Why RBI withdrew the most popular money market product collateralized borrowing and lending (CBLO)

Preamble

What prompted me to write this lengthy write-up:

Big Bang announcement trickled into print media

“To safeguard investors' money from misuse, an ASBA-like facility for trading in secondary markets will be available from January or February, SEBI chief Madhabi Puri Buch said at CII Global Economic Policy Forum on 8th Dec 2023.

This Application Supported by a Blocked Amount (ASBA) like facility already available for the primary market, ensures that the investor's fund gets moved only when the allotment is completed. Under the framework, funds will remain in the client's account but will be blocked in favour of the Clearing Corporation (CC) till the block mandate expires or till the block is released by the CC, or debit of the block towards obligations arising out of the trading activity of the client, whichever occurs first. Further, settlement for funds and securities will be done by the CC without the need for handling client funds and securities by the trading member.

SEBI, which has already reduced the settlement timelines to as short as one day after the transaction, is now looking to shorten the same further same-day settlement.”

The subject matter under reference is serious and purely based on the deliberated facts I have based my writeup. The instances are quoted to highlight the ground situation.

Complete details on the operationalization of the new scheme have not yet been announced SEBI chief said but said that it will be on the lines of ASBA.

I have adequate documentary proof in the form of crucial reports, and proof of active dialogue supported by paper and electronic communications with various associated regulator/s.

I am aware of the likely reaction/response to this write-up upon my sharing it with the concerned regulators. In the interest of justice, and the larger public interest, I felt I should express their matters in a controlled & calibrated manner, in e-media & print media, such that it will cause little damage to the credibility of senior officials representing such regulator/s.

To explain the central idea better I felt it appropriate to share a functional case. I therefore choose one case each from the domain of SEBI and RBI.

There are a few more alarming cases which are not shared as the sole purpose is to drive home crucial points, such that it will generate a healthy debate and the pressure if any built through the public reactions would compel the regulator/s to look at the validity of this and such crazy proposal/s, in future.

A few months ago when I came across a vague news item in the public domain I wanted to write but after seeing how these financial regulators both RBI and SEBI push things and function (as experienced for many decades of dealing with both) I was sure that this would be implemented despite serious objections and supporting pieces of evidence.

It appears people in charge of designing the schemes are focusing on software capability/ doability/ feasibility. For example, blocking unblocking or holding a releasing balance in the specific account is a technology aspect that is easily feasible but unless it has the strength/support of explicit law whether you term it a general or specific lien, lien in favour of named/unnamed third party, contingent lien, omnibus lien or a pledge, or a contractual hold, and so on courts may not recognize such holds to be legitimate.

Perusing the announcement under reference I know that neither the government nor the regulator was going to hold such a ‘Big Bang’ reform announcement, that would provide considerable visibility to its top officials, from its implementation though the relevant laws do not support such acts.

I wonder why no interest was taken by the regulator to ensure that a new scheme of things fits in the country’s legal framework and has a force of existing law such that it won't pose a systemic risk later.

No doubt the mechanism proposed by SEBI would help the settlement of secondary market trades and, among others, reduce the risk of brokers utilising the money till the pay-in, the regulator should remember that there is a risk of attachment of other accounts through orders issued by different laws enforcing agencies under respective laws or Garnishee order.

I repeat in these cases, blocking unblocking/holding releasing the funds are more technological aspects/concepts that do not have any support of existing law. Please read the legal aspects segment of the Aneexure-1.

Currently, a bailment, a pledge, a hypothecation mortgage etc are modes of creating a charge in favour of a third party. There are eligibility norms, a laid down process for creating such charges and stamp duty payable etc to follow.

Hold or block/unblocking is an operational aspect handled by technology. Just because it can be done through technology it does not give any legal force to ASBA bank/s to apportion funds blocked technologically.

For readers with no treasury or considerable finance background, it is important to know the concepts under reference.

Application Supported by a Blocked Amount (ASBA)

Investors can apply for IPO/FPO/Rights issue by authorizing the ASBA participating bank, Self Certified Syndicate Banks (SCSBs), to block an amount equivalent to the application amount in the relevant bank account (both CASA and term deposits). On intimation of allotment, the amount to the extent required is debited to the bank account. In the case of partial / no allotment, an amount for the unallotted portion is released to the applicant as unencumbered. Since the amount is blocked and not debited until allotment, the account holder will continue to earn interest on the amount held in the account.

The related legal aspects are elaborated on in Annexure-1

Collateralized Borrowing and Lending obligation (CBLO)

This new product was approved as a money market instrument by RBI. It was designed by Clearing Corporation of India Ltd. (CCIL) a company prompted by banks/PDs etc. It was not explicitly notified by RBI in the Gazette of India. Term CBLO represents an obligation between a borrower and a lender as to the terms and conditions of a loan. Members of the CBLO group who have excess funds were permitted to lend their funds and gain interest in this arrangement. Members who require funds were permitted to borrow funds by depositing the prescribed securities in a CSGL-Gilt account [with Clearing Corporation of India Ltd. (CCIL)]. Thus the lending was supposed to be done in a collateralized environment.

The related legal aspects are elaborated on in Annexure 2

Application Supported by a Blocked Amount (ASBA)

I am writing all this with responsibility and is not a loose talk. I do have documentary evidence to support what is stated herein.

