Can CICs invest in AIFs? A Regulatory Paradox

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-Anshika Agarwal (finserv@vinodkothari.com)

Core Investment Companies (CIC) and Alternative Investment Funds (AIF) are two very common modes to channelise investments in the Indian market. Both are regulated by different regulators; while CICs are regulated by the RBI, AIFs are regulated by the SEBI. Under their respective regulatory frameworks, both are technically permitted to invest in one another. However, this permissibility introduces an intriguing paradox, especially for a CIC, which is allowed to invest in group companies. It points out that this approach effectively creates two investment pools—one directly under the CICs and another through the AIFs. This dual-pool structure complicates what could otherwise be a straightforward process, introducing unnecessary layers of complexity, thus deviating from the primary purpose of CICs to hold and manage investments efficiently within group companies. 

The following article examines the implications of Paragraph 26(a)1 of the Master Direction – Core Investment Companies (Reserve Bank) Directions, 2016 (“CIC Master Directions”), but before delving into the specifics, it may be worthwhile to discuss in brief the concepts of AIF and CIC. 

What are AIFs (Alternative Investment Funds)?

AIFs have gained prominence as a pivotal part of the financial ecosystem, providing investors with access to diverse and innovative investment opportunities. The key features of an AIF are as follows:

  1. An AIF is a privately pooled investment vehicle, therefore, it cannot raise money from public at large through a public issue of units;
  2. The investors could be Indian or foreign – there is no bar on the nature of the investor who can invest.
  3. The investments made by the fund should be in accordance with the investment policy.
  4. There are three categories of AIFs, depending on the kind of investments they make, and each category is regulated differently:
    1. Category 1 which invests in start up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified.
    2. Category 2 which does not fall in Category I and III and which does not undertake leverage or borrowing other than to meet day to day operational requirements and as permitted in these regulations. It includes private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other regulator shall be included.
    3. Category 3 which employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.

What are Core Investment Companies (CICs)?

CICs are a specialized subset of Non-Banking Financial Companies (NBFCs) established with the primary purpose of holding and managing investments in group companies. CICs do not engage in traditional financial intermediation but play a vital role in maintaining financial stability within the ‘group companies’. CICs are governed under the CIC Master Directions to ensure that their activities align with regulatory standards. 

Below given graph explains the regulatory permissibility of the kind of investments a CIC can make:

In addition with the aforesaid, it may further be noted that CICs are permitted to carry out the following financial activities only:

  1. investment in-
    1. bank deposits,
    2. money market instruments, including money market mutual funds that make investments in debt/money market instruments with a maturity of up to 1 year.
    3. government securities, and
    4. bonds or debentures issued by group companies,
  2. granting of loans to group companies and
  3. issuing guarantees on behalf of group companies. 

It may be noted that the RBI’s FAQs on Core Investment Companies, particularly Question 92 has clarified about the 10% of Net Asset – 

“What items are included in the 10% of Net assets which CIC/CIC’s-ND-SI can hold outside the group?

Ans: These would include real estate or other fixed assets which are required for effective functioning of a company, but should not include other financial investments/loans in non group companies.”

Who are included in Group Companies?

The term “group companies” is defined under Para 3(1)(v) of the CIC Master Directions. It refers to an arrangement involving two or more entities that are related to each other through any of the following relationships:

Subsidiary – Parent (as defined under AS 21),
Joint Venture (as defined under AS 27),
Associate (as defined under AS 23),
Promoter-Promotee (as per the SEBI [Acquisition of Shares and Takeover] Regulations, 1997 for listed companies),
Related Party (as defined under AS 18),
Entities sharing a Common Brand Name, or
Entities with an investment in equity shares of 20% or more

The Issue with Paragraph 26(a): The paradox

Para 26A of the CIC Master Directions deals with Investments in AIFs. The language of the provisions suggest that CICs are permitted to invest in AIFs. However, this provision introduces a significant legal contradiction that undermines the regulatory framework governing CICs. According to the Doctrine of Colorable Legislation, a legal principle ensuring legislative consistency, what cannot be achieved directly cannot be permitted indirectly. By allowing CICs to invest in AIFs, Para 26(a) effectively circumvents the explicit restriction on investments outside group companies. This indirect allowance is inconsistent with the foundational objectives of the CIC Master Directions and creates substantial legal and operational confusion.

Can there be an AIF which in turn invests in the group only? 

