The Market Regulator’s Stride Towards Going Blockchain

In furtherance of the steps taken by  it to strengthen the process of security creation, monitoring of security created, asset cover, and covenants of non-convertible securities by introducing a framework for the same in August 2021 (the “August Framework”), the Securities and Exchange Board of India (“SEBI”) now strides by issuing detailed operational guidelines for the ‘Security and Covenant Monitoring System’ (the “System”) on March 29, 2022 (the “Operational Guidelines”), basis the recommendations of a working group created for this purpose.

Vide the August Framework, SEBI had specified the manner of recording of charges by issuers and manner of monitoring by debenture trustees (“DTs”) and credit rating agencies, among others, and specified that, w.e.f. April 01, 2022, the recording of asset details (and their verification), allotment, listing, and payment of interest or redemption shall be available in the distributed ledger technology (“DLT”) based system – which shall be created, hosted, maintained, disseminated by the depositories to record the information, and any changes thereon.

The August Framework provides for detailed roles and responsibilities of each stakeholder in relation to recording of information related to security creation, asset cover, covenants, interest and redemption payment, and credit ratings of relevant securities into the System, and adhering to the reporting/ monitoring obligations.

Applicability of the Operational Guidelines

All issuers that propose to issue non-convertible securities on April 1, 2022 or thereafter, are required to record the relevant details in the System prior to activating the international securities identification number (“ISIN”). Similarly, depositories have been advised to unfreeze or allot an existing ISIN, only after the relevant information has been recorded in the System.

However, it is pertinent to note that relaxation is provided till July 1, 2022 to issuers unable to record details, with due explanations to depositories. Further, existing outstanding non-convertible securities are required to be updated into the System by September 30, 2022 and DTs are required to verify the information in the System by November 30, 2022.

Uniqueness of Asset

One of the crucial features of the System is the ability to maintain uniqueness among assets, by way of a system-generated unique identifier i.e., a 12-digit alphanumeric string as an asset ID. The uniqueness of each asset ID is further ensured by the System by providing alerts to issuers and DTs to identify and address possible duplicate entries, based on specified parameters.

The responsibility to ensure that each asset is entered only once into the System falls on the issuer, subject to verification by the DT. In case of duplicate / near duplicate asset entry, an alert shall be sent to the issuer and the DT upon detection of such duplication – the issuer and DT shall then verify the details entered in the System for the relevant asset and be able to override the system-generated alert after its verification.

In the initial stages, following assets will be tracked at the portfolio level:

• Movable assets namely, furniture, equipment, inventory, etc.;
• Current assets namely, portfolio of advances/receivables etc.; and
• Any other asset of a similar nature.

Trigger Events

Whilst the depositories are required to ensure that only one unique asset ID is assigned to each asset of issuer, DTs will annually reconcile the assets recorded in the System for an issuer and take necessary steps to eliminate duplicate entries, if any, and verify the relevant security cover and take remedial actions, if required.

In case an event causes a reduction in the security cover below the prescribed limit in terms of regulation 54, SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, such an event shall be termed a ‘trigger event’ and in relation to such trigger event, (i) the issuers shall forthwith update the System; and (ii) the depositories shall send alerts to all stakeholders.

Going forward

The System is envisaged as a quasi-registry of charges to help achieve the objective – “what is the value of security that a charge holder has and who all does it shares with”. Whilst the System is in its infancy, its success or lack thereof could have far-reaching implications on the regulatory attitude and temper towards blockchain and DLT.

The System certainly has a lot of advantages like continuous monitoring, robust audit trail, improved transparency, thereby increasing investor confidence. Leveraging DLT is certainly a visionary stride which could provide a more resilient system than the centralised databases of today whilst enhancing the protection against cyber-attacks etc., credit to its distributed nature, which removes the single point of attack.

However, one must be cautious in inferring foreshadows/hints of crypto regulation basis the update, as the Union Government’s stance has been, even in its staunch-ban-crypto days, to harness and effectively deploy the underlying technology, agnostic of the fate of crypto trading. Even so, equal caution is advisable in understating the importance of this first major regulatory deployment of core blockchain technology.