Has SEBI examined/evaluated the fact that NRI cannot create a lien on the balances held in the CASA account (as per DBOD RBI circular dt:2nd July 2012), can mutual fund, FI create a charge on balances held in the current account? Whether lien favouring the third party be tenable? Is lien a charge etc? You may peruse the annexure-1.

SEBI had roped in ‘SCSB’ that is banks operating in India to achieve its goal of holding the blocked amounts in the account (without creating a valid charge) and banks are seen to be simply obliging without verifying whether they can have such an authority to do it (RBI is keeping mum over the whole episode of ASBA). I experienced through communications between SEBI and RBI that both were busy passing the ball into each other's court again and again. Bringing the matter to the notice of the government had yielded no results.

Age-old laws about pledges and hypothecation can be fine-tuned through an ordinance and amending the relevant statutes. The concept of a lien can be tuned to meet the current needs of society to accommodate its apportionment and payment to the third party. Remission/exemption in stamp duty can be considered through a special dispensation.

Regulators do have functional autonomy. It can take the matter with the Central Govt and impress upon the central government the benefits from amending existing statutes and getting the required support by getting relevant laws passed/amended getting dispensation or remission in the duty etc.

It appears that the regulators are not looking at these aspects and pushing the reform agenda without legal backing which would pose a serious threat to the market

A single instance can create panic in the capital market and could prove to be disastrous.

For simplicity and to keep the article write-up within the boundaries additional inputs for readers interested are provided in annexure 1.

The current chairperson of SEBI coming from a banking background may not be aware what were the limitations of ASBA despite it the previous leadership has pushed it through.

A series of pre-launch discussions with the officials of RBI and executives at Govt could help to align the product/s to the legal side it may however delay the product launch for which probably regulators are keen.

All the concerns mentioned in the article I had taken up with RBI about a decade ago and were taken up with SEBI by RBI (upon my insistence highlighting the inter-regulatory coordination and correction of serious lapses in the product design ASBA). SEBI chose to remain silent to various communications from RBI as it had no answer. Lien on the balances held in banking accounts is a domain of banks and should have been the concern of RBI. While RBI’s directions were clear on the NRE account it remained ambiguous throughout on other CASA accounts. In respect of term deposits, the legal position is different. The non-applicability of concept lien to ASBA was highlighted by a committee of a group of bankers (in its GoB report) to SEBI. SEBI officials have marked it as ‘a legal challenge’ and mentioned so in the board note and got approval from its board (kept it confidential from whistle-blowers like me).

Lack of coordination with other related financial market regulators on the issues falling in the domain of other regulators’ is another miss in ASBA. Except for requesting SEBI to reply to my concerns, RBI did nothing.

These aspects can be better understood if one peruses the annexures and relevant statutes.

I have a copy of all such communications exchanged between SEBI and RBI, me and RBI and SEBI and me.

It is unfortunate that SEBI did nothing to correct the situation in the last 10 years and the market is exposed to the risk. A new generation of market participants ‘from the SCSB segment’ may not be aware of this risk SEBI has put below the carpet, shirking to disclose in the name of national security and information held in trust etc though the chief information commissioner directed SEBI through its order (page 8) dt:28-11-20217 to disclose those details from report Group of Bankers to me.

Unfortunately, knowing fully well what is being done is completely incorrect and that this is likely to hit the financial system of the country very badly if things are continued and entities of Mallyas, Sahara, Nirav Modi and the like enter this segment.

This news item is it trigger point for this write up which is purely written in the larger public interest.

I felt that this write-up would not be credible if I made generic statements without narrating the relevant aspects of the case/s in brief. I have nothing against any person but against the whole system/process through which the issue was sidelined successfully for many years.

Omnibus or separate contract for lien, stamp duty is on one side technological and operational feasibility is another aspect. The legal aspect is completely overlooked. I wonder why otherwise active stamp authority is keeping mum over this high revenue leaking aspect of ASBA contracts.

A general observation about ASBA

What I notice is that everybody wants to bring in a change to make things easier to operate and bring efficiency to the system but while doing so it is necessary to look at the critical aspects such as legal backing, its tenability enforceability when things go wrong.

No doubt many new good things have been brought in by SEBI in the last couple of years.

In the ASBA matter SEBI's concerned officials used their might/power and foiled efforts to desist them from introducing such a product which is slippery on the legal front.

After many years SEBI is again attempting to broaden the scope of ASBA or like product and made sufficient background for its launching while it is aware of serious legal dangers.

This compelled me, in the larger public interest to bring these facts before the learned members of the public. I know despite this SEBI will go ahead as announced/proposed, the government will do nothing to ensure that the regulator follows the law of the land and does not introduce shaky products.

In the current scenario, I did expect that SEBI would push the Govt to make suitable amendments to existing laws such that the new ideas and products have complete legal backing.

It could also make efforts to address illegitimate things going along for many years despite being pointed out as serious concerns by many but had been put by SEBI’s earlier team ‘below the carpet’ so that the ongoing practices and new ideas being put forth now will become legally tenable. Many things can be streamlined by creating an appropriate legal framework around the idea and implementing it so that the systems would get credibility and enforceability.

Collateralised Borrowing and Lending (CBLO)

Concerning CBLO RBI’s attitude was no different than SEBI's. Collateralised Borrowing and Lending (CBLO) was one of the choicest products it had launched around two decades ago. If you peruse the details in the note and the annexure you may wonder why a Banking Regulator endorsed the product which was defective from top to bottom and was indicated so for many years. The product was finally withdrawn 4 years ago.

