Posts

SEBI widens the sweep of related party provisions drastically

/0 Comments/in , , /by

Presentation on Amended SEBI Framework on Related Party Transactions: https://vinodkothari.com/2021/11/presentation-on-amended-sebi-framework-on-related-party-transactions/

Article explaining the amendments in RPT framework with action points: http://vinodkothari.com/2021/11/sebi-notifies-stricter-norms-for-rpts/

Snapshot of SEBI LODR 6th Amendment Regulations 2021: https://vinodkothari.com/2021/11/snapshot-of-sebi-lodr-6th-amendment-regulations-2021/

Read our other articles on the subject: https://vinodkothari.com/article-corner-on-related-party-transactions/

Other Corporate Law articles: http://vinodkothari.com/corporate-laws/

SEBI notifies stricter norms for RPTs

/0 Comments/in , , /by

Presentation on Amended SEBI Framework on Related Party Transactions: https://vinodkothari.com/2021/11/presentation-on-amended-sebi-framework-on-related-party-transactions/

Detailed analysis of the amendments in RPT framework pursuant to SEBI LODR (6th Amendment) Regulations, 2021: https://vinodkothari.com/2021/11/sebi-widens-the-sweep-of-related-party-provisions-drastically/

Snapshot of SEBI LODR 6th Amendment Regulations 2021: https://vinodkothari.com/2021/11/snapshot-of-sebi-lodr-6th-amendment-regulations-2021/

Read our other articles on the subject: https://vinodkothari.com/article-corner-on-related-party-transactions/

Other Corporate Law articles: http://vinodkothari.com/corporate-laws/

Managing significant transactions & arrangements with subsidiaries

/0 Comments/in , , /by

– Decoding Regulation 24 of Listing Regulations

By Payal Agarwal and Himanshu Dubey | corplaw@vinodkothari.com

Updated as on 27th October, 2021

The seamless flow of information between a holding company and its subsidiaries is imperative for effective governance on the level of a group. Since listed companies in India often function with complex structures having a lot of subsidiaries, it is not feasible for the holding company to deliberate upon all the matters of its subsidiary. Therefore, if not all, at least the significant transaction of the subsidiaries shall be placed on the board of the holding company. Regulation 24 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) provide for the same. The same though sounds commendable but is also surrounded by various practical difficulties while its implementation. Sometimes the compliance with the aforesaid provision becomes merely perfunctory. If too much is reported to the holding company, the relevance is lost while if too less is reported then the materiality is lost.

Need of fostering corporate governance requirements with respect to subsidiaries

In the normal course of business, it is very common for companies to have subsidiaries. However, the significance of such subsidiaries on the overall performance of the holding company varies. In case of listed companies, since the interest of the public at large is at stake, it becomes imperative that such stakeholders shall not only be informed about the listed company but also its subsidiaries. Ofcourse, the level and depth of information shall vary depending upon the significance of the subsidiaries as well as the significance of transactions being undertaken by such subsidiaries. Considering the aforesaid, Regulation 24 of the Listing Regulations requires the listed holding company to ensure corporate governance in its unlisted subsidiaries in certain ways. One of such ways is provided under sub-regulation (4) of Regulation 24 (Regulation) which says that the management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary.

The above-mentioned requirement was earlier applicable only to material unlisted subsidiaries but pursuant to amendment applicable w.e.f. April 1, 2019, the requirement has now been made applicable to all the unlisted subsidiaries of the listed holding company. However, the requirement though seems unequivocal, it comes with certain anomalies and practical difficulties. The author tries to present an analysis of the Regulation so as to answer the anomalies coming in the way of its practical implementation.

Applicability to subsidiaries

It is very common for a large corporate group to have various subsidiaries which in turn have various subsidiaries under them i.e. step down subsidiaries, from the angle of the ultimate holding company. The possibility of the holding company being listed and the subsidiaries including step down subsidiaries being unlisted is very high. This kind of a structure is very common and can be seen in most of the major corporate groups in India. Since the Regulation talks about subsidiaries, a question might pop up whether it only includes the immediate subsidiaries or the step down subsidiaries as well.

Given the purpose of the Regulation of enhancing corporate governance in the subsidiaries and also the fact that the shareholders interested in the listed company shall be aware of the business being undertaken by the subsidiaries as well. The principle behind this is that on the consolidated level, the performance of the holding company gets affected by the performance of its subsidiaries including its step down subsidiaries. Therefore it is pertinent to have some degree of supervision over them in terms of corporate governance though they are unlisted. Considering this rationale, there seems to be no purpose of excluding the step down subsidiaries from the purview of this Regulation. Hence, the Regulation will  be applicable to both immediate and step down unlisted subsidiaries. Let us understand the applicability of the Regulation under different cases enunciated below:

 

Case 1: since both the immediate subsidiary and the step down subsidiary are unlisted, the Regulation will apply to both of them and significant arrangements or transactions entered into by them will be reported to the ultimate holding company.

Case 2: since the subsidiary itself is a listed company and the Regulation clearly states that it applies to unlisted subsidiary. Therefore, the Regulation will not apply to the subsidiary. Going further, the step down subsidiary is unlisted, but the holding company just one level above is listed. Therefore, the Regulation will apply to unlisted step down subsidiary in relation to its immediate holding company. The ultimate holding company at the top will not be required to note or review the significant transactions or arrangements of the step down subsidiary under the Regulation.

Case 3: since the subsidiary is unlisted, the Regulation will have to be complied in relation to it. However, going forward to the listed step down subsidiary, since it is itself listed with the stock exchange, the Regulation will not apply as it is applicable only to unlisted subsidiaries.

Issues to address

Regulation 24(4) of the Listing Regulations reads as below –

“The management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary.”

The following may be require to be identified –

While a plain reading entails the aforesaid questions, a deep analysis of the provisions and on consideration of the practical implications, further issues/questions may arise which have been dealt with at relevant places in this write-up.

Meaning of Transactions or Arrangements

The first question that arises while complying with the requirements of Regulation 24(4) is the identification as to what constitutes transaction or arrangement. While the term ‘transaction’ is not defined, the meaning of the same may be construed from Regulation 2(1)(zc) of the Listing Regulations and Indian Accounting Standard (Ind-AS) 24, defining the term “related party transaction” (RPT) .

The term has been defined as –

A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.

Accordingly, the term transaction may be understood to be “a transfer of resources, services or obligations between two parties”. Similarly, arrangements shall mean a plan or programme for undertaking or understanding to undertake such transactions in future.

 

Items not considered as transaction/ arrangement

There are various line items in the financial statements which does not arise out of any transaction or arrangement but as a result of accounting entries. Such line items such as deferred tax expenditure, provisions for future liabilities, unrealised gains or losses, etc do not involve any contract, result into any transfer and does not involve two or more parties. Therefore, these fail to contain the basic features of transaction and should not require reporting.

On the other hand, there are certain off-balance sheet items such as guarantee, or derivative transactions. The component of “transfer” may not be present from the early stage but may arise in due course. Moreover, these arise out of contracts and constitute transactions. Therefore, the same should be reported at the values as recognised in the books of accounts.

Assessment of Significance

The second step that comes after identifying the transaction/arrangement is the assessment of significance. For the purpose of Regulation 24(4), a transaction or arrangement is significant if it individually exceeds or is likely to exceed ten percent of the total revenues or total expenses or total assets or total liabilities, as the case may be, of the unlisted subsidiary for the immediately preceding accounting year.

