Manoj Kumar Tiwari, Executive, Vinod Kothari & Company
SEBI has vide notification published in the Official Gazette dated July 29, 2019 notified the SEBI (Listing Obligations and Disclosure Requirements) (Fourth Amendment) Regulations, 2019 (‘Amendment Regulations’). The said Amendment Regulations shall come into force from the date of publication in the Official Gazette i.e. July 29, 2019.
The amendments pertain to compliances in relation to corporate governance provisions for listed entities which have issued shares with Superior Rights (SRs). SEBI has issued a framework for issuance of DVR as an outcome of SEBI Board Meeting held on June 27, 2019 some of which have been included in the Amendment Regulations.
Brief of the changes made in line with the framework are as under:
Regulation 17(1) w.r.t. Board Composition
- Atleast half of the board of directors of the listed company which has outstanding SR equity shares shall comprise of independent directors;
Regulation 18(1)(b) w.r.t. Audit Committee Composition
- The audit committee of a listed entity having outstanding SR equity shares shall comprise only of independent directors;
Regulation 19(1)(c) w.r.t. Nomination and Remuneration Committee (NRC) Composition
- Two third of the NRC of a listed entity having outstanding SR equity shares shall comprise of independent directors;
Regulation 20(2A) w.r.t. Stakeholders Relationship Committee (SRC) Composition
- Two third of the SRC of a listed entity having outstanding SR equity shares shall comprise of independent directors;
Regulation 21(2) w.r.t Risk Management Committee (RMC) Composition
- Two third of the RMC of a listed entity having outstanding SR equity shares shall comprise of independent directors;
Regulation 41(3) w.r.t prohibition on issue of shares with SR substituted with the following
- The listed entity shall not issue shares in any manner that may confer on any person;
- superior or inferior rights as to dividend vis-à-vis the rights on equity shares that are already listed; or
- inferior voting rights vis-à-vis the rights on equity shares that are already listed:
- a listed entity having SR equity shares issued to its promoters/ founders, may issue SR equity shares to its SR shareholders only through a bonus, split or rights issue in accordance with the provisions of the SEBI (ICDR) Regulations, 2018.
Regulation 41A – Other provisions relating to outstanding SR equity shares
A new regulation has been inserted w.r.t SR equity shares
- The SR equity shares shall be treated at par with the ordinary equity shares in every respect, including dividends, except in the case of voting on resolutions.
- The total voting rights of SR shareholders (including ordinary shares) in the issuer upon listing, pursuant to an initial public offer, shall not at any point of time exceed seventy four per cent.
- List of Circumstances in which SR equity shares shall be treated as ordinary equity shares in terms of voting rights viz. appointment/ removal of IDs, RPTs involving SR shareholder, Voluntary winding up, Voluntary resolution process under IBC, changes in AOA/ MOA except change affecting SR equity share, delisting of equity shares etc.
- Conversion of SR equity shares into ordinary shares w.e.f. 5 years after listing of the ordinary shares. The same can be extended for further 5 years after passing a resolution to that effect, with the SR shareholders abstaining from voting.
- Circumstances when SR equity shares shall be mandatorily converted into ordinary shares viz. demise of promoter holding such shares, SR shareholder resigning from executive position, merger or acquisition of listed entity resulting in SR shareholders cease to have control etc;
The notification in the Official Gazette can be accessed here: http://egazette.nic.in/WriteReadData/2019/209215.pdf
The outcome of the SEBI Board Meeting held on June 27, 2019 can be accessed here: https://www.sebi.gov.in/media/press-releases/jun-2019/sebi-board-meeting_43417.html
The following Regulations have also been amended to include shares with superior voting rights.
SEBI (Delisting of Equity Shares) Regulations, 2009
Regulation 3 w.r.t applicability of the regulation
The term ‘shares’ shall include equity shares having superior voting rights.
The said amendment can be accessed here: http://egazette.nic.in/WriteReadData/2019/209243.pdf
SEBI (Buy-Back of Securities) Regulations, 2018
Regulation 3 w.r.t applicability of the regulation
The term ‘shares’ shall include equity shares having superior voting rights.