The gravity of associated implications cannot be fathomed by the common person hence mentioned necessary aspects in brief in Annexure-2.

After 5 years of rigorous follow-up at top levels at RBI, a few references to the High Court of Bombay, Honourable Supreme Court of India, close follow-up with the Inspector General of Stamps and to Govt of Maharashtra on the stamp duty evasion running in trillions of Rupees. RBI was confronted from all sides, it could not support CCIL (who produced the untenable opinion of retd chief justice of India etc) on stamp duty which was unanimously rejected by an expert committee formed by the Inspector General of Registration/Stamps (IGR/IGS).

RBI had replaced CBLO with a Tripartite Repo in G-sec introducing Clearing Corporation of India as a third party (doing the role of the central counterparty) to these Repo transactions.

This triparty repo is a contract of borrowing and lending of funds from the accounting angle but it runs through as a simultaneous contract of sale of security and its repurchase (the stamp duty implications are based on the substance of the transaction).

While approving such products regulator is expected to see that the law of the country is followed and is not compromised in any manner.

RBI both in CBLO and Triparty Repo is seen assuming that it is not the responsibility of the Regulator but it is the responsibility of the market players to check taxation, stamp duty and other legal aspects.

On the contrary side, the market assumes that the financial market’s relevant regulator (RBI, SEBI) has seen all the aspects including the enforceability of such transactions and compliance with all related statutes etc.

I am sure if readers peruse Annexure-2 on CBLO they will realise how casually RBI acted throughout and went to protect the Clearing Corporation of India Ltd (CCIL) and the product.

I had been rigorously following matters highlighting specific concerns, and related documents, in clear terms mentioning that what they are doing is not legally tenable and poses a serious threat to the financial market market.

Is it not the primary duty of the regulators to see if what they are doing fits within the boundaries of the statute of the land?

I repeat since the focus of the article is a bit different I am not elaborating the detailed inputs on these two products.

If I receive a request from readers to write separate articles on these products I shall consider writing with all the relevant inputs on this matter and do my sacred duty to create awareness around such pushy, aggressive acts.

Why the financial market regulators are introducing/pushing more and more risky unsound products in the financial market, not keen to correct inherent defects in such products by seeking the assistance of the government?

CBLO was one product which CCIL introduced to fulfil the immediate requirement of RBI when RBI decided to limit ‘the call money market’ to the bank's primary dealers and take out financial institutions' mutual funds from the market. It was introduced to give them an interim tool to park the funds. This product flourished due to the blessings of the senior Reserve Bank of India officials who knew the inherent defects but sidelined the concerns for almost 1 ½ decades.

I had many ongoing firm/tough communications with RBI. Finally, I sought interventions from the PGC Supreme Court of India, and the Inspector General of Stamps (IGR/IGS). When RBI noticed that it could not face these agencies it unceremoniously withdrew the CBLO product from the market however the loss of revenue to the exchequer was enormous. CCIL and RBI made all the hectic efforts to keep the product afloat but could not due to the huge leakage of revenue demand formally coming from the inspector general of stamps (IGR), the High Court of Mumbai entering the scenario.

More details on CBLO

Collateralised Borrowing and Lending (CBLO): This product was discontinued by RBI on 05th Nov 2018 after my tough communications with various departments of RBI, Gov of India, Insp Gen of Stamps, etc. for about six years. Insp Gen of Stamps wrote RBI about massive stamp duty evasion on CBLO products for the last 14 years by market participants (to which RBI showed ignorance).

CBLO was: A collateralized borrowing and lending obligation (CBLO) is claimed to be a money market instrument but does not appear in the definition of Money market Instrument nor explicitly notified by RBI under the gazette of India. CBLO represents an obligation between a borrower and a lender as to the terms and conditions of a loan. CBLO members who have excess funds can lend their funds and gain interest in this arrangement. Members who require funds can borrow funds by depositing the prescribed securities in a CSGL-Gilt account [with Clearing Corporation of India Ltd. (CCIL)]. Thus the lending was supposed to be done in a collateralized environment.

Corporates meeting specific criteria were permitted by RBI to borrow and lend in the CBLO market. While they may not be members of CCIL and do not have a funds account with RBI for CCIL to do Delivery Vs. Payment settlement. Hence their CBLO-related settlement obligations are met by the CCIL member entity. CCIL is a Pvt Ltd company formed by various banks and was a settling agency under the Payment and Settlement Act

I had raised serious objections to the product. Despite several dozen formal references/cross-references, RBI was not in a position to reply to simple queries/concerns like:

1. What kind of instrument CBLO is i.e. nature of instrument pro-note (DPN/UPN), Bill of Exchange(BE), Debenture, Secured Borrowing Agreement-cum deed of assignment, SPN, etc (if it is an instrument)

2. Text and wording of this so-called Money Market Instrument

3. Who is the issuer of the instrument i.e, who are the primary obligors,

4. Under which law it is held/converted in electronic form

5. Does CCIL have the power to Issue CBLOs and hold them as a depository

6. Does CCIL have the power to Borrow and Lend?

7. Whether the settlement agent has the power to run the stock exchange like a platform on a private network without SEBI’s license

For many years RBI was dodging matters on one or another pretext

I have highlighted many times stamp duty evasion of trillions of rupees and taxation deduction at source on interest, aspects, and many more serious concerns. They were brushed aside by RBI.

