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Debenture and its presence in Nepal

Jul 03, 2019
Debenture and its presence in Nepal

Background

Every corporate organisation, no matter how big or small it is, and no matter which area of scope it is operating in, the requirement of capital/ fund is always inevitable. Capital is regarded as the most essential of all the elements for any organisation to perform well. The adequate supply of capital results in proper utilization of organisational resources whereas the inadequate supply results in negative growth of the organisation. No business can ever run effectively, efficiently and successfully without the availability of adequate amount of fund. However, the arrangement of the fund as per the requirement of the organisation is a very tedious task. In general, such funds may be raise through internal sources i.e. issuing of new equity share or the profit organisation have had made or through external sources i.e. borrowings, bank loans, public fixed deposits, debentures etc. Equity shares are generally issued during the establishment of the organisation or when organisation is going through the tough situation and no other options of raising capital can be utilized. However, Equity shares most of the times is not suitable owing to various reasons due to why the organisation may need to heed to external sources such as borrowings, bank loans, public fixed deposits, debentures etc. Arrangement of funds through external sources are much beneficial for the organisation compared to the internal resources because of the fact that funds through internal sources find it difficult to meet the financial demand of the organisation for long run. Out of various available external sources, it is up to the decision of the management of the organisation to decide the best source of raising fund which is cost effective and as well as efficient. Out of all the various sources available, issuing of debenture is also one such way to address the requirement of the fund.

Introduction: Debentures

Debenture is basically a loan amount the company raises from the public based on the past and current financial performances and projections and as well as the performances of the organisation. A person who has bought a debenture and holding it is called a debenture holder. A debenture holder is the creditor of the company. Debenture is a document with a commitment of the company to attain certain goals and is also an acknowledgment of the funds received by the company. It is the payment of interest at a fixed rate till the times the principal sum becomes repayable to the debenture holders. The document issued by the organisation all the details such as the date of redemption along with the rate and mode of payment of interest. Though the issue of debentures is also one of the method for raising capital from the market, however, it is comparatively different than other sources such as preference shares, bonus shares, equity shares, rights issues, borrowings, public fixed deposit etc. Further, the essence of debenture is such that it is issued to the general population and not to the certain group of people. Debentures may or may not be converted into the stock, considering the rate of interest paid to the holder and as well as the condition set forth by the by the issuer.

Thomas Evelyn defines debentures as, “A debenture is a document under the company’s seal which provides for the payment of a principal sum and interest thereon at regular intervals, which is usually secured by a fixed or floating charge on the company’s property or undertaking and which acknowledges a loan to the company”.

In short, debenture is an acknowledgement of a debt. Companies generally are found to be using this tool for the purpose of expansion and when they are needed to borrow the money at a fixed rate of interest. Companies prefer to use this tool to raise the money when the fund is required for as per the long term plan. The benefit to the issuer is such that they are the one to determine the interest rate ad which is why they have plenty of options to calculate the risk factor as well. However, once the debentures are issued to the holders, it becomes a legal obligation on the part of the issuer to repay back the debt.

Types of Debentures

1. Secured Debentures: Secured debentures are issued against the security of the assets of the company. It means, the debenture holders have every right to sell the assets of the company in case of failure on the part of the issuer to repay back the debt.

2. Unsecured Debentures: Unsecured debentures are not issued against security of the assets of the company. In short, the company holds no liability in case of failure to repay back the debt amount.

3. Registered Debentures: A registered debenture is recorded in the register of debenture holders of the company. A regular instrument of transfer is required for their transfer.

4. Bearer Debentures: Bearer debentures are easily transferable i.e. their role is  just like negotiable instruments in which the debentures are issued without any registration.

5. Convertible Debentures: Convertible debentures allow the holders with an option to convert such debentures into equity share. Such conversions can be carried out after the completion of specified period.

