Revising minimum public holding requirements for large issuers and companies under CIRP

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Securities Contract (Regulations) Amendment Rules, 2021 notified

Payal Agarwal, Executive ( corplaw@vinodkothari.com )

Background

SEBI had released a consultation paper on 20th November, 2020 order to review the requirements of minimum public offer for large issuers. The Consultation Paper proposed to reduce the requirements of minimum public offer for large issuers while also reducing the time period to meet the minimum public shareholding requirement (“MPS”). Further, SEBI had released another consultation paper on 19th August, 2020 for review of minimum public shareholding requirements for companies undergoing CIRP under IBC, wherein the Consultation Paper suggested three different modes of recalibrating the requirement for MPS upon approval of resolution plan.

Consequently, the Ministry of Finance has notified the Securities Contract (Regulations) Amendments Rules, 2021 (“the Amended Rules”) on 18th June, 2021 to amend Rule 19 and 19A of the Securities Contract (Regulations) Rules, 1957 (“the Rules”) giving effect to the above-mentioned proposals.

Reduction in minimum public shareholding requirement for large issuers

Who are large issuers?

Large issuers are issuers with post issue market capitalisation (‘MCap’) equal to or above Rs. 4000 crores. Currently all issuers with an MCap of Rs. 4000 crores are required to dilute 10% of an IPO to public shareholding. Large issuers have now been bifurcated into large issuers (MCap of Rs. 4000 crores and above) and very large issuers (MCap of Rs.  1 lakh crores).

New minimum public offer requirements for large issuers as per the Amended Rules

The post issue MCAP requirement for large and very large issuers has now been amended as below –

Accordingly, a flat rate of 10% has been set for large issuers while an incremental rate has been set for very large issuers with a post issue MCap of Rs. 1 lakh crores and above. For issuers below these thresholds, the existing requirements continue.

New MPS requirement

Currently, companies are required to meet the MPS within 3 years from the date of listing. However, in case of large issuers, the MPS is to be met as follows –

Rationale as proposed in the Consultation Paper

The reduction in the minimum public offer requirements for large issuers was proposed due to the following reasons –

  • The compliance of such minimum public shareholding requirements is cumbersome for the large issuers.
  • The large issuers already have investments from strategic investors who are classified as “public shareholders” post listing. Therefore, the requirement of minimum public offer results in unnecessary dilution of control of promoters thereby imposing constraints on issuers.

Minimum public shareholding requirement for companies under Resolution Plan

Further, amendments have been made in Rule 19A of the Rules, with respect to the minimum public shareholding requirements for a company under CIRP under Insolvency and Bankruptcy Code, 2016 (‘IBC’).The Amended Rules provide a strict-er timeline for post-CIRP companies to comply with the MPS requirements upon implementation of resolution plans

Change in the requirements as per the Amended Rules are as follows –

Particulars Requirement before amendment Requirement as per Amended Rules
Public shareholding falls below 25% Bring to 25% within 3 years of such fall No change
Public shareholding falls below 10% Bring to 10% within maximum 18 months of such fall Bring to 10% within maximum 12 months from such fall
Minimum public shareholding to be maintained No such requirement Shall not fall below 5%

Rationale as proposed in the Consultation Paper

The relaxations with respect to the strict enforcement of Rule 19 of the Rules have been given in order to ensure revival of a Corporate Debtor pursuant to a resolution plan. However, while the same seems to be in favour of Corporate Debtors, specifying no MPS requirement may result in cases where the public shareholding will become extremely low, leading to less float, thereby hampering the market integrity and price discovery in secondary market.

The Consultation Paper suggested three different alternatives out of which the second one has been preferred since the MPS of 5% being a lower threshold will incentivise the companies to stay listed post-CIRP whereas higher thresholds may cause total delisting

The said requirement shall have significant ramifications for resolution applicants who otherwise are more focused on operational aspects over regulatory requirements. While resolution plans relaxes several requirements like an open offer under SAST regulations, it is significant to note that requirements w.r.t. MPS were never completely waived off. The present step of giving more stringent timelines is introduced with the objective of protecting the investors’ interest and shielding them from the possible loss of value due to delayed MPS adherence. The loss of value can be on account of delisting of such corporate debtors under CIRP, whereas the shareholders may recover potential value from the shares of such corporate debtor if it continues to remain listed post implementation of resolution plan.

Presentation on LODR Amendments

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RBI Guidelines at odds with the Companies Act on appointment of Auditor

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A comparative analysis between the Companies Act, SEBI Guidelines and SEBI Circular dated 18th Oct. 2019

– Ajay Kumar K V | Manager (corplaw@vinodkothari.com)

Introduction

The Reserve Bank of India has issued Guidelines[1] for Appointment of Statutory Central Auditors (SCAs)/Statutory Auditors (SAs) of Commercial Banks (excluding RRBs), UCBs and NBFCs (including HFCs) under Section 30(1A) of the Banking Regulation Act, 1949, Section 10(1) of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980 and Section 41(1) of SBI Act, 1955; and under provisions of Chapter IIIB of RBI Act, 1934 for NBFCs, on 27th April 2021.

The Guidelines provide for appointment of SCAs/SAs, the number of auditors, their eligibility criteria, tenure and rotation as well as norms for ensuring the independence of auditors.

However certain provisions of these Guidelines are either completely different or stringent as compared to the provisions of the Companies Act, 2013 (Act). Further, in case of listed entities the question would arise whether the SEBI circular CIR/CFD/CMD1/114/2019[2] dated 18th October 2019 shall be applicable, where the existing auditor is ineligible to continue as the auditor of the company and a new auditor is to be appointed.

In this write up, we have discussed the requirements under both RBI Guidelines as well as the Act.

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Easing Delisting of Equity Shares

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-Shreya Masalia and Anushka Vohra

corplaw@vinodkothari.com

In order to make the existing delisting Regulations robust, efficient, transparent and investorfriendly, the Securities Exchange Board of India (‘SEBI’) has issued the SEBI (Delisting of Equity Shares) Regulations, 2021[1] (‘Delisting Regulations, 2021’) on June 11, 2021, thereby superseding the erstwhile SEBI (Delisting of Equity Shares) Regulations, 2009[2] (‘Erstwhile Regulations’). The Erstwhile Regulations were notified on June 10, 2009. Thereafter, several amendments have been carried out in the delisting regulations according to the changing need and developments in the securities market. Thus, to further streamline and strengthen the process to be followed for delisting, the Delisting Regulations have been introduced.

In India, a large number of entities are listed on regional stock exchanges, serving no public interest at all. In fact, over the years, most of them have become non-compliant. However, given the cumbersome process of delisting, these companies have chosen to remain listed. The Delisting Regulation, 2021 has made the path of exit for these entities comparatively easier.

In this article, the authors have made an attempt to discuss the changes in the delisting procedure as introduced vide the Delisting Regulations, 2021.

Background

Listing of shares at stock exchanges provides for free transferability and ready marketability to the shares of a company. In contrast to that, when a public company chooses to go private, it has to delist from the stock exchanges – which means that the shares of that company will no longer be available for trading on the platform provided by the stock exchange.

The Companies choose to list themselves to grab the advantages of listing viz; lower cost of capital, greater shareholder base, liquidity in trading of shares, prestige etc. But the companies need to be contended that the benefits of listing outweigh the listing costs, the compliance requirements do not overburden the companies and do not expose them to disciplinary actions.

Initially, there existed 21 regional stock exchanges (‘RSE’) in India of which 20 such RSEs have shut down over the years due course due to their lack of financial viability, exchanges becoming defunct, usage of archaic technology and subsequent derecognition of the exchanges by SEBI. The lone-standing regional stock exchange is the Calcutta Stock Exchange (‘CSE’), which is also at its verge of getting shut. Various companies continue to be listed on CSE, however the economic viability of the same is still questionable. The Delisting Regulations provide for an easy exit opportunity to these companies by significantly reducing the time-period of the delisting process and streamlining the same.

Also with the relisting bar of 5 years in case of voluntary delisting having been reduced to 3 years will now allow the companies to relist in a comparatively lesser period of time and raise funds for their new venture.

Why do companies opt for delisting?

The statistics given below show that there has been a tremendous increase in the number of companies being delisted from the stock exchange. Delisting from the stock exchanges could either be undertaken voluntarily, or compulsory delisting by the Stock Exchanges or delisting pursuant to liquidation.