I wondered, does it sounds good and acceptable if the Banking Regulator (RBI) states that the regulator who has approved the product and introduced the product to the market is not responsible for looking at different dimensions associated with the product such as tax deduction at source (the Income Tax Act) and stamp duty applicable to such instrument of borrowing and lending (which is transferable and creates certain rights and obligation between the parties concerned) claiming that RBI is not responsible for these aspects of the product RBI had approved.

From all the to and fro correspondence on the subject with RBI, I summed up and wrote to the honourable High Court of Bombay and also to the honourable Supreme Court of India in my referred Public Grievance case:

“ CBLO is a Money Market Instrument (without its existence either in physical or depository form of instrument), no one knows the nature of this instrument (debenture, pro-Note, Bill of Exchange agreement of borrowing etc) which is supposed to be evidence of financial transaction of collateralized borrowing and lending for tenure between 1-365 days, against Govt Security (no one knows issuer), no one has ever seen the text wording of such Money Market Instrument, Lending under it is treated as investment by lender, such investment (CBLO) can traded in the Secondary Money Market, completely fungible across the obligors/borrowers of same maturity product, with CCIL as primary obligor –cum- guarantor -cum -settlement ‘novator’ (all in one), no one ever pays stamp duty on this instrument nor deducts TDS on the interest on the underlined borrowing, no one ever bothered to check the appropriateness / validity/legal tenability of the manner in which charge on the Govt security is created (said to be collateralized), dematerialized or brought into electronic mode and transferable in electronic mode by a non-depository (CCIL) without any payment of stamp duty on its transfer, approved by RBI, dealt across by various players in financial market regulated by IRDA, SEBI & RBI and unregulated players like large corporate, claimed to be unique financial product and that wonderful part is it is contracted/dealt for over Rupees trillions per day”.

I wrote to RBI that if a corporate client like Nirav Modi, Mehul Choksi, Vijay Mallya, or Sahara borrows and defaults a considerable amount of CBLO repayment obligations and becomes bankrupt. Suppose their lawyers challenge the charge of underlying government security in favour of CCIL before a civil court. In that case, it will be held to be defective (termed an imperfect charge, a charge not created adequately as per the legal provisions). I wonder how the waterfall mechanism or loss allocation process stated by RBI will save the financial markets. Will the Bank/ Institutions engage in the settlement process for its corporate shell out, or will CCIL own the contract as contractual Novation, or will it stand by its so-called guarantee?

Thus when trades of corporate members are taken for CCIL settlement, the CCIL member participating runs a considerable risk. There are allied issues surrounding this product, and I have challenged every aspect RBI chose not to reply from a legal perspective.

I had brought to the notice of RBI, MoF, and finally to HC of Bombay and SC of India that CBLO is ill-conceived, illegal, untenable, defective from top to bottom, and technically a ‘fraud’ product that can pose a severe threat to the financial system within India and capable of bringing a bad name to the Indian Financial System / RBI, etc. in the international scenario.

In my reference to PGC, HC of Bombay I had mentioned, that I know the product inside out from its birth. It was launched in a great hurry and had suffered several serious shortcomings. After a couple of references highlighting concerns, attempts were made to suppress the lapses instead of correcting those deficiencies and correcting the product by fine-tuning it following the law. I am looking to the High Court as a last resort to avert the systemic risk.

Outstanding market holding in this instrument at any point in time was then close to Rupees trillion 1.20 and a severe threat to the credibility of this product will shake the financial and related markets of the country After the honourable supreme court of India took up the reference for consideration, stamp authority vigorously seeking RBI on the massive loss to the exchequer on account of stamp duty evasion, fine, penalty (initiated vide its letter D5/stamp-17/LR 07/2017/270-73/17 dt: 18-03-2017) seeing no chance to pull on it unceremoniously withdrew CBLO and introduced a third-party repo.

Stamp duty evasion running in trillions of rupees (which could have resulted in a collapse of the banking system of the country) was one of the major issues apart from 1 to 7 above.

It got out using its might and position as a Central Bank of the country, the constitutional power, clout it has with the Government. It just unceremoniously shut (dismantled) the product and kept quiet. Govt of Maharashtra/IGR kept quiet over huge tax duty evasion.

Summing up

As mentioned elsewhere in the document readers who wish to know related technical aspects of both matters, in brief, may peruse annexure-1 and annexure-2.

I have not gone deep into the respective cases as the focus of the article is the need of financial Market regulators namely SEBI and RBI to see their actions are within the framework and are supported by the law of the land. At least regulators could take the lead and suggest the government amend the relevant statutes such that it would support the initiative already taken or contemplated and that the actions of regulators would not pose systemic risks. Regulators have to work within the framework of the statutes, and rules framed under the respective statutes and not suppress the legitimate legal concerns in this manner.

I have full documentary evidence which can be shared upon request by interested reader/s, in the broader public interest. I may even consider writing on each case referred separately for the benefit of readers if I receive such requests.

I wonder why eminent lawyers and the judiciary did not take the matter seriously, in the large public interest?

Wrap-up

It may not be possible to unscramble the scrambled egg but at least one can prevent another egg from being scrambled and bring in additional systemic risk. To generate debate on this point I thought it fit that I should pen on this issue.

I hope and wish that SEBI will address the concerns on the table relating to ASBA, in coordination with the Reserve Bank of India, Government before the concept is extended to the secondary market trades, as proposed from January 1st 2024, and add fuel to the current situation mentioned in this writeup.

Regulators will evaluate all dimensions of any new product going to be introduced by them, on such a massive scale, having a huge impact.