Under the SEBI (Alternative Investment Funds) Regulations, 2012, the primary objective of an Alternative Investment Fund (AIF) is to pool funds from investors and allocate them across diverse investment opportunities. However, structuring an AIF to invest predominantly or exclusively in entities within the same group raises concerns regarding compliance with SEBI’s regulatory framework, particularly its diversification. SEBI imposes strict investment concentration limits, as outlined in one of its Circular3. 

For Category I and II AIFs, no more than 25% of their investable funds can be allocated to a single investee company, while Category III AIFs are restricted to 10%. These regulations inherently prevent AIFs from focusing solely on group entities unless the investment structure strictly adheres to these limits. For CICs intending to invest in AIFs, these restrictions pose significant limitations if the goal is to channel funds primarily into group companies. 

Can AIFs be a Group Entity in a CIC’s Group Structure?

Technically, the answer is affirmative—AIFs can be part of a group entity within a group if it satisfies any of the conditions mentioned in the definition. However, if CICs invest in AIFs within the same group structure, it fails to resolve the underlying issue. AIFs often invest outside the group companies, exposing CICs indirectly to entities external to the group. This contradicts the core purpose of CICs, which is to focus investments within their own group companies. Such a structure not only undermines the original intent of CICs but also raises compliance concerns. The RBI adopts a pass-through approach in these cases and is likely to view such practices as non-compliant. 

Conclusion

The regulatory paradox of allowing CICs to invest in AIFs under Para 26(a) of the CICs Master Direction raises important questions about the practicality and purpose of this provision. At its core, CICs are meant to simplify and streamline the management of investments within their group companies. However, the inclusion of AIFs creates an unnecessary layer of complexity, dividing investments into dual investment pools and making it harder to track, manage, and maintain transparency.

This arrangement doesn’t just complicate operations, it also moves CICs away from their original purpose. By routing investments through AIFs, CICs are exposed to entities outside their group, which can lead to compliance risks, regulatory confusion, and inefficiencies. Even from a taxation perspective, the setup offers no real benefits, adding financial burdens without meaningful gains. Paragraph 26(a) of the CICs Master Direction has been taken from the SBR Master Direction, which is applicable to NBFCs. However, including it in the CICs Master Direction, which provided regulation specifically for CICs NBFC does not appear to serve any purpose. Even if it were to be amended, its relevance of stating the same for CICs NBFC would still remain questionable.

  1.  Reserve Bank of India, Master Direction – Core Investment Companies (Reserve Bank) Directions, 2016. Available at:https://www.lawrbit.com/wp-content/uploads/2021/05/Master-Direction-Core-Investment-Companies-Reserve-Bank-Directions-2016.pdf (Accessed: 19 January 2025). ↩︎
  2. FAQs on Core Investment Companies, available at: https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=836 (Accessed: 19 January 2025). ↩︎
  3.  SEBI (Alternative Investment Funds) Regulations, 2012 available at: https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-alternative-investment-funds-regulations-2012-last-amended-on-march-6-2017-_34694.html ↩︎

SEBI approves cartload of amendments 

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– Team Corplaw | corplaw@vinodkothari.com

SEBI in its Board meeting dated December 18, 2024, has approved amendments pertaining to BRSR, HVDLEs, DTs, SMEs, Intermediaries, etc.  This article gives a brief overview of the approved amendments.

Ease of Doing Business for BRSR

  • Scope of BRSR Core for Value Chain Partners shrunk
    • Value chain partners now consist of individuals comprising 2% or more of the listed entity’s purchases and sales (by value) instead of 75% of listed entity’s purchases/sales (by value).
    • Further, the listed entity may limit disclosure of value chain to cover 75% of its purchases and sales (by value), respectively.
  • Deferred applicability of ESG disclosures for the value chain partners & its limited assurance by one financial year
    • Applicability of ESG disclosures for the value chain deferred from FY 24-25 to FY 25-26.
    • Applicability of limited assurance deferred from FY 25-26 to FY 26-27.
  • Voluntary disclosure of ESG disclosures for the value chain partners & its limited assurance instead of comply-or-explain
    • Top 250 listed entities by market cap can now comply with the ESG disclosures for the value chain partners & its limited assurance on a voluntary basis in place of  comply-or-explain.
  • Term ‘Assurance’ replaced with ‘assessment or assurance’ to prevent unwarranted association with a particular profession (specifically audit profession).
    • Assessment defined as third-party assessment undertaken as per standards to be developed by the Industry Standards Forum (ISF) in consultation with SEBI. 
  • Reporting of previous year numbers voluntary in case of first year of reporting of ESG disclosures for value chain.
  • Addition of disclosure pertaining to green credits as a leadership indicator under Principle 6 – Businesses should respect and make efforts to protect and restore the environment of BRSR

Immediate actionables for Listed entities:

  • Entity to re-assess its value chain partners as per the revised definition.
  • Entity forming part of top 250 listed entities by market cap to undertake third party assessment of its BRSR Core disclosure for FY 24-25 as per the standards to be developed by ISF.
  • To disclose about the green credits procured/generated by the entity during FY 24-25.