(Source: NSE)

Understanding compulsory and voluntary delisting

Compulsory delisting generally, is caused due to procedural and compliance lapses by the companies. Amongst other causes, the major causes for compulsory delisting include non-payment of listing fee, reduction in public shareholding and failure to meet the same, unfair trade practices at the behest of the management/promoters etc.

While compulsory delisting is at the precept of the Stock Exchanges, companies opt to voluntarily delist themselves.

The most common rationale for companies to opt for voluntary delisting in the recent time has been;

  1. To obtain full ownership of the company by the promoter & promoter group which will in turn provide increased financial flexibility to support the Company’s business and financial needs;
  2. To explore new financing structures including financial support from the Promoter Group;
  3. To help in cost savings and allow the management to dedicate more time and focus on the core business;
  4. To provide easy exit to shareholders because of thin trading volume.

Modes of Exit via Delisting

The Delisting Regulations, as laid down by SEBI provides two modes of delisting of equity shares viz; (a) Compulsory and (b) Voluntary:

Further, in the case of voluntary delisting, companies have the following options:

  1. delisting from all the recognised stock exchanges ;
  2. delisting from any but not all the recognised stock exchanges, including delisting from Stock Exchange having nationwide trading terminal;
  3. delisting from any but not all the recognised stock exchanges, while remaining listed on the Recognised Stock Exchange having nationwide trading terminal.

In the case of 1 and 2 above, the companies have an obligation to provide an exit opportunity to the existing shareholders.

While the process in case of iii. above remains the same, changes have been brought about in the way a company has to manage the delisting offer pursuant to provision of exit opportunity. The gist of the changes introduced by the Delisting Regulations have been discussed below.

Overview of the Key Changes

  1. Disclosure by the Acquirer / Promoter[3]–

 In the Erstwhile Regulations, the process flow was that the acquirer used to intimate their intention to delist the Company to the Board and the Board would then intimate the same to the Stock Exchanges before granting its approval.

Now the Delisting Regulations, 2021, cast an obligation on the acquirer to intimate to the Stock Exchanges, their intention to delist the Company first and within one working day of its intimation shall also inform the Company at its Registered Office, this is termed as the Initial Public Announcement.

Comments: An intention to delist a company is a price sensitive event and can have a major impact on the market. Hence, its immediate disclosure to the public is warranted. Therefore, to fill the lacunae on information being made available to the public, intimation by the acquirer has been made mandatory.

2.Time-bound mechanism

The delisting procedure involves intricacies requiring approvals at various stages.Unlike the t new regulations specify the timelines for the entire process, making it less cumbersome and time-bound, as shown in the table below:

Event / complianceExisting TimelineRevised Timeline
Board resolutionNone specifiedWithin 21 days from the date the acquirer expresses his intention
Special resolutionNone specifiedWithin 45 days from the date of approval of the board
Escrow AccountBefore making public announcementNot later than 7 working days from the date of obtaining the shareholder’s approval.
In-principle approvalNone specifiedWithin 15 working days from the date of obtaining shareholders approval or receipt of any statutory or regulatory approval; whichever is later.
Outcome of Reverse Book Building (‘RBB’)None specifiedTo be announced within 2 hours from the closure of the bidding period. The same is also required to be published in the same newspapers as the newspapers in which the detailed public announcement was made within 2 working days from closure of the tendering period.
Release of shares in case of failure of offerWithin 10 working days from the closure of the offer, where bids were not acceptedIn case of failure due to

90% of the shares are not tendered: on the date of disclosure of the outcome of the RBB process

 

Discovered price being rejected by acquirer: on the date of making public announcement for the failure of the delisting

Payment on successful delistingWithin 10 working days from closure of offerDiscovered price same as floor price: payment through secondary market settlement mechanism

 

Discovered price higher than floor price: within 5 working days from the date of making the payment to the public shareholders

Final application to the stock exchanges after successful delistingWithin a period of 1 year from the date of passing of special resolutionWithin 5 working days from the date of making the payment to the public shareholders

 

 

 

3.Due diligence by Peer Reviewed Company Secretary

 Before making the public announcement in case of voluntary delisting, the board had to appoint a Merchant Banker for carrying out the due diligence and then on obtaining the in-principle approval, the acquirer had to appoint a Merchant Banker to act as manager to the issue. The Regulations provided that the Merchant Banker appointed by the board could act as manager to the offer.

Comments: Realising that this could probably result in conflict of interest, the new regulations provide that the board shall appoint a Peer Reviewed Company Secretary, who shall be independent of the promoter/ acquirer/Merchant Banker/or their Associates before the board meeting for granting approval and the Company Secretary shall carry out the necessary due diligence. Further, the acquirer shall before making the initial public announcement, appoint a Merchant Banker to act as manager to the offer. This has also opened up a new avenue for the Company Secretaries in Practice.

4.Escrow Account

Under the Erstwhile Regulation, the acquirer was required to deposit the consideration amount in the Escrow account after getting in-principle approval from SE however before making the PA. The new regulations make it obligatory on the acquirer to open an escrow account even before applying for in-principle approval. The acquirer has to deposit an amount equivalent to 25% of the total consideration at the time of opening the escrow account and the remaining consideration amount of 75% shall be deposited in the escrow account prior to the detailed public announcement.

Comments: Because of stringent timelines, surety is provided that the acquirer has the financial stability and has earmarked funds for the proposed delisting. Moreover, since this is an interest-bearing account, there would be no loss of interest, even if the delisting offer fails at the end.

5.Enhanced responsibility on the Board of Directors

 The new regulations intend to be more robust as far as the responsibility of the board is concerned. The erstwhile regulations required that the board shall before granting its approval certify that the proposed delisting is in the interest of the shareholders. And this certification was mere infructuous because there was no disclosure of the same and no reasonable justification, for that matter.

Comments: Considering a situation, where the Expression of Interest is received from an amicable acquirer i.e. the case of friendly takeover, there is a possibility of collusion between the acquirer and the management and in that case the interest of shareholders’ might take a back seat. However, to avoid the same, Regulation 28 has been added into the new regulations which provides that upon receipt of the detailed public statement the Board of Directors shall constitute a committee of independent directors to provide written reasoned recommendations on the delisting offer and the same shall also be disclosed by the Company in the newspapers where the detailed public statement was published, at least 2 working days before the bidding period.

6.Investor friendly regulations

 SEBI, being the watchdog of the Securities Market, had been established to protect the interest of investors as one of its main objectives, amongst others.

The Delisting Regulations provide that the public shareholders who could not participate in the RBB process could further tender their shares upto 1 year from the date of delisting and the promoter shall accept the tendered shares at the price which was finalised through RBB.

In addition to that, the new regulations now require the promoter/acquirer/Merchant Banker to comply with the following on a quarterly basis for 1 year from the date of delisting:

  1. Submit quarterly reports to the Stock Exchanges specifying details of shareholders at the beginning and end of the quarter and shareholders who availed the offer during the quarter;
  2. To send follow up communications to remaining shareholders;
  3. Publishing advertisement to invite the remaining shareholders to avail the offer

Comments: While the shareholders were given a time of upto 1 year, it was observed that the promoters did not take active steps to bail out the remaining shareholders.

7.Indicative Price

The new regulations have unraveled the concept of Indicative Price. As a general practice, some companies with a view to wriggle out of the complexities of remaining listed on the bourses, used to mention the terms indicative price or attractive price in the letter of offer. This price being higher than the floor price, was used to lure the shareholders to tender their shares.

The new regulations have defined Indicative Price as being a price higher than the floor price.

Comments: Even though the word has found its place in the regulations, in our view, SEBI should place a capping on the indicative price so as to ensure that the Companies do not offer lucrative price to the shareholders.

Changes in addition to the above

 Special provisions for delisting of shares already existed for small companies in the erstwhile regulations. SEBI has further prescribed the following special provisions for delisting:

1.Special provisions for delisting of shares on Innovators Growth Platform

These provisions are similar to the provisions for delisting of shares from the main board however, these provisions require that shares tendered reach 75% of the total issued shares of that class and at least 50% shares of the public shareholders as on date of the board meeting in which such delisting is approved are tendered and accepted instead of the 90% requirement.

 2. Special provisions for a subsidiary company getting delisted through scheme of arrangement wherein the listed holding entity and subsidiary company are in the same line of business

Transactions covered under the given head will not attract provisions of these Regulations provided the various conditions mentioned in regulation 37(2) have been complied with.