Annexure-1

Application Supported by a Blocked Amount (ASBA)

Relevant legal and other inputs

Legal Position of Lien I Pledge I Set-Off

Lien, pledge I Hypothecation are colloquially treated as the same. However one may note that pledge I hypothecation is a charge created through an appropriate agreement and can be against the contingent debt whereas a Lien cannot be against a contingent contract and can be through an appropriate agreement or by explicit legal provision as in the case of General I Banker's lien.

While collateralizing any security banker gets an agreement of Pledge/Hypothecation executed and loosely terms it as registration of lien. In cases such as balances held in the account even though the agreement of Pledge/ Hypothecation is not executed, it does not pose any legal problem to bankers as balances held in the account by a banker are subject to general lien (being a banker). For General Lien, no explicit contract with a customer is required. Thus bank can hold the credit balances due by it to the customer till it's due are paid.

The dues of a client to the bank are important for the banker's lien. The banker also has a right of set-off under which it can appropriate funds that are due to the customer against dues of the customer to it (subject to meeting certain conditions) whether such balances are subject to a lien or not. Thus lien is right to hold. hold and hold. It does not give any right to the bank to set off.

For General Lien, no explicit contract with the customer is required. Thus bank can hold the credit balances due by the bank to the customer till dues to it are paid.

The banker also has a right of set-off under which it can appropriate funds that are due to the customer against dues of the customer to the bank (subject to meeting certain legal conditions) whether such balances are subject to pledge/lien or not. Thus lien is right to hold, hold and hold. Banker has this explicit right of set-off available under the law. In the event of attachment orders bank can first set off the credit balance in the client’s account against the dues by the client to it (in the absence of a contract to the contrary) and may attach only the balance amount.

In the context of ASBA: Blocking is neither a Lien nor a Pledge nor Hypothecation. While blocking and unblocking·can be a technological aspect the presence and absence of legal backing decides the legal enforceability. Thus the amount blocked can be any time easily proclaimed as illegitimate and becomes null and void.

RBl has considered this aspect while instructing banks vide its circular DBOD dt 200 July 2012. RBl had stated that in respect of account holder of NRE savings deposits can withdraw the savings deposits at any time and therefore, banks should not mark any type of lien, direct or indirect, against these deposits and that as regards domestic saving deposits, banks may follow the guidelines issued by IBA I existing practices approved by their Board in this regard.

I am not sure as to why RBI did take the same stand for domestic savings deposits and left the matter to IBA or existing board-approved practices (No IBA guideline exists on this matter and no bank's board had probably spelt any policy on this).

Concerning the lien on NRI’s funds please peruse what RBI has stated:

NRE savings deposits can withdraw the savings deposits at any time and therefore, banks should not mark any type of lien, direct or indirect, against these deposits as regards domestic saving deposits, banks may follow the guidelines issued by IBA / existing practices approved by their Board in this regard.

The ASBA-backed application can be at the most said to be certification and can be said to be similar to marking cheques/instruments good for payment, as a banking practice, is not looked at in favour by Indian Courts. Certifying the ASBA application/instrument by ‘SCSB’ is like marking an instrument good for payment physically with legal backing.

Attachment orders /Garnishee Order

Impact of attachment orders, in the absence of proper charge / legally tenable document that would support the SCSB to hold legal control over the amount and pay the amount to Registrar on account of ASBA bidder (who may not be even a client of the bank), needs to be carefully examined. In the absence of a charge, holding control over funds, to secure a contingent claim may not go well with the courts. Notwithstanding its fate the SCSB would be liable to pay, the registrar on par with the invoked Bank Guarantee and later suffer financially.

High risk due to entry of big stakeholders One can imagine the impact of attachment/one non-payment on the whole process of allotment of issue.

If ASBA is to be considered a Bank Guarantee

Under the ASBA application, SCSB guarantees the Registrar that it would on-demand pay the Registrar a sum up to the ASBA Bid. One may claim that commitment/guarantee is against collateral (!) of ASBA. The banking regulator may need to clarify the regulatory view on these transactions as its treatment as a Guarantee has cost implications.

If ASBA is said to be like pledge/hypothecation (not being lien, given the above) what it is and under which existing law such creation of charge will be treated as valid and tenable?

What is the status of such a charge in the case of MF / FII on the balances held

Whether MF/FII can create charge/security interest on CASA balances in favour of the bank. Though blocking, per se, may not be equal to (legally) the creation of a charge, proper resolutions need to be taken to ensure that banks are not dragged into litigation.

Executive Summary ASBA

Background

In Initial Public Offerings (IPO)/FPO to apply for shares/bonds/MFs investing public had different payment options namely Cash/cheques / DD etc. SEBI in the year 2009 introduced Application Supported by Blocked Amount (ASBA) as an additional mode to pay for the IPO of shares/MF. First two years it continued to be one of the several modes of payment. It was not a compulsory mode of payment for everyone be it FII, PFI, HNIs, Retail investors, who apply for IPOs/FPO.

For 10 years, ASBA as a mode of payment has been made compulsory (made as the only payment mode). In ‘ASBA’ mode the funds remain in the account of the account holder but the IPO applicant can apply on the strength of the balance (kept under lien termed by SEBI as blocked) in the said account (which may or may not belong to him/her). Upon intimation of the actual allotment of shares/debentures, required the amount is called for by the issuer and is paid by the banker, to the debit of said account (against so-called implied mandate) to the Issuer Company / MF.