Debenture Trustee (‘DT’) Regulations:

  • Introduction of provisions relating to ‘Rights of DTs exercisable to aid in the performance of their duties, obligations, roles and responsibilities’, which broadly indicates (as proposed in the CP):
    • Calling information/ documents from issuer w.r.t. the issuance;
    • Calling documents from various intermediaries;
    • Calling of and utilization of Recovery Expense Fund, with consent of holders.
  • Corresponding obligations on the issuers to submit necessary information/documents to DTs.

VKCo comments: In addition to the corresponding obligations on the issuer, CP also proposed to mandate Depositories and Stock exchanges to provide requisite information to DTs, which is yet to be approved. The right to call information from issuers and market participants including corresponding obligations on them will enable DTs to perform their functions efficiently.

  • Introduction of standardized format of the Debenture Trust Deed (‘DTD’)
    • To be issued by Industry Standards Forum with SEBI consultation;
    • In case of deviation from the format of DTD, disclosure is to be made for investor review. (CP proposed to disclose deviation as insertion of a key summary sheet of deviation in GID/KID)

VKCo comments: While the introduction of model DTD is appreciated, the draft model DTD proposed in the CP was not aligned with the general market practices followed by the DTs as well as the applicable laws such as SEBI Listing Regulations, NCS Regulations, Indian Trust Act, etc.

  • Activity-based Regulation for DTs:
    • DTs are to undertake only such activities regulated by other financial sector regulators/ authorities (as SEBI specifies);
    • Hive off non-regulated activities to a separate entity – within 2 years;
    • Sharing of resources between DT and hived-off entity is allowed, subject to segregation of legal liabilities;
    • Hived-off entity can use DT’s brand/logo – only for a period of 2 years (CP suggested 1 year); Both DT and hived-off entity to abide by SEBI’s code of conduct during such period.

Applicability of CG norms on HVDLEs 

Under this segment of changes discussed by SEBI, most of the proposals are in alignment with the Consultation Paper dated 31st October, 2024, except for few changes in relation with PSUs coming together with public enterprises under Public Private Partnership.

  • Threshold for being identified as HVDLE increased from 500 Crores to 1,000 Crores to align with the criteria of Large Corporates

VKCo Comments: The proposal to enhance the extant threshold is encouraging in terms of governing the maximum value of outstanding debt while at the same time achieving the same without bearing the burden of compliance by an increased number of purely debt listed entities. Subsequently, effective implementation of such a proposal aligns it with the identification criteria of Large Corporates. 

  • Introduction of a separate chapter for entities having only debt listed, and sunset clause for applicability of CG norms

VKCO Comments: While this proposal is noteworthy, however, instead of rolling out a new chapter, there could have been certain modifications in the existing regulations by way of a proviso to align with the needs of an HVDLE. Further, one also needs to wait to see the fine print -of the provisions once the same is issued.

VKCo Comments: The proposal is welcome since it clearly sets the HVDLEs free from the barrier of once an HVDLE so always an HVDLE. This proposal sets a clear nexus between the compliance and the size of the debt outstanding, for the protection of which in the very first place, the compliance triggered.

  • Optional constitution of RMC, NRC, and SRC and delegation of their functions to the AC and Board respectively.

VKCo Comments: Given the close construct of debt listed entities, it is often observed that the constitution of such committees becomes more of a hardship than in smoothing compliance and discussing specific matters. Accordingly, it looks appropriate to redirect the functions of NRC and RMC to the Audit Committee and that of the SRC to the Board.

  • HVDLEs to be included in the counting of maximum no. of directorships, memberships and chairmanships of committees. However, this shall exclude directorships arising out of ex-officio position by virtue of statute or applicable contractual framework in case of PSUs and entities set up under the Public Private Partnership (PPP) mode respectively, in the count. The said exclusion was not in the CP.

VKCo Comments: The rationale completely aligns with the proposal made and seems to be justified. Further, as far as the exclusion is concerned, this seems more from excluding those members who are part of the board not on the basis of their appointment but their current tenure being served in a particular position in the company.