SEBI, vide notifcation dated July 09, 2021 has exempted the listed subsidiary companies, getting delisted through scheme of arrangement, that are –
– in the ‘same line of business’ as of its holding company;
– the subsidiary shall be a listed subsidiary of a listed holding company for a period of 3 years.

Further, vide said notification, SEBI has also laid down the following criteria for ascertaining whether the listed holding entity and subsidiary are in the ‘same line of business’:

 3. Special provisions for delisting by operation of law

These provisions shall be applicable in case of winding up of a company and recognition of a stock exchange by SEBI. In the former, the process of winding up shall be as prescribed by the prevalent regulatory framework. However, the latter seems highly unlikely.

Some Miscellaneous Changes

  1. The erstwhile regulations identified only peer reviewed chartered accountants and merchant bankers as valuers, however the same has now been defined with reference to section 247 of the Companies Act, 2013 which widens the scope of the definition. Therefore, any individual with a post-diploma/postgraduate degree or a bachelor’s degree with 3 and 5 years experience respectively in the specified field or having membership of a professional institute established by an Act of Parliament enacted for the purpose of regulation of a profession with at least 3 years’ experience after such membership shall also be considered as eligible valuers.
  2. The detailed public announcement, amongst other details, is now also required to provide the indicative price if any given by the acquirer and a list of documents copies which shall be available for inspection by public shareholders at the registered office of the manager during the working days.
  3. The copy of the letter of offer shall be made available on the website of the company as well as that of the manager to the offer. The order copy of the stock exchange ordering compulsory delisting of the entity shall be uploaded on the website of the stock exchanges.
  4. As a pre-condition to voluntary delisting, the erstwhile regulations provided that the Companies cannot apply for delisting pursuant to buyback/preferential allotment offer being made. But there was lack of cohesiveness on when the buyback/preferential allotment offer being made by the Company would restrict delisting offer. Therefore, the new regulations specify that voluntary delisting shall not be permitted unless a period of 6 months has elapsed from the date of completion of last buyback/preferential allotment.
  5. For counting minimum 90% of the issued shares of a class, shares held by custodian of depository receipts, by Trust under SEBI (Share Based Employee Benefit) Regulations, by inactive shareholders such as vanishing and struck off companies have been excluded aiding the acquirer to achieve the minimum share tendering criteria with greater ease.

Effect of the instant changes

The new regulations have eased the earlier complex procedure of voluntary delisting. The enhanced disclosures and transparency will help to instil confidence among the shareholders. The business environment is dynamic and the time-bound procedure would help the companies to avail exit from the Stock Exchanges and explore their business opportunities by going private.

Concluding Remarks

In India, “Delisting” process has seen very less success as compared to the global market. The new regulations irrefutably addresses some core aspects and also emphasizes on incremental improvements by plugging some of the gaps in the Erstwhile Regulations, as the new Regulations inter alia provide for delisting of equity shares of a subsidiary company (having the same line of business), delisting pursuant to a scheme of arrangement and delisting due to operation of law such as due to winding up of a company or de-recognition of a stock exchange. However, in view of the authors, the cautious approach taken by the SEBI in the New Regulations may still narrow its applications. The impact of the changes brought in through New Delisting Regulations on the success rate of the delisting process is yet to be seen.

[1] https://egazette.nic.in/WriteReadData/2021/227507.pdf

[2] https://www.sebi.gov.in/legal/regulations/jun-2009/sebi-delisting-of-equity-shares-regulations-2009-last-amended-on-march-6-2017-_34625.html

[3] “acquirer” includes a person –

(i) who decides to make an offer for delisting of equity shares of the company along with the persons

acting in concert in accordance with regulation 5A of the Takeover Regulations as amended from

time to time ; or

(ii) who is the promoter or part of the promoter group along with the persons acting in concert.

Ourresources on the topic:- 

  1. http://vinodkothari.com/wp-content/uploads/2020/04/Note-on-Delisting-of-equity-shares-1.pdf 
  2. http://vinodkothari.com/2023/09/sebi-proposes-to-ease-delisting-process-consultation-paper-on-review-of-voluntary-delisting-norms/

BRSR Reporting: Actions and disclosures required for business sustainability

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Abhishek Saraf, Manager and Payal Agarwal, Executive (corplaw@vinodkothari.com)

Background

The Business Responsibility and Sustainability Reporting (“BRSR”), originating from the MCA report on Business Responsibility Reporting, has found its way into the regulatory provisions by way of an amendment to the Regulation 34(2)(f) of the Listing Regulations[1], notified on 5th May, 2021. Further, SEBI vide circular dated 10th May, 2021 introduced the format of BRSR and the guidance note to enable the companies to interpret the scope of disclosures.

The BRSR will replace the existing BRR format w.e.f. FY 2022-23. For the FY 2021-22, the top 1000 listed entities may voluntarily submit the BRSR and from FY 2022-23 onwards, the same has to be submitted mandatorily. It is notable that the BRSR, though replacing BRR, is actually an extension of the existing BRR reporting While the BRSR has been made effective from FY 2022-23, it has to be understood that reporting is secondary, and needs to be backed by the company taking appropriate actions to ensure a positive report. Where the BRSR reporting of a company is negative, the same, though not a non-compliance of the regulatory provisions, will result in a negative impact on the minds of the stakeholders.

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Centralised database for Corporate Bonds & Debentures

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-SEBI’s new circular provides further ease of access of information

Payal Agarwal, Executive | Vinod Kothari and Company ( corplaw@vinodkothari.com )

Introduction

SEBI, the capital market regulator in India, has brought a series of amendments in the month of May, 2021 amending all the major regulations applicable to the entities under its regulatory ambit. The trend is still being continued by SEBI. This time, SEBI has brought a circular for streamlining the information available in the centralised database, in order to provide ease of access of information to the investors. In view of the same, the erstwhile circular dated 22nd October, 2013 (2013 Circular) dealing with the centralised database for the corporate bonds/ debentures have been superseded by the circular dated 4th June, 2021 (Circular).  Through this Circular, some enhanced disclosure requirements are required to be ensured by the issuers, while responsibility is placed upon the shoulders of credit rating agencies and debenture trustees to verify the information given by the issuer as well as notify the discrepancies, if any to the stock exchanges.

Applicability

This Circular is applicable for all recognised stock exchanges, registered depositories, registered credit rating agencies, debenture trustees, and issuer of listed debt securities.

Further, this Circular is applicable for debt securities issued on or after 1st August, 2021.

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Financial transactions with promoter entities become part of CG disclosure

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SEBI’s move to strengthen transparency

Pammy Jaiswal| Partner| Vinod Kothari and Company

corplaw@vinodkothari.com

Background

It has always been interesting to see how SEBI takes various steps to increase the level of transparency for augmenting the level of corporate governance in a listed company. Recently, SEBI notified the changes under the SEBI Listing Regulations on 6th May, 2021, which contained several significant changes to enhance corporate governance (hereinafter referred to as CG), like specifying the scope of the risk management committee or intimation of recordings and transcripts for analyst meetings[1]. Following the said notification, SEBI, on 31st May, 2021, came up with a circular[2] dealing with enhanced disclosures under CG report to be submitted to the stock exchange under Regulation 27 (2) of the SEBI Listing Regulations by adding Annexure IV to the existing formats.

The new requirement coming out from this circular is extremely significant since it aims at revealing almost all types of financial transactions (to say almost 24 types of permutations) which the company has entered into with its close connections and which may have the highest chances of involving any conflict of interest.

 

 

In this write up we have tried to critically discuss and examine the requirements emanating from the said circular.

Scope and time of applicability

  • Annexure IV which contains the new disclosures will have to be filed by the listed entities which have listed their specified securities.
  • The same is to be filed on a half yearly basis starting from the first half year 2021-2022, i.e., for the half year ended 30th September, 2021.
  • While Regulation 27 (2) only talks about quarterly filings within 21 days from the end of the quarter, therefore, there is no explicit time period within which this new annexure will have to be filed with the exchange from the end of the half year.
  • The disclosure will not only cover the financial transactions undertaken during the half year ended 30th September, 2021, but also cover all outstanding financial contracts which the entity has entered any time in the past.