The criteria of significance as provided above requires that the threshold needs to be checked against different parameters “as the case may be”. The parameter to be checked will depend upon the nature of the transaction. Therefore, depending upon the nature of the transaction, the significance shall be assessed against the threshold determined on the basis of figures under relevant head as explained below:

 

There may be instances where the transaction does not affect any one parameter in isolation but  two or more of the parameters i.e. revenue, expenses, assets or liabilities together. In such cases, an issue may arise as to which parameter has to be considered. In such cases, all the parameters applicable to such a transaction shall be considered. 10% threshold of all such applicable parameters shall be determined and the lowest of such threshold shall be applied for assessment of significance of such transaction.

For example, S Ltd, the subsidiary of A Ltd, has entered into a transaction with Z Ltd, involving sale of goods. Such transaction involves revenue and therefore, significance of such transaction has to be assessed as a percentage keeping the total revenue of the preceding accounting period as the base for deriving such percentage. Say for example, the revenue of S Ltd is Rs. 100 crore in the preceding financial year. Therefore 10% of it will be Rs. 10 crores. Hence, if the value of the transaction being entered by  S Ltd with Z Ltd exceeds Rs. 10 crores, the same will qualify as a significant transaction for the purpose of the Regulation.

However, consider another example in which S Ltd has entered into an arrangement which impacts both the assets and expenses of the Company (creation of a new capital asset involving a huge outflow of cash). In such a case, both the assets and expenses being involved, the significance of the transaction has to be assessed for each of the bases individually and the one that hits the requirement at the lower end shall be taken for assessment of significance. Say for example, the assets and the expenses of S Ltd in the preceding financial year was Rs. 500 crores and Rs. 150 crores each. In such a case, thresholds shall be calculated based on both the figures and the lower of the two shall be the one that will determine the significance of the transaction. In the instant case, the thresholds are Rs. 50 crores and Rs. 15 crores, therefore the lower of the two i.e. Rs. 15 crores will be the one that will be considered. Hence, if the amount of transactions being undertaken exceeds Rs. 15 crores, it will qualify as a significant transaction.

 

Basis for assessment – standalone or consolidated?

Having settled with the parameter to be considered for various transactions, another question that may tweak our mind is whether the total revenues or expenses or assets or liabilities, as the case may be , has to be considered on a standalone basis or on a consolidated basis for the subsidiary. Here, one has to consider the fact that the compliance of the provision has to be ascertained by the listed holding company. Any company, which is a subsidiary of the subsidiary company, ultimately becomes the step-down subsidiary of the listed holding company thereby attracting Reg 24(4) of the Listing Regulations for reasons as discussed above and reporting its significant transactions or arrangements to the board of the listed company. In view of the same, an inference may be drawn that the aggregate figures for the preceding financial year shall be taken on a standalone basis, and not on a consolidated basis. This will also help in getting a clear picture and involving only those transactions that are actually significant for the subsidiary.

Determination of significance: Transactions/Arrangements based on contract

It is a very general phenomenon in companies to enter into contracts with different parties. Such contracts often extend to years and give rise to transactions. A common ambiguity that may arise in such cases is on determining the amount of such transaction for the purpose of the Regulation. Let us understand this scenario with some examples.

A Ltd., a subsidiary of B Ltd., enters into a rent agreement with X Ltd. The rent agreement extends to 5 years at a total value of Rs. 30 lakhs i.e. at a monthly rent of Rs. 50,000 per month. Now what shall be considered as the value of transaction for the purpose of the Regulation, Rs. 30 lakhs or Rs. 50 thousand? In our view, the total amount attributable to that particular financial year shall be considered for the purpose of the Regulation. In the instant case, assuming that the contract is effective from October 1, 2021, the amount shall be Rs 3 lakhs (rent during the FY 2020-21). Therefore, for assessing the significance of the transaction, the amount of Rs. 3 lakhs shall be compared against the threshold.

In the same case above, even if there has been no specific tenure of the contract but it rather would have only discussed monthly payment of Rs. 50 thousand as rent, still the amount payable in total throughout that financial year shall be taken and not the monthly rent.

The underlying principle is that the total amount of that transaction attributable to that financial year shall be considered as the amount of transaction for assessing significance under the Regulation.

Reporting: decoding the meaning of management and periodicity

Meaning of management

Regulation 24(4) says that “the management of the unlisted subsidiary shall periodically bring to the notice of the board of directors of the listed entity xxxxxxxxx”. This again comes up with two questions: who constitutes management and what shall be the periodicity for bringing significant transactions or arrangements to the notice of the board of the listed holding company.

Going by the general meaning as well as the intent and purpose of this requirement, the board of directors of the subsidiary as well as the KMPs/other senior executives just a level below the Board should be taken to constitute ‘management’.

Periodicity of reporting

Coming to the question of periodicity, the same has not been specified in the Listing Regulations itself, but left to the discretion of the board. However, the intent of the Regulation is to enhance corporate governance in the subsidiaries. Hence the periodicity should be reasonable enough to capture such a purpose.

Here, one may note that Regulation 17(2) of the Listing Regulations requires the board of the listed company to meet at least four times a year. Further, under Regulation 33, financial results are placed before the board quarterly which also includes results of its subsidiaries (since the results have to be submitted on both standalone and consolidated basis). Therefore, in consonance with the same, the list of significant transactions or arrangements of the subsidiaries should also be placed before the board of the listed company, if not more frequently, at least on a quarterly basis.

De-minimis exemptions – can a leeway be created?

Regulation 24(4) of the Listing Regulations, though very significant in terms of enforcing corporate governance requirements and ensuring transparency in respect of the unlisted subsidiaries of the listed company, may sometimes prove extraneous in the spirit of law. There may be cases where the subsidiary as a whole may be too small to have any significance on the accounts of the holding company.

A classic example of the same may be in case of a company, as a listed holding company, having a paid-up capital of Rs. 50 crores or above, having a subsidiary with total asset size of Rs. 1 crore. In this case, the total assets of the subsidiary amounts to mere 2% of the total asset size of the listed company. Here, a transaction involving purchase/ sale of an asset of Rs. 10 lacs will fall within the meaning of a significant transaction for the subsidiary company, however, will have a minimal impact on the listed holding company.

In such cases, going by the letter of the law, such transactions, even though having no significant impact on the listed entity as such, will have to be placed before the board thereby creating an unnecessary compliance burden producing no meaningful results.

A possible leeway that may be created as a make-through to provide certain de minimis exemptions on the basis of certain amounts or percentages. For example, a listed company may approve through its board and audit committee, that any transaction undertaken by a subsidiary, which amounts to not greater than 2% of the turnover or the paid-up capital or the networth of the listed company, will not be required to be reported to the board of the listed company.

However, while putting such de minimis exemptions, utmost care has to be taken to ensure that the self-approved exemptions do not turn out to completely erode the intentions of the law. Further, the requisite approvals have to be obtained and properly documented so as to avoid falling into a legal moss at a later stage.

Conclusion

The requirement under Regulation 24(4) enhances corporate governance standards in subsidiaries which were otherwise unlisted and exempted from such scrutiny. It allows the listed holding company to exercise due diligence in significant transactions entered by subsidiaries. However, in certain cases, the requirement becomes redundant due to absence of any material effect of subsidiary’s transactions on the overall performance of the holding company due to minimal asset size or revenue. Therefore, the idea of exempting subsidiaries below a certain threshold in terms of asset size or revenue of the listed company can be thought upon.The market regulator may also take a step to bring this as an amendment to the law, so as to ensure reduction of extra-compliance burden as recently suggested by FM Nirmala Sitharaman in her speech on the 53rd Foundation day of ICSI.

