Market-linked debentures, or MLDs, are debt instruments that were clearly envisioned as an innovative structured product, but have lost their sheen thanks to the underdeveloped Indian bond market and the stringent regulatory framework governing debt securities. can. MLD is a type of debt security that provides returns based on the performance of an underlying index/security. When the underlying security does well, the return on the MLD will be higher and vice versa. While the underlying security to which the MLDs are linked is at the discretion of the issuer, however, it should be market-related, such as the Nifty 50, and indices such as the Sensex, or securities such as equities, debt securities, government securities, etc. The details of such underlying security, along with the terms of its performance, are communicated to the holder in the offer document itself.
For example, suppose a company issues MLDs for a tenure of 36 months. Coupon rate is based on the movement of Nifty i.e. if Nifty at the end of 36 months is more than 125% at the time of issue, the holder will get a coupon of 15%; If it is between 100% to 125%, the holder will get a coupon of 12%; And if it is less than 100%, no coupon payment will be made to the investor. Hence, here the coupon rate of MLD will be directly linked to the movement of Nifty.
MLDs are tax-efficient, usually listed, and capital gains from such listed debentures are taxed at 10% (excluding surcharge and cess) after a holding period of more than one year. Such tax efficiency does not apply to unlisted MLDs. MLDs do not receive any regular and fixed coupon payments, and are paid directly to investors at the time of redemption as a single bullet payment.
MLD Status
On analysis of various issues in the market (we examined various case studies taken from several information memoranda available on stock exchanges and companies’ websites to prove this point), what was observed was that most of the MLDs in the market are fraught with downsides that are highly unlikely to happen. This actually makes the returns fixed and not really tied to the market.
We examined 18 issues, of which only five had underlying conditions that were likely to occur, while the remaining 13 had conditions that were highly unlikely to occur. Possible situations include Nifty falling to 2,850 in which case the holder will get no coupon rate, while anything above 2,850 will badge the holder with the specified coupon rate. An instance where the value of Nifty or G-Sec would fall by 50-75% seems quite unlikely, where even the ‘Great Depression of 2008’ caused only a 40% drop in the stock index. Therefore in almost all situations, the investor will always receive a coupon and thus the hedging shown is a hoax. Thus, MLDs were not linked to the market, thereby defeating their very purpose. On uncovering the underlying terms used, it turns out that MLDs are equivalent to plain vanilla debentures.
However, some entities actually estimated different coupon rates at different levels of the Nifty which seemed like a genuine correlation of the holder’s earnings with the underlying market performance.
conclusion
The true intent and spirit of starting MLDs can be seen missing from the many issuances issued by the 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 MLD and exemption from electronic book mechanism (an electronic platform for private placement of securities) for issue of securities on private placement basis are some of the major benefits that issuers get by launching MLDs .
It is an indication of what the market considers to be a bottleneck or loss and what the market wants. This in itself may call for a re-look at the existing regulatory framework. Exemptions or exemptions should be considered where laws are not serving the intended purpose or are more stringent than required, except where such exemption becomes unconscious or goes against the fundamentals of policy-making.
Aanchal Kaur Nagpal looks after non-banking regulations and corporate laws at Vinod Kothari Consultants.
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