New lease accounting standard kicks off from 1st April, 2019

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Financial Services Division

(finserv@vinodkothari.com)

The Ministry of Corporate Affairs (MCA) has put a small announcement on its website that the new lease accounting standard, IndAS 116 will get implemented from 1st April 2019. The new Standard, globally implemented in several countries from 1st Jan 2019, is called IFRS 16. The Standard eliminates the 6-decade old distinction between financial and operating leases, from lessee accounting perspective, thereby putting all leases on the balance sheet. The phenomenon of off-balance sheet lease transactions was one of the burning analyses after bankruptcy of Enron in 2001, and since then, had been erupting off and on, until the global standard setter decides to push the new standard on the rule book in Jan 2016, effective 1st Jan 2019.

After the introduction of IFRS 16, the ICAI came out with an exposure draft on the new standard in 2017 and kept it open for comments for some days. However, nothing further was heard about it thereafter.

The exposure draft and the final published Ind AS 116 are same except for the below mentioned change which has been incorporated in the final published Ind AS 116:

Para 47 dealing with presentation in books of lessee:
In Exposure Draft Text of published Ind AS 116
Para 47 A lessee shall either present in the balance sheet, or disclose in the notes: Para 47: A lessee shall either present in the balance sheet, or disclose in the notes:
(a) right-of-use assets separately from other assets. (a) right-of-use assets separately from other assets. If a lessee does not  present right-of-use assets separately in the balance sheet, the lessee shall:
(i) include right-of-use assets within the same line item as that  within which the corresponding underlying assets would be  presented if they were owned; and
(ii) disclose which line items in the balance sheet include those  right-of-use assets.
(b) lease liabilities separately from other liabilities. (b) lease liabilities separately from other liabilities. If a lessee does not  present lease liabilities separately in the balance sheet, the lessee  shall disclose which line items in the balance sheet include those liabilities.

(above para is same as para 47 IFRS 16, thereby making IFRS 16 and Ind AS 116 exactly same now, except for the fair value option for investment property- ref para 1 of comparison with IFRS 16 )

Giving the above option makes it clear how the lessee is going to show the asset in books.

For example, if A takes Aircraft-1 on lease and owns Aircraft-2, A can either include both of them in PPE or can show Aircraft-1 in PPE and Aircraft-2 just below PPE under the head ROU.

Correspondingly, a lease liability can be disclosed separately, if not disclosed separately, then disclose which line item in BS includes the lease liability.

Globally, several jurisdictions have implemented the Standard with effect from 1st January, 2019. A list of jurisdictions which have already adopted can be viewed here.

Some of the key takeaways from the implementation of this Standard are:

  • Currently, there are two accounting standards for lease transactions, first, Ind AS 17, which is applicable to the Ind AS compliant companies and second, AS 19, which is applicable to the remaining classes of companies. Ind AS 116 proposes to replace Ind AS 17, therefore, the companies which are not covered by Ind AS shall continue to follow old accounting standard. 
  • The applicability of this standard shall have to be examined separately for the lessor and the lessee, that is, if the lessor is Ind AS compliant and lessee is not Ind AS compliant, then lessor will follow Ind AS 116 whereas lessee will follow AS 19. 
  • The new standard changes treatment of operating leases in the books of the lessees significantly. Earlier, operating leases remained completely off the balance sheet of the lessee, however, vide this standard, lessees will have to recognise a right-to-use asset on their balance sheet and correspondingly a lease liability will be created in the liability side. 
  • Lease of low value assets and short tenure leases (up to 12 months) have been carved out from the requirement of recognition of RTU asset in the books of the lessee.
  • No change in the accounting treatment in case of financial leases. 
  • No change in the lessor’s’ accounting.

While leasing has not been greatly popular in India compared to the world, there has been a substantial pick up in interest over recent years. Therefore, a question comes – will the new standard put a death knell to the feeble leasing industry in India? To the extent the demand for leasing comes from off balance sheet perspective for a lessee, the standard may have some impact. However, there are many economic drivers for lease transactions – such as the ease of usage, tax benefits, better residual realisation, etc. Those factors remain unaffected, and in fact, the focus of lease attractiveness will shift to real economic factors rather than balance sheet cosmetics.

The apparent question that arises here is whether the new standard unsettle the taxation framework for lease transactions in India, especially direct taxes – the answer to this question is negative. The tax treatment of lease transaction does not depend on the treatment of the transaction in books of accounts. Instead, it depends on whether the transaction is case a true lease or is merely a disguised financial transaction. There will be no impact on the indirect taxation framework as well.

Securitisation laws prevailing in various countries are listed below :

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  • Singapore:
  1. Monetary Authority of Singapore (MAS) Guidelines on Securitisation (The guidelines were finalized in 2000)
  2. Amendment in 2018
    http://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Finance%20Companies/Notices/MAS%20Notice%20832%20%20Amendment%20%202018.pdf
  3. Amendment in 2007
    http://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Commercial%20Banks/Regulations%20Guidance%20and%20Licensing/Notices/MAS%20Notice%20628%20(2007).pdf
  4. News on Securitisation
    http://vinodkothari.com/2013/11/sing/
  5. Rules on Securitisation
    http://vinodkothari.com/seclawsg/
  • USA:
  1. 15 U.S. Code § 78o–11. Credit risk retention:
    https://www.law.cornell.edu/uscode/text/15/78o-11
  2. Dodd-Frank Wall Street Reform and Consumer Protection Act [Public Law 111–203] [As Amended Through P.L. 115–174, Enacted May 24, 2018]
    https://legcounsel.house.gov/Comps/Dodd-Frank%20Wall%20Street%20Reform%20and%20Consumer%20Protection%20Act.pdf
  3. Securitisation Market
    http://vinodkothari.com/secusa/
  4. Laws on Securitisation
    http://vinodkothari.com/seclawus/
  • Australia:
  1. Australian Prudential Standard (APS) 120 made under section 11AF of the Banking Act 1959 (the Banking Act) By Australian Prudential Regulation Authority
    https://www.apra.gov.au/sites/default/files/aps_120_securitisation.pdf
  2. Covered Bonds issued under Part II, Division 3A of the Banking Act 1959 (Cth)
    https://www.legislation.gov.au/Details/C2017C00067
  3. Laws on Securitisation
    http://vinodkothari.com/seclawaustral/
  4. Securitisation Market
    http://vinodkothari.com/austral/
  • Indonesia:
  1. Bank Indonesia Regulation No. 7/4/PBI/2005 Prudential Principles in Asset Securitisation for Commercial Banks
    https://www.bi.go.id/en/peraturan/perbankan/Pages/bir%207405.aspx
  2. Securitisation Market
    http://vinodkothari.com/secindon/
  • Hong Kong: 
  1. There is no specific legislative regime for securitisation. Securitisation is subject to various Hong Kong laws, depending on the transaction structure, transaction parties, underlying assets, and the nature of the offering of the securities
  2. Securitisation Market
    http://vinodkothari.com/sechong/
  • Canada:
  1. Office of the Superintendent of Financial Institutions, Government of Canada
    http://www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/gl-ld/Pages/CAR18_chpt7.aspx
  2. Securitisation Market
    http://vinodkothari.com/seccanad/
  • European Union:(UK, Germany, France,Italy, Sweden, Poland, Spain, Greece, Finland, Malta)
  1. Regulation(EU) 2017/2402 (the Securitisation Regulation) as on December 12,2017
    https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017R2402
  2. Regulation (EU) 2017/2402 of the European Parliament and of the Council of September 30, 2015
    https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A52015PC0472
  3. Securitisation Market:
    http://vinodkothari.com/europe/