  • RPT Approval by way of NOC from DT (who obtains it from holders), before going for shareholders’ approval [w.e.f. 1st April, 2025]

VKCo Comments – While the CP suggested two ways of seeking approval for material RPTs of an HVDLE. The Board has only considered the alternative mode of first seeking NOC of DT and thereafter approaching the shareholders. Further, as discussed in our related write up on the CP, there does not seem to be any incentive to first approach the DT and thereafter the DT to approach the NCD holders. Instead the approval of the NCD holders can be taken up directly by the HVDLE. 

  • Submission of BRSR on a voluntary basis

VKCo Comments: The inclusion of a voluntary provision in the legislation with respect to a comprehensive report like BRSR is not likely to be submitted given the huge details under the BRSR. However, an opportunity to submit BRSR can be a game changer for an HVDLE from the perspective of being able to raise funds based on its reporting standards in this regard. 

One of the changes discussed by the Board is relaxation to HVDLEs set up under the PPP mode from composition requirements of directors. While this was not a part of the CP, however, even if we have to understand that change proposed, this looks like relaxing the composition requirement of the Board of Directors. 

CHANGES NOT APPROVED: 

  • Compulsory filing of CG compliance report in XBRL format

VKCo Comments: This proposal was with an objective to align and standardize the filing of quarterly CG compliance report for bringing parity as in the case of equity listed entities 

  • Exemption to entities not being a Company

VKCo Comments: While SEBI refers to the introduction of similar exclusion for equity listed entities, however, it has also mentioned the subsequent amendment wherein the same was omitted. The proposal not being notified is in alignment with the position of equity listed entities, however, the same would have been a welcome change since it would have helped such entities to give preference to their principal statutes and not an ancillary one like LODR. 

Our detailed write up on the CP can be accessed here.

Amendments in the definition of UPSI – making the law more prescriptive

  • Inclusion of 17 items in definition of UPSI: The illustrative list of USPI in reg. 2 (1) (n) of the PIT Regulations has been expanded to include 17 items from the list of material events laid out in Part A of Schedule III of the Listing Regulations [Originally proposed in the CP – 13 items] 
  • Threshold limits under reg. 30 made applicable: materiality thresholds specified in reg. 30 (4) (i) (c) of the Listing Regulations have been made applicable for identification of events as UPSI 
    • As per the current practice, any event that is likely to materially affect the price of the securities can be identified as UPSI 
  • Extended timelines for making entries in SDD: for an event of UPSI that emanates outside the company, entries can be made in the SDD within 2 days of occurrence. Further closure of the trading window will not be mandatory in such cases. 
    • This has been introduced as a part of EODB
    • As per the current practice entries in the SDD have to be made promptly

Refer to our discussion on CP in: Laundry List: SEBI’s proposal to elongate list of deemed UPSIs

Share-hawkers of digital era: Legality of platforms offering unlisted shares

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– SEBI cautions investors from transacting in securities of unlisted public companies on electronic platforms

– Burhanuddin Kholiya (corplaw@vinodkothari.com)

From rental rooms to cabs to domestic furniture, almost everything is made available using technological aggregators. But the moment one tries to sell securities on public platforms, the chances of potential investors being duped by dream merchants increase – something which regulators have very carefully barred over the years. Hence, unless it is a recognised stock exchange, making securities available on public platforms constitutes “offer for sale”. Sometimes, people look at the number of investors as less than 200 and tend to argue that is not a deemed public offer, but it is important to understand that if the offer has gone to people in general, the actual number of investors who bite the bait does not matter.

Many platforms encourage investments in unlisted or pre-IPO stocks. At times bunching either securities or investors. SEBI, in its press release dated December 9, 2024, warned investors against transacting on such platforms, emphasizing the risks involved and clarifying that these platforms operate outside SEBI’s regulatory framework. 

Regulatory framework for platforms:

On the intermediaries front, stock brokers are permitted to deal only on recognised stock exchanges and are prohibited from facilitating trading outside these exchanges. In 2022, SEBI extended its regulatory framework to Online Bond Platform Providers (‘OBPP’) by mandating them to register as stock brokers in the debt segment and restricted their offerings to  listed debt securities or debt proposed to be listed through a public offering. Only recognized stock exchanges are authorised to provide a platform for fund raising  and  trading  in  securities  of  “to  be  listed”  and  “listed”  companies.

Apart from above, today, numerous platforms have emerged offering unlisted securities to the public at large. However, being unregulated, it poses significant risks to investors. While SEBI’s mandate may not extend to unlisted securities, it continues to caution investors about platforms dealing with such securities. Recognizing the potential risks and lack of oversight, SEBI and the Registrar of Companies (ROC) have issued several orders against platforms offering unlisted securities to the public. These actions aim to protect investors from being misled and address violations of private placement & public issue related provisions under the Companies Act, 2013. 