 

Read our other article on the subject –

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

https://vinodkothari.com/2021/05/understanding-metrics-of-materiality/

SEBI approves stricter norms for RPTs

/0 Comments/in , , /by

CS Vinita Nair | Vinod Kothari & Company

September 29, 2021

SEBI in its Board meeting held on September 28, 2021 approved the amendments in RPT framework that were proposed by the Working Group[1] (‘WG’) in January, 2020. The notification amending SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) is awaited. Certain amendments to come into force from April 1, 2023 and remaining from April 1, 2022. This write up discusses the key amendments approved by SEBI in the Board meeting held on September 28, 2021[2].

In view of the recent amendment made in Listing Regulations w.e.f. September 7, 2021 the framework for Related Party Transactions (‘RPTs’) is also applicable to a High Value Debt Listed Entity (‘HVDLE’)[3].

Read more →

Presentation on Corporate Governance for Debt Listed Entities

/0 Comments/in , , , , /by

Our resources can be accessed through below links:

  1. FAQs on recent amendments under the Listing Regulations – https://vinodkothari.com/2021/08/faqs-recent-amendments-listing-regulations/
  2. Articles on fifth amendment regulations:
  3. Ease of doing business: Debt listed companies slide down to unlisted companies – https://vinodkothari.com/2021/02/debt-listed-companies-slide-down-unlisted-companies/ 

Our  Book on Law and Practice Relating to Corporate Bonds and Debentures, authored by Ms. Vinita Nair Dedhia, Senior Partner and Mr. Abhirup Ghosh, Partner can be ordered through the below link:
https://www.taxmann.com/bookstore/product/6330-law-and-practice-relating-to-debentures-and-corporate-bonds

Corporate governance enforced on debt listed entities

/0 Comments/in , , /by
  • LODR (Fifth Amendment) Regulations, 2021 notified

Payal Agarwal, Executive (payal@vinodkothari.com)

Brief background

SEBI has, continuing with its trends of the recent months, notified SEBI (Listing Obligations and Disclosure Requirements) (Fifth Amendment) Regulations, 2021 [hereinafter referred to as the “Amendment Regulations”] on 7th September, 2021 to amend the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 [hereinafter referred to as the “Listing Regulations”]. The amendments have huge implications on debt listed companies and provide for various mandatory requirements to be fulfilled by an entity which has listed its debt securities on stock exchanges. While some changes deal with alignment of the requirements with those under the Companies Act, 2013 [“Act”], some are significantly different calling for actionable on the part of debt listed companies.

Applicability

Particulars Applicable entities Applicable dates
Chapter IV – Regulations 16 to 27

(“Corporate Governance Provisions”)

 Entities which has listed its non-convertible securities (“NCS“) on a recognised stock exchange and has outstanding listed debt securities of Rs. 500 crores or more [hereinafter referred to as “high value debt listed entities” or “HVDs”]

 

Presently, limit has to be checked as on 31st March, 2021

 Applicable w.e.f. 07th September, 2021 on “comply or explain” basis

 

Mandatory w.e.f. 31st March, 2023

 

·         Comply or explain shall mean –

a.       Comply with the requirements within 31st March, 2023

b.      In case of non-compliance/partial compliance, explain reasons for same along with steps initiated to ensure compliance

·         to be reported in the quarterly compliance report filed under Reg 27
Applicability attracted during the course of a year to be complied within six months of such applicability
Amendments relating to Chapter V of the Listing Regulations applicable on all entities which have listed its non-convertible securities on recognised stock exchange with effect from 7th September, 2021

Further, it is mentionable that vide amendment in Reg 3(3) of the Listing Regulations, the Corporate Governance Provisions once applicable on a HVD entity, has to be complied with and does not cease to apply subsequently unless the company has no listed debt outstanding.

Corporate governance requirements applicable on HVDs

The debt-listed companies are mostly private companies or public companies that are unlisted for the purposes of the Act, and therefore, the alignment of their board composition with that of other listed entities may call for various actionable and some practical difficulties during the course of implementation. Here, we have tried to present the composition of board and committees as will be required to be ensured by the debt-listed entities and the possible constraints that may follow.

Relevant head Under the Act Under the Listing Regulations
Private company Unlisted public company
Ratio of executive (ED) and non-executive directors (NED) NA NA optimum combination with at least 50% NEDs
No. of independent directors (IDs) NA 2 IDs 1/3rd if Chairperson (CP) is NED

½ if CM is ED
Maximum age of NED NA NA 75 years (if beyond that, a special resolution is required along with justification for such appointment)
Minimum no. of board meetings (BM) with maximum gap between two meetings 4 (with a max gap of 120 days between two subsequent meetings) Same Same
Remuneration/ commission to directors NA As per the limits of net profits u/s 197 of the Act read with Sc. V –

Special resolution of members required if exceeds limits

·         Aggregate remuneration to all – 11%

·         Single ED – 5%

·         All EDs in aggregate – 10%

·         All NEDs in aggregate – 1%/ 3% (if no NEDs)

 

 Approval of members by way of shareholders’ resolution required if –

·         Commission to single NED > 50% of total commission payable to NEDs

·         Annual remuneration to each ED > Rs. 5 crores or 2.5% of net profits – HIGHER

·         Aggregate remuneration to all EDs > 5% of net profits
Performance evaluation of IDs NA criteria of evaluation to be formulated by NRC to be done by entire board
Maximum no. of directorships in 20 companies (out of which max 10 can be public cos.) in 20 companies (out of which max 10 can be public cos.) Not more than 8 directorships in listed entities (excludes debt listed entities)

Not more than 7 directorships in listed entities as ID (excludes debt listed entities)
Composition of Audit Committee (AC) NA  

●      Min 3- directors

●      Majority of IDs

●      Majority of members (inl. chairperson) shall be a person with ability to read and understand financial statements.

 ●      Min- 3 directors

●      At least 2/3rd of (ID)

●      All members to be financially literate and at least 1 member shall have accounting or related financial management expertise.)

●      Chairman – shall be ID

●      CS – Secretary of Committee.
Meetings and quorum of AC – Not Specified. ●      At Least 4 times in a year and  (with a max gap of 120 days between two subsequent meetings)

●      Quorum – 2 or 1/3rd of the members, whichever is greater, with at least 2 IDs.

 
Composition of Nomination and Remuneration Committee (NRC) NA ●      Min- 3 NEDs

●      At least not less than half directors shall be ID.

●      Chairperson of the entity, Executive or not, may be member of committee but not the CM of Committee

 similar requirements except that CM must be an ID
Meetings and quorum of NRC – Not Specified. ●      Quorum – 2 members or 1/3rd of the members, whichever is greater, with at least 1 ID.

●       At least one meeting in a year.

 
Composition of Stakeholders Relationship Committee (SRC) Applicability- Company which consists of >1000 shareholders, debenture-holders, deposit-holders and any other security holders at any time during a FY.

●      CP- shall be a NED.

●      Members as decided by board.

 ●      CP- shall be a NED.

●      Min- 3 directors, with at least 1 being ID.

 
Meetings of SRC Not Specified. ●      Committee shall at least meet once a year.
Composition of Risk Management Committee (RMC) NA NA  

●      Min- 3 directors, with majority of them being members of BOD, including at least 1 ID

●      Chairperson- Member of BOD and Sr. executives may be members.

 
Meetings and quorum of RMC – ●      Quorum – 2 members or 1/3rd of the members, whichever is higher, incl.  at least one member of BOD in attendance.