 

  • Italy:
  1. Law 130 of 30 April 1999, Italian securitisation law
    https://www.housing-finance-network.org/fileadmin/user_upload/hfn/Country_Law/Law-Italy/2006-00281.pdf
  2. Securitistion Market
    http://vinodkothari.com/secitaly/
  • Greece:
  1. GREEK LAW 3156/2003
    http://www.greeklawdigest.gr/topics/finance-investment/item/317-securitization-law-bonds-l-3156-2003
  • France:
  1. Order No. 2017-1432 of October 4, 2017 , Modernizing the Legal Framework for Asset Management and Debt Financing (Initial Version)
    https://www.legifrance.gouv.fr/affichTexte.do?cidTexte=JORFTEXT000035720833&categorieLien=id
    Version in force on 26/03/2019
    https://www.legifrance.gouv.fr/affichTexte.do?cidTexte=JORFTEXT000035720833&dateTexte=20190326
  2. Securitisation Market:
    http://vinodkothari.com/france/
  • Japan: Securitisation in Japan is governed by laws and regulations applicable to specific types of transactions such as the Civil Code (Law No. 89, 1896), the Trust Act (Law No. 108, 2006) and the Financial Instruments and Exchange Law (Law No. 25, 1948) (FIEL).
  1. https://www.fsa.go.jp/common/law/fie01.pdf
  2. http://jafbase.fr/docAsie/Japon/CodCiv.pdf
  3. http://www.japaneselawtranslation.go.jp/law/detail_download/?ff=09&id=1946
  4. Laws on Securitisation
    http://vinodkothari.com/seclawjapan/
  5. Securitisation Market
    http://vinodkothari.com/japan/
  • China:
  1. Administrative Rules for Pilot Securitization of Credit Assets(the Administrative Rules) on April 2005
    http://www.cbrc.gov.cn/EngdocView.do?docID=1720
  2. Securitisation Market
    http://vinodkothari.com/secchina-2/
  • Ireland:
  1. European Union (General Framework For Securitisation And Specific Framework For Simple, Transparent And Standardised Securitisation) Regulations 2018 (Central Bank of Ireland)
    http://www.irishstatutebook.ie/eli/2018/si/656/made/en/pdf
  • South Africa:
  1. In South Africa, securitisations are regulated according to the securitisation regulations issued under the Banks Act 94 of 1990 (the Banks Act)
    https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/2591/Banks+Amendment+Act+2007%5B1%5D.pdf
  1. Government Gazette 30628 of 1 January 2008 (Securitisation Regulations)
    https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/2734/30628%20sec%20schemes%202008.pdf
  2. Laws on Securitisation
    http://vinodkothari.com/seclawsa/
  3. Securitisation Market
    http://vinodkothari.com/secafric/
  • Morocco:
  1. Law No. 33-06 on Securitization
  2. Draft amendment of Law on Securitization
    http://www.sgg.gov.ma/portals/0/AvantProjet/8/Projet_loi_Amendement-titrisation_Ang.pdf

Consolidation of new ECB and Trade Credit framework: RBI issues Master Direction 2019

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Vallari Dubey

corplaw@vinodkothari.com

Introduction

With the backdrop of revision of various frameworks for raising funds outside India (other than by way of equity participation), RBI has issued the Master Direction – External Commercial Borrowings, Trade Credits and Structured Obligations on 26th March, 2019, in supersession of the existing Master Direction – External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorised Dealers and Persons other than Authorised Dealers dated 1st January, 2016 (last updated on 22nd November, 2018).

The new Master Direction seeks to consolidate all applicable circulars and notifications in respect of the following:

  1. External Commercial Borrowing framework (ECB framework) covered in the Master Direction as Part I
  2. Trade Credit framework covered as Part II
  3. Structured Obligations covered as Part III.

The first set of changes was introduced through the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 on 17th December, 2018. Thereafter, the New ECB framework was issued on 16th January, 2019 and the Trade Credit Policy on 13th March, 2019.

New Master Direction

The erstwhile Master Direction included provisions pertaining to borrowing and lending in foreign currency, which has now been removed and is solely dealt with by Foreign Exchange Management (Borrowing and Lending) Regulations, 2018. Further, it replaces the erstwhile ECB framework and Trade Credit framework with the recently issued frameworks, separately.

The revised ECB policy and Trade Credit Policy were issued, coinciding with Foreign Exchange Management (Borrowing and Lending) Regulations, 2018.

The changes introduced pursuant to new ECB policy and Trade Credit policy have been covered by our colleagues extensively in the following write ups:

  1. RBI revises ECB framework – aligns with FEM (Borrowing and Lending) Regulations, 2018
  2. RBI revises Trade Credit Policy Framework.

Few important additions in the revised frameworks, now consolidated under the Master Directions include Standard Operating Procedure for Untraceable Entities for Ad Banks, ECB for entities under resolution under IBC, ECB for resolution applicants, Late Submission Fee for late submission of returns.

Conclusion

The revision of the Master Direction which was originally issued in 2016 was quite anticipated in light of the recent changes made by RBI. Although the new Master Direction does not introduce any additional change in the ECB and Trade Credit framework, it unifies all the applicable policy frameworks, thereby giving more clarity.