Financial Permutations covered

 

Critical Aspects

While the format under the new annexure may seem to be simple in terms of presentation, however, it has various aspects related to it which needs to be discussed. Owing to the extent of disclosure required, listed companies will have to consider and understand every part under the format before feeding the details. Some points which need to be discussed include the actionable, the meaning of the entities controlled by the promoters, the meaning of direct and indirect accommodation, distinction between a LoC and a co-borrowing arrangement, and last but not the least the ‘affirmation’ on the economic interest of the company.

Actionable on the part of the listed entity

  • Identify the entities
    • This identification process may reveal that companies have a large number of interested entities falling under these 4 types of entities.
  • Identify transactions
    • After having prepared the list of entities that are included under the 4 categories, the next step will be to identify the financial transactions which include loan, guarantee or security in connection with the loan to the entities under the list.
  • Identify outstanding balances
    • Once the entities and the transactions entered into with them have been identified, listed companies will have to identify the outstanding balance as on the date of the report.
    • Since the transactions involve providing guarantee or security as well, there can be a situation that companies will have to look for both on and off-balance sheet items to come to the actual outstanding balance for the purpose of reporting.

Entities controlled by Promoters/ PG

While the meaning of the term promoter and PG is well defined under SEBI ICDR Regulations, the question that may arise is which entities will be considered to be controlled by the promoters or the PG. The meaning of control here has to be taken form SEBI Takeover Regulations, which defines it as a right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or PAC, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

As per the definition of PG, entities which have a substantial stake (20%) held by the promoters or by common group pf shareholders are covered under the said definition of PG. However, if one has to identify the entities which are controlled by PG, it may cover even larger number of companies.

Ambit for covering directors and controlled entities for the purpose of disclosure

The ambit for making disclosures is very wide under Annexure IV. Therefore, it becomes imperative to pinpoint the entities related to the directors of the listed entity that are covered for the purpose of disclosure under the said Annexure. The same is represented below:

SEBI Listing Regulations refer to the definition of ‘relatives’ provided under Section 2(77) of the Companies Act, 2013.

In a situation where the directors do not have any direct control over the entity to whom the listed entity has extended the financial accommodation, but the control is with the relatives of such directors alone, the same should be enough to make the financial transaction be covered for the purpose of the disclosure under Annexure IV.

Leaving such transactions outside the disclosure will frustrate the whole intent of the said requirement since, it is very unlikely that a financial accommodation will be offered to an entity controlled by the director’s relative without any nexus or benefit to the directors altogether. There exists a possibility of the directors or their relatives indirectly gaining benefit or influencing transactions undertaken. Therefore, such transactions will also be required to be disclosed, given the intent of the disclosures.

Nature of book debt covered

As per the format of annexure IV, any other form of debt advanced is also required to be included for the purpose of the said disclosure. Looking at the intent of the disclosure, any book debt that is present in the books like merely selling of goods on credit should not be made part of this disclosure. In our view, only the book debt which has the color of an advance and which is in the nature to serve as a financial accommodation (for example selling of goods on credit for an unreasonable period of time or under unreasonable terms of understanding) is required to be disclosed.

Meaning of direct and indirect financial accommodation

As per the requirement, one of the biggest challenges for the listed entities will be to identify the connecting links or conduits through which these interested entities have been benefitted. Such transactions are generally camouflaged and put through layers to create smokescreen. These entities which are used to route the benefits to the interested parties are merely acting as a stopover. Therefore, it is extremely important to identify such transactions where there is a clear and direct nexus between flow of money from the listed entity to the intermediary and ultimately to the interested party. For instance, if a company raises preference share capital with the reason that it needs it for its own business operations, however, uses the funds so raised to on lend to another entity.

Difference between LoC and co-borrowing arrangement

The new requirement includes an LoC to be disclosed in the half yearly report. One needs to understand that providing a guarantee or giving an LoC by the listed company is nothing but to agree and provide financial accommodation to the borrower. It is significant to note that companies cannot disguise the LoC into a co-borrowing arrangement and therefore, avoid the disclosures to be made under Annexure IV.

Under a co-borrowing arrangement, if the listed entity is the co-borrower, then it should be getting the benefit or be a beneficiary of the loan being taken together with the interested party. Acting merely as a signatory to the co-borrowing agreement will make it no different from being considered as a guarantee or providing an LoC.

Affirmation for being in economic interest of listed company

One of most crucial and difficult part of the disclosure is the part requiring affirmation that loan (or other form of debt), guarantee / comfort letter (by whatever name called) or security provided in connection with any loan or any other form of debt is in the economic interest of the Company.

Some pointed issues under this are:

  • Who will give this affirmation?

The report on CG as per the SEBI circular (annex I, annex II and annex III) are required to be signed either by the compliance officer or the company secretary or the MD or CEO or CFO. However, Annex IV (which is the new requirement) requires the affirmation to be signed either by the CEO or CFO.

Further, the practicing professionals who provide their report on compliance with CG requirements and which has to be annexed with the CG report cannot be expected to dive into this question and scrutinize the reasoning provided by the company.

  • What will be the basis of this affirmation?

Further, it is imperative to note that the entities covered under this disclosure are mainly upstream entities which are either promoters or PG or controlled entities by them. Therefore, it becomes all the more difficult to justify the act of financial accommodation to be in the economic interest of the company. If it were a case of downstream accommodation (like subsidiaries, associates, joint ventures, etc.), it would have been much easier to form a basis to affirm that the same is serving the economic interest of the company since any profits in them will reflect in the consolidated financial results of the listed entity, however, the same reason cannot be for an upstream entity.

Also, merely earning an interest on loan granted or a commission on a guarantee or security or even on lending cannot act as a justification here since the earning interest or commission cannot be said to serve the economic interest of a company which is not even in the business of lending. Having said that listed NBFCs may have an upper hand in terms of providing justifications in this case.

• Whether the same needs to be reviewed by the Audit Committee as well?

Regulation 18 of the Listing Regulations read with Part C of Schedule II as well as section 177 of the Companies Act requires that the audit committee needs to scrutinize the inter-corporate loans and investments. While the same is required and covers loans, there does not seem to be any reason to exclude provision of security or extending guarantee since it is given in connection with loan.
The management needs to show the audit committee how does the transactions covered for the purpose of the said disclosure are in the economic interest of the Company.

Comparison between section 185 of the Companies Act, 2013 and Annexure IV

Section 185 of the Companies Act, 2013 (Act, 2013) deals with the provisions to provide loan and related services to directors or the interested entities. While section 185 is more from an angle of regulated provisions, the extent of casting restrictions on providing loan to directors or its connected parties is divided into two parts. One is completely prohibited (to directors and to firms where the director or his relative is partner) and the other one is restrictive, which means, financial accommodation can be given subject to prior approval of the shareholders.

The new disclosure requirement has several similarities with section 185 which are given below:

Basis of comparison Section 185 Annex IV of SEBI Circular dated 31st May, 2021
Services covered Provision of loan, provision of guarantee or Letter of Comfort and providing security in connection with the loan Similar
Mode Direct as well as indirect Similar
Entities covered ·      director of company, or its holding company or any partner or relative of any such director;

 

·      any firm in which any such director or relative is a partner;

 

o  The aforesaid two bullets are completely prohibited

 

·      any private company of which any such director is a director or member;

 

·      any body corporate at a general meeting of which not less than twenty-five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together;

 

·      any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company

 Refer to figure 1 above.

While the format requires the financial accommodation made, if any, to the directors or their relatives or entities controlled by them, it will surely not include or have any disclosure relating to financing of directors since it is completely prohibited under section 185 of the Act, 2013.

Exclusions

The aforementioned disclosure shall exclude the reporting of any loan (or other form of debt), guarantee / comfort letter (by whatever name called) or security provided in connection with any loan or any other form of debt:

  1. by a government company to/for the Government or government company
  2. by the listed entity to/for its subsidiary [and joint-venture company whose accounts are consolidated with the listed entity.
  3. by a banking company or an insurance company; and
  4. by the listed entity to its employees or directors as a part of the service conditions.

While one of the exclusions is for a banking company, it is imperative note the following:
 SEBI (LODR) Regulation does not define the term “banking company” but the term “banks”.
 Section 5(c) of the Banking Regulation Act, 1949 (‘BR Act’) defines banking company as: “banking company” means any company which transacts the business of banking in India;”
 Further, section 5(d) of the BR Act defines company as: “company” means any company as defined in section 3 of the Companies Act, 1956 (1 of 1956) and includes a foreign company within the meaning of section 591 of that Act;”
 Public sector banks like State Bank of India, being a body corporate, do not fall under the aforesaid definition of banking company. However, it is engaged in the business of banking and should therefore, be excluded.

