Explained: What prompted SEBI to flag Axis Capital’s underwriting activity & guarantee

After capital market regulator SEBI barred Axis Bank Ltd subsidiary Axis Capital Ltd (ACL) indefinitely from acting as a merchant banker for new debt issues over alleged violation of rules, the private lender said the investment bank believes that it was in compliance with laws and will operate in all other segments including equities. The bank also pointed out that its own business will have no material impact from the SEBI interim order. SEBI's action followed the release of a report written by eminent research analyst Hemindra Kishen Hazari. 

"Axis Capital is of the view that its merchant banker, arranger and underwriter related activities for any issue or offer for sale of securities in the debt segment were bona-fide and in compliance with all applicable regulatory provisions; and further no loss has been caused to any investor or market participant from such activities as on date,” Axis Bank said in a clarification in response to the SEBI order. 

“ACL has already discontinued and has not taken any new assignments as a merchant banker, arranger, or underwriter for any issue/offer for sale of securities in the debt segment in over a year now and is of the view that there is no material impact on ACL on account of the Interim Order. Based on the merits of the matter and prevailing law, ACL is evaluating all available legal remedies in respect of the Interim Order,” the private sector bank added. 

On a concall with Axis Bank, Zee Business had raised the issue of Axis Capital’s merchant banking practices in this particular matter. 

What’s the matter, really? This article will explain in detail what triggered the market regulator to take stern action against Axis Capital: 

SEBI’s interim order, dated September 19, prohibits Axis Capital from taking up new assignments as a merchant banker for debt securities.

According to the regulator, back in March 2021, Axis Capital provided a repayment guarantee to non-convertible debentures (NCDs)—a type of bonds—worth Rs 260 crore issued by Sojo Infotel, a holding company floated by the majority shareholders of phone maker Lava Group. However, In March 2024, Sojo was unable to settle their does owed to bondholders, which is when Axis Capital stepped in to pay the dues on outstanding bonds. 

According to SEBI, this act was not in compliance with merchant banking laws, with the regulator holding that Axis Capital’s guarantee was to "redeem the non-convertible debentures in the event of default on maturity", said SEBI, and so it could not be "termed as permitted underwriting activity". 

Axis Capital’s role “in the transaction went beyond the permissible activities as a merchant banker” as the guarantee “should have been limited to underwriting the issue at the time of subscription”, according to SEBI. 

Instead of market risk, Axis Capital took credit risk

As per law, merchant bankers are allowed to take the risk related to markets but not the risk of repayments in case an issuer defaults. Merchant bankers can also act as underwriters, which means they can subscribe to the unsubscribed portion of an issue.  

"ACL provided guarantee/indemnity towards redemption of NCDs in the guise of underwriting, which it was not permitted to do under the existing regulatory framework… Such activity poses risk to the financial system as it can potentially disrupt the orderly functioning of the market,” SEBI wrote in its order. 

SEBI has flagged improver use of Axis Bank’s rating and position by Axis Capital in acting as a guarantor and taking credit risk instead of market risk. Under the guise of acting as an underwriter, Axis Capital illegally acted as a guarantor, according to the regulator. 

It was this guarantee that helped Sojo raise funds amounting to Rs 260 crore by issuing NCDs to Aditya Birla Finance (Rs 150 crore), Sun TV Network (Rs 100 crore), and Ram Foundry (Rs 10 crore). Axis Trustee Services (Axis DT) acted as the trustee for the issue and Axis Capital was the arranger.

In January 2023, SEBI returned the draft IPO papers of LAVA International, asking the phone maker to refile the documents with additional information. LAVA had filed the papers in September 2021.

The delayed LAVA IPO dealt a blow to Axis Capital, which had pledged 26 per cent of the homegrown phonemaker in anticipation of significant listing gains roughly estimated to be three times of the worth of the NCDs. The Enforcement Directorate (ED) later took action against former LAVA International MD Hari Om Rai, among others, on charges of criminal conspiracy, cheating, and forgery. 