●      Committee shall meet at least twice in a year(w.e.f 5.5.2021)
Related Party Transactions (RPT) In case of private company –  second proviso to Sub-section (1) of Section 188  shall not apply. ●      Approval required only for specified transactions under Sec 188

●      All members of AC can vote

 ●      All RPTs shall require prior approval of the AC.

●      Only those members who are IDs shall approve RPT
Secretarial Audit Applicability- O/S loans or borrowings from banks or public financial institutions of 100 crore or more. Applicability-

PUSC- 50 cr or more, or

Turnover- 250 cr or more

O/S loans or borrowings from banks or public financial institutions of 100 crore or more.

 

Note- Material Unlisted company of a listed entity is also covered.

 Every listed entity and its material unlisted subsidiaries incorporated in India shall undertake secretarial  audit.

 

Every listed entity shall submit a secretarial compliance report within 60 days of the end of FY.

Analysis of the amendments

As demonstrated in the table above, the compliances that will be made applicable to an HVD entity are much more diverse than that applicable to a private company/ unlisted public company. However, these debt listed entities are mostly non-banking financial companies (NBFCs), on which the corporate governance directions of RBI are applicable. Considering the same, the amendments may not result in wide impact and changes in the existing board and committee structure. Only minor modifications may be required to align the composition in such a way that it meets the criteria of both RBI (under Corporate Governance Directions) and SEBI (under Listing Regulations).

Maximum number of committees’ memberships – an anomaly in the language of law?

Reg 26 of the Listing Regulations specifies the maximum no. of committees in which a director can hold membership/chairmanship. It provides that a director cannot be a member in more than 10 committees and Chairman in more than 5 committees at any one time. In regard with the same, certain classes of companies are specifically included/ excluded as below –

Here, while the public companies are specifically included in one hand, HVDs have been excluded which can be public as well as private companies. Therefore, there arises an anomaly as to whether public companies, being HVDs, are exempted while calculating the number of committees, or whether the same has to be included?

A possible interpretation that may follow is that a company, only on account of being a HVD, will not get included for the purpose of counting committee memberships under this Regulations. However, a public company, being specifically included irrespective of being listed or not, committee memberships of such public companies should also be taken into account which are listed as HVD entities.

Board-level compliances

 

Increased compliance burden on debt listed entities

Besides the corporate governance provisions that have newly become applicable on the HVD entities, the regular compliances of the debt listed entities have also undergone vivid changes mostly in line with the requirements applicable to a listed entity having its equity shares listed in stock exchange. The compliance requirements are two fold – (i) increasing the disclosures required to be made to the stock exchanges and (ii) increasing the frequency of such reporting/ disclosures (shifting half yearly compliances into quarterly etc). The Amendment Regulations also provide clarity with regard to the time within which disclosures are required to be made. General terms have been replaced with more specific matters and timelines.

Quarterly compliances

Requirement with respect to financial results*

In the erstwhile Reg 52, the debt listed entities had an option to submit unaudited financial results followed by annual audited financial results once approved by the Board. However, vide the Amendment Regulations, it has been mandatory for the debt listed entities to submit audited financial results within 60 days from the end of the financial year. Some additional accounting ratios have also been specified to be disclosed by the companies. Further, the asset cover is also required to be disclosed along with the results.

A clarificatory change is with regard to the exemption of providing information related to debt service coverage ratio and interest service coverage ratio by Housing Finance Company (HFC) along with NBFC.

Half-yearly compliances

Website disclosures

Any change in the information has to be updated within two days. The stock exchange intimations are required to be kept in the website for a period of 5 years and archived thereafter.

Stock exchange intimations

Matters concerning the debenture holders are also required to be intimated to the debenture trustee simultaneously with intimation to the stock exchanges.

Material modifications in structure of NCS

Reg 59 deals with the approvals required for any material modifications to be made in the structure of NCS. The three step process requires –

  1. Approval of board and debenture- trustee
  2. Approval of debenture-holders
  3. Approval of stock exchanges

In the erstwhile Regulations, the consent of a requisite majority of securities holders was required to be taken before applying to the stock exchange for its approval. However, in the Amendment Regulations, the written consent of atleast 3/4th (by value)of the securities holders is required to be taken, before proceeding with any material modification in the structure of NCS. The company is further required to provide e-voting facilities in respect of the same.

Our comments –  Requirement of consent of 3/4th by value is in line with the requirements for variation of rights under Section 48 of the Act, which applies to variation in rights of shareholders. However, the same may not be practically possible in case of debenture holders, who may not care to vote at all. Moreover, considering that the debenture trustee is already approving the modification, adequate protection to debenture holders are already ensured.  Further, what is material modification is not a defined term and left to the discretion and judgement.

Concluding Remarks

The status of debt listed companies had undergone a change with effect from 1st April, 2021 after an amendment in the definition of listed companies under the Companies Act, 2013, vide which the debt listed companies were no more considered as a ‘listed’ company for the purposes of the Companies Act, 2013. This might have led to loose ends in the corporate governance of such debt listed companies. SEBI’s move of enforcing corporate governance provisions on HVD entities can be seen as a measure to refill the gaps. However, the corporate governance provisions under the Listing Regulations are quite stringent and will make it tougher for the private companies to get their debt securities listed. While there is a minimum outstanding listed debt threshold to determine applicability of such corporate governance provisions, however, the limits are very minimal from the viewpoint of companies and will take a huge chunk of debt listed companies under its ambit.

 

Our other resources on related topics –

  1. https://vinodkothari.com/2021/09/high-value-debt-listed-entities-under-full-scale-corporate-governance-requirements/
  2. https://vinodkothari.com/2021/09/presentation-on-lodr-fifth-amendment-regulations-2021/
  3. https://vinodkothari.com/2021/09/debt-listed-entities-under-new-requirement-of-quarterly-financial-results/
  4. https://vinodkothari.com/2021/09/full-scale-corporate-governance-extended-to-debt-listed-companies/

 

Understanding the unification of SEBI’s share-based employee incentive schemes

/0 Comments/in , /by

– Highlights of the SEBI SBEB and Sweat Equity Regulations

– Corplaw Division, corplaw@vinodkothari.com

In order to consolidate SEBI (Share Based Employee Benefits) Regulations, 2014 (‘SBEB Regulations’) and SEBI (Issue of Sweat Equity) Regulations, 2002 (‘Sweat Equity Regulations’), SEBI had issued a discussion paper on July 8, 2021. The changes proposed in this discussion paper as well as incorporation of the previously issued SEBI Circulars in the context of SBEB Regulations have now been imbibed under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (‘New Regulations’) which are effective from August 13, 2021. The same aims at rationalization of the erstwhile provisions in order to make them more vigorous with best global practices and ease of doing business.

In this article, we have discussed the major highlights and actionable rolling out of the said New Regulations.

 

1. Enabling definition of employees

  1. Following the intent stated in the discussion paper issued in this regard, the New Regulations give a free hand to a company coming up with a share-based employee benefit scheme (SBEB Scheme). That is to say that as per the language used under the New Regulations under regulation 2(1)(i), the company can choose which employees can be included under any SBEB Scheme. Accordingly, from the date of enforcement of the said provisions, permanent as well contractual employees may be considered for the purpose of granting SBEB. Further, this change is applicable in reference to issuance of sweat equity shares as well.
  2. Furthermore, an employee, whether permanent or not, must be exclusively working for the company or its group companies. The word ‘exclusive’ is added by the New Regulations for ensuring that even though a non-permanent employee is also eligible for SBEB but he must be working on an exclusive basis either in India or outside. This exclusive working criteria is only applicable for SBEB and not for issuance of sweat equity.
  3. Also, as a matter of clarificatory change, the New Regulations specifically state that an NED is also included within the ambit of the term ‘employee’ who is not a promoter or a member of the promoter group. It is pertinent to note that the concerned provision was already present in the erstwhile SBEB Regulations [regulation 2(1)(f)(ii)]; however, an explicit provision in this connection has been made for the sake of avoiding any ambiguity or difference of interpretation.
  4. Lastly, the New Regulations have increased the ambit of the term ‘employee’ under regulation 2(1)(iii) in the context of by stipulating that an employee or director of a group company including holding, subsidiary or associate group shall also be eligible to be included under the purview of the term ‘employee’. Under the erstwhile SBEB Regulations [regulation 2(1)(f)(iii), only an employee or director of a holding or subsidiary company was included under the criteria.

