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SEBI Issues operational guidelines for security and covenant monitoring using DLT

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–  Covering obligations applicable to issuer only

Burhanuddin Dohadwala, Senior Manager & Kaushal Shah, Executive | corplaw@vinodkothari.com

Introduction:

Securities and Exchange Board of India (‘SEBI’) vide its circulars had outlined the following:

Sr. NoDate of the CircularsParticulars
1SEBI Circular dated November 03, 2020Process of independent due diligence by debenture trustees on assets of an Issuer company for the purpose of creation of security
2SEBI Circular dated November 12, 2020Periodical monitoring of security created and enhanced disclosures on the website by debenture trustees on continuous basis.
3SEBI Circular dated August 13, 2021Specified the manner of recording of charges by Issuers and manner of monitoring by Debenture Trustees, Credit Rating Agencies, etc. and responsibilities thereof.
4SEBI Circular dated March 29, 2022With effect from April 01, 2022, the recording of asset details (and their verification), allotment, listing and payment of interest or redemption is available in the system.
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Enhanced disclosures for RPT approvals under LODR

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SEBI accepts WG proposal for detailed review

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

Introduction

Related Party Transactions (‘RPTs’) involve conflict of interest and may consist of a potential means to transfer funds under the smoke screen of an unrelated party, however, for the benefit of certain related persons. Taking this fact into cognizance, SEBI constituted a Working Group in November 2019 to review the policy structure and gaps pertaining to RPTs in the SEBI (Listing Obligations and Disclosure Requirements) Regulations (‘Listing Regulations’), 2015 vis-à-vis the Indian Accounting Standards and the Companies Act, 2013 (‘Act’).  The Working Group made recommendations on expanding the scope of RPs and RPTs, as well as enhancing disclosures before the audit committee (‘AC’), shareholders, and to the exchanges (‘SEs’).

Consequently, SEBI in its meeting held on 28th September 2021[1] considered and approved the amendments to Listing Regulations in line with the recommendations of WG. The decisions have been implemented vide two separate notifications.

SEBI, vide its notification dated November 9, 2021[2], amended Regulation 23 of the Listing Regulations thereby making significant changes in the definition of Related Parties (‘RPs’), RPTs including the approval mechanism for material RPTs, etc. A detailed analysis of the said amendment can be read here.

However, the provisions with respect to the information to be placed before AC and shareholders for seeking their approval, as well as half-yearly disclosures to stock exchanges were not made part of the aforesaid amendment. These amendments have been introduced vide SEBI circular SEBI/HO/CFD/CMD1/CIR/P/2021/662 dated 22nd November 2021[3] (‘SEBI Circular’).

The Circular broadly provides for the following –

  • Information to be placed before AC;
  • Information to be provided to shareholders for consideration of RPTs; and
  • Format of disclosure of RPTs on a half-yearly basis

The Circular takes effect from 1st April 2022 (while the disclosure is to be triggered in the first half-year of 2022-2023, i.e., for the half-year ended 30th September 2022.)

Various practical implications and considerations arising out of the prescriptions of the Circular are discussed in this write-up.

Applicability

The Circular applies to listed entities which have listed their ‘specified securities’. Pursuant to the SEBI Listing Regulations 5th Amendment, a High Value Debt Listed Entity (‘HVDLEs’) is required to submit the disclosure on RTPs under Reg. 29(3) along with its standalone financial results for each half year.

HVDLEs are those listed entities which have listed its non-convertible debt securities and have an outstanding value of listed non-convertible debt securities of Rs. 500 crore and above as on 31st March 2021.

Thus, from the half-year ended 30th September 2022, HVDLEs are required to submit the disclosure of RPTs in the format prescribed in the SEBI Circular. Our detailed analysis of the amendments w.r.t HVDLEs can be read here.

Information to be provided to Audit Committee

The Act requires ‘relevant information’ to be placed before AC in case of omnibus approvals [refer, rule 6A of Companies (Meetings of Board and its Powers) Rules, 2014 (‘MPB rules’)]; however, relevant information has not been prescribed as such. While one may refer to section 188 read with rule 15 of the MPB rules which prescribes specific information to be placed before the board and shareholders for approval of RPTs. It would be counter-intuitive to say that the information which goes to the board for RPT approval would not go to AC. By obvious interpretation, all such information which rule 15 lists out, ought to be placed before AC as well.