Accordingly, clarity on the same is still awaited from SEBI.

Concluding remarks

As stated in the beginning, SEBI’s move to increase the standards for CG has been extremely interesting. Further, considering the fact that listed companies have a limited amount of time to arrange for huge amount of information, this circular needs the immediate attention of the listed entities.

[1] Our write up on the same can be viewed here

[2] To view the circular, click here

Our other articles on relevant topic can be read here – http://vinodkothari.com/2019/07/sebi-amends-format-of-compliance-report-on-corporate-governance/

SEBI revisits the concept of Promoter and Promoter Group

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Proposes shift from ‘promoter’ to ‘persons in control’

Ajay Kumar K V | Manager (corplaw@vinodkothari.com)

Introduction

The capital market watchdog, Securities and Exchange Board of India (‘SEBI’) has come out with a consultation paper on changing the concept of company ‘promoters’, and moving towards the idea of ‘person in control’. The proposal has come in the light of a drift from the conventional Indian ownership structure to the contemporary ownership structure where more than one person or persons controls an entity. The start-up ventures and the most celebrated ‘unicorns’ of the industry have substantial investment from Institutional investors and Private Equity players (‘PE firms’) who exercises control over the decision-making process through board representation and other means.

Further, SEBI has also proposed changes to the existing lock-in period requirements, streamlining disclosures of group companies, and rationalising the ‘Promoter Group’ definition in SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR’).

In this write-up, we have made an analysis of the concept of Promoter and Promoter Group, various obligations of the Promoter under SEBI Regulations, and the rationale for the shift from ‘Promoter and Promoter Group to ‘Person in Control’

Who is a Promoter?

Generally, any person who plays a major part in forming a company or establishing its business usually the prospective owners or directors of the company is regarded as a Promoter. They bring the business idea into existence and sets the vision and growth targets.

Promoter under Companies Act, 2013

Under the Companies Act, 2013, a promoter is a person who has been named as such in the prospectus or is identified by the company in the annual return filed every year. The definition also covers person(s) who has control over the affairs of the company, directly or indirectly whether in the capacity of a shareholder, director, or otherwise. Further, those person(s) in accordance with whose advice, directions, or instructions the Board of Directors of the company is accustomed to act, except in case of a person acting in a professional capacity, would also be considered as a promoter of a company.

Promoter under SEBI Regulations

The term ‘Promoter’ is defined under ICDR and various other SEBI regulations has the reference to the definition as given in ICDR.

Promoter under ICDR

The Regulation 2 (1) (oo) of ICDR defines the term ‘promoter’. The definition is similar to the definition in the Companies Act, 2013 and provides that a financial institution, scheduled commercial bank, foreign portfolio investor other than individuals, and the other specified body corporates shall not be deemed to be a promoter merely by holding 20% or more of the equity share capital of the issuer unless such person satisfies other requirements prescribed under the regulations.

Obligations on Promoters under SEBI Regulations

The identification of promoters is crucial in the listing process as the ICDR places substantial responsibilities on the Promoters. To ensure their ‘skin in the game’ after the IPO, the ICDR place various obligations on the promoters such as a 20% minimum shareholding in the post-issue share capital of the company and lock-in restriction of three years on such shareholding. There are also onerous disclosure requirements on promoters with respect to disclosures in the prospectus so that the general public has adequate information on the company for deciding whether to invest in the IPO or not.

However, being classified as a promoter of an investee company (Company) may not be favourable for a PE investor especially for those investors targeting the IPO as an exit route from the company. Therefore, it is vital for a PE investor to understand the key responsibilities and continuous disclosure requirements when classified as a promoter under the ICDR, including disclosure requirements relating to members of promoter group entities.

Figure – 1

Freezing of Promoter holding in case of default

 Under Chapter XI, Regulation 98 of LODR provides that in case of contraventions of the provisions of LODR, the shareholding of promoter/promoter group may be frozen by the respective stock exchange(s), in the manner specified in circulars or guidelines issued by the Board in coordination with depositories.

Thus, the promoters are subject to such action by the SEBI or the stock exchange in case of contraventions which adds up to the responsibilities of the promoter/promoter group. They need to ensure that the entity is in compliance with all the rules & regulations even if they are not involved in the day-to-day management of the entity.

The concept of Promoter Group

Regulation 2 (1) (pp) of ICDR defines Promoter Group (‘PG’) based on the nature of the promoter i.e. if the promoter is an individual and if the promoter is a body corporate. The definition, essentially, includes the promoter and the relatives of the promoter (spouse, parents, brother, sister, or child of the person or of the spouse).

PG, if the promoter is an individual PG, if the promoter is a body corporate
·        a body corporate in which 20% or more of the equity share capital is held by the promoter or an immediate relative of the promoter and

·        a firm or Hindu Undivided Family in which the promoter or any one or more of their relative is a member would fall under the promoter group category.

·         a body corporate in which a body corporate as mentioned above holds 20% or more, of the equity share capital and

·        a Hindu Undivided Family (HUF) or firm in which the aggregate share of the promoter and their relatives is equal to or more than 20% of the total capital of the company.

 

 ·        a subsidiary or holding company of such body corporate

·        a body corporate in which the promoter holds 20% or more of the equity share capital; and/or

·        a body corporate which holds 20% or more of the equity share capital of the promoter

·        a body corporate in which a group of individuals or companies or combinations thereof acting in concert, which hold 20% or more of the equity share capital in that body corporate and such group of individuals or companies or combinations thereof also holds 20% or more of the equity share capital of the issuer and are also acting in concert

The promoter group will also include all persons whose shareholding is aggregated under the heading “shareholding of the promoter group” in the shareholding pattern of the company.

It should be noted that, under the proviso to the definition of the promoter group, financial institutions, scheduled bank, foreign portfolio investor other than individuals, mutual funds, and such other body corporates as provided, are not deemed to be promoter group merely by virtue of the fact that 20% or more of the equity share capital of the promoter is held by such person or entity. However, such entities will be treated as promoter group for the subsidiaries or companies promoted by them or for the mutual fund sponsored by them.

The SEBI has proposed to delete Regulation 2(1) (pp)(iii)(c) from the definition of prompter group in the case of a promoter being a body corporate. The sub-clause covers those entities in which a group of individuals or companies or a combination thereof holds 20% or more who are also holding 20% or more of the equity in the issuer. These entities could be unrelated and the financial objectives of the investors can also be different. Since the only factor connecting the two entities is the common financial investors, the data captured under the said sub-clause may not be a piece of fruitful information to the investors and in turn, adds up the compliance & disclosure burden on the listed entity.

There arises a situation where persons who are not involved with the business of the issuer are covered by the definition and are required to make disclosures merely by falling within the ambit of the definition. The said proposal of deletion of the clause will bring in much more meaningful data to the investors for better analysis and will also help the issuer in reducing its compliance burden.

The definition of promoter group under ICDR is referred to in various SEBI regulations as in the case of the definition of the promoter. The obligations of the promoter group are similar to those of the promoters in terms of continuous disclosures and compliances under various SEBI regulations.

Figure 2

The need for re-visiting the concept of Promoter

The recent studies show that institutional investors are gaining a notable share in the Indian capital market, especially in the space of Top 500 listed companies by market capitalisation. The OECD report[1] shows that institutional investors represent an estimated investment of close to USD 400 billion in the public equity market, which is around 30% of total market capitalisation in India. In the year 2018, the institutional investors held almost 34% of equity holding of the top 500 Indian listed companies by market capitalization[2].

Among the top 500 listed entities by market cap, there is a sharp increase in the shareholding by the institutional investors from 14% in 2001 to 26% in 2018.

The current growth of the Indian primary and secondary markets is also due to the growing number of foreign institutional investors who have made considerable investments in the listed and unlisted space.

Institutional ownership in Indian listed companies (2001-2018)[3]

The data shows that there is a considerable shareholding in listed companies that may not fall under the ‘promoter/promoter group’ instead appears under the ‘public’ category but is in a position to influence the management and the decision-making process.

Thus, to bring such entities and persons who are now outside the umbrella of the promoters for the benefit of the retail investors as well as to have better governance over such entities to be accountable under the various provision of the SEBI Regulations, a re-visit to the very definition of the promoter is necessary.

