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Open in new tab Bond issuers set to become Market Maker to enhance liquidity
Issuer to provide Liquidity Window facility to eligible investors
– Vinita Nair & Heta Mehta| corplaw@vinodkothari.com
While SEBI took numerous measures to deepen the bond market and increase transparency and participation viz. Electronic Book Building Platform (‘EBP) for issue above Rs. 50cr, Request for Quote (‘RFQ’) platform, reduction in face value of privately placed bonds, online bond platform (‘OBP’), corporate bond repo system etc, illiquidity in bond market continued to remain one of the major concerns for SEBI. To address the issue of liquidity mainly for retail investors, SEBI vide its consultation paper dated August 16, 2024 proposed introduction of Liquidity Window facility, a unique concept in bond market.
Read more →Research Analysts v/s Investment Advisors – Is the Line Blurring ?
– Payal Agarwal, Associate and Dayita Kanodia, Executive | finserv@vinodkothari.com
An investment in knowledge pays the best interest
– Benjamin Franklin
Investment advisors and research analysts, including the unregistered ones have been on SEBI’s radar for quite some time. As per latest data available on SEBI’s website, there are 971 Investment Advisors and 1368 Research Analysts registered with SEBI. Recently, SEBI has brought a consultation paper on review of regulatory framework for investment advisors and research analysts. While some proposals are aimed at an ease of registration for an entity/ person as an RA/ IA, the CP also contains substantial proposals w.r.t. the activities and functioning of IAs and RAs.
In this article, we discuss the broad concept of IAs and RAs and a few major proposals under the CP, with our analysis on the potential implications.
Read more →Bye bye to Share Buybacks
– Finance Bill 2024 puts buybacks to a biting tax proposal w.e.f. 1st October, 2024
-Team Corplaw | corplaw@vinodkothari.com
Among the tax law changes proposed by Finance Bill, 2024, the one on share buybacks, explained as one intended to remove tax inequity, is perhaps the most unexplainable. The proposed change, by introduction of a new sub-clause (f) to section 2 (22) [deemed dividend], and simultaneous amendments to sec. 46A and sec. 115QA, not only shifts the tax burden from companies to shareholders, but surprisingly, brings to tax the entire amount paid on buyback, irrespective of the excess realised by the shareholder. It leaves the cost of shares to be claimed as capital loss and set off against potential capital gains, of course only if such gains arise within the prescribed timelines for carry forward and set off.
Buyback of shares is the only way a company seeks to scale down its capital. The proposed amendment makes it impossible for companies to reduce their capital base by returning capital not needed, as the only other way is through reduction of share capital, which is subject to shareholders’, creditors’, and NCLT approval. It is surprising that this amendment by the very same Budget which proposes to introduce the novel concept of “variable capital companies”.
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SEBI amends regulations after 6 years of Fair Market Conduct committee’s recommendation
-Garima Chugh, Executive | corplaw@vinodkothari.com
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AIFs cannot be used as regulatory arbitrage
SEBI mandates ongoing due diligence for investors and investments made by AIFs
-Vinita Nair, Senior Partner and Lavanya Tandon, Executive | corplaw@vinodkothari.com
Background
Alternative Investment Funds (‘AIFs’), presently around 1324 registered with SEBI, channels risk capital to enterprises, including unlisted companies, as well as cater to sophisticated investors. One of the major concerns highlighted by SEBI was that while the AIF industry had registered robust growth over the years, a number of instances of AIFs being structured to facilitate circumvention of different financial sector regulations was witnessed, thereby eroding trust in the system.
SEBI had raised following concerns in its Consultation Paper issued in January, 2024:
- Evergreening of loans by regulated lenders:
A regulated lender would subscribe to a junior class of units of an AIF, and the AIF in turn would fund the lender’s stressed borrower. The borrower would use these funds to repay the loan given by the regulated lender, without disclosure of any stress. The stressed asset in the books of the regulated lender would in effect be replaced with the investment in the junior class units of an AIF.
- Circumvention of FEMA norms:
Some foreign investors set up AIFs with domestic managers/sponsors to invest in sectors prohibited for FDI, or to invest beyond the allowed FDI sectoral limit. Further, foreign investors may set up AIFs to invest foreign money in debt/debt securities where foreign investment is envisaged through the FPI/ECB route.
- Circumvention of QIB regulations:
In terms of SEBI (ICDR) Regulations, 2018 all AIFs are designated as QIBs. QIBs are generally perceived as large, regulated, sophisticated and informed institutional investors. Certain AIFs have single or very few investors, at times belonging to same investor group, and avail benefits available to QIBs (for e.g. investing in IPO under QIB quote) which would otherwise not be available to them. It also permits otherwise ineligible entities/ persons to influence the price discovery process in public market in the garb of AIF.