‘ASBA’ was a hurriedly introduced product in the year 2009 without giving appropriate thought or adequate groundwork. Since it was a brainchild of the then chairman of SEBI (Mr.Bhave) there was a lot of pressure to introduce it soon also with a lot of fanfare. Hence, while banks had deliberated several serious/vital aspects they were overlooked and termed as ‘legal challenges’ and set aside/pushed below the carpet(?) by SEBI.

Under ASBA, investors can apply for IPO/FPO/Rights issue by authorizing the ASBA participating bank, Self Certified Syndicate Banks (SCSBs), to block an amount equivalent to the application amount in the relevant bank account. On intimation of allotment, the amount to the extent required is debited to the bank account. In the case of partial / no allotment, an amount for the unallotted portion is released/unblocked. Since the amount is blocked and not debited until allotment, the account holder will continue to earn interest on the amount held in the account.

‘ASBA’ is a conditional authorization by the account holder to his banker to pay to the issuer of shares/bonds/MF unit’s shares/bonds/MF units up to a certain amount subject to the allotment (a contingent event). One can use the balance held in his/her account to pay for the application for shares/bonds/MF units shares/bonds/MF units of the third party. It is an application against earmarking balances held in an operative account. This gives adequate scope for Money laundering and/or submitting multiple applications to improve the chances of allotment using applicants who would not have applied due to not having funds.

The amount withheld in the account (referred to as a blocked account, in IT jargon) is neither a pledge/ hypothecation nor a ‘lien’. There is neither specific nor omnibus documentation to support it. It is a facility given by all banks to all their SB/CD (CASA) customers. No document on ASBA refers to what the blocking means in its legal substance. E-blocking / withholding funds without any supporting mandate and documentation has no legal backing as it is not a valid charge. As such any attachment order / Garnishee order on the gross balance maintained in the operative account has precedence over the so-called blocked funds.

SEBI should have examined the legal aspects associated with the blocking of balances, its maintainability visa-a-vis Garnishee order, statutory / IT /direct taxes attachment orders and several aspects as stated in the attachment to this summary.

In the late 1950s, there existed a concept of cheques marked ‘good for payment’. However, the concept of marking goods for payment was not recognized by courts and hence had its end in the early 60’s.

In the mid-90s there was a capital market product called ‘stock invest’ (this was against the term deposits). This was a better product as there was a proper legal mandate from the customer. It had several operation issues as it was against term deposits. This product failed, became redundant and was later abandoned, and withdrawn officially.

SEBI designed this ‘ASBA’ product which is ‘old and discarded wine in a new bottle’ and pushed it by forcing the main merchant bankers and SCSB Banks to accept ‘ASBA’ despite bankers' concerns. No stamp duty is paid on the ASBA instrument or transaction as no hypothecation, pledge or any charge is created. The lien is not a charge. No charge in favour of a third party can be created as per the existing law of this land.

ASBA few working notes

The dues of the client to the bank are important for a valid lien. A lien in favour of the third party and also a lien against a contingent contract have no legal validity. Mere blocking is neither a Lien or a Pledge nor Hypothecation. Blocking/unblocking can be termed as a technological mechanism of the system holding money, while the presence and absence of the force of law would decide its legal validity and enforceability.

In ASBA no instrument creating legal rights and obligations is ever created. That is one major cause for concern. I have been raising this serious and basic concern with SEBI and also with RBI (in writing) for the last 5-6 years. No action has been taken nor contemplated as yet.

Under the ASBA mechanism, SCSB guarantees the Registrar that it would on demand pay the Registrar a sum up to ASBA Bid. One may claim that commitment/guarantee is against collateral (!) of the balance held in the ASBA (CASA) account. The banking regulator may need to clarify its view on these transactions (if it is treated to guarantee as it has capital cost implications).

The bid submitted by ‘SCSB’ under ASBA is an implied guarantee. However, banks do not account for it as a guarantee and appropriate any risk capital against it. This is just like LOU or Letter of Comfort Punjab National Bank junior officials had issued in the latest case of Viral Modi and Choksi (Scam) which had led to a lot of issues that will have a cascading effect and will bring ripples in the banking sector.

Though ASBA product features are helpful for the market if both regulators were concerned rather than tossing the ball into ‘each other’s court’ both could have focused on bringing about required legislative changes, if any, to get the product fully legally compliant and to avert systemic risk.

No satisfactory replies were given to me over the concerns raised in a specifically called ‘my meeting with SEBI’ in the year 2013-14.

Efforts to get required information using the RTI query route proved futile / foiled by SEBI citing the following:

“Information sought hereinabove has strategic or commercial confidence angle to it. Information impacts the competitive position of someone or amounts to sharing confidential judiciary information and may impact countries economic interest.”

Sharing information Knowledge of how a capital market regulator found a successful workaround to legal challenge actually would have added confidence and credibility of SEBI.

Given the magnitude and volume of transactions that are taking place and going to take place in future (being a senior banker who has worked in this field for four decades), I felt that the persistent legal deficiency has the potential to be a systemic risk and took the matter with judiciary (PGC) who did not do anything except directing SEBI and RBI to look into the concerns and address them. No response from either.

Stamp authorities had sought specialized assistance from Govt of Maharashtra Finance dept. to decide on the quantum of stamp duty on ASBA transactions.

Final observations

Regulators (SEBI and RBI) are expected to respect the law and work within the existing legal framework, act swiftly, especially when the lapse has been brought to the notice of those concerned.