A paradigm shift from promoter to the person in control is essential because several businesses, including new age and tech companies, are non-family owned and/or do not have a distinctly identifiable promoter group. The typical Indian family-owned companies are slowly moving away from their “once a promoter, always a promoter” status with the change in their leadership.

Shifts in the pledge of Promoters’ shares (2001-2018)[4]

In India, the promoters of listed entities pledge their shares as collateral to secure finance from banks & financial institutions. The underlying risk factor on the pledging of promoter stake is that an instance of default would significantly affect the share prices thereby putting the market as well as the retail individual investors at potential losses.

The number of shares pledged shows an upward trend until 2016 across all listed companies. However, the market value of shares pledged has remained stable while the number of pledged shares shows a slight downward trend since 2013.

In the Financial Stability Report, December 2014” (2014), RBI stated, “a typical Indian company, the promoters pledge shares not for funding outside business ventures but for the company itself. Given the vulnerabilities in some promoter-led companies, pledging of promoters’ shares could pose risks to the financial stability.”

SEBI has made the disclosure framework in respect of pledge of shares as collateral more stringent through the SAST regulations and has also provided strict timelines for such disclosures by promoters and promoter group. The data is disseminated through the stock exchange for the benefit of the investors.

Shifts in directors who are Promoters (2001-2018)[5]

Due to the traditional family-owned business setup, the promoters also get a seat on the board of directors of the company. The above figure shows the paradigm shift in the board participation by promoters and the average proportion between promoter directors and non-promoter directors during the period 2001- 2018.

The SEBI has brought safeguards to protect the minority shareholders’ rights especially to cover the companies with promoters holding board positions. The Regulation 17 of the LODR provides that;

  • Where a regular non-executive chairperson of a listed entity is a promoter of the listed entity or is related to any promoter, at least half of the board of directors of the listed entity shall consist of independent directors.
  • The fees or compensation payable to executive directors who are promoters or members of the promoter group shall be subject to the approval of the shareholders by special resolution in the general meeting of the members where such fees or compensation exceeds the limits prescribed therein.

These are a few measures to ensure that the promoter directors do not get an undue advantage due to their ability to influence the decision-making process by the Board of directors of the company and an element of independence is involved in the Board process.

However, it is pertinent to note that, the restrictions are only attracted to the ‘promoters’ and persons ‘related to promoter’ of the company.  A shift from ‘promoter’ to ‘person in control’ may cover those persons who are currently outside the ambit of the definition of ‘promoter’ but enjoys an element of influence on the entities.

SEBI discussion paper on Brightline Tests for the acquisition of ‘Control’[6]

The SEBI had issued a discussion paper on Brightline Tests for Acquisition of ‘Control’ under SEBI Takeover Regulations in 2016, with the intent to decide whether a numerical threshold as the current practice or a principle-based test can be conducted to determine whether a person is in control of a listed entity.

The term ‘control’ implies the ability of a person or a group of persons acting with a common objective to influence the management and policy-making process of an entity. It can be said that such person(s) is(are) in the ‘driving seat’ with a substantial influence over the key business decision making, even without involving in the day-to-day affairs of the company.

The identification of control is undemanding in the instances where the rights arise from the shareholding/voting rights in the company. The real test of control in the cases of contractual agreements becomes complex and demands elaborate consideration of facts and circumstances of the case.

Therefore, the nature of the definition of control in such cases has to be based on a set of defined principles rather than the rules. In the matter of Subhkam Ventures (I) Pvt. Ltd.[7] the Hon’ble SAT, in its judgment dated January 15, 2010, rejected SEBI’s view stating that none of the clauses of the agreements, individually or collectively, demonstrated control in the hands of the acquirer wherein SEBI argued that the rights conferred upon the acquirer, through the agreements, amounted to ‘control’ over the target company.

The essence of the order was, control, according to the definition, is a proactive and not a reactive power. The test is whether the acquirer is in the ‘driving seat’.

The SEBI’s proposal for replacing the term ‘promoter’ with ‘person in control’ would change the current regulatory framework and will align with what was intended to be amended under SAST. However, the amended definition should exclude protective rights/ veto exercised by the acquirer that are participative in nature.

The concept of Control under various other Acts, Rules & Circulars

-The Insurance Laws (Amendment) Act, 2015 provides that control shall include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements. Thus, the ambit of coverage of promoter under the Act is wide enough to include various types of business ownership structures.

-Consolidated FDI Policy Circular of 2020 has a similar definition as provided in the Insurance Laws (Amendment) Act, 2015.

-In Competition Act 2002, the concept of control includes controlling the affairs or management by one or more enterprises,

(a)either jointly or singly, over another enterprise or group;

(b)one or more groups, either jointly or singly, over another group or enterprise

-International Financial Reporting Standard (IFRS) also defines the principle of control and establishes control as the basis of determining which entities are consolidated in the consolidated financial statements. Under IFRS, the principle of control sets out the following three elements of control:

(a) power over the investee;

(b) exposure, or rights, to variable returns from involvement with the investee; and

(c) the ability to use power over the investee to affect the amount of the investor’s returns.

Whether test applied for identifying SBO under CA, 2013 is of any relevance here?

The MCA vide its Notification dated June 13, 2018,[8] has enforced the provisions of amended Section 90 of the Companies Act, 2013 and also issued the Companies (Beneficial Interest and Significant Beneficial Interest) Rules, 2018 concerning Significant Beneficial Ownership (‘SBO’).

Meaning of SBO

The Significant Beneficial Owner is an individual who alone or together with or through one or more persons or trust, holds a beneficial interest (as prescribed under the SBO Rules) in the shares of a company or has the right to exercise, or the actual exercising of significant influence or control as defined in clause (27) of section 2 of the Companies Act, 2013.

The revised SBO rules have prescribed the following definition to SBO;

Often when it comes to investments the PE investors structure their investments into a Company through multi-layered entities, with the immediate holding entity of the Company will merely act as an investment vehicle and not a substantive entity.

The premise of SBO rules is to identify the natural person behind the entity. Therefore, to identify such natural persons exercising ultimate control over the Company, the SBO rules can be applied. However, the persons in control of the entity may be a natural person or a body corporate as mentioned above. Hence, the basic principle of SBO may not be useful to identify the latter, as the SBO rules have the primary objective of identifying money-laundering activities and their related provisions under the Prevention of Money Laundering Act of 2002.

The SEBI Board meeting held on 6th August 2021, accepted the changes proposed in the consultation paper on ‘Review of regulatory framework for promoter, promoter group and group companies’. The table showing the proposals and the SEBI Board decision on the same is tabulated below:

Proposal SEBI Consultation paper SEBI Board decision
Reduction in lock-in periods for minimum promoter’s contribution and other shareholders for public issuance on the Main Board

 

 The lock-in of promoters’ shareholding to the extent of minimum promoters’ contribution (i.e. 20% of post issue capital) shall be for a period of 18 months from the date of allotment in initial public offering (IPO)/further public offering (FPO) instead of existing 3 years, in the following cases:

 

a)      If the object of the issue involves only offer for sale

b)      If the object of the issue involves only raising of funds for other than for capital expenditure* for a project (more than 50% of the fresh issue size)

c)       In case of combined offering (Fresh Issue + offer for sale), the object of the issue involves financing for other than capital expenditure for a project (more than 50% of the issue size excluding OFS portion)

* The term capital expenditure shall be clarified to include purchase of land, building and civil work, plant and machinery, miscellaneous fixed assets, technology etc.