SEBI also recorded 40+ cases wherein the structure of AIF had been abused and used to circumvent extant financial sector regulations. Read our analysis in the article ‘AIFs ail SEBI: Cannot be used for regulatory breach’ dated January 31, 2024.
Last year, SEBI had issued ‘Guidelines with respect to excusing or excluding an investor from an investment of AIF dated April 10, 2023 that empowered an AIF to excuse its investor from participating in a particular investment in the following circumstances:
Further, RBI had also barred all regulated entities (REs) with respect to their investments in AIFs, discussed in our article.
Present Amendment
Accordingly, in order to restore the trust and prevent such circumvention in the AIF ecosystem and to facilitate ease of doing business, it was proposed introduce a general obligation in the existing AIF regulations that would require AIFs, managers and their key management personnel (‘KMPs’) to ensure that their operations and investments do not facilitate circumvention of regulations administered by any financial sector regulator.
Subsequent to receipt of public comments on the Consultation Paper, the proposal to mandate due-diligence of investors and each of the investments made by the AIF was approved in the SEBI Board meeting held on March 15, 2024. SEBI notified SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2024 effective from April 25, 2024 amending Reg. 20 of the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’) dealing with general obligations thereby requiring every a. AIF, b. investment manager of the AIF, c. KMP of the AIF, and d. KMP of the investment manager, to exercise specific due diligence with respect to their investors and investments in order to prevent facilitation of circumvention of such laws as may be specified by SEBI from time to time
Scope of laws covered under the ambit of due diligence
‘Laws’ here include Acts, Rules, Regulations, Guidelines or circulars framed thereunder that are administered by a financial sector regulator, including those administered by SEBI. SEBI shall prescribe a framework under the above-mentioned regulation, by way of issuance of circular, to address circumvention of specifically identified financial sector regulations
As indicated in Annexure A of the SEBI Board meeting agenda the list of identified specific regulations of financial sector regulations for which specific due-diligence checks shall be formulated to prevent AIFs facilitating circumvention of the same comprises of following:
Due diligence requirement – one-time or ongoing?
As discussed in the SEBI BM Agenda, the purpose of the due-diligence check is to prevent facilitation of any circumvention of provisions of financial sector regulators, which cannot be a time specific check. An entity who intends to circumvent can design the structure in such a way that, at a later date post investment, it acquires the units of AIFs post investment, such as buying the units of an existing investor or by acquiring control over the existing investor entity, as per prior arrangement. Accordingly, it has been indicated that due diligence around investors and investments will be an ongoing one.
Applicability of due diligence – prospective or retrospective?
It was suggested that any proposed due diligence criteria should only be applicable in relation to prospective investments and SEBI should grandfather investments made as on date. Further, it was also discussed that in case it has been ascertained that the AIF has facilitated circumvention with respect to the investments already made, the manager may be mandated to report the same to SEBI or the respective financial sector regulator for examination.
Standards for due-diligence
In order to ensure that the due-diligence requirements are not open-ended or subject to interpretation, the specific implementation standards for verifiable due diligence to be conducted on investors and investments of AIFs will be formulated by the pilot Industry Standards Forum for AIFs, in consultation with SEBI.
Conclusion
The present amendment lays an onerous burden on the AIF, manager and KMP of the AIF and the manager. The obligation of on-going due diligence will result in a compliance burden. It will be worth watching to see the standards for due diligence framed by the industry forum in line with ‘trust, but verify’ principle and ascertain the actionable arising therefrom.
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Mandatory bond issuance by Large Corporates: FAQs on revised framework
Sustainability linked derivatives: An instrument with a potential
– Vinod Kothari, vinod@vinodkothari.com
Sustainability-linked loans and bonds have been surging globally. While there has been a dip in the recent periods (Q3 and Q4 of 2023) owing to tightening of regulatory conditions, the global volumes of sustainability-linked loans stood at around $ 400 billion[1].
However, there is another instrument – a derivative, which also has a linkage with sustainability targets, and that is making a global buzz. ISDA, having named this Sustainability Linked Derivatives or SLDs, is creating proper documentation basis to take this market forward. As of now, the market for SLDs is neither large nor highly standardised, but as credit defaults rose from nowhere and from a purely OTC product into being in the very thick of the global financial crisis, SLDs also merit close attention.
What is an SLD?
Think of usual derivatives in financial business – it will be an interest rate swap, or cross currency swap/FX forward. An SLD adds a sustainability-linked overlay on a typical IRS or FX hedge transaction.
For instance, assume Borrower X has taken a floating rate loan of $ 100 million, say at SOFR + 100 bps. X now hedges interest rate risk by entering into an IRS with Bank A, whereby Bank swaps this for a fixed rate of 4.5%.