SEBI proposes to restructure the issuance of shares with DVRs

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By Nikita Snehil and Shaifali Sharma | corplaw@vinodkothari.com

Vinod Kothari & Company

The basic principle behind the issuance of shares with differential voting rights, commonly known as ‘DVRs’ in India and dual class shares or ‘DCS’ in the international context, is to enable the companies to raise capital without dilution of control and decision-making power in company. In promoter/ founder led companies where promoters/ founders are instrumental in the success of the company, such structures enable them to retain decision-making powers and rights vis-a-vis other shareholders either through retaining shares with superior voting rights or issuance of shares with lower or fractional voting rights to public investors.

The concept was first recognized under the Companies (Amendment) Act, 2000 followed by similar provisions adopted by the Companies Act, 2013. However, the current practical scenario depicts a different picture, as the provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 does not permit DVRs with higher or superior voting rights. However, subject to certain conditions, DVR shares with lower voting rights are permitted. Till date, only 5 listed companies have used this structure in India. Strict pre-condition and corporate governance norms, unavailability of investors due to lack of awareness are some grounds of company’s reluctance from adopting such idea.

SEBI’s Consultation Paper to restructure the issuance of DVRs

On December 19, 2018, Mr. Ajay Tyagi, Chairman of SEBI, had said in an interview that SEBI has made a sub-committee for reintroducing Differential Voting Rights on shares, which will make recommendation on the same by next month. Post this, SEBI on March 20, 2019, has come out with a Consultation Paper[1] on issuance of shares with Differential Voting Rights. The Consultation Paper provides that the matter of issuance of shares with DVRs was deliberated in the Primary Market Advisory Committee of SEBI (‘Committee’) and a group (‘DVR Group’) was constituted amongst the Committee members to do an in-depth study of the proposal of introduction of shares with DVRs in Indian Scenario.

The Consultation Paper addresses the norms for issuance of shares with DVRs under two categories –

  1. issuance by companies whose equity shares are already listed on stock exchanges;
  2. companies with equity shares not hitherto listed but proposed to be offered to the public.

The basic moto behind allowing shares with differential voting rights is to raise equity without dilution of promoter control i.e., to allow the promoters/ founders to maintain control as they would hold shares with superior voting rights.

Therefore, considering SEBI’s proposed structure, there shall be four categories of companies which can issue DVRs:

  • Equity listed cos – as per this Consultation Paper;
  • Unlisted cos, which are intending to get their equity listed — as per this Consultation Paper;
  • Unlisted cos, not intending to list their equity shares – as per Section 43 of the Companies Act, 2013 (‘Act’) read with Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014;
  • Private Cos — exempted from applicability Section 43 of the Act, if either its memorandum or articles of association so provides- vide notification number G.S.R. 464(E) dated 5th June 2015.

Need for DVRs in India

In order to maintain the current growth phase in India, it is pertinent for the companies to raise capital to sustain this growth. For companies with high leverage or asset light models, they may prefer equity over debt capital. Raising DVRs will reduce the dilution of founder/ promoter stake which would otherwise be a case in capital raised by equity.

The protection of founder/ promoter’s stake/ control is especially relevant for new technology entities which have asset light models, with little or no need for debt financing. However, these entities generally raise funds through equity which dilutes the promoter’s/ founder’s stake, thereby diluting control. Considering the issue, the Consultation Paper states that retaining founder’s interest & control in the business is of great value to all shareholders and the same can be achieved by:

  1. Issue of shares with superior voting rights (‘SR’) to founders and/or
  2. Issue of shares with lower or fractional voting rights (‘FR’) to raise funds from private/ public investors.

International Scenario

The global market has witnessed a mixed response to the concept of DVRs, while many countries have permitted the listing of companies with Dual Class Shares or DCS (internationally used term for DVRs), some countries like UK, Australia, Spain, Germany and China do not permit the Issuers with DCS structure for listing. Singapore and Hong Kong have recently permitted DCS structures with detailed checks and balances. Considering the international scenario, the Consultation Paper has provided a detailed comparison of the issuance & listing of DCS structure in internal jurisdictions, the summary of which is presented below:

  • 700 public companies in the US have DCS structures, predominant listed ones being Google, Facebook, Snapchat, Nike and Alibaba. There is ongoing debate in the SEC about the continuation of DCS[2].
  • Hong Kong and Singapore recently allowed DCS to encourage more new technology firms to list.
  • In the UK[3], DCS structures were used in the 1960s to protect corporations from hostile takeovers or for the Queen to have ‘golden share’, before institutional investors expressed strong opposition to such structures. DSC is presently not allowed in the UK.
  • Over the past decade, a number of European governments have implemented or debated the use of different voting rights.
  • US, Canada, HK, Singapore, Denmark, Spain, Sweden and Italy allow dual-class shares. Germany, Spain, China, Australia disallow listing of shares of companies with DCS structures.

Recommendations of the DVR Group

Ø Pre-conditions

A company would be entitled to issue DVR Shares, subject to following pre-conditions:

  • issue of DVR Shares must have been be authorized in the AoA of the company; and
  • the issue of DVR Shares should be authorized by a special resolution passed at a general meeting of the shareholders.
  • for companies already listed, by way of e-voting as per Companies Act, 2013
  • The notice should mention specific matters, including but not limited to, size of issuance, ratio of the difference in the voting rights, rights as to differential dividends, if any, sunset clause, coattail provisions, etc., as made applicable by SEBI regulations to be notified in this regard.

Ø Requirements for both the categories

Category I: Companies whose equity shares are already listed – issuance of FR Shares;

Category II: Companies whose equity shares are proposed to be listed – issuance of SR shares.

Eligibility

 

 Requirements for Category I Requirements for Category II
Conditions Cos whose shares have been listed on a SE for atleast a year, may issue FR Shares.

 

Note: listed cos are still not allowed to issue SR Shares.

 Unlisted cos may issue SRs, only to promoters.
 

First issuance of FR/ SR shares
Type of issuance Through a) rights issue; b) bonus issue pro rata to all equity shareholders; or c) a Follow-on Public Offer (“FPO”) of FR shares. An unlisted co. where the promoters hold SR Shares shall be permitted to do an Initial Public Offer (“IPO”) of only ordinary equity shares provided the SR Shares are held by the promoters for more than one year prior to filing of the draft offer document with SEBI.
 