The said amendment can be accessed here: http://egazette.nic.in/WriteReadData/2019/209214.pdf
-by Dibisha Mishra
(firstname.lastname@example.org ; email@example.com)
SEBI vide Notification dated 25th July, 2019 further amended the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015. The major part of this amendment is to make curative changes in the Regulations, in response to difficulties expressed by the stakeholders. In this regard, VK&Co. also had occasion to make representation to SEBI, a few of which have been brought in via this amendment.
Highlights of the SEBI (PIT) (Second Amendment) Regulations, 2019.are as follows:
- Employees having access to unpublished price sensitive information are to be identified as ‘designated persons’ [DPs]: Keeping the intent of regulating and monitoring trading by such employees, the earlier provision of identifying them as ‘designated employees’ was merely a laxity in drafting since no corresponding duties/obligations were put upon ‘designated employees’ anywhere in the PIT Regulations.
- Mandatory closure of trading window from the end of every quarter till 48 hours after the declaration of financial results [the word ‘can’ substituted by ‘shall’]
- Permitted transactions by DPs while trading window is closed:
a. off-market inter-se transfer between DPs having possession of the same unpublished price sensitive information where both parties have made informed trade decision;
b. transaction through block-deal mechanism between persons having possession of the same unpublished price sensitive information where both parties have made informed trade decision;
c. arising out of a statutory or regulatory obligation to carry out a bona fide transaction;
d. exercise of stock options in respect of which the exercise price was pre-determined;
e. pursuant to a trading plan;
f. pledge of shares for a bonafide purpose like raising of funds subject to pre-clearance by the compliance office
g. acquisition by conversion of warrants or debentures, subscribing to rights issue, further public issue, preferential allotment or tendering of shares in a buyback offer, open offer, delisting offer: Difficulties were frequently being faced by companies as to whether the trading window bar will apply to corporate actions involving transaction in shares. This amendment makes a clear way out for the same. While only a few corporate actions are listed in the amendment, these should be taken as illustrative rather than exhaustive.
4. In order to qualify as a “material financial relationship”, payment by way of loan or gift should flow from a designated person equivalent to at least 25% of his annual income [excluding payment is based on arm’s length transactions] in last twelve months.
5. Educational institutions from which designated persons have graduated, is to be disclosed to the intermediary or fiduciary on an annual basis and as and when the information changes.
“Our mission is to develop IFRS Standards that bring transparency, accountability and efficiency to financial markets around the world”, the International Accounting Standards Board (IASB) is indeed on a way towards fulfilling its mission. The International Financial Reporting Standards (IFRS) have been worldwide acknowledged and appreciated as a benchmark of transparency, trust and growth. In another specimen of its attempt to increase transparency in financial markets around the world, the IASB, back in 2016, introduced the IFRS 16, to be applicable w.e.f. annual reporting period beginning on or after 01.01.2019.
Introduced with the objective of introducing a single lessee accounting model, the IFRS-16, aims at ensuring faithful representation of lease transactions and pioneers the concept of “Right-to-Use” Assets.
In this article, we intend to delve deeper into what IFRS-16 brings to the table, its objective and most importantly its impact.
Understanding the Concept
In the present financial set-up of our economy and business environment, “Lease” is an indispensable element. With the advantages it carries and the flexibility it has provided to financing, the concept of lease has penetrated to every strata of being. However, from an accounting perspective, the nexus of “lease” with “assets” makes it essential to understand the procedure of incorporating the lease transactions in the books of both the lessor (legal owner of the asset) and the lessee (user of the asset); and, IFRS-16 is the answer.
While it does not modify the accounting treatment in the books of the lessors from that laid down in IAS 17, IFRS-16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.
To understand better, let us now take an illustration:
A is the legal owner of a car. B, a small businessman, intends to take the car on lease for a period of 3 years. Here, A becomes the Lessor, and B, steps into the shoes of a Lessee. Now that B has the right to use the car, he must identify this car as a right-to-use asset, more colloquially knows as RTU Asset.
Hence, the Lessee records the car along with other non-financial assets like property, plant and building, and the lease liabilities along with other liabilities. It is pertinent to note that the RTU asset must however, be recorded at its present value, arrived at by discounting at its Internal Rate of Return (IRR). As a result, the lessee also recognises depreciation of the RTU Asset and interest on the lease liability in its Statement of Profit and Loss.