According to SEBI, Sojo Infotel is a private limited company incorporated on June 24, 2016. “It is engaged in the business of high technology consultancy services in the field of electronics, telecommunications and information technology including software,” the order mentioned. 

Sojo has four shareholders: 

• Hari Om Rai
• Sunil Bhalla
• Vishal Sehgal
• Shailendra Nath Rai

The promoters of Sojo were major shareholders of Lava international with a total stake of 82.24 per cent, as on March 31, 2021.

From fee of Rs 33 crore to loss of Rs 174 crore…

Axis DT declared an "event of default" against Sojo due to unpaid debts, which forced Axis Capital to meet its obligation to fulfill its "underwriting commitment" to recover Rs 174 crore. 
Axis Capital deposited Rs 166.84 crore into Sojo's escrow account, which, combined with existing funds, repaid the outstanding debt, as part of its guaranteed repayment to Sojo's bondholders as it was “unconditionally, unequivocally and irrevocably obligated to purchase or fund the purchase of the Pledged Shares”. 

“The commission earned by ACL was apparently spread over the period of such support enhancement or subsistence of guarantee. Accordingly, ACL has undertaken impermissible activities by providing credit support/credit enhancement/guarantee by mislabelling such activities as underwriting,” SEBI noted. 

Between April 1, 2021, and May 5, 2024, Axis Capital earned Rs 33 crore in fees through its merchant banking activities in debt securities.

“The commission earned by ACL was apparently spread over the period of such support enhancement or subsistence of guarantee. Accordingly, ACL has undertaken impermissible activities by providing credit support/credit enhancement/guarantee by mislabelling such activities as underwriting,” noted SEBI. 

Credit Enhancement on the basis of underwriting commitment of Axis Capital

From the rating rationale published by ICRA, the sole CRA for all the private placements in respect of the abovementioned issuances, it was noted that Credit Enhancement (CE) ratings were assigned to the issued instruments on the basis of the credit enhancement provided by Axis Capital in the form of the underwriting commitment. 

“Very clearly, the intent of the Regulations is to permit a Merchant Banker to take market risk by subscribing to the unsubscribed portion of the securities offered to the investors and to dispose of the securities so procured, by charging a fee. However, in the case of NCDs of Sojo, ACL provided credit risk cover to the subscribers of the NCDs issued by Sojo,” the SEBI order mentioned. 
The game plan was based on the LAVA International IPO 

Sojo Infotel issued NCDs worth Rs 260 crore in March 2021 to fund its purchase of Lava International shares. The plan was to repay the NCDs through the IPO or pre-IPO sale of Lava shares. However, Lava's IPO application was still pending with SEBI 15 months after the NCD issuance.

To meet the repayment deadline, Sojo's promoters made a partial repayment of Rs 60 crore in September 2022 by redeeming NCDs worth the same amount. This brought down the outstanding NCDs to Rs 200 crore. 

MD of Lava International arrested by ED and the Chinese angle...

According to news agency Press Trust of India, the Enforcement Directorate in October 2023 arrested four persons including the managing director of Lava International mobile company and a Chinese national in connection with a money-laundering probe against smart phone-maker Vivo, terming their activities detrimental to India’s economic sovereignty. 

The ED claimed in its remand papers before a local court that the alleged activities of the four enabled Vivo India to make wrongful gains. They four arrested were identified as Hari Om Rai, the MD of Lava International company, Chinese national Guangwen alias Andrew Kuang, and Chartered Accountants Nitin Garg and Rajan Malik. 

The agency told the court that Rai, “in collusion” with the three others “enabled Vivo, China to fraudulently establish a complex centrally controlled structure all over the country under the corporate veil of Vivo, India in circumvention of the extant FDI norms and by concealing the true nature of their ownership and control, by using forged identity cards. Thus, they cheated the government authorities and in the process enabled Vivo, India (controlled by Vivo, China), (to) acquire huge wrongful gains for themselves to the “detriment of economic sovereignty of the country”, the ED said. 

With inputs from agencies