SEBI Circular now specifically provides for minimum information to be placed before AC for consideration/approval of RPTs, including the items as listed below. The quantum of information to be placed before AC under the revised framework is more exhaustive than what is provided in rule 15. Also, while it is the obligation of the listed entity to place these information before AC, as a corollary, it appears equally incumbent on AC to demand such information from the entity.

It may also be important to note (as we discuss below), the notice sent to shareholders for seeking RPT approval shall consist of a “summary of information provided to the audit committee” as well. Hence, all such things which are placed before AC, shall also come before the shareholders, albeit in a summarised form.

Information to be provided to shareholders

The SEBI Circular has specifically listed out the details required to be placed before the Audit Committee and the Shareholders which has far-reaching impact on listed entities. It states that a summary of the information provided by the management of the listed entity to the Audit Committee while the RPT was placed before it for approval, shall also be given to the Shareholders while seeking their approval. The probable outcome of the same can be:

  • Where the Audit Committee seeks very limited information for approval of RPTs
  • Where the Audit Committee over-step into an enquiry state where information that may not be relevant to the transaction be placed before it, giving birth to thoughts of concerns in the mind of Shareholders

Another important change is that while placing information to the Shareholders, a statement that the valuation or other external report, if any, relied upon by the listed entity in relation to the proposed transaction will be made available through the registered email address of the Shareholders instead of making the same available for physical inspection at the registered office of the company which has been the existing practice.

The definition of RP as amended vide SEBI LODR Sixth Amendment Regulations, excluded acceptance of fixed deposits by Banks/NBFCs at the terms uniformly applicable/offered to all shareholders/public from the same, however, such transactions still require disclosure in the format specified by SEBI. This seems to be counter-productive as the intent of the law is to ensure that no transaction intended to benefit the RPs get away from the scrutiny of the Audit Committee and the Shareholders. To the paradox, even such transactions that have been executed 100% at par with public shareholders/customers of the company are also required to be disclosed by every listed company.

Snapshot of details requires to be placed before the AC & Shareholders

Some of the items are briefly discussed below:

  1. Type, material terms and particulars of the proposed transaction – By type, one means the kind of transaction – whether it is a purchase or a sale or a loan, etc. “Material terms” is a common expression meaning all such terms which might affect decision-making. Similar expression appears in rule 15(1)(c) as well.
  2. Source of funds for loans/ICDs, etc. in connection with the proposed transaction (clause 4(f)(i)).
  3. Financial indebtedness incurred (clause 4(f)(ii)) – This would indicate the financial burden which the listed entity/subsidiary might be bearing to enter into RPTs. Most entities will have Bank/Financial Institution borrowings (or even other borrowings) as their liabilities; however, it would be important to establish a ‘direct nexus’ between such borrowings and the proposed transaction. As to what constitutes ‘direct nexus’, is a function of various factors depending upon facts of each case. This aspect is also related to disclosure related to ‘source of funds’.
  4. Justification for RPT to be in interest of the listed entity (clause 4(g)) – This requirement is in consonance with the earlier requirement put forth by SEBI relating to the affirmation to be given by CEO/CFO of the listed entity on a half-yearly basis in Annex IV[4] of the Corporate Governance Report to the SEs.
  5. Ratio of proposed transaction to turnover (clause 4(e) read with clause 4(i))-The percentage of the listed entity’s annual consolidated turnover, for the immediately preceding financial year, is represented by the value of the proposed transaction, which is mandatorily (in case a subsidiary is a party, standalone turnover shall be considered) to be placed for approval.  Further, the listed entity may, on a voluntary basis, provide the percentage of the counter-party’s annual consolidated turnover that is represented by the value of the proposed RPT.
  6. Any other relevant information – This is the residual clause. While it enables the entity to put such other information as may be relevant’ notably, it is also open to AC to seek any other information, which in AC’s view is relevant.