Rationale behind IFRS-16:
By what can be called the “5 Rule Check”, IAS 17, distinguishes leases into two broad classesviz. Operational and Financial Leases. While the leased assets wererecorded in the books of the lessor, in case of both operational and financial leases; as per IAS 17, an operational lease in the books of a lessee was treated as an “off-balance sheet” item. Regards the objective with which the new standard was introduced, IASB Chairman, Mr. Hans Hoogervorst, said that “These new accounting requirements bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligation. The new standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off balance sheet lease financing is no longer lurking in the shadows. It will also improve comparability between companies that lease and those that borrow to buy.”
Hence, it is clearly a step towards IASB’s vision of transparency, accountability and efficiency.
Put simply, IFRS 16 eliminates the distinction between operational and financial lease in the books of a lessee. We shall now analyse its impact in the real field and compare the outcome with the expectations.
On the surface, the accounting treatment will have a knock-off effect on financial elements; for instance, Earnings before Interest, Tax, Depreciation & Amortization (EBITDA) and Profit After Tax (PAT).
Let us understand this effect with the help of an illustration:
A Ltd., an aviation company, has taken on lease, aircrafts worth Rs. 1000 crore, having residual value (RV) 20%, for 36 months, @ 12% p.a., having revenue of Rs. 15,000 crore
On the basis of the above information, we get the following:
- Lease Rental p.a. : Rs. 342.86 crores
- Right to Use Asset (RTU) : Rs. 860.22 crores
- Depreciation on RTU Asset (on SLM Basis) : Rs. 286.74 crores
- Annual Interest @ 12% p.a. : Rs. 89.59 crores
Now let us compare the impact of the accounting treatment under IAS 17 vs. IFRS 16:
Note: Unlike IFRS-16, under IAS 17, the entire operating lease transaction remains to be an off-balance sheet transaction. Under IFRS 16, the RTU less depreciation is recorded under the assets side vis-à-vis. Lease payables under the liabilities head.
Hence, as evident from the above illustration, sum towards rentals (fixed cost) under IAS 17, have now been substituted with Interest obligation under IFRS 16, and as such the EBIDTA is higher in the initial years. Further, recording the asset at RTU value also gives way for depreciation, and hence, as a result of depreciation along with interest, the PBT reduces in the initial years. From a bird’s eye view, both the assets and liabilities of the lessees adopting IFRS 16 will increase.
Re-negotiation of Loan Covenants:
Further, now that the lease assets are to be recorded, it will typically result in companies appearing to be more debt leveraged; however, since leases are most likely on the operating transaction side vis-à-vis loan transactions, this is not the true picture. This pseudo-presence of huge liabilities is also likely to take a toll on the lessee’s credit rating. Hence, formal communication with the lenders will become a matter of concern, and a sound two-way communication and transparency with the lenders will be the key to managing the transition from IAS 17 to IFRS 16, smooth and efficient.
With the first quarter of F.Y. 2019-20 embarking the first quarter of implementation of IFRS 16, the author makes a humble attempt to study the impact, on the basis of financial results declared by several industry-majors.
According to a study by Cushman & Wakefield in June 2019, the Indian markets show a strong presence in office space leasing. It has also been observed that the IT-BPM sector, has a higher share in office lease activities, as compared to its contemporaries. Hence, it is evident that the “leasing” is an essential element in the BPM industry.
As the Mumbai-based BPM giant, WNS Global announced its first quarter results; we observe that while the operating profit increased as a result of IFRS 16, the profit for the quarter has decreased. This increase in the operating margins comes to picture as fixed costs reduce with interests of lease payments replace the rentals; the counter result of which is the increase in finance costs due to which the ultimate profit dips.
It is said that the three objectives of any business is Survival, Profit and then Growth. However, as may be seen from above, application of IFRS 16 has led to fall in the profit. It is apprehended that the fall in profit may hold back companies, in the BPM sector from continuing office-space leasing.
Ever imagined that the airplanes we fly in, are most likely not even present on the company’s balance sheet? This non-appearance in the balance sheets was the outcome of accounting standards laid down under IAS 17. However, with IFRS 16 in the picture, the new financial year will be different from previous fiscals, especially for the aviation industry, as they now have to record all lease transactions in their books.