Here, if we add an SLD overlay, Bank A will agree to provide a discount of, say 5 bps if X is able to meet certain specified sustainability KPIs. On the contrary, if X fails to meet the KPIs, then X pays a penalty of equal or a different amount. Depending on the agreement, the discount or penalty, or bonus/malus, may either be exchanged between the counterparties or by spent by either counterparty by way of a donation for a sustainability cause.
Read more →Contra trade restrictions – traversing out of PAN to common control
Anushka Vohra | Senior Manager
corplaw@vinodkothari.com
Introduction
The SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) impose certain restrictions and obligations on the DPs, one of which is contra trade restriction.
The DPs and their immediate relatives are restricted from entering into contra trade which refers to opposite trades executed viz. buy / sale within a shorter period of time usually within a period of 6 months with an intent to book short term profits. Where contra – trade is executed in violation of the restriction, the profit earned is to be disgorged for remittance to the IPEF.
In case of an individual DP (promoters / directors / etc. as recognized by the listed company), the immediate relatives also have certain obligations under the Regulations as their trades may be said to be influenced by the DPs. Similarly, in case of non-individual DPs (promoters), there may be other promoters and persons belonging to the promoter group who may act in concert with a particular non-individual promoter.
Having said that, it is important to understand the intent of contra trade, whether the same would apply individually on DPs based on trades executed against their PAN or the same would apply jointly on DPs and their immediate relatives or the entire promoter group inter-se. The same has been a matter of discussion in various Informal Guidance (‘IG’) of SEBI. We discuss the same briefly along with other illustrations.
Informal Guidance
Generally, the concept of Persons Acting in Concert (‘PACs’) is used in the Takeover Code and under the PIT Regulations, the perspective so far has been PAN based. In the recent IG in the matter of Deccan Gold Mines Ltd[1], SEBI in its interpretative letter has given the view that contra trade restrictions would apply on the promoter group jointly, given the case in hand. The facts of the case have been represented diagrammatically below.
We see that the listed company is being held by two corporate promoters, which in turn are held by common shareholders. Here, RMML intended to sell its shareholding in open-market within 6 months of the allotment made to AIRL.
Since there is common control in both the promoter entities, it was stated that contra-trade restriction would apply jointly on both.
Intent of contra-trade
The intent of contra trade, as also mentioned above is to ensure that the persons who are privy to UPSI do not make short term profits in the securities of the listed company. For instance, if a DP has bought a security of the listed company in anticipation of a rise in prices that might be caused by the UPSI, such DP cannot sell such security within 6 months of the purchase. While trades can be executed by different DPs having different PAN, however where a single person is the “driving force” (as cited by the SAT in Shubhkam Ventures (I) Private Limited v. SEBI[2], it cannot be said that the persons acted in their individual capacity.
There have been instances in the past where SEBI has given the view that contra trade restrictions apply individually on DPs. The view seems to be supported by the interpretation of clause 10 of Schedule B of the Regulations, which states that:
The code of conduct shall specify the period, which in any event shall not be less than six months, within which a designated person who is permitted to trade shall not execute a contra trade. XXX
Previously, in 2020, in the matter of Raghav Commercial Ltd[3], SEBI in its interpretative letter took the view that the contra trade restrictions apply to trades made by promoters individually and not the entire promoter group.
Taking the case of individual DPs, in the matter of Star Cement Limited[4], while answering the question on applicability of contra trade restrictions – whether individually or to the entire promoter group, SEBI cited the above clause 10 stating that the same applies individually.
Reference of the above case was taken in 2019 in the matter of Arvind Limited[5], where contra trade restrictions were said to apply individually on DP through PAN, disregarding who took the trading decision. Our detailed article on the same can be read here.
The current case makes it quite clear that the facts of the case have to be considered to analyze whether there is a single person taking trading decision.
Let us take several other examples to understand the intent of contra trade.
1.
Whether Leg 2 will be contra to Leg1? Here we see that significant stake i.e. 50% is being held by Partner A (promoter of X Ltd) in the LLP. The trades of LLP can be said to be influenced by the decision of Partner A. This can be a case of common control and therefore Leg 2 becomes contra to Leg 1.
2.
In this case, we will have to see who is behind A Ltd and B Ltd. If both A Ltd and B Ltd are held by the same set of shareholders, Leg 2 would become contra to Leg 1.
Further, there are certain exemptions w.r.t. contra-trade restrictions that have been prescribed in the PIT Regulations and also in SEBI FAQs.
As per PIT Regulations, contra trade shall not apply for trades pursuant to exercise of stock options. SEBI Faqs further elaborate on the same stating that, in respect of ESOPs, subscribing, exercising and subsequent sale of shares, so acquired by exercising ESOPs (hereinafter “ESOP shares”), shall not attract contra trade restrictions.