 

The whys and wherefores: The new Regulations have increased the arena of the term ‘employee’ in order to provide flexibility to the companies so that they can cover more employees under the schemes offered for their benefit. Further, the New Regulations have permitted the designated employees of group companies to be qualified for the purpose of SBEB schemes.  

 

2. Cash-settled SARs fall outside the purview of the New Regulations

Explanation 2 as added under regulation 2(1)(qq) of the New Regulations explicitly state that any reference to stock appreciation right or SAR shall mean equity settled SARs and will not include any scheme which does not, directly or indirectly, involve dealing in or subscribing to or purchasing securities of the company. This gives an indication that any scheme which is settled only in cash and not involves equity will fall  outside the purview of the New Regulations.

As clearly specified under the New Regulations, the provisions shall be applicable in case of an equity settled SARs scheme as well as a scheme wherein the company has not stated upfront whether the same would be settled in cash or equity. However, in case of a scheme which is to be settled in cash only, the same has been seemingly made to fall outside the purview of the New Regulations.

The whys and wherefores: The rationale behind the present change is to make the provision related to SAR in line with the applicability criteria for an employee benefit scheme as covered under both the erstwhile SBEB Regulations and the New Regulations under regulation 1(4)(ii) which states that for application, a scheme should be for direct or indirect benefit of employees and involves dealing in or subscribing to or purchasing securities of the company directly or indirectly, Therefore, it is now cleared that cash settled SAR will not be governed by the New Regulations.

3.Applicability to equity listed companies

Regulation 1(4) of the New Regulations explicitly states that the provisions of the concerned regulations shall apply to any company whose equity shares are listed on a recognised stock exchange in India. The word ‘equity’ is specifically added by the New Regulation while in the erstwhile SBEB Regulations, the reference was made with respect to a company whose shares are listed on a recognised stock exchange [Regulation 1(4)].

The whys and wherefores: This change is put forth only for the purpose of clearing the language of the concerned provision although the intention was clear under the erstwhile SBEB Regulations as well.

4. NRC may act as Compensation Committee

As per the recommendations proposed in the consultation paper of the Expert Group, the New Regulations have enabled the NRC to act as compensation committee for the purpose of these regulations. The reference to Regulation 19 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR Regulations’) has been provided under the New Regulations under regulation 5(2).

The whys and wherefores: The Expert group asserted that a listed company already constitutes NRC as per the mandate and therefore, it could perform all the functions as are endowed on a compensation committee.

5. Switching of route of administration: Trust v/s Direct

Second proviso as added to Regulation 3(1) of the New Regulations stipulates that a company is allowed to change the mode of implementation of the scheme if the following conditions are satisfied:

  • Prevailing circumstances should warrant such change.
  • Fresh approval from shareholders via special resolution is obtained before affecting such change.
  • Such change should not be prejudicial to the interest of the employees.

The whys and wherefores: This can be inferred as one of the most liberating changes introduced by the New Regulations. A company can now flexibly switch the administration of a SBEB scheme i.e. from direct route to trust or vice versa. This move will eliminate the difficulty being faced by the companies in deciding upfront whether a scheme is to be implemented through a trust or otherwise.

In order to avail the benefit of the amendment, the company will be required to state the circumstances warranting the change. As the trust can be used as a good device to fund the acquisition of the company’s own shares at an opportune price, thereby minimising the cost to the company, the same may constitute as a reason warranting the change in route of implementation.

6.Varying terms of scheme due to regulatory changes

A company is allowed to vary the terms of the scheme offered subject to shareholders approval via special resolution and ensuring that the intended variation is not in any way prejudicial to the employees. However, under the erstwhile SBEB Regulations, companies were dubious with respect to the applicability of the shareholder’s approval via special resolution for varying the terms of the scheme for the purpose of meeting any regulatory requirement. This issue was mainly on account of the language used which lacked clarity on the concerned subject. Therefore, in order to bring clarity, the New Regulations have amended the provision with respect to varying the terms of the scheme on account of any regulatory requirement which was earlier made part of the restrictive sub-regulation under the erstwhile SBEB Regulations [Regulation 7(1)]. Hence, any variation in the terms of the scheme on account of any regulatory requirement which is restrictive in nature and without changing which the scheme becomes inoperative can be made without shareholder’s approval.

The why and wherefores: Since regulatory changes, the periodicity of which is unpredictable, are not in the control of a company therefore, any SBEB scheme which warrants variation to be made on account of regulatory changes should be allowed to be undertaken by the company without any pre condition as to obtaining shareholder’s approval.

7. Repricing now only with help of a special resolution

Under the erstwhile provisions [Regulation 7(5)], re-pricing of options/SARs/shares required passing of an ordinary resolution. However, Regulation 7(5) of the New Regulations mandate for a special resolution to be obtained.

Any compliance which is being made pursuant to the amendment should abide by the same, however, acts of the past need not be re-done therefore, any options/SARs/shares which were repriced basis shareholders’ approval via ordinary resolution prior to the advent of the New Regulations, will not be affected with the new compliance requirement.

The whys and wherefores: Repricing decision, especially in the situation when the market is not doing good, can affect the wealth of the shareholders on account of the increased financial burden that a company would have to bear pursuant to heavy discounting in order to make the scheme attractive.

8. Determining total ceiling for secondary acquisition

Explanation 1 to Regulation 3(11) of the New Regulations stipulates that the reduction of share capital by virtue of a buy-back or scheme of arrangement, etc. should also be factored in the calculation of limits of shareholding of trusts under secondary acquisition.

The whys and wherefores: The erstwhile SBEB Regulations [Explanation 1 to regulation 3(11)] prescribed that where there is expansion of capital on account of corporate actions including issue of bonus shares, split or rights issue then such expansion shall be taken into account while reckoning the limits of shareholding of trusts under secondary acquisition. However, the Expert Group was of the view that similar to situations such as bonus issues, where the paid-up share capital (and accordingly the shareholding of the trust) of the company increases proportionately, the reduction of capital may also take place due to corporate actions such as buy-backs. Therefore, taking into account only expansion would not be feasible. When capital is reduced, the shareholding of the trust should also react accordingly and hence the present change is introduced.

9. Transfer of surplus on winding up of scheme

Regulation 8 of the New Regulations stipulates that the surplus money or shares remaining on winding up of the scheme, may be transferred to other existing schemes under the regulations, subject to approval obtained by shareholders on the recommendation of the compensation committee.

The whys and wherefores: The rationale behind the same is that the assets of the trust are acquired and earmarked for the benefit of the employees of the company, therefore, if any surplus remains with the trust upon winding up, an option has been provided for deferring the utilisation of such funds or using it for the benefit of employees through a different scheme under the regulations.