Adopting IAS 116, the Indian counterpart of IFRS 16, the airline industries now have to capitalise operating leases as RTU assets. While recording lease transactions and its by-products like interest, depreciation, the impact will majorly depend on factors like
- Proportion of operating lease in the overall asset pool;
- Duration of leases.
With leasing forming an indispensable element of airline companies, even though accounting should not be the key driver in commercial negotiations, market behaviour might change towards shorter lease tenures to minimize lease liabilities.
Owing to the fall in profits in the initial years, it is expected that there might be fall in operating leases, and sale & lease-back arrangements, which will prompt the airlines to purchase more aircrafts. Mr. Wui Jin Woon, Head of Aviation, Asia Pacific, Natixis CIB, also said that “Airline with sufficient access to liquidity may be more incline to purchase now that there is no difference from an accounting perspective between operating and finance leases.”
However, adopting IAS 116, the Indian counterpart of IFRS 16, the airline industry major, IndiGo stated that while there might be changes in the future reported profits, which may necessitate a change in current P/E based valuation methodology, it will not impact IndiGo’s cash profits, cash flows and growth strategy.
Hence, while there is broad consensus on how the standard will affect various financial metrics, there is considerably less agreement on how it might influence operating decisions and market sentiments.
Most Communications companies enter into lease agreements both as lessors and lessees, as such, leases in the industry are prevalent. The new standard is likely therefore to have a material impact for Communications companies.
Arrangements which may contain leases could include – customer contracts for using identified network or infrastructure equipment, equipment provided to customers through which the operator delivers communication services such as set top boxes and modems, and data centre services etc.
As a consequence of IFRS 16, the potential business impact could include renegotiation of network development and network sharing agreements. Further, companies already having large asset bases, may be prey to the impairment risk with the addition of further assets in the balance sheet.
(a) Corporate Car Leasing
Corporate Car Leasing is a very innovative employee benefit scheme that has cropped up off late. Under this scheme, big corporates provide its employees, car taken on operational lease, which the end of tenure is sold to the employee at a nominal value.Hence, while the car is essentially for the benefit of the employees, the company is the actual lessee. As this set up was in the nature of an operating lease, the lessee, as per IAS 17, was not required to record the car in its balance sheet.
However, will the roll in of IFRS 16, the corporates will be required to record these cars at their RTU as assets and a corresponding lease liability in their books; as a result of which, the balance sheet of the corporate shall increase manifold.
(b) Fleet Management
In the Fleet Management market, leasing, especially operating lease has proven to be a smart move to optimise its costs and maintain adequate ratios, as until now, it was not required to be recognized in the balance sheet of the lessee.
Murray Price, managing director of EQSTRA Fleet Management said, “These include the impact on the company’s financial report, key ratios, disclosures, the cost of implementation, the ability to access desired information, the impact of covenants and debt renegotiations and leasing strategies.
This magnification of balance sheet, by virtue of change in accounting policies is anticipated to be detrimental to this industry. It is expected that this will hold back corporates from entering into such arrangements.
Change in the Lessors’ Approach:
Like every action has a reaction, even though IFRS 16 does not essentially alter or modify accounting methodologies adopted by the lessors, the lessors may be impacted in their business models due to change in lessees’ behaviour. From the foregoing, a common thread that can be observed is that lessees having better liquidity, will now tend to incline towards purchasing the assets rather than leasing, as such, lessors may be required to revaluate the current portfolio of leases and prospective targets to identify lessees that may seek to alter their strategies as a result of IFRS-16.
Moving ahead from the industry wise acceptance, we shall now see how the new standard has been welcomed at the global level.While India has come up with IAS 116, drawn on the same lines and principles as IFRS 16, the United stated shall continue to follow ASC 842, dealing with the same subject.
Further, barring variances in implementation due to local regulatory requirements, IFRS 16 has been relatively consistently adopted in most of the Asia-Pacific markets. In Hong Kong, for example, most companies have a December financial year-end and submit financial statements to in around August in the following year. IFRS 16 impacts may become more apparent when listed companies release interim results in July 2019.
In Australia, most year-ends are in June, so some companies will not technically need to grapple with IFRS 16 until the second half of 2019.Similar patterns are evident in Singapore, Malaysia, India and the Philippines, where common accounting periods and reporting practices mean many companies won’t have to address IFRS 16 until later in the year.