Any regulator whether it is SEBI, RBI IRDA, or PFRDA should operate within the boundaries of the law and the regulations framed and the rate it should do nothing that violets the law and approves things unless it has been deliberated and the government supports such steps taken in the larger public interest. It should not do anything to keep the government in the dark and should make sincere efforts to rectify lapses when there pointed out rather than surprising or pushing them below the carpet and ignoring the larger public and national interest

Even if the intent is good, crossing the boundary (and ignoring the serious systemic risk) is not expected by financial regulators.

Annexure-2

Collateralized Borrowing and Lending obligation (CBLO)

Relevant legal and other inputs

Executive Summary CBLO

Corporations meeting certain criteria are permitted to borrow and lend in the ‘CBLO’ (a short-term investment) product. Daily traded volume/issuance is around 1.20 to 1.25 lac crores (.12 trillion)

The product was launched in a great hurry more than a decade ago. Commercially this product has been a success. Despite the serious deficiencies I had pointed out and my continuous correspondence with RBI, it is observed that RBI was in no mood to correct its serious lapses and wanted to go ahead without looking at its prime responsibility to see that the instrument it supports wholeheartedly is strong on the legal wicket. A proper review of the product should have been taken much earlier.

CBLO

A collateralized borrowing and lending obligation (CBLO) was claimed to be a money market instrument but did not appear in the definition of a Money market Instrument/s nor explicitly notified by RBI under the gazette of India.

It was launched by the Clearing Corporation of India Limited (CCIL) in 2003 to provide liquidity support to non-bank entities, who are restricted from accessing funds from the Call Money Market.

This product was discontinued by RBI on 05th Nov 2018 after my tough communications with various departments of RBI, Gov of India, Insp Gen of Stamps, etc. for about six years.

RBI was not been able to reply to me in the last couple of years following basic questions:

1. What kind of instrument CBLO is? i.e nature of instrument ProNote (DPN/UPN), Bill of Exchange(BE), Debenture, Secured Borrowing Agreement-cum deed of assignment, SPN etc (if it is an instrument)

2. Text and wording of this so-called Money Market Instrument CBLO

3. Who is the issuer of the instrument i.e. who are the primary obligors?

4. Under which law it is held/converted in electronic form?

5. Does CCIL have powers to Issue CBLOs and hold them as a depository?

6. Does CCIL have the power to Borrow and Lend?

7. Whether the settlement agency (CCIL) has the power to run the stock exchange-like platform on a private financial network through CCIL’s fully owned subsidiary, without SEBI’s license

In the last 14 years, no one* precisely knew: (*including the designer and approver of the product)

• What kind of instrument CBLO is: Is it demand Pronote? Is it a Bill of Exchange, Is it NCD? If none what is it?
• No one knows the text/wording of the instrument neither CCIL (who is stated to be its creator/designer) nor RBI (who approved it).
• Who is the issuer of CBLO (whose primary financial obligation it is)? Borrower or CCIL (acting on behalf of Borrower)?
• RBI states that CBLO is in the form of a ‘demat’ / ‘book-entry’ form. In some places, it is referred to as Electronic Instrument. CCIL is not PSU. It is formed by banks as a company under the Companies Act. It is not formed under an Act of Parliament. It does not have the right to hold securities issued by it (its primary debt obligations) in the book-entry form (as it is not under its statute).

Even if one assumes that CBLO is a legitimate Money Market Instrument and as per Regulation 28 (b) of Depository Regulations,1996 it can be dematerialized, the dematerialization has to be by a depository and the process prescribed under it is required to be followed.

Further, CCIL is not a depository. The depository is licensed and Regulated by SEBI

• CCIL cannot Borrow or Lend on its name but then how does it ‘novates’ (novation*) the contract under Sec 62 of the Indian Contract Act* step in that capacity?
• The product was never notified in the Gazette of India. It is not clear whether RBI had the authority to introduce such a product in Jan 2003 in the manner it was introduced through the Monetary Policy announcement. The RBI Amendment Act, 2006 also doesn't grant powers to RBI to introduce a Money Market instrument.
• Stamp duty is not paid on the instrument. Stamp authorities have reported huge tax evasion to GoM and started an active dialogue with RBI to demand dues retrospectively.
• It being borrowing interest on borrowing should be subject to TDS on interest.
• The concept of ‘lien on Govt security’ was legally invalid when the product was introduced in the year 2003. As of date, the concept is legal but the process stipulated in Govt. Securities Regulation, 2007 for the pledge, Hypothecation is not followed to create beneficial interest/charge/lien over the security as such lien/charge will certainly not be enforceable and interest of the lender would be jeopardized. In the event of the non-availability of the security due to legal hurdles, the lender may knock doors of CCIL (supposed to be the guarantor) for the underlying transaction whose worth may be very inadequate given the size of the financial transaction.
• For ‘collateralized borrowing’ it is not clear “Lien” is in whose favour as the lender is anonymous. If it is CCIL can CCIL as a company Lend and Borrow funds from financial market players and if yes, for what period? Who has to collateralize whose borrowings with whose security and in whose favour?
• If CCIL /Clear Corp Ltd become a counterparty the exposure would rest on CCIL. If CCIL is a counterparty then how same party can become a guarantor for the CBLO trade settlement?
• RBI stated that CCIL will create, hold, credit and transfer CBLOs (meaning a CCIL as Registrar and Transfer Agent, more so function like a Depository and DP). Who gave this authority to RBI?
• On fungibility of CBLO maturing on one single date: If there would have been trades in the secondary market, in electronic mode, one would not know the ‘Obligor’. No one knows it is whose obligation. Netting is freely done by CCIL. This will certainly pose a problem in times of insolvency of any borrower if such a borrower happens to be corporate like Vijay Mallya, Nirav Modi or Sahara Group. If a corporation (say Vijay Mallya Company or Sahara) defaults for a huge amount of CBLO repayment obligation and/or becomes bankrupt and if the charge on underlying government security in favour of CCIL is challenged by their lawyers before civil court it will held to be defective (termed as imperfect charge- charge not properly created as per the existing legal provisions) I wonder how the waterfall mechanism or loss allocation process stated by RBI in its reply will save the financial markets. Will the Bank/ Institutions engaged in the process of settlement for its corporate shell out or will CCIL own the contract as contractual Novation or will it stand by its so-called guarantee?