Information to be placed for approval of RPTs under the Act

Information to be placed before Board as per Section 188 read with Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014

  • name of the related party and nature of relationship;
  • the nature, duration of the contract and particulars of the contract or arrangement;
  • the material terms of the contract or arrangement including the value, if any;
  • any advance paid or received for the contract or arrangement, if any;
  • the manner of determining the pricing and other commercial terms, both included as part of contract and not considered as part of the contract;
  • whether all factors relevant to the contract have been considered, if not, the details of factors not considered with the rationale for not considering those factors; and
  • any other information relevant or important for the Board to take a decision on the proposed transaction.

Information to be placed before shareholders as per Section 188 read sub-rule 3 of Rule 15 of the Companies (Meetings of Board and its Powers) Rules, 2014

  • name of the related party;
  • name of the director or key managerial personnel who is related, if any;
  • nature of relationship;
  • nature, material terms, monetary value and particulars of the contract or arrangements;
  • any other information relevant or important for the members to take a decision on the proposed resolution

Though rule 15, as stated above, does not explicitly state the details to be placed before Audit Committee except in case of Omnibus approval of RPTs under rule 6A of MBP Rules , it can be construed that the details to be placed before the Board of directors of the Company for approval of RPTs should be placed before the Audit Committee while seeking prior approval for RPTs by the listed entity.

On a careful analysis of the above, it can be seen that the capital market regulator has made the regulatory framework of RPTs more water-tight as compared to the existing norms under the Act. The listed entities shall now place exhaustive details before the Audit Committee and the Shareholders as compared to the norms for unlisted companies in the country.

New format of disclosure of RPTs under Reg. 23(9) of Listing Regulations

The SEBI Working Group had in its report, provided a format for disclosure of RPTs on a half-yearly basis as specified under Reg. 23(9). So far, the listed entities have been preparing the disclosure as per the IND-AS 24 since the regulator had not specified a format for the disclosure of RPTs.

The SEBI has now prescribed a format for disclosure of RPTs as recommended by the Working Group. The notes to the disclosure format put forward significant questions on how listed companies will ensure compliance w.r.t RPTs.

The note 1 states, opening and closing balances, including commitments, to be disclosed for existing related party transactions even if there is no new related party transaction during the reporting period. This would mean that those transactions which are continuing in nature, even though there were no transactions during the reporting period shall be disclosed, including any commitments. The term ‘commitments’ would mean those arrangements where both the parties agree to perform their obligations under the contract.

In note 3, exemption has been granted to listed banks for disclosures with respect to related party transactions involving loans, inter-corporate deposits, advances or investments. However, the same has not been extended to listed NBFCs. This could lead to additional compliance burden for NBFCs even though they are engaged in the financial activities.

The note 9 states “Transactions such as acceptance of fixed deposits by banks/NBFCs, undertaken with related parties, at the terms uniformly applicable /offered to all shareholders/ public shall also be reported.”

SEBI had excluded acceptance of fixed deposits by Banks/NBFCs at terms uniformly applicable/offered to all shareholders/public from the definition of RPTs but had explicitly stated that such transactions shall be disclosed.

Having said that, one should interpret the said note in such a way that the requirement of disclosure is only for acceptance of deposits by Banks/NBFCs which have been excluded from the definition of RPTs and not any other transaction which have been availed by any related party at par with the general public.

Conclusion

The recent amendments to the Listing Regulations evidences the growing concern over the regulatory framework for RPTs. The definition of RPT has been widened to include a bunch of transactions that have never been in the radar when it comes to RPTs.

SEBI Circular also put forward new challenges for listed entities for ensuring absolute compliance of the revised regulatory framework for RPTs and few of the new requirements may bring concerns for NBFCs to ensure compliance. Furthermore, the disclosure requirements for RPTs under the Listing Regulations have been made more stringent and elaborative to enable enhanced public disclosure of RPTs.

 

[1] https://www.sebi.gov.in/media/press-releases/sep-2021/sebi-board-meeting_52976.html

[2] https://www.sebi.gov.in/legal/regulations/nov-2021/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-sixth-amendment-regulations-2021_53851.html

[3] https://www.sebi.gov.in/legal/regulations/nov-2021/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-sixth-amendment-regulations-2021_53851.html

[4] https://www.sebi.gov.in/legal/circulars/may-2021/format-of-compliance-report-on-corporate-governance-by-listed-entities_50338.html

 

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/

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/