10. Certification by secretarial auditor

Annual Compliance Certificate

Regulation 13 of the New Regulations expressly envisages that board of directors are required to obtain compliance certificate on annual basis from secretarial auditors of the company. The words ‘secretarial auditors’ have been added in order to clear the ambiguity created by the erstwhile SBEB Regulations [regulation 13] where the only word mentioned was ‘auditors’. As a matter of practice, companies used to obtain the certificate from their statutory auditors.

Compliance certificate certifying administration and implementation of General Employee Benefit Scheme (‘GEBS’) as per the prescribed regulation

Further, Regulation 26(2) of the New Regulation dealing with administration and implementation of GEBS stipulates that  “the shares of the company or shares of its listed holding company shall not exceed ten per cent of the book value or market value or fair value of the total assets of the scheme, whichever is lower, as appearing in its latest balance sheet (whether audited or limited reviewed) for the purposes of GEBS”. As per the New Regulations, the threshold should be considered as on the date of balance sheet since the erstwhile approach of reckoning threshold not to exceed “at any point of time” was practically not feasible on account of fluctuating share prices.  Furthermore, a compliance certificate from the secretarial auditor in this regard at the time of adoption of such a balance sheet by the company is also introduced as a mandatory requirement.

Compliance certificate certifying administration and implementation of Retirement Benefit Scheme (‘RBS’) as per the prescribed regulation

Also, Regulation 27(3) of the New Regulation dealing with administration and implementation of RBS stipulates that “the shares of the company or shares of its listed holding company shall not exceed ten per cent of the book value or market value or fair value of the total assets of the scheme, whichever is lower, as appearing in its latest balance sheet (whether audited or limited reviewed) for the purposes of RBS”. Alike GEBS, similar change is introduced by the New Regulations under the RBS provision as well with the same intention challenging the erstwhile approach of reckoning. And again alike GEBS, a compliance certificate from the secretarial auditor to this effect is introduced as a mandatory requirement under RBS as well.

The whys and wherefores: As per the usual practice, it was statutory auditors who were issuing this compliance certificate however, it was perceived by the Expert Group, constituted by SEBI for recommendations with on the New Regulations, that the secretarial auditor was more conversant with these laws compared to other categories of persons, and it is the secretarial auditor that is required under Regulation 24A of the LODR Regulations, to furnish a secretarial audit report on an annual basis therefore, it would be more feasible if the concerned compliance certificate is issued by secretarial auditor and accordingly, the concerned change is introduced. Further, introduction of secretarial auditor certificate certifying compliance w.r.t implementation and administration of GEBS or RBS is to ensure due compliance under the New Regulations.

11.Extension of time period for appropriation of shares

Under regulation 3(12) of the New Regulations, the period of appropriation of shares acquired through secondary market acquisition, not backed by grants, has been extended from the current time period of 1 year to a period of 2 years, subject to the approval of the compensation committee.

The whys and wherefores: The idea behind the present change is to provide flexibility from the rigid time period. However, this may allow companies to use the provision for appropriation to support their own share prices by purchasing the same without any intention to make grants.

12. In-principle approval prior to grant of options

Regulation 12(3) of the New Regulations explicitly stipulates that for listing of shares issued pursuant to ESOS, ESPS or SAR, the company shall obtain the in-principle approval of the recognized stock exchanges where it proposes to list the said shares prior to the grant of options or SARs.

The why or wherefores: The words ‘prior to the grant of options or SARs’ are added in the New Regulations primarily to address the issue arising on account obtaining in-principle approval after grant and exercise. It was asserted by the Expert Group that this practice might cause delay in allotment because of non-receipt of such approval as the regulator may determine that the listed entities are non-compliant or the scheme is not in accordance with SBEB Regulations.

13. Role of compensation committee w.r.t. buy-back of options

Part B to the Schedule-I of the New Regulations provides that the compensation committee shall prescribe the procedure for buy back of securities issued under SBEB scheme.

The whys and wherefores: Buy back of stock options have been mentioned under the Companies Act, 2013 as well as the SEBI Buyback Regulations, however, there is no standard procedure to implement the same. Before we first understand what is the amendment, we need to know the concept of buy back of stock options.

A situation for buyback of stock option is likely to occur when the option holder is not willing to exercise the said option for reasons like, fall in share prices leading to the exercise becoming unattractive, lack of funds in the hands of the option holder etc. Under such a situation, if the company wants to pay cash to the option holder instead of the shares, the same can be done by buying back the options held by the option holders. The Expert Group in the Consultation Paper has also mentioned about a situation where due to a regulatory requirement; issuance of shares is not possible and consequent to which the company decides to pay cash instead of issuing shares. While a practical case under the situation stated by the Expert Group may not be ascertained as of now, however, it has been thought of a probable situation for carrying out buy back of options. Further, buy back of options is likely to happen for those which have been vested.

The Expert Group was of the view that flexibility in formulating requisite terms and conditions and procedure for buy back of options would be more meaningful rather than setting out a framework requiring all listed companies to follow a standard procedure in this regard. The requirement for setting out the terms and conditions of schemes to be formulated by the compensation committee was provided under the circular issued previously in this regard. However, the same did not include an express provision relating to procedure and terms and conditions for buy-back including permissible sources for financing the buy-back, minimum financial threshold to be maintained, quantum of securities to be bought back etc.

14. Consolidation of SEBI Circulars

SEBI Circular dated July 15, 2021, provided for immediate vesting of options, SAR or any other benefits in the event of death of an employee. In the said circumstance the requirement of minimum vesting period of 1 year has been done away with. The same has been prescribed under regulation 9(4) of the New Regulations, which stipulates that the options shall vest immediately from the date of death in the legal heirs or nominees of the deceased employee, thus doing away with the minimum vesting requirement.

Further, various disclosure requirements had been prescribed under SEBI Circular dated June 16, 2015, relating to contents of the trust deed, terms and conditions to be formulated by the compensation committee, matters to be stated in the explanatory statement, disclosure to stock exchanges and by the board of directors, etc. The said disclosures have been incorporated under the New Regulations as part C to the Schedule-I with certain additional disclosures like period of lock-in and terms & conditions for buyback, if any, of specified securities covered under these regulations.

 

15.Vesting of benefits on retirement or superannuation

Explanation as added to the Regulation 9(6) under the New Regulations stipulates that where employment is ceased due to retirement or superannuation then options, SAR or any other benefits granted to an employee would continue to vest in accordance with their respective vesting schedules even after retirement or superannuation in accordance with company policies and applicable law.

The whys and wherefores: Regulation 9(6) of the erstwhile SBEB Regulations stipulated that in case of cessation of employment on account of resignation or termination, benefits which are granted and not vested as on that day shall expire. However, there was a confusion as to the applicability of the concerned provision in case of cessation due to other reasons. In order to bring clarity, the Expert Group recommended that cessation of employment on account of retirement or superannuation should be left out of the ambit of regulation 9(6). In order to provide leniency in special circumstances, it is now explicitly inculcated in the New Regulations that the options, SAR or any benefits granted to an employee and not yet vested would not expire on cessation of employment due to retirement or superannuation and the same will continue to vest in accordance with the vesting schedule.

16. Cashless Exercise

The New Regulations, like the erstwhile SBEB Regulations, do not specifically define the term ‘cashless exercise’ however, have prescribed certain transactions which shall be covered under the ambit of cashless exercise. Regulation 3(15)(a) of the New Regulations stipulate that following is the process pursuant to which cashless exercise may be undertaken:

  1. to enable the employee to fund the payment of the exercise price,
  2. To enable the employee to fund the payment of the amount necessary to meet his/her tax obligations and other related expenses pursuant to exercise of options granted under the ESOS.