Modus Operandi of unlisted share brokers

Unlisted securities are primarily traded by way of a transfer. Traditionally, the transfer of securities is a private arrangement between two identified parties, namely the transferor and the transferee, who explicitly agree on the sale and purchase of a fixed number of securities. 

The key distinction between transfer of securities and public offer of securities lies in the pre-identification of parties, exclusive offer and defined terms. 

Therefore, when securities are offered for sale to unidentified persons without limiting the number of purchasers, this could effectively constitute an indirect public offer (which also includes an offer for sale). 

As pointed out above, many unregistered platforms offering unlisted securities have emerged. These platforms often target unidentified persons and provide no limit on the number of purchasers, effectively transforming such offers into indirect public offers in the form of “offer for sale”.

Listing securities for sale on a publicly accessible platform may, intentionally or unintentionally, transform a private arrangement into an offer resembling a public offer. Unlike private transfers, public offers are subject to stringent regulatory requirements, such as issuing prospectus, detailed disclosures, and continuous regulatory oversight. Failing to adhere to these requirements could undermine investor protection and market integrity.

Structuring of Transactions as “Secondary Sale” 

The practice of structuring transactions as secondary sales is an innovative strategy employed by fintech platforms to broaden market access while navigating regulatory challenges. However, this approach raises significant concerns about compliance, investor protection, and market integrity. Striking a balance between innovation and regulatory compliance is essential to establish a transparent, fair, and robust investment ecosystem.

In this model, a fintech platform, operating through its legal entity, subscribes to securities offered via private placement by a company. Often, these platforms are the sole or principal investors in such placements. Once the securities are acquired, the platform lists them on its portal as available for investment by way of  transfers from itself to individual investors, presenting them as secondary market transactions ostensibly outside the scope of public offer regulations. The interface almost resembles a broking app, where one can click and ‘buy 1 share’ instantly.

In some cases, the platform and the warehousing entity are separate. Additionally, some platforms claim that the transferors comprise of promoters, employees, KMPs of those enlisted public companies.

Motivations behind structuring as Secondary Sale are twofold:

1.     Avoiding Public Offer Regulations:

Public offers of securities are subject to extensive regulatory oversight, including stringent disclosure requirements and mandatory listing. By structuring transactions as secondary sale, platforms consider to bypass these regulations.

2.     Enabling Retail Investor Access:

Structuring investments as secondary sale allows platforms to make securities available to retail investors who might otherwise be ineligible to participate in private placements.

Making securities available to large number of unverified investors 

As discussed earlier, an offer that can be accepted by anyone effectively qualifies as a public offer, regardless of how it is officially labeled. In contrast, private placements are designed for a limited, pre-identified group of investors and are subject to stricter regulatory controls to maintain their exclusivity.

Fintech platforms, however, challenge this distinction by leveraging technology to make securities accessible to a broad audience of unverified users, thereby creating a regulatory gray area. By listing securities on their portals—accessible to anyone who registers—these platforms effectively transform private placements into publicly available investment opportunities.

Moreover, these platforms often lack stringent verification processes to ensure that users meet the criteria for accredited or eligible investors. Instead, they use digital advertising, user-friendly applications, and social media campaigns to promote investment opportunities, indirectly engaging in general solicitation. This practice, while sometimes technically compliant, directly conflicts with the principles governing private placements, which prohibit public solicitation.

These practices raise significant concerns regarding investor protection and compliance with the existing regulatory framework. By making securities easily accessible to a wide, largely unverified audience, fintech platforms blur the line between private and public offerings. This not only undermines the purpose of private placement regulations but also exposes retail investors to potential risks without the safeguards typically associated with public offers.

While fintech platforms argue that their practices promote financial inclusion and innovation, they also highlight the urgent need for regulatory clarity. Striking a balance between fostering innovation and ensuring compliance is critical to maintain market integrity and protect investors.

Pricing Mechanism: Misalignment with Market Practices

Fintech platforms often claim that the pricing of unlisted shares is driven by demand and supply, similar to listed securities. However, this approach diverges significantly from standard practices for valuing privately placed securities, which typically rely on Fair Market Value (FMV) mechanisms.

Unlisted securities, being inherently illiquid and less transparent, are usually valued based on financial fundamentals, such as earnings, book value, or discounted cash flows, rather than speculative demand and supply dynamics. The reliance on a demand-supply pricing mechanism for illiquid securities can result in significant price distortions. Prices may be artificially inflated or deflated, often without any material change in the underlying company’s fundamentals.