Subsequent issues of FR Shares once FR Shares are already listed
Type of issuance A company that has already listed FR Shares shall be eligible to do:

a) rights issue; b) bonus issue; c) preferential issue; d) QIP of FR Shares of the same class;

 

 A company whose SR Shares and ordinary equity shares are already listed shall be permitted to issue FR Shares in terms of the applicable provisions for issue of FR Shares by listed companies – which means same as Category I.

 

Note: Issuance of SR shares not allowed post listing.
Depository Receipts A company whose FR Shares are listed for at least one year shall be eligible to issue depositary receipts where the underlying shares are FR Shares. —
Convertible Instruments A company can issue convertible instruments which will convert into FR Shares subject to applicable regulatory considerations. —
Voting and other rights The FR shares shall not be treated at par with the ordinary equity shares.

 

Max ratio

 

The FR Shares shall not exceed a ratio of 1:10, i.e. one vote as applicable to one Ordinary Equity Share, would be voting entitlement on 10 FR Shares. The ratio can be in full numbers from 1:2 to 1:10.

 

 

At any point of time, the co. can only have one class of FR Shares.

 The SR Shares shall be treated at par with the ordinary equity shares in every respect except in the case of voting on certain matters.

 

Max ratio

 

The SR Shares shall be of a maximum ratio of 10:1, i.e. ten votes for every SR Share held. The ratio can be in whole numbers from 2:1 to 10:1. A ratio once adopted by a company shall remain valid for any subsequent issuances of SR Shares.

 

A co. can issue only one class of SR Shares.

 

Any rights or bonus issue by the co. post-listing shall be offered only as ordinary equity shares

to the holders of the SR Shares.

 

On certain matters to be notified by regulations, the SR Shares would be treated as having only one vote. The initial list of the same is set out in the coattail provisions set out in the Committee Report (the same has been explained later in this Article).

 
Dividends The company may, at its discretion, decide to pay additional dividend per FR Share compared to dividend paid on ordinary Equity Share, which shall be higher than the dividend per

ordinary Equity Share and the same shall be stated in the terms of the offering. No dividend may be payable on FR Shares for such years where no dividend has been declared by the company for the ordinary equity shares.

 

 Post IPO, the SR shares shall be eligible for the same dividend and other rights as ordinary equity shares, except for superior voting rights.
Minimum Public Shareholding The co. should comply with the req of Securities Contracts (Regulation) Rules, 1957 (“SCRR”) and other applicable regulations formulated in this regard. The co. shall comply with the SCRR and other applicable regulations formulated, for the ordinary equity shares that will be listed.

 

Post-listing, the voting rights with the promoters through the SR Shares and ordinary equity shares shall not exceed 75% of the total voting rights.
Pricing The pricing of FR shares shall be in accordance with regulatory considerations applicable to

mode of issuance of FR Shares

 —
Face Value The face value of a company’s FR Shares shall be the same as that of its

ordinary equity shares.

 The face value of a company’s SR Shares shall be the same as of that of the ordinary equity shares.
Number of FR / SR Shares The number of FR Shares that may be issued by a company shall be subject to

provisions of the Companies Act, 2013 and the rules framed thereunder

 A company shall be permitted to issue any number of SR Shares of the same class prior to an IPO, subject to provisions of the Companies Act, 2013.
Lock-in period — All SR Shares shall remain under a perpetual lock-in after the IPO.
Pledge of shares — Creation of any encumbrance over SR Shares including pledge, lien, negative lien, non-disposal undertaking, etc. shall not be permissible.

In other words, no third-party interest may be created over the SR Shares and any instrument purporting to do so would be void ab initio.
Fasttrack issuance

 

 A company shall be eligible to issue FR Shares in a rights issue or an FPO through the fasttrack method in case it meets the eligibility criteria of fast-track issuances. —
Conversion of FR / SR shares

 

[Also known as ‘Sunset Clause in case of SR Shares]

 The FR Shares can be converted into ordinary equity shares only in cases of schemes of

arrangement.

 The validity of SR shares is 5 years from the date of listing of ordinary shares. Which means, such shares shall be compulsory converted into ordinary shares on the 5th year anniversary of the listing of such ordinary shares i.e. superior rights will fall under the standard rule of ‘one-share one-vote’. Conversion shall be done in the following manner:

 

For promoters: at any time prior to the 5th year anniversary of the listing of the Ordinary Shares or such extended period as decided by the shareholders by passing special resolution.

 

For other than promoters: on completion of the 5th year anniversary of the listing of the Ordinary Shares or such extended period of 5 years with the approval of shareholders by way of special resolution in the meeting where all members vote on one-share-one vote basis.

 

Besides the aforementioned validity of 5 years, the SR shares shall be converted into ordinary shares on the merger or acquisition of the company or sale of such shares by the identified promoters who hold such shares or in the case of demise of the promoter(s).
Extinguishment The FR Shares can be extinguished only through buy-back by the company or reduction of capital in accordance with applicable laws. —
Delisting The company can delist the FR Shares in accordance with the SEBI (Delisting of Equity Shares) Regulations, 2009. However, in the event ordinary equity shares of the company are delisted, the company shall be mandatorily required to delist the FR Shares. —
Listing and Trading The FR Shares shall be held in dematerialized form. However, FR Shares can be

issued in physical form, if such FR Shares have been issued pursuant to a bonus issue and the underlying shares are held in physical form.

 

The FR Shares shall be listed and traded on all SEs where ordinary equity shares of the co. are listed with a separate identifier from the ordinary equity shares.

 All SR Shares shall be held in dematerialized form and shall be listed on the main board platform of the recognized SEs.

For listing of SR Shares, exemption will be granted from Rule 19(2)(b) of SCRR.

 

The SR Shares, however, cannot be traded except upon conversion into ordinary equity shares.
Post-Issue Disclosures The shareholding pattern filed by the co. with the SEs shall provide the details of the FR Shares separately and in the format specified by SEBI and the SEs The shareholding pattern to be filed by the co. with the SEs shall provide the details of both ordinary equity shares and SR Shares in the format specified by SEBI and the stock exchanges.
ESOPs A co. can issue ESOPs of FR Shares post the listing of such shares, subject to applicable laws. —
Bonus issue by the co. which has issued FR shares If a co. which has issued FR shares, issues bonus shares, then it shall issue to FR shareholders bonus FR shares in the same proportion in which bonus shares are issued on ordinary equity shares. —
Applicability of other SEBI Regulations SEBI regulations in respect of buy-back, and takeovers shall apply to FR Shares, subject to such modification as may be required in the context of FR Shares. The FR Shares once listed shall not be delisted on a standalone basis and may be delisted as and when the ordinary equity shares are delisted. SEBI regulations in respect of buy-back, and takeovers shall be applicable to SR Shares, subject to such modification as may be required in the context of SR shares.

