bank account (where the money has to be credited), frozen bank accounts on the back of directions of tax or law enforcement authorities, etc. In such cases, a company may be slapped with a temporary D rating for no fault of its own.

To avoid such a situation, rating companies, besides confirming the availability of adequate funds with the issuer, will have to ensure that money that cannot be paid to certain investors due to technical reasons are maintained in a separate escrow account with a scheduled commercial bank.

"If an investor's bank account is frozen or dormant, how would an issuer know? In verifying whether an account is active, an issuer could credit a rupee each to bank accounts of all investors a week before the due date of payment. The transfers which bounce could be credited to the escrow account. Now, none of the companies which borrow or float debentures do this. This would increase some compliance load. However, one thing is clear: issuers would have to put in place such a mechanism to spot inactive accounts to avoid a sudden downgrade," said an industry person familiar with the issue.

According to another person, rating action on loans which have just defaulted would not go down well among issuers. A bank loan is categorised as non-performing asset if the interest or principal is overdue for 90 days.

"In several SMA0 (special mention account-zero) cases, where the default has just happened or the overdue period is less than 31 days, the non-payment is often due to technical reasons," said a banker.

However, regulatory circles believe issuers as well as banks and other market participants must appreciate the fact that Sebi is simply going by the old rule of default, which was temporarily relaxed due to operational interruptions that companies grappled with during the pandemic. It's always 'one rupee, one day' delay that is considered as default, said a person. And, if the delay is not caused by credit crunch, borrowing entities must have systems to avoid technical defaults.