 Accepted
Lock-in of Promoter holding in excess of  minimum promoter contribution Further, in all the above-mentioned cases, the promoter shareholding in excess of minimum promoter contribution shall be locked-in for a period of 6 months instead of existing 1 year. Accepted
Reduction in lock-in periods for other shareholders for public issuance The entire pre-issue capital held by persons other than the promoters shall be locked-in for a period of 6 months from the date of allotment in the initial public offer as opposed to the existing requirement of 1 year. The lock-in of pre-IPO securities held by persons other than promoters shall be locked-in for a period of 6 months from the date of allotment in IPO instead of existing 1 year. The period of holding of equity shares for Venture Capital Fund or Alternative Investment Fund (AIF) of category or Category II or a Foreign Venture Capital Investor shall be reduced to 6 months from the date of their acquisition of such equity shares instead of existing 1 year.
Rationalization of the definition of ‘Promoter Group’ Deletion of Regulation 2(1) (pp)(iii)(c) in the definition of promoter group The definition of promoter group shall be rationalized, in case where the promoter of the issuer company is corporate body, to exclude companies having common financial investors
Streamlining the disclosures of group companies Only the names and registered office address of all the Group Companies should be disclosed in the Offer Document.  All other disclosure requirements like financials of top 5 listed/unlisted group companies, litigation etc., presently done in the Draft Red Herring Prospectus can be done away.  However, these disclosures may continue to be made available on the websites of the listed companies. The disclosure requirements in the offer documents, in respect of Group Companies of the issuer company, shall be rationalized to, inter-alia, exclude disclosure of financials of top 5 listed/unlisted group companies. These disclosures will continue to be made available on the website of the group companies.
Shifting from concept of ‘promoter’ to concept of ‘person in control’ To revisit the concept of promoter and shift to the concept of ‘person in control’ or ‘controlling shareholders’. Agreed in-principle.

 

To this effect, the Board, advised SEBI to:

 

a) engage with other regulators to ascertain and resolve regulatory hurdles, if any.

 

b) prepare draft amendments to securities market regulations and analyse impact of the same.

 

c) further deliberate at the PMAC and develop a roadmap for implementation of the proposed transition.
Consequent to the acceptance of the proposals in the Board meeting, the SEBI notified Issue of Capital and Disclosure Requirements (Third Amendment) Regulations, 2021 on 13th August 2021, and the actionable for listed companies pursuant to the said amendment are;

The FAQs of CDSL on System Driven Disclosure in Securities Market also provides that In case of any subsequent update in the information about Promoters, members of the promoter group, director(s), designated persons, the listed company shall update the information with the designated depository on the same day.

Further, the disclosure requirements under various SEBI regulations as depicted in Figure 2 will not be applicable to such entities henceforth.

Conclusion

The Indian investor perception is evolving at a faster pace and the regulatory framework needs to align at the same pace. The move of SEBI in bringing a paradigm shift from ‘Promoter/Promoter group to ‘Person in control’ will have a substantial effect in the capital market as it would bring in considerable changes in various SEBI regulations like ICDR, LODR, SAST, PIT, etc., and would pave the way for the introduction of a more comprehensive framework for IPOs.

How will the regulator define the term ‘person in control’?  Whether the existing framework in respect of SEBI SAST would be re-designed with a rule-based as well as a principle-based test of control as discussed in the discussion paper on ‘Brightline test’? these questions could interest us as we dig deeper into SEBI’s proposal.

[1] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[2] OECD (2019), OECD Equity Market Review of Asia 2019

[3] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[4] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[5] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[6] https://www.sebi.gov.in/sebi_data/attachdocs/1457945258522.pdf

[7] https://www.sebi.gov.in/satorders/subhkamventures.pdf

[8] https://www.mca.gov.in/Ministry/pdf/CompaniesSignificantBeneficial1306_14062018.pdf

Our other article on the relevant article can be read here – http://vinodkothari.com/2020/12/sebi-proposes-liberal-provisions-for-promoter-reclassification/

Assessing the Viability of a Gold Spot Exchange in India

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-Megha Mittal 

(mittal@vinodkothari.com)

The Securities and Exchange Board of India (‘SEBI’) has issued a consultation paper dated 19th May, 2021, on proposed framework for Gold Exchange in India and draft SEBI (Vault Managers) Regulations, 2021 (‘Consultation Paper’), thereby seeking public comments on the framework for operationalising gold exchange and the regulation of intermediaries inter-alia Vault Managers.

While the idea of setting up a regulated gold exchange was highlighted in the Union Budget 2018-19 as well as in the Budget 2021-22, the Consultation Paper comes as the first concrete step towards bringing into operation a gold exchange for the Indian market. This comes in the backdrop of the fact that despite being the second largest consumer and importer of gold, India continues to be a price-taker – India does not play any significant role in influencing the global price-setting for the commodity. As such, the Consultation Paper envisages an entire ecosystem of trading and physical delivery of gold so as to create a transparent and robust market which paves the way for India to become a global price setter.

That being said, before delving into the procedural aspect, it is important to understand the fundamentals as to what are the objectives being aimed, what would the target market look like, and if at all the proposed framework would put the investors, the parties and the nation in a better place that is today.

Read more →

‘Material Subsidiary’ under LODR Regulations: Understanding the metrics of materiality

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Barsha Dikshit | corplaw@vinodkothari.com

Himanshu Dubey | corplaw@vinodkothari.com

The term ‘subsidiary’ or ‘subsidiary company’ as defined under the Companies Act, 2013[1] (‘Act’) refer to a company in which a holding company controls the composition of the Board of directors or may exercise at least 51% of the total voting power either on  its own or together with one or more of its subsidiaries. A company may have a number of subsidiaries; however, all of them may or may not have a material impact on the holding company or on the group at a consolidated level. Therefore, regulations sometimes require identification of such subsidiaries which may have a material impact on the overall performance of the holding company/group.

Though SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015 (‘SEBI LODR’), define the term ‘Material Subsidiary’ as a subsidiary, whose income or net worth exceeds ten percent (10%) of the consolidated income or net worth, respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year, however, there remains confusion w.r.t. the criteria provided for determining the materiality of a subsidiary. For instance, whether a subsidiary having negative net worth exceeding 10% of the consolidated net worth of the listed company will be qualified as a material subsidiary? Or say if the net worth at the group level is negative, however the net worth of the subsidiary is positive, will that subsidiary be treated as a material subsidiary, etc.

Through this article the author has made an attempt to decode some of these puzzling issues relating to determination of materiality of a subsidiary.

The Concept of ‘Material Subsidiary’

In present day corporate world, operating through a network of subsidiaries and associates is quite common. Sometimes, it is a matter of corporate structuring discretion, and sometimes, it is purely a product of regulation – for example, overseas direct investment can be made only through subsidiaries or joint venture entities. While the listed subsidiaries are always under the observation of SEBI, an appropriate level of review and oversight is required by the board of the listed entity over its unlisted subsidiaries for protection of interests of public shareholders. The board of directors of a holding company cannot take a tunnel view and limit their perspective only to the company on whose board they are sitting. After all, subsidiaries operate with the resources of the parent, and therefore, what happens at subsidiaries and associates is of immediate relevance to the holding company.  Accordingly, the obligation of the board of a listed entity with respect to its subsidiaries has been increased vide SEBI LODR Amendment Regulations, 2018 dated 9th May, 2018[2], thereby reducing the threshold for determining materiality of a subsidiary to 10% (as opposed to the previous limit of 20%) of the consolidated income or net worth respectively, of the listed entity and its subsidiaries, in the immediately preceding accounting year.

Since the material subsidiaries have a considerable role in the overall performance of the holding company or the group as a whole, it is important to arrive at the correct interpretation of the term in line with the intent and purpose of the definition as well as the compliance requirements following it.

In terms of the definition provided under Regulation 16(1)(c) of SEBI LODR the triggers for determining materiality of a subsidiary are- Net Worth [3]and Turnover. That is to say, the pre-requisites for determining materiality of a subsidiary are:

  1. It has to be a subsidiary, in terms of the definition provided under Act, 2013; and
  2. Its income/net worth in the immediately preceding financial year exceeds 10% of the consolidated net worth of the listed company.

It is pertinent to note that the definition of material subsidiary currently provides for 10% or more impact on the consolidated turnover or net worth of the listed company/group, however, it does not specify whether the said impact has to be in positive or negative. It just says that the impact has to be 10% of the overall income/net worth. Since the turnover of a company cannot be negative, the focus has to be made on the later.

A parent company is required to prepare consolidated financial statement taking into account the performance of its subsidiaries. While a subsidiary, with a good performance and positive net worth/income can add on the overall growth of the group, the same can affect the overall performance of the group with its negative net worth, and if the said impact exceeds 10% of the income/net worth of the consolidated performance of the group, the said subsidiary will become material and shall require special attention of the parent company. Therefore, for the purpose of determining the ‘materiality’, one has to drop the minus sign of the net worth of the subsidiary or group and has to see the absolute term and the overall impact it has on the group. In other words, if a subsidiary is big enough to shake the performance of its holding company, it shall be qualified as a ‘material subsidiary’.