This speculative approach to pricing can mislead investors into believing that the listed price represents a fair valuation of the security. In reality, such pricing mechanisms expose investors to risks of overvaluation or mispricing, especially in the absence of robust valuation methodologies.

Furthermore, the process for investors seeking to liquidate their unlisted shares on these platforms is often vague and lacks the transparency necessary for informed decision-making. Without clear guidelines on how prices are determined or how liquidity is managed, investors may face challenges in accurately assessing the risks and returns associated with their investments.

Violation of private placement & public issue norms 

The aforementioned two modes of issuance differs from each other on various parameters:

ParametersPrivate PlacementPublic Offer
MeaningOffer or invitation to a select group of persons to subscribe to securities, excluding the general public.Includes IPO or FPO of securities to the public or an offer for sale of securities by an existing shareholder through issue of prospectus.
Who can invest?Restricted to pre-identified investors addressed in the private placement offer-cum-application letter.Open to the public at large.
Maximum number of investors200 persons in a financial year, excluding QIBs and employees offered securities pursuant to ESOP scheme under Section 62 (1) (b) of CA, 2013.No maximum limit on number of investors.
Offer CommunicationCommunicated directly to the identified investor; cannot be advertised to the general public.Communicated via advertisements, circulars, or a prospectus to the public.
ProcessConducted via a private placement offer-cum-application, adhering to specific conditions outlined in Section 42 of Act.Requires a prospectus with mandatory disclosures and regulatory oversight, governed by SEBI (ICDR) Regulations, 2018

In terms of Section 25(2) of CA, 2013 a private placement will be considered as securities being offered for sale to the public if it is shown that an offer of the securities or any of them was made within 6 months after the allotment or agreement to allot; or on the date when offer was made, the consideration was not received by the company in respect of the securities. Therefore, subscribing to private placement merely with the intent to warehouse temporarily and downsell to the public will attract the public issue norms. Penal provisions for flouting private placement norms, not following public issue norms are quite stringent. 

Conclusion

While securities of public companies are freely transferable, it cannot be traded on unregulated platforms. The fintech platform’s current modus operandi raises concerns about pricing practices, process transparency, and regulatory compliance. SEBI’s advisory underscores the need for vigilance, as these platforms often lack regulatory oversight, investor safeguards, and transparency. Unlike public issues, which ensure grievance redressal mechanisms like SCORES and SMART ODR transactions on these platforms leave investors without formal recourse. The numerous platforms offering unlisted equity shares need to revisit in view of SEBI’s caution letter.

Technical hiccups in payments: Is it a default and impact the credit rating?

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SEBI Circular prescribes uniform approach to be ensured by CRAs

Vinita Nair, Senior Partner & Palak Jaiswani, Manager | corplaw@vinodkothari.com

Default in payment of interest or redemption amounts has far reaching repercussions for an issuer of debt securities. A delay of 1 day even of 1 rupee (of principal or interest) from the scheduled repayment date is considered as default in terms of SEBI Master Circular for Credit Rating Agencies (CRAs) and the same triggers an immediate downgrade of the rating of the issuer. After a default is cured and the payments are regularized, the CRA would generally upgrade the rating from default to non-investment grade after a period of 90 days based on the satisfactory performance by the company during this period.

Inability on the part of the issuer to ensure payment in case of incorrect bank details or dormant a/c of the debenture holders resulting in bounce back of the amounts intended to be credited is a common phenomenon experienced by issuers especially in case of servicing publicly issued debentures involving retail investors. Till date, these were considered as technical default and dealt with by the CRAs in accordance with the policies framed by it. Unlike a financial default, where the issuer fails to make payments due to insufficient funds, technical defaults occur despite the issuer having sufficient funds to fulfill its payment obligations. 

SEBI Circular dated November 18, 2024 issued in line with the recommendations of the working group for CRAs for EoDB provides guidance on the manner of identification of technical default and verification and disclosures to be ensured by CRAs thereafter. In terms of the SEBI Circular, failure to remit payment due to absence of correct information or due to incorrect or dormant investor account furnished by the investor(s) or due to notice/ instruction received from a government authority to freeze the account of investor(s) will be considered as technical default.

Is technical default a default?

