On 28 October, the Securities and Exchange Board of India (SEBI) issued a regulatory censure against Axis Capital Limited for violating merchant banking regulations in connection with non-convertible debentures (NCDs) issued by Sojo Infotel Private Limited.

Quasi-judicial authority, Biju S. held that a merchant banker cannot undertake a repayment obligation that effectively guarantees debt repayment under the guise of a securities transaction. He said:

“….while regulation 13A of the MB Regulations confines merchant bankers to securities market related activities, a mere connection to “securities” is not sufficient to bring an activity within its scope. If the Noticee's interpretation is accepted, then any repayment guarantee dressed as “private secondary sale of securities” would fall within the merchant banking perimeter and allow merchant bankers to take credit risk.”

In March 2021, Sojo Infotel issued NCDs worth Rs. 260 crore, with Axis Capital acting as the sale arranger and Axis Trustee Services Limited serving as the debenture trustee. The repayment was secured, among other things, by a pledge of 26% of the shares of Lava International Limited held by Sojo's promoters.

After Sojo failed to fully honour a call option exercised in September 2023, Rs. 174 crore remained outstanding. Following an event of default, Axis Capital deposited Rs. 166.84 crore into the NCD escrow account in March 2024. The amount was used to repay the outstanding NCDs and interest. Axis Capital earned approximately Rs. 33 crore in fees from the transaction.

Following an inspection, SEBI initiated proceedings alleging violations of the SEBI (Merchant Bankers) Regulations, 1992. The Designated Authority concluded that Axis Capital's commitment effectively guaranteed repayment of the NCDs rather than constituting genuine underwriting and recommended a regulatory censure.

Axis Capital denied providing a guarantee, arguing that its obligation was limited to arranging a purchaser for the pledged shares or acquiring them if no buyer was found.

SEBI noted that Regulation 13A of the Merchant Bankers Regulations restricts merchant bankers to activities related to the securities market, while Regulation 22 permits underwriting. Although Axis Capital's role in arranging subscriptions to Sojo's NCDs fell within issue management, its obligation to purchase the pledged shares upon default arose from Sojo's failure to repay the debt and did not constitute genuine underwriting.

The Board also observed that the Share Agreement required Axis Capital to pay the debenture holders even if it could not acquire the pledged shares. The payments were non-refundable, and Axis Capital could recover the amounts only from the promoters.

Unlike conventional underwriting, where the obligation ends upon subscription to the securities, the arrangement ensured repayment of the NCDs and interest even if the shares were not transferred to Axis Capital. It said:

“This makes it clear that ACL was not merely acting as an intermediary responsible for arranging a sale, but had assumed an independent financial payment obligation of its own.”

SEBI also noted that CRISIL's rating rationale placed significant emphasis on Axis Capital's financial strength and underwriting commitment. The rating agency had expressly applied its criteria for instruments backed by guarantees, indicating credit support similar to a guarantee rather than mere underwriting.

Rejecting Axis Capital's contention that the rating agencies' assessments and the existence of additional security could not establish a guarantee, SEBI held that the substance of the arrangement mattered more than its description. It held:

“The fact that the Noticee's obligation would be triggered upon failure to find a buyer for the “Pledged Shares” does not change the “guarantee” like nature of the arrangement, because the ultimate obligation remained on the Noticee that it had to step in to ensure repayment of the NCDs.”

Further, it noted that the fee structure reflected compensation for the credit risk Axis Capital assumed, while its cumulative year-wise liability under the arrangement exceeded its net worth.

Accordingly, SEBI issued a regulatory censure against Axis Capital Limited for violating the merchant banking regulations.

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To Read the full text of the Order CLICK HERE