Market Linked Debentures (MLDs)
Introduction
Market Linked Debenture (MLD) is a debt instrument with a hybrid nature that couples the features of both plain vanilla debt security and exchange-traded derivatives, currency, commodities, etc. Generally, MLDs can be Principal Protected or Principal Non-Protected MLDs. Any income arising on transfer, redemption or maturity of MLD is treated as short-term capital gain and taxable at the normal tax rate as applicable in the case of the assessee.
1. Statutory provisions governing MLDs
The Market Linked Debentures are regulated in India by:
(a) SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021;
(b) The Operational Circular No. SEBI/HO/DDHS/P/CIR/2021/613, dated 10-08-2021;
(c) Section 71 of the Companies Act, 2013; and
(d) Income-tax Act, 2025
Section 76 of the Income-tax Act defines MLDs as security which has an underlying principle component in the form of debt security and where the returns are linked to the market returns on other underlying securities or indices and includes any security classified or regulated as an MLD by the SEBI.
The SEBI Regulation defines MLDs as non-convertible debentures linked to a specific market index or security performance, such as a stock or a basket of stocks, a commodity, or a currency. The movement of the underlying index or security determines the returns on MLDs. Generally, the MLDs do not have periodic payments towards coupons and are payable only at the maturity of the instrument.
2. Features of Market-Linked Debentures
2.1. Computation of coupon rate
An MLD is a debt instrument whose staggering feature is that the returns arising from such MLDs are not fixed but linked to an underlying market/index. Unlike traditional fixed-income investments, the returns on MLDs can vary based on market performance. Various nomenclatures are used to represent MLDs, such as equity-linked debentures, stock-linked debentures, etc.
If the underlying index or security performs well, the MLDs will provide a higher return at maturity than their initial principal amount. On the other hand, if the underlying index or security performs poorly, the MLDs may provide a lower return at maturity or even result in a loss of principal.
2.2. Who can issue MLDs?
The issuer who has a minimum net worth of at least Rs. 100 crores at the time of issue can issue MLDs.
2.2-1. Minimum ticket size for MLDs
The issuers are free to determine the face value of MLDs. However, no invitations for the subscription or allotments shall be made for an amount less than Rs. 10 lakhs in any issue. Generally, HNIs or Ultra HNIs invest in the MLDs.
2.2-2. Tenure of MLDs
According to Section 71 of the Companies Act, 2013 maximum tenure for which a debenture may be issued is 10 years. Usually, the tenure of MLDs ranges between 12 to 36 months, depending upon the issuer's funding requirement.
2.2-3. Repayment structure of MLDs
Unlike other investment vehicles, MLDs do not provide intermittent returns but offer returns upon maturity. When the MLDs reach maturity, the repayment will consist of the principal sum plus interest earned.
2.3. Types of MLDs
MLDs can be broadly classified into the following two categories.
2.3-1. Principal Protected MLDs
Principal Protected MLDs guarantee the return of the investor's principal investment at maturity, regardless of the underlying asset's performance. Such MLDs protect the bondholder from the downside risk of the market and provide enhanced returns as compared to normal debentures.
For example, ABC Financial Services Ltd. raises funds through MLDs that mature in 24 months. The underlying asset for these MLDs is the Top 50 Share Index ('SE 50'). The MLDs offer different coupon rates depending on the performance of the SE 50 over 24 months. If SE 50, at the end of the tenure, increases by more than 10% of its original value, the holder will receive a coupon of 15%. If the increase is between 0% and 10%, the holder will receive a coupon of 12%. However, if the SE 50 decreases and its value falls below 80% of its original value, no coupon will be paid to the investor.
2.3-2. Principal Non-Protected MLDs
Principal Non-Protected MLDs combine the characteristics of a debenture and a market-linked investment. These MLDs do not guarantee the return of the investor's principal investment at maturity. Consequently, these are not considered debt securities under Regulation 2(k) of SEBI (Issue and Listing of Non-Convertible Securities) Regulations 2021 and are not eligible for issue and listing.
For example, ABC Financial Services Limited issues MLDs with a tenure of 24 months. The underlying asset for these MLDs is the Top 50 Share Index ('SE 50'). The MLDs offer different coupon rates depending on the performance of the SE 50 over 24 months. The coupon on MLDs shall be calculated in the following manner:
• 15% coupon: If SE 50 performs more than 10%.
• 30% coupon: If SE 50 performs more than 25%.
• 50% coupon: If SE 50 performs more than 45%.
• 4% coupon: If SE 50 falls more than 10%.
• No coupon and 6% reduction from the principal: If SE 50 falls more than 20%.
2.4. Advantages of the MLDs for the issuer
MLDs offer several advantages for the issuer:
(a) Flexibility: MLDs do not have a predetermined schedule of coupon payments, providing greater liquidity for the issuer without impacting cash flow.
(b) Increased Issuance: Issuers can issue up to 12 International Securities Identification Numbers (ISINs) per financial year for plain vanilla debt securities. However, in the case of MLDs, the issuer gets an additional 5 ISINs over and above 12 ISINs per financial year
(c) Exemption from Electronic Book Provider mechanism: The Electronic Book Provider (EBP) mechanism is an online platform that facilitates the bidding process for the private placement of debt securities that are intended to be listed on stock exchanges. However, the EBP mechanism does not apply to MLDs. This exemption allows the issuer to issue structured securities on a private placement basis without the requirement of using the EBP platform
3. Taxation of Market-Linked Debentures
Main article: Capital gains on transfer of market-linked debentures or specified mutual funds
The capital gains from MLDs shall be calculated according to Section 76. However, if MLDs are held as stock-in-trade, the business income will be computed as per Section 26.
References
Circular No. CIR/IMD/DF-1/67/2017, dated 30-06-2017
SEBI's Operational Circular SEBI/HO/DDHS/P/CIR/2021/613, dated 10-08-2021
This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.