6. Non-Convertible Debentures : Non- convertible debentures have no privilege of converting itself to equity shares make it compulsorily required to be repaid to the holders. They are compulsorily required to be repaid to the holders

7. Redeemable Debentures: Redeemable debentures are required to be redeemed after a certain period within which interest rates are required to be paid periodically and principal after a specific time period.

8. Irredeemable Debentures : Irredeemable debenture does not create any obligations on the part of the issuer to repay the debt back to the holders without in the situation of winding up of the company or at the time of any default.

Debenture in Nepal

In the recent years the capital markets of Nepal has been developing at a very   faster rate with reasons being the introduction of new instruments and as well as the modifications in the old technology. Meanwhile, in the present context debentures are proving to be playing a significance role in contributing towards addressing the financial needs of the corporate sector. The history of Debenture in the country dates back to 2054 when Shree Ram Sugar Mills first issued the debenture whereas Himalayan Bank issued the debentures in 2058 for the first time in case of banking sector.

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In last 7 years of debentures history in Nepal, 23 issues have been carried out by various organisation in in which all the issuers are from the banking sector. Though the fiscal years 2015/16, 2016/17 and 2017/18 witnessed no issues at all, however, there is a significant improvement in the numbers in the fiscal year 2018/19 in which 9 issues were carried out totaling to total transaction of Rs. 6,616 million. This shows the noteworthy trust between both the issuers and holders in terms of debenture market in the country.

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This table is in line with table 1 shows the comparative increase in number of issues of debentures from the fiscal year 2012/13 to 2018/19.

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This table is in line with table 1 shows the comparative increase in total amount of debentures issued from the fiscal year 2012/13 to 2018/19.

Legal Provisions related to Debentures in Nepal

Debentures are legally identified by the legal system in Nepal with the same being categorically defined in the Companies Act, 2063. The Companies Act, 2063 has made provision related to the issuance of debentures in Nepal. As per the definition of debenture given in Section 2(s) of the Companies Act 2063 "Debenture means any bond issued by the company whether putting its assets as collateral or not". This section clearly states the right of the company to issue bonds or debenture which are instruments as a debt. Further, it also explains that such bonds may or may not be both secured or unsecured.

Similarly, the Companies Act has provisioned that company may issue debentures as a type of long-term unsecured bond on agreeing to repay it at a predetermined future date or by paying interest to the debenture holders at the end of every year till the time of maturity, however, if it is not able to pay either the interest or the principal amount, the same can be recovered by selling off the assets of the company.

Section 2(t) of the Companies Act, 2063 defines about Debenture Trustee as a body corporate taking responsibility for the protection of interests of debenture-holders at the time of issuance of debentures by a company. This clearly shows the legal provisions available in the country to ensure free and fair issuance of dentures by the issuers and the holders do not fall into the prey of any fraudulent.

Section 34 of the companies Act, 2063 has provisioned the criteria for the public company to issue debentures to the public. It states that, a complete work plan regarding the proceedings and budget is compulsorily be required to be presented to the office.

Section 35 of the Companies Act, 2063 has listed down the criteria as to which procedures are required to be followed by the organisation before and during the issuance of the debentures.

Role of Debentures in the context of Nepalese Capital Market

The financial market in Nepal though is small, yet, is a growing market. With the companies related to both the service sectors and manufacturing sectors increasing every year, the importance of finances too is increasing simultaneously. At the current scenario, though the organisations are seen to be keen with issuance of equity shares, borrowings or bank loans, debentures too are slowly being identified as an option for the long term financing opportunities.

Debentures being a secured form of investment, investors may find it risk less as to the interest rates and as well as the repayment time period is fixed.

Debentures since promotes long term funding plan during which the interest rates are required to be maintained at the same level, in the long run it helps the economy to have a specific interest rates without major fluctuations.

Debentures being a debt, do not provide any authority to its holders towards voting which is why, it is a safe measure for the issuers as well.

The cost of issuance of debentures is comparatively lower compared to that of other sources of funding.