The equivalent standards in Thailand and Indonesia are not effective until January 2020. In China, the Ministry of Finance only released the local version of the standard in December 2018, giving non-listed companies up to 2021 to adopt.
Given the gravitas and indispensable presence of leases and the fact that it resides on such a large scale ground, to judge with certainty, the impact of IFRS 16 certainly requires more time. The dust around the same has not settled yet, hence one can say the picture is not yet vivid; however, it surely sets up the pace for what might unveil in days to come.
The Unregulated Deposit Banning Bill, 2019 was introduced in the Lok Sabha on 24th July, 2019 and has since been passed.
The Bill enacts into law the provisions promulgated by a Presidential Ordinance from 21st February 2019.
From our preliminary comparison, it appears that the Bill is largely the same as the text of the Ordinance.
However, a very significant, though very vague, amendment is the insertion of section 41 in the Bill which provides as under: “The provisions of this Act shall not apply to deposits taken in the ordinary course of business”
Of course, one will keep wondering as to what does this provision imply? What exactly is deposit taking in ordinance course of business? Is it to exclude deposits or loans taken for business purposes? Notably, almost all the so-called deposits that were taken during the Chit funds scam in West Bengal were apparently for some business purpose, though they were effectively nothing but money-for-money transactions. While the intent of this exception may be quell fears expressed across the country by small businesses that even taking of loans for business purposes will be barred, the provision does not jell with the meaning of excluded deposits which gives very specific carve-outs.
Also, one may potentially argue that deposit-taking itself may be a business. Or, deposits sourced may be used for money-lending business, which is also a deposit taken in ordinary course of business.
Basically, the insertion of this provision in section 41 may completely rob the statute of its intent and impact, even though it has an understandable purpose.
Please see our write ups on the Ordinance
by Vinod Kothari
The Companies (Amendment) Bill, 2019 has been placed before the Parliament on 25th July, 2019. While the Bill, 2019 is largely to enact into Parliamentary law the provisions already promulgated by way of Presidential Ordinance, the Bill also brings some interesting changes.
The key feature of the Bill is to replace the existing system of judicial prosecution for offences by a departmental process of imposition of penalties. As a result, while the monetary burden on companies may go up, but offenders will not be having to face criminal courts and the stigma attached with the same.
Some of the other highlights of the changes are as follows:
Dematerialisation of securities may now be enforced against private companies too
It is notable that amendments were made by the Companies (Amendment) Act, 2017 effective from 10th September, 2018 effective from 2nd October, 2018, whereby all public unlisted companies were required to ensure that the issue and transfer of securities shall henceforth be done in dematerialised mode only. This provision alone had brought about major cleansing of the system, as in lots of cases, shareholding records included men of straw.
However, the reality of India’s corporate sector is private companies, constituting roughly 90% of the total number of incorporated companies.
The provision of section 29 is now being extended to all companies, public and private. This means, that the Govt may now mandate dematerialisation for shares of private companies too. Whether this requirement will be made applicable only for new issues of capital by private companies, or will require all existing shares also to be dematerialised, remains to be seen, but if it is the latter, the impact of this will be no lesser than “demonetisation-2” at least for the corporate sector. Evidently, all shareholders of all private companies will have to come within the system by getting their holdings dematerliaised.
CSR is now mandatory, and unspent amounts will go to PM’s Funds
When the provision for corporate social responsibility was introduced by Companies Act 2013, the-then minister Sachin Pilot went public to say, the provision will follow what is globally known as “comply or explain” (COREX). That is, companies will not be mandated to spend on CSR – the board report will only give reasons for not spending.
Notwithstanding the above, over the last few months, registry offices have sent show-cause notices to thousands of companies for not spending as required, disregarding the so-called reasons given in the Board report.
Now, the rigour being added takes CSR spending to a completely different level:
- If companies are not able to spend the targeted amount, then they are required to contribute the unspent money to the Funds mentioned in Scheduled VII, for example, PM’s National Relief Fund.
- Companies may retain amounts only to the extent required for on-going projects. There will be rule-making for what are eligible on-going projects. Even in case of such on-going projects, the amount required will be put into a special account within 30 days from the end of the financial year, from where it must be spent within the next 3 years, and if not spent, will once again be transferable to the Funds mentioned in Schedule VII.
