SEBI Chief Says Failure To Monitor End Use Of Funds Behind IL&FS Crisis

SEBI Chief Ajay Tyagi said the failure to monitor the end use of funds was the reason behind the Infrastructure Leasing & Financial Services Ltd. debacle, which has sparked concerns in both credit and equity markets.

“One of the issues that this episode brought out is the inter-connectedness arising as a result of complex corporate subsidiary structures and how the maze of subsidiaries facilitate masking the end use of funds,” Tyagi, chairman of the Securities and Exchange Board of India, said at the Crisil's 5th Annual Seminar on corporate bond market—the speech was uploaded on its website. Proper monitoring of how funds are used even at the last level of the corporate structure is important, he said.

A string of defaults by IL&FS led to fears of a contagion in financial markets. To control the damage, the government took over the beleaguered infrastructure conglomerate. The new board, however, found that the IL&FS group was far more complex than expected with a maze of 348 associate companies—most of them unlisted entities.

The market regulator recently made a limited review of subsidiaries that are part of the consolidated balance sheet compulsory for statutory auditors. “A similar review is required in the case of unlisted holding companies,” Tyagi said. But since unlisted entities fall under the preview of the Ministry of Corporate Affairs, SEBI cannot mandate a similar oversight for them.

How Insolvency Process Can Help Bond Market

Tyagi, who was involved in the drafting of the Insolvency and Bankruptcy Code at the Finance Ministry before joining SEBI, sees an opportunity to develop the bond market in this process of bad-loan resolution. The orderly and time-bound recycling of the stressed financial assets is important for the development of credit and fixed-income market, he said.

The buyers of stressed assets can tap the corporate bond market for financing needs. More so after SEBI mandated large companies to raise 25 percent of their financing needs from the corporate bond market. The regulator will be issuing operational framework shortly.

Issues With The Bond Market

While detailed information is required to be disclosed by issuers before bonds are listed on exchanges, the lack of information from short-term issuers of unlisted commercial papers needs to be addressed, Tyagi said.

He said high-net-worth individuals and companies that park funds in fixed income assets were at a disadvantage. That's because loans against shares are par for the course, loans against corporate bonds are hard to get, he said.

Not just that, while loans are treated at book value, corporate bonds, being marketable instruments, are marked to market. “In view of this difference in the regulatory treatment of loans and investments in bonds, banks find loan financing more convenient as they do not need to mark to market loans vis-à-vis bonds.”