Debentures help maintain a stable market as is not tradable in the secondary market and not volatile in nature.

The value of debentures cannot be manipulated as the stocks are in the secondary market.

In the time to come, the role of debentures will certainly expand further in the country. From the issuer’s point of perspective, since the interest paid can be calculated as an expense for the purpose of tax calculation, they can show less profit resulting in calculation of less tax payable to the government. Likewise, other sources being lengthy and with cost of fund being high, debentures will prove to be a beneficial option in the domestic market.

Challenges of Implementing Debentures in Nepal

The presence of Debentures in the Nepalese capital market has already witnessed more than 2 decades of long history, yet, the number of participants in the debenture market in terms of both the issuer and the holder is comparatively very low. Fiscal years 2015/16, 2016/17 and 2017/18 witnessed no issuance of debentures at all whereas in other fiscal years the number of issuances could not even touch two digits.

Debentures are more preferred by the organisations than the general public owing to the fact that general public are more inclined towards investing the share market with the hope of earning quick and higher rate of return. Additionally, public do not find it charm as it is non-volatile in nature.

The availability of liquidity in the market stands as another big challenge towards the proper execution of debentures. The CCD ratio in Nepal, per law, is required to be maintained at the ratio of 80percent and 20percent which basically means is the bank deposit is Rs. 100, it can lend only up to Rs. 80. This has made the loanable fund shortage in the market and has ultimately hit the debentures market as well.

Debentures are a long term debt and funding. Unlike the bank rates that keep  on fluctuating according to the economic situation of the country, the rate of interest cannot be changed which is why issuers are faced with major challenges like determining the uncertain factors like political scenario of the nation, unemployment rate, future policies, risk factors etc. Therefore, issuers of debentures should be availed with firsthand information without which there is a high chance of mismanagement.

In recent years, Nepal Rastra Bank has been directing the banking and financial institutions to increase the paid-up capital, which is why debentures may have been compelled not to be a point of focus for them as required fund could be raised through other sources of funding.

In Nepal, the rate of return through Debentures are comparatively lower than that of the rate of return through fixed deposits. At present, the banks are so much into the race of collecting deposits that they have a higher rate of return in fixed deposits. Similarly, the return provided by the co-operatives too are on a higher side. And since the deposits are easier than holding debentures, people are more inclined to other sources.

Debenture market in Nepal is still a very slim market which needs proper rules, regulations and guidance. The volatility in the political quarter has always hampered the economic development of the country. Therefore, until and unless the commercial genre have an impactful support from the government, this sector will continue strive to progress.

Bibliography

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Toppr-guides. (2019). Debentures - Types of Debentures, Advantages & Disadvantages. [online] Available at: https://www.toppr.com/guides/business-studies/sources-of- business-finance/debentures/ [Accessed 1 Jun. 2019].

Legalserviceindia.com. (2019). Concept of Debentures In India. [online] Available at: http://www.legalserviceindia.com/legal/article-262-concept-of-debentures-in- india.html [Accessed 1 Jun. 2019].

eFinanceManagement.com. (2019). Advantages and Disadvantages of Debentures | efinancemanagement. [online] Available at: https://efinancemanagement.com/ sources-of-finance/benefits-and-disadvantages-of-debentures [Accessed 1 Jun. 2019].

Accountlearning.com. (2019). Debentures | Meaning, Issue, Features, Types, Advantages, Disadvantages – Money Matters | All Management Articles. [online] Available at: https://accountlearning.com/debentures-meaning-issue-features-types-advantages- disadvantages/ [Accessed 1 Jun. 2019].

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BDC. (2019). What is a debenture. [online] Available at: https://www.bdc.ca/en/articles- tools/entrepreneur-toolkit/templates-business-guides/glossary/pages/debenture. aspx [Accessed 1 Jun. 2019].

The Companies Act, 2063 (Nepal)

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