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SEBI Mandates Separate Legal Entities for Debt Trustees to Boost Market Integrity

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  Published in Business and Finance on Tuesday, November 25th 2025 at 11:22 GMT by Goodreturns

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Debt Trustees Must Be Separate Entities – A New SEBI Mandate to Strengthen Market Integrity

In the wake of mounting concerns over conflicts of interest and the integrity of debt‑securitization markets, the Securities and Exchange Board of India (SEBI) has clarified that debt trustees engaged in non‑SEBI‑regulated activities must operate as separate legal entities. The directive, announced in a recent Goodreturns.in news story, is part of a broader effort to tighten regulatory oversight, protect investors, and enhance transparency in the burgeoning Indian debt market.

The Role of a Debt Trustee: An Overview

A debt trustee acts as an independent custodian for securities, typically in the context of collateral‑based lending or asset‑backed securities (ABS). The trustee’s core responsibilities include:

1. Safekeeping of collateral and ensuring that it is used only for its intended purpose.
2. Monitoring compliance with loan covenants and other contractual obligations.
3. Distributing proceeds to investors in a timely and fair manner.
4. Mediating disputes between lenders and borrowers.

Because these duties sit at the intersection of credit, collateral management, and investor protection, the trustee’s independence is paramount.

SEBI’s Rationale: Why Separation Is Essential

The regulatory clarification stems from a growing awareness that many debt trustees are currently housed within non‑banking financial companies (NBFCs) or other financial entities that also provide credit. This dual role can create a conflict of interest:

• Credit Origination vs. Custodial Duties: If a trustee also offers financing, it may be tempted to relax monitoring standards or allow preferential treatment of its own loans.
• Information Asymmetry: The trustee’s knowledge of borrower fundamentals could be exploited in ways that disadvantage other investors.
• Reputational Risk: Any failure or misstep could erode trust not only in the trustee but in the entire debt‑securitization ecosystem.

SEBI’s directive therefore mandates that debt trustees engaging in non‑SEBI‑regulated activities—such as managing collateral for ABS issuances—must be legally separate from any credit‑providing arms. This separation is designed to ensure that trustees remain impartial custodians, thereby safeguarding the interests of all stakeholders.

What the Rule Means in Practice

1. Legal and Corporate Structure

• Separate Legal Entity: A debt trustee must be incorporated as a distinct company or trust, with its own board, directors, and governance structure.
• No Overlap in Services: The entity must not offer credit or any other regulated financial service that could create a conflict.
• Clear Demarcation of Duties: The roles of the trustee and any parent or affiliated company must be unambiguously delineated in corporate documents and regulatory filings.

2. Compliance Timeline

• Immediate Implementation: SEBI has given a short window (typically 90 days) for existing debt trustees to restructure or separate their operations.
• Ongoing Monitoring: Post‑implementation, SEBI will conduct audits and require regular reporting on the trustee’s activities, governance, and financial health.

3. Operational Adjustments

• Risk Management: The trustee will need to adopt robust risk‑management frameworks tailored to its custodial functions, independent of any credit‑risk frameworks used by the parent NBFC.
• Reporting & Disclosure: Regular disclosures on collateral valuations, distribution schedules, and any default events will be mandatory.
• Capital Adequacy: While not subject to the same capital adequacy norms as banks, trustees may need to maintain a buffer to cover operational contingencies.

Implications for the Debt Market

Investor Confidence Boost

By eliminating potential conflicts of interest, the directive is expected to reinforce investor confidence. Institutional investors, who form a large portion of ABS buyers, are likely to welcome the assurance that their investments are protected by an independent custodian.

Improved Transparency

Separate entities must adhere to stringent reporting norms. This will provide greater visibility into collateral valuations and the performance of underlying assets, thereby reducing information asymmetry.

Operational Cost Increase

The restructuring and compliance burden may lead to higher operational costs for debt trustees. These costs could, in turn, be passed on to issuers and lenders, possibly affecting the pricing of ABS and collateral‑based lending.

Market Consolidation

Smaller NBFCs may find it difficult to absorb the cost of setting up separate trustee entities. This could lead to consolidation in the trustee space, with larger, specialized firms dominating the market.

Synergies with SEBI’s Broader Regulatory Agenda

SEBI’s move dovetails with its broader strategy to strengthen the Indian debt market through clearer guidelines on asset‑backed securities, collateral‑management, and credit enhancement mechanisms. In 2024, SEBI released additional circulars outlining the role of custodians in ABS, and the new trustee requirement can be seen as a logical extension of that framework.

A Look at the Broader Ecosystem

The debt‑trustee mandate is part of a larger regulatory push in India. SEBI has also focused on:

• Asset‑Backed Securities (ABS) Regulations – detailing how ABS should be structured, marketed, and monitored.
• Collateral Management Rules – requiring banks and NBFCs to set up dedicated collateral‑management teams and adopt standardized valuation methods.
• Credit Enhancement Guidelines – clarifying the roles of credit rating agencies, guarantors, and other parties involved in strengthening ABS tranches.

In this context, the separate‑entity rule for debt trustees helps to create a clean separation between those who issue debt and those who hold it, much like the separation mandated for banks and non‑bank financial institutions.

Looking Ahead

As the Indian debt market continues to grow, driven by a surge in infrastructure financing, real‑estate development, and small‑medium enterprise (SME) lending, the role of debt trustees will become increasingly critical. SEBI’s new requirement marks a significant step toward ensuring that the market’s foundational institutions—trustees—operate with the highest level of integrity and independence.

Lenders, issuers, and investors must monitor the progress of this transition, as the re‑organization of trustees will influence transaction structures, pricing dynamics, and risk profiles across the debt‑securitization landscape. While the initial costs may be steep, the long‑term benefits—greater transparency, reduced conflicts of interest, and enhanced market confidence—promise to outweigh these challenges, paving the way for a more robust, trustworthy debt market in India.