 

Ø ”Coattail”  Provisions for issuance of SR shares

Post-IPO, the SR Shares shall be treated as ordinary equity shares in terms of voting rights (i.e. one SR share-one vote) in the following circumstances:

  1. provisions relating to appointment or removal of independent directors and/or auditor;
  2. in case there is a change in control of the company;
  3. any contract or agreement of the company with any person holding the SR Shares, in excess of the materiality threshold prescribed under Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015;
  4. voluntary winding up of the company;
  5. any material changes in the company’s AoA or MoA, including but not limited to, undertaking variation in the voting rights of the shareholders, changing the principal objects of the company, granting special rights in favour of a particular shareholder or shareholder groups and such other items as may be prescribed by the SEBI;
  6. initiation of a voluntary resolution plan under the Insolvency and Bankruptcy Code, 2016;
  7. extension of the validity of the SR Shares post completion of 5 years from date of listing of ordinary equity shares; and
  8. any other provisions notified by SEBI in this regard from time to time.

Conclusion

The major benefits of DVRs structure highlighted in the DVR Group Report are as follows:

  1. DVRs promote fund raising without diluting control;
  2. In a promoter led companies, DVR structure will enable such promoters to retain control, the decision-making powers and other rights in the company;
  3. DVRs structure acts as defense mechanism for hostile takeover.

The recommendations by DVRs Group seems to extend a hand of opportunity to listed companies and those companies including, newly incorporated companies, who intend to issue DVRs but do not have a consistent track record of distributable profits as stated in the existing ICDR regulations, i.e. 3 years.

The Sunset Clause in case of SR shares shall keep a check on the tenure of the DVRs, however, the provisions requiring companies issuing the DVRs to observe better corporate governance practices is missing in the proposed structure of DVRs. Further, there might be instances where the interest of minority shareholders could be adversely affected by the holder of SR shares, therefore, certain checks and balances to prevent the misuse of the instruments should be imposed by SEBI to protect the interest of the shareholders as well as the genuine issuers.

[1] https://www.sebi.gov.in/reports/reports/mar-2019/consultation-paper-on-issuance-of-shares-with-differential-voting-rights_42432.html

[2] http://www.pionline.com/article/20180216/ONLINE/180219888/sec-commissioner-calls-for-curb-on-dual-class-forever-shares#

[3] https://ecgi.global/sites/default/files/working_papers/documents/SSRN-id2138949.pdf

Indefinite deferral of IFRS for banks: needed reprieve or deferring the pain?

/0 Comments/in , , /by

Vinod Kothari (vinod@vinodkothari.com); Abhirup Ghosh (abhirup@vinodkothari.com)

On 22 March, 2019, just days before the onset of the new financial year, when banks were supposed to be moving into IFRS, the RBI issued a notification[1], giving Indian banks indefinite time for moving into IFRS. Most global banks have moved into IFRS; a survey of implementation for financial institutions shows that there are few countries, especially which are less developed, where banks are still adopting traditional GAAPs. However, whether the Notification of the RBI is giving the banks a break that they badly needed, or is just giving them today’s gain for tomorrow’s pain, remains to be analysed.

The RBI notifications lays it on the legislative changes which, as it says, are required to implement IFRS. It refers to the First Bi-monthly Monetary Policy 2018-19[2], wherein there was reference to legislative changes, and preparedness. There is no mention in the present  notification for preparedness – it merely points to the required legislative changes. The legislative change in the BR Act would have mostly been to the format of financial statements – which is something that may be brought by way of notification. That is how it has been done in case of the Companies Act.

This article analyses the major ways in which IFRS would have affected Indian banks, and what does the notification mean to the banking sector.

Major changes that IFRS would have affected bank accounting:

  • Expected Credit Loss – Currently, financial institutions in India follow an incurred credit loss model for providing for financial assets originated by them. Under the ECL model, financial assets will have to be classified into three different stages depending on credit risk in the asset and they are:
    • Stage 1: Where the credit risk in the asset has not changed significantly as compared to the credit risk at the time of origination of the asset.
    • Stage 2: Where the credit risk in the asset has increased significantly as compared to the credit risk at the time of origination of the asset.
    • Stage 3: Where the asset is credit impaired.

While for stage 1 financial assets, ECL has to be provided for based on 12 months’ expected losses, for the remaining stages, ECL has to be provided for based on lifetime expected losses.

The ECL methodology prescribed is very subjective in nature, this implies that the model will vary based on the management estimates of each entity; this is in sharp contrast to the existing provisioning methodology where regulators prescribed for uniform provisioning requirements.

Also, since the provisioning requirements are pegged with the credit risk in the asset, this could give rise to a situation where the one single borrower can be classified into different stages in books of two different financial institutions. In fact, this could also lead to a situation where two different accounts of one single borrower can be classified into two different stages in the books of one financial entity.

  • De-recognition rules – Like ECL provisioning requirements, another change that will hurt banks dearly is the criteria for derecognition of financial assets.

Currently, a significant amount of NPAs are currently been sold to ARCs. Normally, transactions are executed in a 15:85 structure, where 15% of sale consideration is discharged in cash and the remaining 85% is discharged by issuing SRs. Since, the originators continue to hold 85% of the SRs issued against the receivables even after the sell-off, there is a chance that the trusts floated by the ARCs can be deemed to be under the control of the originator. This will lead to the NPAs coming back on the balance sheet of banks by way of consolidation.

  • Fair value accounting – Fair value accounting of financial assets is yet another change in the accounting treatment of financial assets in the books of the banks. Earlier, the unquoted investments were valued at carrying value, however, as per the new standards, all financial assets will have to be fair valued at the time of transitioning and an on-going basis.

It is expected that the new requirements will lead to capital erosion for most of the banks and for some the hit can be one-half or more, considering the current quality of assets the banks are holding. This deferment allows the banks to clean up their balance sheet before transitioning which will lead to less of an impact on the capital, as it is expected that the majority of the impact will be caused due to ECL provisioning.