Thus when trades of corporate members are taken for CCIL settlement the CCIL member participating runs a huge risk. There are allied issues surrounding this product. I have challenged every aspect to which RBI chose not to reply from a legal perspective. All responses till now had been evading.

• I was worried that a situation is not far off if borrowers like Mallya, Sahara who are in the CBLO market, default and their lawyers present the real legal side of the CBLO, challenge the charge rights and liabilities of borrower, and lender over the security etc.
• Being a product of ‘Systemic risk’ financial Regulators may face awkward moments in the event of legal cases arising. Thus in the above situation loss allocation process as per CCIL membership Regulation would become applicable. If CCIL is a central counter party how and why loss allocation should be of any concern to participants?
• CCIL has not set up the Settlement Guarantee Fund as required by RBI and is dependent on the waterfall mechanism. Corporates who are not members operate through CCIL members and members own settlement risk for such non-members. Does it not equal to member bank guaranteeing the obligations of participating corporations?

Stamp duty evasion of trillions of rupees (I mean the figure and have a copy of the stamp authorities unanimous report, obtained formally under RTI) and a few other serious concerns have been brushed aside

I wonder whether it sounds acceptable if the banking regulator states that the regulator who has approved the product and introduced the product to the market is not responsible for looking at different dimensions associated with the product such as stamp duty applicable to such instrument of borrowing and lending (which is transferable and creates certain rights and obligations between the parties concerned) claiming that it is not responsible for these aspects and it does not have answers to following:.

• What kind of instrument CBLO is: Is it demand Pronote? Is it a Bill of Exchange, Is it NCD? If none what is it?
• No one knows the text/wording of the instrument neither CCIL (who is stated to be its creator/designer) nor RBI (who approved it).
• Who is the issuer of CBLO (whose primary financial obligation it is)? Borrower or CCIL (acting on behalf of Borrower)?

In fact in the background history of scams such repeats could shake the image of the country and also the credibility of regulators.

Believe me, all the above statements come from a very senior and responsible banker who has in-depth knowledge of this worked for over 25 years in the bank’s treasury in a senior supervisory position and related field for 35 years and has been Ex CEO of FIMMDA.

Stamp authorities had sent 3-4 communications to RBI and CCIL (RBI did not respond). IGR, Stamps was in the process of submitting a demand notice (a huge demand mind-boggling sum of around Rupees in trillions) being the stamp duty evaded by the market on CBLO. I have formal documentary evidence which I can share.

I feel any regulators should work within the framework of law and also look into public interest. No regulator has unlimited rights to operate in an uncontrolled manner just because it has been assigned the role of regulator.

It is improper for RBI to state in one of its replies: “It is open to RBI to allow the introduction of CBLO, operation of the product with such conditions, regulation and limitation as may be decided by RBI for the purpose” (FMD, RBI letter dt: 14-12-2012).

If one peruses all the above inputs concerning the most popular market products ASBA and CBLO (only two examples are included in this reference write-up) one may know whether the concerned are performing their role effectively.

Chronology of major events relating to product CBLO matter

• I have been in active correspondence with RBI since the year 2012. At least 40 ‘to and fro’ communications with RBI at CGM, ED level. Met RBI ED in 2015 who assured initiating corrective steps
• As nothing moved significantly, approached the RBI governor in the year 2016
• Approached the High Court of Bombay in April 2017. Responding to the High Court of Bombay’s advice to RBI, RBI replied to me but completely evaded all core points of my concern listed above.
• I reported the matter to Ministry of Finance through email and to the PMO office in Feb 2018 (no acknowledgement from either of them till now).
• No corrective action was taken by the RBI Governor on the reference to set right. RBI is not willing to share the notes on the subject quoting some excuses.
• I had a press conference with another RTI activist, highlighting part of the concerns (only stamp duty violation) reported widely in e-media & press
• As the case did not fit in the current norms set by the honourable Supreme Court of India reference did not get a PIL tag with the SC of India.
• RBI brushed evaded/shirked from its responsibility in ensuring the compliance to overall compliance of products that were last dealt in Rupees trillions daily (Rupees 1.2 Lac crores per day)
• CCIL did attempt to misdirect the stamp authorizes and procured legal opinion from the retired chief justice of a supreme court of India misdirecting the concerned
• Stamp authorities had formed a working group and decided to levy stamp duty on CBLO transactions. Even if no penalty levied by the stamp duty burden would have caused the liquidation of CCIL and posed a serious threat to the credibility of RBI.