According to SEBI Listing Regulations, a “default” occurs when there is non-payment of interest, dividend, or principal amount on the pre-agreed date, recognized at the first instance of delay. Default is triggered when the issuer fails to pay due to insufficient funds. In contrast, a technical default happens when payment is delayed due to factors like incorrect bank account details or frozen accounts, despite the issuer having adequate funds. The Working Group also highlighted in the SEBI Circular, that instances mentioned above (as technical default) arise where the non-payment is due to reasons beyond the control of the issuer.

It is also to be considered that similar technical issues arise in case of payment of dividends, wherein the Company is unable to credit the amount in the bank account of the members due to incorrect account details provided by them. However, such cases are not treated as default.

While the term used the word ‘default’, it is actually a case of technical delay

Impact on credit ratings

CRA Master Circular requires CRAs to closely monitor the servicing of debt obligations by the issuer and review the ratings, through various modes: 

  1. stock exchange intimations made by the issuer- Regulation 57 of Listing Regulations requires issuers to inform stock exchanges on the status of payment (interest/redemption) within one working day from the due date;
  2. payment status intimated by the debenture trustees (para 3 of Chapter VIII of DT Master Circular and para 28.2.1 of CRA Master Circular);
  3. no default statements submitted by issuer on a monthly basis (para 9.3.1 of CRA master Circular)

Credit ratings reflect the creditworthiness of an issuer. Defaults trigger a downgrade to the default grade, significantly affecting the issuer’s reputation. For issuers having multiple ISINs, there may be numerous instances of technical delays, but the same does not indicate financial distress on the part of the issuer. Treating technical delays as default will lead to unjustified rating downgrades and have a negative impact on the issuer’s reputation. Technical delays, caused by factors like incorrect account details or frozen accounts, do not reflect the issuer’s financial health and cannot be treated at par with financial default.

The SEBI Circular omits the term “technical default” from the scope of policy in respect of the upgrade of default rating to investment grade rating framed by CRAs and highlights the instances of non-payment due to reasons beyond the issuer’s control. 

Steps to be followed by CRAs for technical defaults:

Conclusion:

While the SEBI Circular gives clarity on the treatment of technical defaults and obligations of the CRA in this regard, clear actionable on the part of the issuer has not been specified. Therefore, in those instances, the issuer should provide the above details to the CRA for onward disclosure. Further, the details to be provided under Reg. 57 inter alia requires providing ‘reasons for non-payment/ delay in payment’. The feasibility of reporting the same in case of technical defaults is not clear as several times the issuer becomes aware of the failure to credit the amount after 1-2 days.

Our related resources:

  1. Enhanced role of CRAs in technical defaults by issuers
  2. Regulating ESG Rating Providers in India

FAQs on Specific Due Diligence of investors & investments of AIFs

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Team Vinod Kothari & Company | corplaw@vinodkothari.com

Refer to our related resources below:

  1. Trust, but verify: AIFs cannot be used as regulatory arbitrage (updated as on October 9, 2024)
  2. AIFs ail SEBI: Cannot be used for regulatory breach
  3. Cat I & II AIFs can borrow to meet temporary shortfall in investment drawdown
  4. RBI bars lenders’ investments in AIFs investing in their borrowers
  5. Some relief in RBI stance on lenders’ round tripping investments in AIFs

Cat I & II AIFs can borrow to meet temporary shortfall in investment drawdown

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– Sakshi Patil, Executive | Corplaw@vinodkothari.com

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Bond issuers set to become Market Maker to enhance liquidity

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Issuer to provide Liquidity Window facility to eligible investors effective from Nov 1, 2024

Vinita Nair & Palak Jaiswani | corplaw@vinodkothari.com

August 18, 2024 (Updated October 22, 2024)

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. 50 cr., 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, had proposed the introduction of Liquidity Window facility, a unique concept in bond market. SEBI notified this facility vide circular dated October 16, 2024 effective from November 01, 2024.

What is the proposed Liquidity Window Facility (‘LWF’):

LWF, at the issuer’s discretion, allows eligible investors to exercise a put option on NCDs on predetermined dates. This enables investors to sell their securities back to the issuer, removing the need to find prospective buyers in the market. In this setup, the issuer assumes the role of market maker, a concept that has not yet been fully implemented in the bond market.