- Failure to comply with the provisions makes the company liable to a fine, but very seriously, officers of the company will be liable to be imprisoned for upto 3 years, or pay a fine extending to Rs 5 lacs. Given the fact that the major focus of the Injecti Srinivas Committee Report, which the Ordinance tried to implement, was to restrict custodial punishment only to most grave offences involving public interest, this by itself is an outlier.
Unfit and improper persons not to manage companies
The concept of undesirable persons managing companies was there in sections 388B to 388E of the Companies Act, 1956. These sections were dropped by the recommendations of the JJ Irani Committee. Similar provisions are now making a comeback, by insertions in sections 241 to 243 of the Act. These insertions obviously seem a reaction to the recent spate of corporate scandals particularly in the financial sector. Provisions smacking similar were recently added in the RBI Act by the Finance Bill.
The amendment in section 241 empowers the Central Govt to move a matter before the NCLT against managerial personnel on several grounds. The grounds themselves are fairly broadly worded, and have substantial amplitude to allow the Central Govt to substantiate its case. Included in the grounds are matters like fraud, misfeasance, persistent negligence, default in carrying out
obligations and functions under the law, breach of trust. While these are still criminal or quasi-criminal charges, the notable one is not conducting the business of the company on “sound business principles or prudent commercial practices”. Going by this, in case of every failed business model, at least in hindsight, one may allege the persons in charge of the management were unfit and improper.
Once the NCLT has passed an order against such managerial person, such person shall not hold as a director, or “any other office connected with the conduct and management of the affairs of any
Company”. This would mean the indicted person has to mandatorily take a gardening leave of 5 years!
Disgorgement of properties in case of corporate frauds
In case of corporate frauds revealed by investigation by SFIO, the Govt may make an application to NCLT for passing appropriate orders for disgorgement of profits or assets of an officer or person or entity which has obtained undue benefit.
-Financial Services Division and IFRS Division, (firstname.lastname@example.org email@example.com)
The transition of accounting policies for the non-banking financial companies (NBFCs) is on the verge of being completed. As was laid down in the implementation guide issued by the Ministry of Corporate Affairs, the Indian Accounting Standard (Ind AS) was to be implemented in the following manner:
|Non-Banking Financial Companies (NBFCs)|
|From 1st April, 2018 (with comparatives for the periods ending on 31st March, 2018)|
|· NBFCs having net worth of rupees five hundred crore or more (whether listed or unlisted)|
|· holding, subsidiary, joint venture and associates companies of above NBFC other than those already covered under corporate roadmap shall also apply from said date|
|Phase II||From 1st April, 2019 (with comparatives for the periods ending on 31st March, 2019)|
|· NBFCs whose equity and/or debt securities are listed or in the process of listing on any stock exchange in India or outside India and having net worth less than rupees five hundred crore
|· NBFCs that are unlisted companies, having net worth of rupees two-hundred and fifty crore or more but less than rupees five hundred crore|
|· holding, subsidiary, joint venture and associate companies of above other than those already covered under the corporate roadmap|
|· Unlisted NBFCs having net worth below two-hundred and fifty crore shall not apply Ind AS.
· Voluntary adoption of Ind AS is not allowed (allowed only when required as per roadmap)
· Applicable for both Consolidated and Individual Financial Statements
As may be noted, the NBFCs have been classified into three major categories – a) Large NBFCs (those with net worth of ₹ 500 crores or more), b) Mid-sized NBFCs (those with net worth of ₹ 250 crores – ₹ 500 crores) and c) Small NBFCs (unlisted NBFCs with net worth of less than ₹ 250 crores).
The implementation of Ind AS for Large NBFCs has already been completed, and those for Mid-sized NBFCs is in process; the Small NBFCs are anyways not required implementation.
The NBFCs are facing several implementation challenges, more so because the regulatory framework for NBFCs have not undergone any change, despite the same being closely related to accounting framework. Several compliance requirements under the prudential norms are correlated with the financial statements of the NBFCs, however, several principles in Ind AS are contradictory in nature.