World over most of the jurisdictions have already implemented IFRS in the banking sector. In fact, a study[3] shows that major banks in Europe have been able to escape the transitory effects with small impact on their capital. The table below shows the impact of first time adoption of IFRS on some of the leading banking corporations in Europe:

Impact of this deferment on NBFCs

While RBI has been deferring its plan to implement IFRS in the banking sector for quite some time, this deferral was not considered for NBFCs at all, despite the same being admittedly less regulated than banks. The first phase of implementation among NBFCs was already done with effect from 1st April, 2018.

This early implementation of IFRS among NBFCs and deferral for banks leads to another issue especially for the NBFCs which are associates/ subsidiaries of banking companies and are having to follow Ind AS. While these NBFCs will have to prepare their own financials as per Ind AS, however, they will have to maintain separate financials as per IGAAP for the purpose of consolidation by banks.

What does this deferment mean for banks which have global listing?

As already stated, IFRS have been implemented in most of the jurisdictions worldwide, this would create issues for banks which are listed on global stock exchanges. This could lead to these banks maintaining two separate accounts – first, as per IGAAP for regulatory reporting requirements in India and second, as per IFRS for regulatory reporting requirements in the foreign jurisdictions.

—

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11506&Mode=0

[2] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=43574

[3] https://www.spglobal.com/marketintelligence/en/news-insights/research/european-banks-capital-survives-new-ifrs-9-accounting-impact-but-concerns-remain

Should OCI be included as a part of Tier I capital for financial institutions?

/2 Comments/in , , /by

India has been adopted International Financial Reporting Standards (IFRS) in the form of Indian Accounting Standards (Ind AS) in a phased manner since 2016. Different implementation schedules have been issued by different regulatory authorities for different classes of companies and they are:

  • Ministry of Corporate Affairs –
    • For non-banking non-financial companies – Implementation schedule started from 1st April, 2016
    • For non-banking financial companies – Implementation schedule started from 1st April, 2018
  • Reserve Bank of India –
    • For banking companies – The original scheduled start date was 1st April, 2018, subsequently, it was shifted to 1st April, 2019. However, a recent notification from the RBI has shifted the implementation schedule indefinitely.[1]
  • Insurance Regulatory Development Authority of India –
    • For insurance companies – The implementation schedule starts from 1st April, 2020.

Consequent upon implementation of IFRS, it is logical that the regulatory framework for financial institutions will also require modifications to bring it in line with the provisions requirements under the new standards.

Though the Ind AS already been implemented in the NBFC sector, no modifications in the existing regulations have been made. Consequently, this has led to the creation of several ambiguities; and one such is regarding treatment of the Other Comprehensive Income (OCI), as per Ind AS 109, for the purpose of computing Tier 1 capital.

This write up will solely focus on the issue relating to treatment of OCI for the purpose of Tier 1 capital.

Other Comprehensive Income (OCI)

Before delving further into specifics, let us have a quick recap of the concept of the OCI. The format of income reporting under Ind AS has undergone a significant change. Under Ind AS, the statement of profit or loss gives us Total Comprehensive Income which consists of a) profit or loss for the period and b) OCI. While the first component represents the profit or loss earned by the reporting entity during the financial year, OCI represents unrealized gains or losses from financial assets of the reporting entity.  

The intention of showing OCI in the books of the accounts, is that it protects the gains/losses of companies from oscillation. As the fair values of assets and liabilities fluctuate with the market, parking the unrealized gains in the OCI and not in the P/L account provides stability. In addition to investment and pension plan gains and losses, OCI also captures that the hedging transactions undertaken by the company. By segregating OCI transactions from operating income, a financial statement reader can compare income between years and have more clarity about the sources of income.

While profit or loss earned during the year forms part of the surplus or other reserves in the balance sheet, OCI is shown separately under the Equity segment of the balance sheet.

Capital Risk Adequacy Ratio

Moving on to the meaning of capital risk adequacy ratio (CRAR), it is a measurement of a bank’s available capital expressed as a percentage of a bank’s risk-weighted credit exposures. The CRAR is used to protect creditors and promote the stability and efficiency of financial institutions. This in turn results in providing protection against insolvency. Two types of capital are measured: Tier-I capital, which can absorb losses without a bank being required to cease trading, and Tier-II capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.

The concept of CRAR comes from the Basel framework laid down by the Basel Committee on Banking Supervision (BCBS), a division of Bank of International Settlement. The latest framework being followed worldwide is Basel III framework.

RBI has also adopted the Basel framework, however, with modifications to suit the economic environment in the country. The CRAR requirements have been made applicable to banks as well as NBFCs, however, the requirements vary. While banks are required to maintain 9% CRAR, NBFCs are required to maintain 15% CRAR.

To understand whether OCI should form part of CRAR, it is important to understand the components of CRAR.

Components of Tier I and II Capital as per RBI Master Directions[2] for NBFCs

For the purpose of this write-up, requirements have been examined only from the point of view of NBFCs, as Ind AS is yet to be implemented for banking companies.

CRAR comprises of two parts – Tier I capital and Tier II capital. Each of the two have been defined in the Master Directions issued by the RBI, in the following manner:

(xxxii) “Tier I Capital” means owned fund as reduced by investment in shares of other non-banking financial companies and in shares, debentures, bonds, outstanding loans and advances including hire purchase and lease finance made to and deposits with subsidiaries and companies in the same group exceeding, in the aggregate, ten percent of the owned fund; and perpetual debt instruments issued by a non-deposit taking non-banking financial company in each year to the extent it does not exceed 15% of the aggregate Tier I Capital of such companies as on March 31 of the previous accounting year;

The term “owned funds” have been defined as:

“owned fund” means paid up equity capital, preference shares which are 9 compulsorily convertible into equity, free reserves, balance in share premium account and capital reserves representing surplus arising out of sale proceeds of asset, excluding reserves created by revaluation of asset, as reduced by accumulated loss balance, book value of intangible assets and deferred revenue expenditure, if any;

Tier II capital has been defined as:

(xxxiii) “Tier II capital” includes the following:

  • preference shares other than those which are compulsorily convertible into equity;
  • revaluation reserves at discounted rate of fifty five percent;
  • General provisions (including that for Standard Assets) and loss reserves to the extent these are not attributable to actual diminution in value or identifiable potential loss in any specific asset and are available to meet unexpected losses, to the extent of one and one fourth percent of risk weighted assets;
  • hybrid debt capital instruments;
  • subordinated debt; and
  • perpetual debt instruments issued by a non-deposit taking non-banking financial company which is in excess of what qualifies for Tier I Capital, to the extent the aggregate does not exceed Tier I capital.

