The Securities and Exchange Board of India (Sebi) has taken significant action by prohibiting Axis Capital Limited (ACL) from accepting new assignments as a merchant banker, arranger, or underwriter in the debt segment. This decision comes amid allegations that the firm violated regulatory norms related to the issuance of Non-Convertible Debentures (NCDs).
Allegations of Improper Guarantee Practices
Sebi’s interim order highlights concerns that ACL provided guarantees or indemnities for the redemption of NCDs, misrepresenting these guarantees as underwriting services. This practice is explicitly not permitted under existing regulations. According to Sebi, this kind of behavior puts the financial system at risk since it can interfere with the market’s ability to operate in an orderly manner.
The regulator’s scrutiny was triggered by an inspection prompted by a research analyst’s article that raised red flags about ACL’s operations.
The Context of the NCDs
Sojo Infotel Pvt. Ltd., for which ACL was acting as the merchant banker, had issued NCDs intended to fund its investment in Lava International. These NCDs were meant to be redeemed through the sale of shares by Sojo’s promoters, either via an initial public offering (IPO) or a secondary sale. However, when Sojo failed to meet its redemption obligations, it set off a chain of events that brought ACL under scrutiny.
As part of the arrangement, the Axis Debenture Trustee invoked a pledge on 26% of Lava’s shares, which had been pledged as security for the NCDs. Unfortunately, ACL was unable to locate buyers for these shares, leading the firm to deposit ₹167 crore into an escrow account to fulfill its underwriting commitment.
Investigation Triggers and Findings
Sebi conducted a detailed inspection of ACL’s activities concerning the NCDs. The findings revealed that ACL’s commitments extended beyond standard underwriting practices, effectively positioning it as a guarantor rather than a mere facilitator of capital raising. Sebi clarified that ACL’s involvement amounted to providing a guarantee for the redemption of NCDs, a role reserved for banks rather than merchant bankers.
Sebi’s order emphasizes that ACL’s actions constituted a violation of the definition of underwriting as outlined in the Merchant Bankers Regulations of 1992. The regulator underscored that ACL’s commitments were not in line with the expectations of a merchant banker, thus raising serious concerns about market integrity.
The Role of Credit Rating Agencies
The ramifications of ACL’s actions were compounded by the involvement of credit rating agencies, which classified the guarantees provided by ACL as credit enhancements. This misclassification led to investors relying on these ratings, unwittingly exposing themselves to increased risks. Sebi has emphasized that this situation could disrupt the financial system and undermine the orderly functioning of capital markets.
Interim Measures and Next Steps
In light of these findings, Sebi has issued an interim order restricting ACL from engaging in any new debt merchant banking assignments. This ban will remain in effect until further notice. Sebi’s Whole Time Member, Ashwani Bhatia, stated that this measure is essential to ensure market stability while the investigation is ongoing.
Axis Capital has been given a window of 21 days to respond to the observations made in Sebi’s order. Additionally, the regulator has forwarded its findings to the Reserve Bank of India (RBI) for a comprehensive examination of ACL’s activities, given its status as a subsidiary of a banking institution.
The situation surrounding Axis Capital serves as a cautionary tale about the complexities and responsibilities inherent in the financial services sector. As the investigation unfolds, it remains crucial for market participants to adhere strictly to regulatory guidelines to maintain the integrity and stability of the financial system.
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