One such issue of contradiction relates to determination of qualifying assets for the purpose of NBFC classification. RBI classifies NBFCs into different classes depending on the nature of the business they carry on like Infrastructure Finance Companies, Factoring Companies, Micro Finance Companies and so on. In addition to the principal business criteria which is applicable to all NBFCs, RBI has also laid down special conditions specific to the business carried on by the different classes of NBFCs. For instance, the additional qualifying criteria for NBFC-IFCs are:
(a) a minimum of 75 per cent of its total assets deployed in “infrastructure loans”;
(b) Net owned funds of Rs.300 crore or above;
(c) minimum credit rating ‘A’ or equivalent of CRISIL, FITCH, CARE, ICRA, Brickwork Rating India Pvt. Ltd. (Brickwork) or equivalent rating by any other credit rating agency accredited by RBI;
(d) CRAR of 15 percent (with a minimum Tier I capital of 10 percent)
Similarly, there are conditions laid down for other classes of NBFCs as well. The theme of this article revolves the impact of the Ind AS implementation of the conditions such as these, especially the ones dealing with sectoral deployment of assets or qualifying assets. But before we examine the specific impact of Ind AS on the compliance, let us first understand the implications of the requirement.
Relevance of sectoral deployment of funds/ qualifying assets for NBFCs
The requirement, such as the one discussed above, that is, of having 75% of the total assets deployed in infrastructure loans by the company happens to be a qualifying criteria. IFCs are registered with the understanding that they will operate predominantly to cater the requirements of the infrastructure sector and therefore, their assets should also be deployed in the infrastructure sector. However, once the thresholds are satisfied, the remaining part of the assets can be deployed elsewhere, as per the discretion of the NBFC.
The above requirement, in its simplest form, means to have intentional and substantial amount of the total assets of the NBFC in question to be deployed in the infrastructure area, both, at the time of registration, as well as a regulatory requirement, which has to be met over time. Breaching the same would result in non-fulfilment of the RBI regulations.
Impact of Ind AS on the qualifying criteria
The above requirement might seem simple, however, with the implementation of Ind AS on NBFC, there can be important issues which might result in the breach of the above requirement.
With the overall slogan of “Substance over Form”, and promoting “Fair Value Accounting” and an aim to make the financial statements more transparent and just, Ind AS have been implemented. However, the same fair value accounting can result in a mismatch of regulatory requirement, to such an extent that the repercussion may have a serious impact on the existence of being an NBFC.
As already stated above, once an NBFC satisfies the qualifying criteria, it can deploy the remaining assets anywhere as per its discretion. Let us assume a case, where the remaining assets are deployed in equity instruments of other companies. All this while, under the Indian GAAP, investments in equity shares were recorded in the books of accounts as per their book value, but with the advent of Ind AS, most of these investments are now required to be recorded on fair values. This logic not only applies in case of equity instruments, but in other classes of financial instruments, other than those eligible for classification as per amortised cost method.
The problem arises when the fair value of the financial instruments, other than the NBFC category specific loans like infrastructure loans, exceed the permitted level of diversification (in case of IFC – 25% of the total assets). Such a situation leads to a question whether this will breach the qualifying criteria for the NBFC. A numeric illustration to understand the situation better has been provided below:
Say, an NBFC-IFC, having a total asset size of Rs. 1,000 crores would be required to have 75% of the total assets deployed in infrastructure loans i.e. Rs. 750 crores. The remaining Rs. 250 crores is free for discretionary deployments. Let us assume that the entire Rs. 250 crores have been deployed in other financial assets.
Now, say, after fair valuation of such other financial assets, the value of such assets increases to ₹ 500 crores, this will lead to the following:
|Under Indian GAAP||Under Ind AS|
(in ₹ crores)
|As per a % of total assets||Amount
(in ₹ crores)
|As per a % of total assets|
|Other financial assets||250||25%||500||40%|
Therefore, if one goes by the face of the balance sheet of the NBFC, there is a clear breach as per the Ind AS accounting, as the qualifying asset comes down to 60% as against the required level of 75%. However, is it justified to take such a view?
The above interpretation is counter-intuitive.