The above definitions of Tier I and II capital do not talk about OCI. However, the Directions were prepared before the implementation of Ind AS 109 and no clarity on the subject has come from RBI post implementation of Ind AS 109.

Therefore, for determining whether OCI should be made a part of Tier I or Tier II capital, we can draw reference from Basel III framework.

Components of Tier I capital as per Basel III framework [3]

As per Para 52 of the framework, the Tier I capital consists of:

Common Equity Tier 1 capital consists of the sum of the following elements:

  • Common shares issued by the bank that meet the criteria for classification as common shares for regulatory purposes (or the equivalent for non-joint stock companies);
  • Stock surplus (share premium) resulting from the issue of instruments included Common Equity Tier 1;
  • Retained earnings;
  • Accumulated other comprehensive income and other disclosed reserves;
  • Common shares issued by consolidated subsidiaries of the bank and held by third parties (ie minority interest) that meet the criteria for inclusion in Common Equity Tier 1 capital. See section 4 for the relevant criteria; and
  • Regulatory adjustments applied in the calculation of Common Equity Tier 1

Retained earnings and other comprehensive income include interim profit or loss. National authorities may consider appropriate audit, verification or review procedures. Dividends are removed from Common Equity Tier 1 in accordance with applicable accounting standards. The treatment of minority interest and the regulatory adjustments applied in the calculation of Common Equity Tier 1 are addressed in separate sections.

The Basel III norms clearly states that accumulated other comprehensive income forms a part of the Tier I capital.

It is very interesting to note that RBI had also adopted Basel III framework on July 1, 2015, however, the framework adopted and introduced is silent on the treatment of the OCI, unlike the original Basel III framework. The reason for the omission of the concept of OCI is that the framework was adopted in India way before Ind AS implementation and under the erstwhile IGAAP, there was no concept of OCI or booking of unrealized gains or losses in the books of accounts.

It is well understood that due to the very recent implementation of IndAS 109, the guidelines have not been revised in line with the IndAS. However, going by the spirit of Basel III regulation, this leaves us very little doubt what the treatment of OCI for the purpose of CRAR computation should be. Therefore, one can safely conclude that the OCI should form part of Tier I capital, unless, anything contrary is issued by the RBI subsequently.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11506&Mode=0

[2] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45MD01092016B52D6E12D49F411DB63F67F2344A4E09.PDF0

[3] https://www.bis.org/publ/bcbs189.pdf

Guidelines for Review of Loans and Investments by the Audit Committee

/3 Comments/in , /by

Team Vinod Kothari & Company
corplaw@vinodkothari.com

Background

 

Securities and Exchange Board of India (Listing Obligations and Disclosure Requirement) Regulations, 2015 (‘Listing Regulations’) as well as Companies Act, 2013 (‘Act, 2013’) specify the role of the audit committee and mandates the audit committee to mandatorily review certain matters. Among the matters to be reviewed by the audit committee, section 177 of the Act, 2013 provides for review of inter-corporate loans and investments. Additionally, under Regulation 18 read with Schedule II and Regulation 24 of the Listing Regulations, the audit committee shall review the utilization of the loans/advances given to subsidiaries which exceed a certain threshold and shall also review the financial statements of its unlisted subsidiary.

 

The intent of audit committee review is to provide an independent view of the strength, objectivity and transparency of long-term investments made by the company and financial exposures taken by the company into other entities. Additionally, the audit committee may also review whether the loans/investments are still serving the purpose that they were intended to achieve, and whether the health/fair value of the loans and investments has substantially been affected over time. The audit committee’s review may also become the basis for strategic decisions on continuing the said financial exposures.

 

In case of subsidiaries, they are a part of the extended enterprise led by the holding entity. The holding entity puts in capital and other resources into subsidiaries. The subsidiaries are engaged in specific activities/verticals based on the business model of the enterprise. The subsidiaries may make further downstream investments and thus, create a network, once again, within the larger group objective of the enterprise. However, the review by the audit committee ensures that the subsidiaries are serving the larger group objective that they were designed to serve.

 

The following is a guideline as to what should be the perspective of the review and the specific areas of concern for such loans and investments which are placed for review/scrutiny before the audit committee; when such review is to be made etc. Further, the perspective and purpose of the audit committee is different while reviewing the loans and investments to its subsidiaries and that given to others.

Relevant provisions of Listing Regulations:

 

Regulation 24(2):

 

“The audit committee of the listed entity shall review the financial statements, in particular, the investments made by the unlisted subsidiary.”

 

Para A of Part C of Schedule II:

 

“The role of the audit committee shall include the following:

…

  1. Scrutiny of inter-corporate loans and investments.

XX

  1. reviewing the utilization of loans and/ or advances from/investment by the holding company in the subsidiary exceeding rupees 100 crore or 10% of the asset size of the subsidiary, whichever is lower including existing loans / advances / investments existing as on the date of coming into force of this provision”

Parallel provisions of Companies Act, 2013:

 

Section 177(4) 

“Every audit committee shall act in accordance with the terms of reference specified in writing by the board which shall, inter alia, include:

…

(v) Scrutiny of inter-corporate loans and investments;

…”

 

Clarification on the terms loans, advances and investment

 

Need to review inter corporate loans and investments by the audit committee:

 

Inter corporate loans and investments made by the company implies a long term financial exposure. Generally speaking, unless the company is into the business of making investments, the inter-corporate investments are not directional investments; they are strategic in nature. Similarly the inter-corporate loans, except in case of companies engaged in the business of lending, are not intended for reaping interest income. Therefore, the review of these long-term financial exposures to be taken by the audit committee is to ensure that these outlays of funds do not lead to long-term resources of the entity being diverted to a purpose which is not congenial or related to the corporate objective. The objective also includes review of the health and integrity of these loans and investments. Where required, disinvestment calls may also have to be taken based on review by the audit committee.

 

While the law requires the audit committee to review the inter-corporate loans and investments, there seems to be no reason for excluding the review of guarantees/ securities provided by the company in connection with the loan.