Key Features of LWF:

  • Issuer’s discretion: It is optional for the issuer to provide LWF.
  • Nature of issuance: Issuers can provide this facility for prospective bond issuances through public issues as well as on a private placement (proposed to be listed) at the ISIN level.
  • Quantum of LWF: Minimum 10%[1] of final issue size. Aggregate limits and sub-limits (in no. of securities) for put option that can be exercised in each window to be disclosed in the offer document.
  • Timing: LWF to commence after the expiry of 1 year from date of issuance. Facility may be operated on a monthly or quarterly basis at issuer’s discretion, as indicated in the offer document upfront.
  • Eligible Investors: The issuer will determine which investors are eligible, with a particular focus on retail investors. Investors need to hold securities in demat form to avail this benefit. If put options exercised during the period exceed sub-limits, acceptance will be on a proportionate basis.
  • Pricing of bonds under LWF:
    • Date of valuation: ‘T-1’day where T is the first day of the LWF[2].
    • Issuers can provide a maximum discount of 1% on the valuation arrived. Price plus accrued interest payable.
    • Display valuation on the website of the issuer and SE during the liquidity window period.
  • Option with the issuer for bonds purchased under LWF: Within 45 days of closure of LWF or before the end of quarter, whichever is earlier:
    • sell on debt segment of SE; or
    • sell on RFQ platform, if eligible to access; or
    • sell through an online bond platform provider; or
    • extinguish the NCDs. 
    • In case of sale, amount realized will be added back to the aggregate limit and will replenish any past usage of the limit.
  • Restriction on re-issuance[3]: Re-issuance is not allowed under ISINs in which LWF is offered
  • Exemption in ISIN capping[4]: ISI.Ns in which LWF is offered are exempted from computation of ISIN limits as per Chapter VIII of NCS Master Circular.
  • Operational Guidelines: Stock exchange, in consultation with clearing corporations and depositories, will issue detailed guidelines on how to use the LWF, including the process for exercising the put option.

Other Conditions:

  1. Authorisation and Implementation
    1. Prior approval of BOD.
    2. Monitoring of implementation & outcome SRC or BOD (in case there is no SRC).
    3. Transparent, non-discretionary and non-discriminatory within the class of investors.
    4. Does not compromise market integrity or risk management.
  2. Liquidity Window Period:
    1. Duration: Open for 3 working days.
    2. Intimation of proposed schedule: To be provided 5 working days before the start of the financial year in which facility it is to be given via SMS/WhatsApp.
  3. Mode and manner of availing:
    1. Put options can be exercised by blocking the securities in demat a/c during trading hours and using the specified mechanism to intimate issuer w.r.t. the exercise of put option.
    2. Investors may modify or withdraw bids during the window period[5].
    3. Submissions received during window period (during trading hours) will only be considered valid
    4. Further guidelines to be provided by SE
  4. Settlement[6]: T+4 days
  5. Reporting and disclosure requirements:
    1. Submit report to SE – within 3 WD from closure of window; and
    2. Inform the depositories and DT regarding NCDs to be extinguished – within 3 WD from end of 45 days from the closure of window (timeline to sell/ extinguish purchased securities)[7]
  6. Website disclosure:
    1. By: SE, depositories, DT, and Issuers
    2. When: Disclose on website upon issuance of each ISIN in which facility is provided. Details to be maintained and updated at all times.
    3. Details: List of ISINs for option is available, o/s amount, credit rating, coupon rate, maturity date, valuation details and other relevant information (as per para 6.11 of circular)
    4. Issuer to submit above details to SE, depositories and DT to disclose on their website
    5. In case of change: Issuer to intimate SE, depositories and DT within 24 hrs of change. SE, DT and depositories to update their website within 1WD of such intimation.

[1] Minimum 15% was proposed in the CP.

[2] CP proposed the date of valuation as the day of closure of liquidity window.

[3] Not proposed in the CP earlier.

[4] Not proposed in the CP earlier.

[5] Not proposed in the CP earlier.

[6] Not proposed in the CP earlier.

[7] CP proposed the timeline  of 3 working days from the date of window closure

Other resources related to the topic:

  1. SEBI rationalises offer document contents and certain timelines for NCD public issuance
  2. LODR norms of equity extended to debt listed entities
  3. SEBI further caps limit for ISINs to reduce fragmentation and boost liquidity

Research Analysts v/s Investment Advisors – Is the Line Blurring ?

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Last updated on 1st October, 2024

– 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 (30th September, 2024), there are 953 Investment Advisors1 and 1358 Research Analysts2 registered with SEBI. Following the consultation paper on review of regulatory framework for investment advisors and research analysts SEBI, in its Board meeting on 30th September, 2024, has approved many of these proposals. While some proposals are aimed at an ease of registration for an entity/ person as an RA/ IA, the CP also contained 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. The fine text of the Amendment Regulations is awaited, for getting the necessary clarity on the position of IAs and RAs, pursuant to the revised regulatory framework.

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Bye bye to Share Buybacks

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– 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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