It may be noted that the stress is on “deployment” of its assets by an IFC. Merely because the value of the equity has appreciated due to fair valuation, it cannot be argued that the IFC has breached its maximum discretionary investment limits. The deployment was only limited to 25% or so to say that even though the fair value of the exposure has gone up but the real exposure of the NBFC is only to the extent of 25%. Under Ind AS, the fair value of an exposure may vary but the real exposure will remain unchanged.
Taking any other interpretation will be counter-intuitive. If the equity in question appreciates in value, and if the fair value is captured as the value of the asset in the balance sheet, the IFC will be required to increase its exposure on infrastructure loans. But the IFC in question may be already fully invested, and may not have any funding capability to extend any further infrastructure loans. Under circumstances, one cannot argue that the IFC must be forced to disinvest its equities to bring down its investment in equities, particularly as the same had nothing to do with “deployment” of funds.
This is further fortified by Para 10. Accounting of Investments, Chapter V- Prudential Regulations of the Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 about valuation of equities:
“Quoted current investments for each category shall be valued at cost or market value whichever is lower”.
Hence, the RBI Regulations have been framed keeping in view the historical cost accounting. There is no question of taking into consideration any increase in fair value of investments.
Therefore, it is safe to say that while determining the compliance with qualifying criteria, one must consider real exposures and not fair value of exposures as the same is neither in spirit of the regulations nor seems logical. This will however be tested over time as we are sure the regulator will have its own say in this, however, until anything contrary is issued in this regard, the above notion seems logical.
Partner, Vinod Kothari and Company
The listed entities are burdened with the compliance requirements under numerous regulations issued by SEBI including the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’). The said regulations lay down various to dos for the listed companies as well as the designated persons (‘DP’) for the purpose of regulating and prohibiting the insider trading in the securities of the listed company.
SEBI has vide its circular dated 19th July, 2019 laid a format for reporting insider trading lapses thereby forcing all companies to follow a standard reporting format. The existing practice of companies using rather informal and self- generated reporting formats will no longer be available to them.
It is not that insider trading lapses noted by companies are those of profiteering based on Unpublished Price Sensitive Information (UPSI). Most of the noted instances in practice are technical and unintentional breaches of either the trading window closure or contra trading restrictions. Most of these are reported to the audit committee or stakeholder’s relationship committee which typically takes action based on the gravity of the offence. However, reporting to SEBI was done on a rather diminutive manner.
Further, the circular also provides for recording the violations in the digital database maintained by the compliance officer under the PIT Regulations for the purpose of taking appropriate action against the offender. The said circular is effective with immediate effect.
Current Reporting Scenario
The current practice of the corporates for reporting the violation under the code (either for entering into contra-trade within a period of six months or trading during the closure of trading window, etc.) along with the action taken by the entity is diverse. While some companies used to mark a copy of the reprimand to SEBI while sending the same to the concerned DP or their immediate relatives, others used to send a brief of the violation along with the action taken to SEBI depending on the frequency and gravity of the violation so made in accordance with their respective codes.
The revised reporting format contains all the required fields for the entity (listed entity, intermediary or fiduciary) to report the violation to SEBI. Following is the summary of details that is mandatory required to be filled up about the entity, the DP or his immediate relative and the violation along with the action taken by the entity:
|Information about the entity||Information about the DP/ immediate relative||Transaction details|
|· Name and capacity of the entity.
· Action taken by the entity.
· Reasons for the action taken.
|· Name and PAN.
· Designation and functional role of DP.
· Whether a part of the promoter and promoter group or holding CXO position.
|· Name of the scrip
· No. and value of shares traded (including pledge)
· In case trading value exceeds Rs. 10 lakhs date of disclosure made under regulation 7 of the PIT Regulations by both the entity as well as the concerned person.
· Details of violation observed under the PIT Regulations.
· Instances of any violation in the previous financial year.
Evidently, the format contains concrete information about the violation which will place SEBI in a better position to oversee and take on record the instances of violation taking place in the regulated entities. While the current practice had deficiencies in terms of the basic information supplied to SBI, the revised reporting format will take care of the same henceforth.
However, the prompt reporting will be a task for the entities. At the same time, SEBI will now be in receipt of the complete information on the offence and may take strict action against the offender or may even direct the entities to take stricter action in cases where it feels the action taken is not commensurate with the nature and gravity of the violation.
Our other resources on SEBI PIT Regulations can be viewed here