Further trades pursuant to any non- market transaction is exempted (SEBI Faqs).
The rationale behind exemption is that for stock options and non-market transactions, the exercise price / purchase price is predetermined. The selling transaction pursuant to exercise of stock options or pursuant to acquisition of shares in non-open market is not influenced by purchases made basis some UPSI. The exercise price / acquisition price is already decided by the company.
Let us understand another example.
3.
In the above case, it is evident that A is the decision maker for A Pvt Ltd. Here, Leg 2 is not contra to Leg 1.Leg 4 is contra to Leg 3 as there is no exemption provided.
Often, it is also interpreted that contra-trade is applicable share wise. To take an example, suppose; first – stock options are acquired by a DP, second – open market purchase is done, third – stock options are sold (all three within a period of 6 months). Here, it is interpreted that third would not be contra to first and second. This is a wrong interpretation, as the moment the DP makes any open market purchase or already has the company’s shares in portfolio, the immunity w.r.t. selling shares acquired pursuant to exercise of stock options is lost. One cannot differentiate between the shares as what is important to establish for contra-trade is the intention to make short term profits. Such intention, also, is evident when trading decisions are made by a single person, irrespective of the different individuals executing trades.
Global scenario
Contra-trade is understood by different names in other jurisdictions. It is referred to as short swing in the US and reversal trade in some jurisdictions.
- United States – Securities Exchange Commission Act, 1934[6]
Section 16(b) deals with prohibition on short-swing trades by beneficial owner, director, or officer of the companies. The section reads as under:
“For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner[7], director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) or a security-based swap agreement involving any such equity security within any period of less than six months, unless such security or security-based swap agreement was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security or security based swap agreement purchased or of not repurchasing the security or security-based swap agreement sold for a period exceeding six months.XXX”
- China – Securities Law of the People’s Republic of China[8]
Article 41 and 42 deals with contra trade restrictions. It reads as under:
Article 41 A shareholder that holds five percent of the shares issued by a company limited by shares shall, within three days from the date on which the number of shares held by him reaches this percentage, report the same to the company, which shall, within three days from the date on which it receives the report, report the same to the securities regulatory authority under the State Council. If the company is a listed company, it shall report the matter to the stock exchange at the same time.
Article 42 If the shareholder described in the preceding article sells, within six months of purchase, the shares he holds of the said company or repurchases the shares within six months after selling the same, the earnings so obtained by the shareholder shall belong to the company and be recovered by the board of directors of the company. However, a securities company that has a shareholding of not less than five percent due to purchase of the remaining shares in the capacity of a company that underwrites as the sole agent shall not be subject to the restriction of six months when selling the said shares.
If the company’s board of directors fails to comply with the provisions of the preceding paragraph, the other shareholders shall have the right to require the board of directors to comply.
If the company’s board of directors fails to comply with the provisions of the first paragraph and thereby causes losses to the company, the directors responsible therefore shall bear joint and several liabilities for the losses.
Concluding remarks
We had earlier in our article (supra) given the view that contra-trade should be seen jointly and not individually, considering the intent. To establish violation of PIT Regulations, one has to go beyond tracking trades based on PAN. It is important to know the decision maker behind the trades, in order to establish a clear nexus. It would be important to see whether such a view was taken by SEBI because of the case in hand or is it reflective of a new trend i.e. position of common control.
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[1] https://www.sebi.gov.in/enforcement/informal-guidance/oct-2023/in-the-matter-of-rama-mines-mauritius-ltd-under-sebi-prohibition-of-insider-trading-regulations-2015_78308.html
[2] https://www.sebi.gov.in/satorders/subhkamventures.pdf
[3] https://www.sebi.gov.in/sebi_data/commondocs/sep-2020/SEBI%20let%20Raghav%20IG_p.pdf
[4] https://www.sebi.gov.in/sebi_data/commondocs/jul-2018/StarCementGuidanceletter_p.pdf
[5] https://www.sebi.gov.in/sebi_data/commondocs/nov-2019/Inf%20Gui%20letter%20by%20SEBI%20Arvind_p.pdf
[6] https://www.govinfo.gov/content/pkg/COMPS-1885/pdf/COMPS-1885.pdf
[7] Every person who is directly or indirectly the beneficial owner of more than 10% of any class of any equity security (other than exempted security) [Ref. 16(a)(1)]
[8] http://www.npc.gov.cn/zgrdw/englishnpc/Law/2007-12/11/content_1383569.htm#:~:text=Article%201%20This%20Law%20is,of%20the%20socialist%20market%20economy.
REIT and InvIT unitholders with 10% aggregate holding get Board nomination rights
Avinash Shetty, Assistant Manager | corplaw@vinodkothari.com