Let us take some illustrations to understand the definition provided under Reg. 16 (1) (c) of SEBI LODR:

Illustration 1:

XYZ Limited is a subsidiary of ABC Limited. In the FY 2019-20, the net worth of XYZ Limited was Rs. 50 Crs. and the consolidated net worth of ABC Limited company was Rs. 400 Crs., Whether XYZ Limited be considered as a material subsidiary of ABC Limited?

Yes. The contribution of XYZ Limited towards the consolidated net worth of ABC Limited is more than 10%, therefore XYZ Limited shall be consolidated as a ‘material subsidiary’ of ABC Limited.

Illustration 2:

Net worth of XYZ Limited in FY 2019-20 was Rs. (50) Crs., however, the consolidated net worth of ABC Limited was Rs. 400 Crs, will XYZ Ltd. be considered as a material subsidiary of ABC Ltd?

Yes. Irrespective of having a negative net worth, since XYZ Limited contributes more than 10% of the consolidated net worth of ABC Limited, XYZ Limited shall be considered as a ‘material subsidiary’ of ABC limited.

Illustration 3:

Net worth of XYZ Limited in FY 2019-20 was Rs. (50) crores, and the consolidated net worth of ABC Limited was Rs. (400) Crs., will XYZ Limited be considered as a material subsidiary of ABC Limited?

Yes. Even if the net worth at the subsidiary level and the consolidated level are negative, however, one has to see as to how much contribution the subsidiary has in the consolidated net worth of the holding company. Therefore, irrespective of having negative net worth, XYZ Limited shall be considered as a ‘material subsidiary’ of ABC limited.

Illustration 4:

Net worth of XYZ Limited in FY 2019-20 was Rs. 50 crores and the consolidated net worth of ABC Limited was Rs. (400) Crs., will that subsidiary be considered as a material subsidiary of ABC Limited?

Yes. In the given case, because of the positive net worth of the subsidiary the net worth of the holding company has contributed to reduce the negative net worth of the holding company by more than 10%. Therefore, the subsidiary, viz. XYZ Limited shall be considered as a material subsidiary of ABC Limited.

Illustration 5:

Net worth of XYZ Limited in FY 2019-20 was Rs. 30 Crs. and the consolidated net worth of ABC Limited was  Rs. (400) Crs., will that subsidiary be considered as a material subsidiary of ABC Limited?

No. Even though the positive net worth of the subsidiary is contributing to reduce the negative consolidated net worth of the holding company, however, that contribution is less than 10%, therefore in this case, XYZ Limited shall not be considered as a ‘material subsidiary’ of ABC Limited.

Thus, for determining ‘materiality’ of a subsidiary, the emphasis should not be on whether net worth is positive or negative, rather the impact of its net worth or income on the overall consolidated performance of the listed entity is to be seen.

Special Situation in case of Regulation 24 (1)

 In the SEBI LODR, the term ‘Material Subsidiary’ has been defined twice, i.e under regulation 16 (1)(c) and under regulation 24 (1). While the threshold for determining ‘materiality’ provided under regulation 16 (1) (c) is 10%, the one provided under reg. 24 (1) is 20%. The reason behind the said increase in the threshold is the higher level of impact the said subsidiary can make on the performance of the listed company/group. That is to say, when a subsidiary is ‘material’ it requires attention of the parent company, however when it becomes significantly material, such that it can give shock to the parent company with its performance, it requires higher attention. Therefore regulation 24 (1) requires those significantly material subsidiaries to have on independent director of the parent company in its board.

The need for an independent director can be established by the fact that they are expected to be ‘independent’ from the management and act as the fiduciary of shareholders. This implies that they are obligated to be fully aware of the conduct which is going on in the organizations and also to take a stand as and when necessary, on relevant issues.

The requirement of appointing independent director is applicable only in case of significantly material subsidiary (unlisted), whether incorporated in India or not, and not in case of material subsidiary. 

Obligation of the Listed Entity with respect to its Material Subsidiary(ies)

Other than the obligations provided under Reg. 24 of SEBI LODR for the listed companies w.r.t. their subsidiaries, the following additional obligations are applicable in case of material subsidiaries:

  • Formulating Policy– The listed entity is required to formulate a policy for determining materiality of its subsidiaries, and shall disseminate the same on its website.
  • Appointment of Independent Director– Pursuant to Regulation 24(1) of the LODR, at least one (1) independent director of the listed entity is required to be a director on the board of an unlisted material subsidiary (with respect to this provision, material subsidiary has been defined with a threshold of 20% of the consolidated income or net worth).
  • Disposing of shares in Material Subsidiary – A listed company shall not dispose of shares in its material subsidiary resulting in reduction of its overall shareholding to less than 50% or cease to exercise control over subsidiary without passing special resolution in general meeting except in case where such divestment is made under a scheme of arrangement (duly approved by the Tribunal/ Court) or in case of resolution plan duly approved in terms of section 31 of IBC, 2016.
  • Selling, disposing and leasing of assets – Pursuant to Regulation 24(6) of the LODR, the sale or disposal or leasing of assets amounting to more than 20% of the assets of a material subsidiary (on an aggregate basis during a financial year), subject to certain exceptions, requires prior approval of the shareholders of the listed holding company by way of a special resolution.
  • Secretarial Audit: Pursuant to Regulation 24A of the LODR, all listed entities and their Indian unlisted   material   subsidiaries   are   required   to   undertake   a secretarial audit and annex such reports to the annual report of the listed entity.

The discussion above can be summarised in the presentation below:

Role of Policy on determining Materiality of Subsidiary

The definition of ‘material subsidiary’ under regulation 16(1)(c) defines a subsidiary that is material to the listed entity and the explanation to the aforesaid provision allows the listed entity to formulate a policy for the same, i.e., a listed entity can develop criteria that is stricter than what has been provided in the Regulations. However, nothing has been provided regarding the contents of the Policy in the SEBI LODR. Therefore, the Policy is nothing but a replica of what has already been provided in the law, as in order to ensure compliance of the law, listed entities frames policy for determining materiality of subsidiaries based on the contents of the regulations. Thus, the requirement of the policy is limited to ensure compliance of the law.

Can a section 8 company be treated as ‘Material Subsidiary’?

Section 8 Company, as defines in the Act, 2013 are companies that are formed with an object of promoting commerce, art, science, sports, education, research, social welfare, religion, charity, protection of environment or any such other object. These companies are required to apply their profit, if any or other income in promoting their objects and are prohibited from payment of any dividend to its members. Whereas, the benchmark for satisfying the definition of ‘material subsidiary’ is contribution towards consolidated income or net worth of the holding company.

When we consolidate the holding company with a Section 8 company, it will however depict a wrong picture of the wealth of the holding company, as the holding company can never claim any right over the profits of a Section 8 Company. Therefore, the question of consolidation of section 8 with that the holding company does not arise.

Given that the income of a section 8 company cannot be consolidated with that of the listed company or can say that since the performance of a section 8 company has no role to play on the overall performance of the listed company, a section 8 company cannot be treated as a ‘material subsidiary’. 

Concluding Remarks

The term “material subsidiary” has been prioritized over the years because of the impact it may have over the consolidated performance of the listed entity. The principle behind emphasizing absolute numbers of the net worth is the impact of the same on the consolidated figures. Any changes in the income/net worth of these material subsidiaries will be reflected proportionally on the listed entity since the net worth derived from the said material subsidiaries constitutes an integral part of the consolidated net worth of the listed entity. Accordingly, the listed entities should determine the materiality of its subsidiaries wisely and comply with the requirements of SEBI LODR as are applicable on the material subsidiaries.

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Our article on similar topics –

  1. http://vinodkothari.com/wp-content/uploads/2019/04/Final_PPT_on_SEBI_LODR_Amendment_Regulations_2018.pdf
  2. http://vinodkothari.com/2019/02/decoding-large-number-in-case-of-group-governance-policy-under-lodr/

 

[1] Section 2 (87) of the Act

[2] https://www.sebi.gov.in/legal/regulations/may-2018/sebi-listing-obligations-and-disclosure-requirement-amendment-regulations-2018_38898.html

[3] Section 2 (57) of the Act defines net worth as:

“Net worth” means aggregate value of the paid up share capital and all reserves created out of the profits and securities premium account, after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off, as per the audited balance sheet, but does not include reserves created out of revaluation of assets, write-back of depreciation and amalgamation