 

Need to review investments in and made by the unlisted subsidiaries:

 

The holding company invests in the capital of subsidiaries. While the need for reviewing the investment in subsidiaries does not come from the Companies Act, 2013, the Listing Regulations specifically requires the listed holding company to review the investments of its unlisted subsidiaries. The investments made by the subsidiaries are indirect investments of the holding company itself. Where the subsidiaries are listed entity, the investments made are subject to similar review by their audit committee. However, in case of unlisted subsidiaries, there is less likelihood that the subsidiary will have its own audit committee. Irrespective, the audit committee of the holding listed entity is entrusted with the responsibility of monitoring and reviewing the investments made by such subsidiaries. The audit committee of the holding company has to review such investments to understand if there is any diversion from the objectives of the investment. Further, in case of downward investment by the subsidiary, the audit committee shall review whether the larger objective of the holding company is being served.

 

Need to review loans given to unlisted subsidiary

 

The audit committee the holding company is required to review whether the loans granted by it to its subsidiary is being utilized for the approved purpose or not. Any case of diversion of funds has to be brought to the notice of the audit committee since any sort of funding to the subsidiary is always with an intent of expanding or stabilizing the operations of the holding company. Further, the audit committee while reviewing needs to check whether the terms on the loan are reasonably fair and at arm’s length.

 

Scope of ‘loans’ to be reviewed by audit committee:

 

The audit committee of the listed entity is required to scrutinize inter-corporate loans availed/ granted by the listed entity. Inter- corporate loans for the purpose of review shall include-

 

  • Inter-corporate guarantees given by the listed entity;
  • Inter-corporate security provided by the listed entity;
  • Loans with terms and conditions substantially at variance with the loans ordinarily provided;
  • Guarantees with terms and conditions substantially at variance with the guarantees usually provided;
  • Loans other than in the ordinary course of business

 

Loans/ guarantees which are granted or security provided in the ordinary course of business or to exempted categories need not be reviewed by the audit committee.

 

Scope of ‘Investments’ to be reviewed by audit committee:

 

Investments as are assets held by an enterprise for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock-in-trade are not ‘investments’.

 

Investments which shall be reviewed by the audit committee of the listed entity will include strategic investments made with the motive to earn yield or regular investment income. Investing the funds reduces the investible funds of the entity, funds available for business and therefore it is necessary to review the same. Investments should not be restricted to investments in securities only. Investment in the assets/property should also be covered within the ambit. Certain investments, as specified here under, need not be included within the ambit:

 

  • Trade investments made by the listed entity or its unlisted subsidiary;
  • Investments made in the ordinary course of business;
  • Statutory investments made under applicable law;

 

Specific concerns for review by the audit committee:

 

The perspective of the audit committee is different while scrutinizing loans and investments of the listed entity as well as while reviewing the investments made in/by the unlisted subsidiary. For this purpose the following points should be included by the audit committee in its review –

 

1.      Specific concerns for loans to other entities

 

  • Purpose of loan, how does it serve the business interest of the company;
  • Tenure of loan;
  • Where the company has raised any money by issuing any shares/ debentures, does the giving of the loan amount to utilization of issue proceeds for a purpose other than that disclosed in the offer document;
  • Rate of interest appropriate in view of credit risk of investee;
  • Security interest and liquidity;
  • Whether the loan is being serviced or has become impaired;
  • Whether the quality of the borrower has deteriorated;
  • Whether repayment happens as per stated repayment schedule;
  • Whether there exists a scope for premature repayment;
  • Whether there exists any reason to opt for premature repayment;
  • If loan is not to a related party, how and why the transaction emanate;
  • Whether the loan has been extended on reasonably fair terms and conditions and at arm’s length.

2.      Specific concerns for investment in other entities

 

  • Purpose of investment, how does it serve the business interest of the company;
  • Whether there has been any diversion in utilizing the investment of the company from the objects and purposes approved by the audit committee;
  • Whether the subsidiary has made any downstream investment and whether such downstream investment is at par with the objectives of the investment of the company
  • Performance of investment – in terms of yield, returns;
  • Likely performance of the investment in future;
  • Liquidity of the investment;
  • Any reason to seek liquidation/ exit from investment.

  

  1. Specific concerns in case of subsidiaries

 

While many of the above may not be relevant in case of subsidiaries, the following areas of concern shall be looked into by the audit committee in case of loans and investment made:

 

Loans

 

  • Whether the loan is being utilized for the purposes approved by the company;
  • Is there any diversion in the end use of the loan;
  • Covenants of the loan, particularly, with a view to ensure that there are no chances of diversion of funds from the purpose for which they are purportedly intended to be provided.

 

Investment

 

  • Whether there has been any diversion in utilizing the investment of the company from the

objective and purposes approved by the audit committee;

  • Whether the subsidiary has made any downstream investment and whether such downstream investment is at par with the objectives of the investment of the company;
  • Whether the investment made is a fit case for impairment considering the performance of the investee company.

On-going review by audit committee:

 

As per Regulation 24(2), investments of the unlisted subsidiary shall be reviewed by the audit committee of the holding listed entity at the time of review of financial statements of the unlisted subsidiary. Financial statements are prepared annually; therefore, the review shall be done on an annual basis for the investments made by unlisted subsidiaries during the year.

 

Further, as per Clause 9 of Para A, Part C of Schedule II to Listing Regulations the loans/ investments of the listed entity shall be subject to scrutiny by its audit committee before making investment/disbursing loans, to the extent possible or after the same have been made.

 

Furthermore, the holding company also reviews the following in case of its unlisted subsidiary, on an on-going basis:

 

  • Whether the subsidiary has sufficient accumulated reserves while considering its performance;
  • Whether the dividend policy of the subsidiary is in line with the larger objectives of the holding company;
  • Whether the subsidiary has large amount of surplus lying in its books so as to enable it to plan a buy back.

 

Format for reporting to the audit committee

 

There is no specific format for reporting the performance / status report to the audit committee for enabling the committee to review the same. However, the same may be reported in the following manner:

 

Sr. No Particulars of investment / loan

 

[Name of the party, date of investment or loan, purpose, tenure, etc.]

 Concerns Amount involved Performance / Update
    Whether Secured or unsecured    
What is the yield
Whether liquid or illiquid
Market price of the securities
Whether there is any potential risk associated with the investment /loan
Servicing / repayment schedule
Any change in the credit rating of the investee company