The whys and wherefores: Since the term ‘cashless exercise’ was not defined under the erstwhile SBEB Regulations, the Expert Group was of the view that a clarity w.r.t the ambit of transactions that would be covered under the concerned term would be helpful and accordingly, the present change is introduced.

17. Changes pertaining to provisions of sweat equity shares

The New Regulations have combined the SBEB Regulations with the SEBI (Issue of Sweat Equity) Regulations, 2002. Under the New Regulations, there are certain changes introduced with respect to the provisions relating to sweat equity shares.

  1. Purpose of issuance of sweat equity shares: The purpose of issuance of sweat equity shares was not previously specified under the erstwhile regulations. Regulation 30 of the New Regulations provides for permitted purpose/objective for issuance of sweat equity shares which are in accordance with the current provisions of the Companies (Share Capital and Debentures) Rules, 2014.
  2. Maximum quantum of shares: Vide a newly inserted provision, the New Regulations under regulation 31 have prescribed for a maximum limit on the quantum of sweat equity shares that may be issued by a listed company. The regulations have prescribed a cap of 15% of the existing paid up capital on the issuance done in a year and further state that the total quantum of sweat equity shares issued by a company shall not exceed 25% of the paid up equity capital at any time. This is in line with the Companies (Share Capital and Debentures) Rules, 2014.

Further, the New Regulations provide for relaxation with respect to quantum of sweat equity to be issued by companies which are listed on Innovators Growth Platform i.e the overall limit of 50% of the paid-up equity share capital of the company at any time upto 10 (ten) years from the date of its incorporation or registration.

  1. Lock-in requirement: Regulation 38 of the New Regulations has made the lock-in period for equity shares issued under sweat equity consistent with the lock-in period prescribed in relation to preferential issue under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’). The rationale for the change is to make sweat equity shares more attractive, by doing away with the lock-in period of 3 (three) years under the erstwhile regulations.
  2. Pricing: The erstwhile provisions prescribed for a specific mechanism for determination of price of sweat equity shares, which stated the higher amount of the average of weekly high and low prices of the period as specified was to be considered. However, the pricing mechanism of sweat equity shares has now been aligned with the provisions relating to preferential issues under ICDR Regulations by the New Regulations via Regulation 33.

The whys and wherefores: The new Regulations have now provided clarity that companies may issue sweat equity shares only for the prescribed purposes. Further, by specifying the quantum of sweat equity shares that can be issued, the New Regulations have inculcated a clarity and increased the scope of compliance.

18. Definition of “Promoter Group Company” and its impact throughout the Regulations

The erstwhile SBEB Regulations [regulation 2(1)(v)] while referring to the definition of promoter group under the ICDR Regulations, stated that in case the promoter or promoter group is a body corporate, the promoters of such body corporates shall also fall under the ambit of the definition. Regulation 2(1)(dd) of the New Regulations has omitted the said proviso, thus making it in line with the definition as stated under ICDR Regulations.

Recommendations that couldn’t form part of the New Regulations

There were certain recommendations of the Expert group that were discussed, however, the same were not made part of the New Regulations since majority of them did not stand the test of necessity for inclusion. These include:

  1. Inclusion of trust shareholding under the ambit of public shareholding.
  2. Explicit recognition of employee stock options under managerial remuneration under the New Regulations.
  3. Relaxation of compliances for trust under SEBI (Prohibition of Insider Trading) Regulations, 2015.
  4. Approval of stock exchange for acquisition by trust via secondary acquisition.
  5. Delegation of responsibilities by compensation committee pertaining to approval of schemes and other matters.
  6. Specification of pricing guidelines or disclosure requirements for determination of exercise price.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FAQs on recent amendments under the Listing Regulations

/0 Comments/in , , /by
Loader Loading…
EAD Logo Taking too long?

Reload Reload document
| Open Open in new tab

Download as PDF [768.95 KB]

Other write-ups on the subject matter:

1.Recent amendments relating to independent directors

2.SEBI notifies substantial amendments in Listing Regulations

3.New year brings stricter norms for appointment of IDs

4. LODR changes on Independent Directors – Things to do before 1st Jan., 2022

Dividend restrictions on NBFCs

/1 Comment/in /by
– Financial Services Division (finserv@vinodkothari.com)

Background

The Reserve Bank of India (RBI) vide a notification dated 24th June, 2021[1] imposed restrictions on distribution of dividends by non-banking financial companies (‘Notification’). The restrictions cover both systemically important NBFCs as well non-systemically important ones. The guidelines have been issued in line with the draft guidelines for the declaration of dividends by NBFC issued in December 2020. Restrictions on dividend payout essentially force financial sector entities to plough back a minimal part of their profits, and therefore, result in creation of a profit conservation. Such restrictions are common in case of financial institutions world-over, and are also imbibed as a part of Basel III capital adequacy requirements. Similar restrictions exist in case of banking entities[2]. In case of NBFCs, such restrictions were proposed by the RBI vide Draft Circular on Declaration of Dividend by NBFCs dated December 9, 2020[3]. Dividend Payout Ratio (DP Ratio) is an important policy measure for companies for shareholder wealth maximisation. A conservative dividend distribution policy ensures churning of profits thereby ensuring organic growth of the net worth, and assisted by leverage, a return on shareholders’ funds higher than what the shareholders can fetch on distributed money. On the other hand, aggressive dividend distribution policy entails that profits be returned to the shareholders as there are less business investment opportunities, thus wealth of shareholders be returned. The foregoing arguments does not encompass stictict dividend payout criteria, but a broad policy objective which organisations seek to achieve. However, in the case of financial institutions like Banks and NBFCs  the motivation of regulators to limit the dividend payout is from the perspective of prudential regulation. The limit on dividend distribution allows regulators to ensure that adequate capital conservation buffers are maintained at all times by the financial institutions. Most NBFCs follow very conservative dividend policies, and based on publicly available data, the DP Ratios of some of the NBFCs for FY 2019-20 are as follows:
  1. Manappuram- 18.86%
  2. Cholamandalam- 12.78%
  3. Bajaj Finserv- 11.93%
  4. Muthoot Finance- 19.91%
  5. Tata Capital Financial Services- 32.96%
  6. DCM Shriram- 17.19%

Applicability

Who all are covered? The opening statement of the Notification provides that the Notification is applicable on all NBFCs regulated by RBI. Further, reference is made to the term ‘Applicable NBFCs’  as defined under the respective RBI Master Directions on NBFC-ND-SI and NBFC-ND-NSI. The concept of Applicable NBFC is relevant to determine the applicability of the provisions of the aforesaid RBI Master Directions. Accordingly, it can be understood that, along with the ‘Applicable NBFCs’, the following categories of NBFCs shall be covered under the ambit of the Notification-
  1. Housing Finance Companies (HFCs),
  2. Core Investment Companies (CICs),
  3. Government NBFCs,
  4. Mortgage Guarantee Companies,
  5. Standalone Primary Dealers (SPDs),
  6. NBFC-Peer to Peer Lending Platform (NBFC-P2P)
  7. NBFC- Account Aggregator (NBFC-AA).
  8. NBFC-D (deposit taking NBFCs)
  9. NBFCs-ND (non-deposit taking NBFCs) (both SI and NSI)
  10. NBFC-Factor (both SI and NSI)
  11. NBFC-MFI (both SI and NSI)
  12. NBFC-IFC (both SI and NSI)
  13. IDF-NBFC
However, it is to be noted that For NBFCs that do not accept public funds and do not have any customer interface no limit has been imposed with regards to the dividend payout ratio. Effective from which financial year? Effective for declaration of dividend from the profits of the financial year ending March 31, 2022 and onwards. Which all dividends are covered? Proposed dividend shall include both dividend on equity shares and compulsorily convertible preference shares. However, other than CCPS, dividends declared on preference shares are not included under the Notification. Note that the issue of bonus shares is, in essence, capitalisation of profits, and therefore, is not affected by the present requirement.

Computation of dividend payout ratio:

Besides the upfront conditionalities such as capital adequacy ratio, leverage ratio, etc., the stance of the present Notification is limitation on dividend payout ratio. Hence, the meaning of the DP ratio becomes important. The Notification defines the same as : ‘the ratio between the amount of the dividend payable in a year and the net profit as per the audited financial statements for the financial year for which the dividend is proposed.’ As we discussed elsewhere, the word “dividend” shall be restricted to only equity and CCPS dividend. Hence, dividend on redeemable preference shares shall be excluded. Also note that the word “profit for the year” refers to profits after tax. There is no question of adding the brought forward profits of earlier years, whether parked in reserves or retained as surplus in the profit and loss account. In case of companies adopting IndAS, there are always questions on what constitutes distributable profits – whether the gains or losses on fair valuation, taken to P/L are a part of the distributable profits or not. The relevant provisions of the Companies Act, viz., proviso to sec. 123 (1) shall have to be borne in mind.

Eligibility Requirement and Quantum Restrictions

Category Eligibility Requirement Quantum*
NBFCs (including SDPs) meeting prudential requirements ●  Complies with applicable regulatory capital adequacy requirements/leverage restrictions/Adjusted net-worth for each of the last three financial years including the financial year for which the dividend is proposed

○ For SPDs, minimum CRAR of 20% to be maintained for the financial year for which dividend is proposed.

● Net NPA ratio shall be less than 6% in each of the last three years, including as at the close of the financial year for which dividend is proposed to be declared.

○ Calculation of NNPA

● Complies with the provisions of Section 45 IC of the RBI Act/ Section 29 C of the NHB Act, as the case may be, that is to say, has transferred 20% of its net profits to the regulatory reserve fund ● No explicit restrictions placed by the regulator on declaration of dividend		 ●  Type I NBFCs- No limit●  CICs and SPDs- 60% ●  Other NBFCs- 50%
NBFCs (other than SPDs) not meeting prudential requirements ● Complies with the applicable capital adequacy requirements/ leverage restrictions in the financial year for which dividend is proposed to be paid● Has net NPA of less than 4% as at the close of the financial year. 10%
As regards NBFC-ND-NSI, the applicable regulatory capital requirement, as mentioned in Annex I[4] of the Notification,  seems to suggest that if there is a breach of leverage ratio at any time since 2015, the NBFC is disqualified. This however, does not seem to be the intent of the regulator. The meaning of the aforesaid restriction should be that the provision became applicable from 2015; however, it should not be leading to a conclusion that a dividend distribution will ensure that there is no breach of leverage ratio at any time in the history of the said NBFC. We are of the view that each of the ratios (CRAR or Leverage of Adjusted Net worth, as the case may be) need to be observed ideally at the time of distribution (last three FYs including the year for which dividend is declared), and even conservatively, during the year in question. *The Notification has prescribed the same limits on quantum for a certain class of NBFCs, however, the draft guidelines had prescribed the limits based on the CRAR or adjusted net-worth of the NBFCs. (Refer Annex I of draft guidelines)

Reporting Requirements

NBFC-D, NBFC-ND-SIs, HFCs & CICs declaring dividend shall report details of dividend declared during the financial year as per the prescribed format within a fortnight after declaration of dividend to the Regional Office of the RBI/Department of Supervision of NHB, as the case may be. There seems to be a lack of clarity w.r.t. the disclosure requirement for NBFC-MFIs and NBFC-IDFs. Though they are covered under the definition of ‘Applicable NBFCs’ under the RBI Master Directions, however, they are not generally classified as NBFC-ND-SI. Hence, whether the disclosure requirement is applicable to them or not seems to create confusion. In our view, going by prudence, this must be adhered to by such systemically important MFI and IDFs as well. Accordingly, it can be inferred that the disclosure requirements shall not be applicable to following:
  • Mortgage Guarantee Companies,
  • Standalone Primary Dealers (SPDs),
  • NBFC-Peer to Peer Lending Platform (NBFC-P2P)
  • NBFC- Account Aggregator (NBFC-AA).
  • NBFCs-ND-NSIs

Comparison with the dividend regulations on Banks

Criteria Bank NBFCs
Eligibility Only those banks would be eligible to declare dividends who have a CRAR of at least 9% for preceding two completed financial years and the accounting year for which it proposes to declare dividend and Net NPA less than 7% NBFC-ND-NSI with leverage upto 7 times and NBFC-ND-SI with a CRAR of not less than 15% for last three years (including the FY for which dividend is declared) and Net NPA less than 6% in each of the last three years
In case not meeting eligibility In case any bank does not meet the above CRAR norm, but has a CRAR of at least 9% for the accounting year for which it proposes to declare dividend, it would be eligible to declare dividend provided its Net NPA ratio is less than 5% In case any NBFC does not meet the above eligibility criteria for each of the previous three FY, but meets the capital adequacy for the accounting year, for which it proposes to declare dividend and has a Net NPA ratio of less than 4% at the close of the FY, it shall be allowed to declare dividend, subject to a maximum of 10% on the DP ratio.
Quantum Dividend payout ratio shall not exceed 40 % and shall be as per the prescribed matrix CIC’s and SPDs shall ensure the maximum dividend payout ratio does not exceed 60%, while the other NBFCs shall not exceed 50% of the DP ratio. For Type I NBFCs there is no limit.
Reporting All banks declaring dividends should report details of dividend declared during the accounting year as per the proforma furnished by RBI NBFC-Ds, NBFC-ND-SIs, HFCs & CICs declaring dividend should report the details of dividend within a fortnight after declaration of dividend to RBI/NHB, as may be applicable.

Immediate Actionables

NBFCs, who already have a Dividend Distribution Policy in place, may have to amend the policy in line with the Notification. As per SEBI LODR Regulations, top 1000 listed companies are mandatorily required to have a dividend distribution policy.  Further, NBFCs may also have voluntarily adopted a policy. The dividend distribution policy includes the following parameters:
  • the circumstances under which the shareholders may or may not expect dividend;
  • the financial parameters that shall be considered while declaring dividend;
  • internal and external factors that shall be considered for declaration of dividend;
  • policy as to how the retained earnings shall be utilized; and
  • parameters that shall be adopted with regard to various classes of shares
The eligibility requirements and limits on quantum of dividend, as provided in the Notification,  may be additional criterias for such NBFCs to declare dividend. In such a case, the existing dividend distribution policy shall be required to be amended in order to include the additional parameters. It is noteworthy here that, as per regulation 43A of the LODR, if a listed entity proposes to amend its dividend distribution policy, it shall disclose the changes along with the rationale for the same in its annual report and on its website. [1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12118&Mode=0 [2] https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=2240&fn=2&Mode=0 and other associated circulars [3] https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=50777 [4] https://rbidocs.rbi.org.in/rdocs/content/pdfs/NBFCS24062021_A1.pdf Our related write-ups:
FAQs on Dividend Distribution Policy
Our presentation on dividends – https://vinodkothari.com/2021/09/an-overview-of-the-regulatory-framework-of-dividends/ Watch our YouTube video on Restrictions on dividend distribution on NBFCs