SEBI eases investing norms for NRIs, OCIs, and RIs through FPI route in IFSC
-Surabhi Chura | corplaw@vinodkothari.com
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Open in new tab A policy on policies: Guide to writing corporate policies
finserv@vinodkothari.com | corplaw@vinodkothari.com
Why Policies:
- Policies have become a regulatory necessity in many cases. The Companies Act and Listing regulations require several policies: for example, nomination and remuneration policy, CSR policy, whistle blower policy, policy for determination of material subsidiary etc.
- The RBI’s regulations require policies every now and then – an indicative list of policies needed by NBFCs (for base layer and middle layer) is here
- RBI regulations for banks require an even larger list of policies. An indicative list of policies for banks can be accessed here.
- To conclude: policies are needed for companies in many respects/fields.
What’s the policy behind policies:
Read more →Online workshop on Verification of Market Rumour by listed entities and other related amendments
| Register here |
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Other resources on the amendment:
- YouTube video on aforesaid amendment: https://www.youtube.com/watch?v=-BvHsUtR4TI&feature=youtu.be
- Article on Top companies forced to respond to rumours on big price spikes: Changes in Listing Regulations relate rumour responses to “material price movement”
- Snippet summarizing the amendment: https://lnkd.in/gSJM-YUj
Trust, but verify: AIFs cannot be used as regulatory arbitrage
SEBI mandates ongoing due diligence for investors and investments made by AIFs
-Vinita Nair, Senior Partner and Lavanya Tandon, Executive | corplaw@vinodkothari.com
May 03, 2024 (updated on October 9, 2024)
Background
SEBI had raised concerns relating to evergreening of loans, circumvention of FEMA norms, QIB regulations and other concerns on regulatory arbitrage by Alternative Investment Funds (‘AIFs’) in its Consultation Paper issued in January, 2024. SEBI also recorded 40+ cases wherein the structure of AIF had been abused and used to circumvent extant financial sector regulations. Read our analysis in the article ‘AIFs ail SEBI: Cannot be used for regulatory breach’ dated January 31, 2024. Further, RBI had also barred all regulated entities (REs) with respect to their investments in AIFs, discussed in our article.
Subsequent to receipt of public comments, the proposal to mandate due-diligence (‘DD’) of investors and each of the investments made by the AIF was approved in the SEBI Board meeting held on March 15, 2024. SEBI notified SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2024 effective from April 25, 2024 amending Reg. 20 of the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’) dealing with general obligations thereby requiring every a. AIF, b. investment manager of the AIF, c. KMP of the AIF, and d. KMP of the investment manager, to exercise specific DD with respect to their investors and investments in order to prevent facilitation of circumvention of such laws as may be specified by SEBI from time to time.
The list of laws, thresholds and conditions for DD, reporting requirements etc. has been provided in SEBI circular dated Oct 8, 2024 (‘SEBI Circular’). DD is required to be carried out prior to making of investments as per implementation standards formulated by Standard Setting Forum for AIFs (‘SFA’) and published on websites of the industry associations which are part of the SFA, i.e., Indian Venture and Alternate Capital Association (‘IVCA’), PE VC CFO Association and Trustee Association of India.
Scope of laws covered under the ambit of due diligence
The list of laws provided in the SEBI Circular comprises of the following:
- Provisions of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’), and other regulations of SEBI wherein benefits or relaxations have been provided to entities designated as Qualified Institutional Buyers (‘QIBs’).
- Provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’) wherein benefits are provided to entities designated as Qualified Buyers (‘QBs’).
- Prudential norms specified by RBI for regulated lenders with respect to Income Recognition, Asset Classification, Provisioning and restructuring of stressed assets;
- Rule 6 of FEMA (Non-Debt Instruments) Rules, 2019 (NDI Rules) for investment from countries sharing land border with India ( read with Press Note 3 dated April 17, 2020 of FDI Policy 2020)
Timing, thresholds for DD, reporting requirements
Pursuant to the SEBI Circular, the due diligence for various investors and investments is required to be carried out by a. AIF, b. investment manager of the AIF, c. KMP of the AIF, and d. KMP of the investment manager in accordance with the Implementation Standards. The table below indicates in brief the criteria, checkpoints and timelines for conducting due diligence along with the consequences of the outcome.
| Sr. No | Objective intended to be achieved by investors through investments in AIF scheme | Regulations/ Directions/ Norms applicable | Applicability of requirement of DD for every scheme of AIF (refer Note 1) | Checkpoints for manager for specific DD | Timing of DD | Consequence of outcome of DD & reporting requirements, if any |
|---|---|---|---|---|---|---|
| 1 | Benefits designated for QIBs | ICDR and other SEBI Regulations | If an investor, or investors belonging to the same group, contribute(s)50% or more to the corpus of the scheme. | Manager to check if such if investor/ investors of the same group is/are:(i) QIBs themselves or,(ii) Entities established, owned or controlled by the Central Government or a State Government or the Government of a foreign country, including central banks and sovereign wealth funds.Note: Where such investor is an AIF or fund set up in IFSC or outside India, above check to be carried out on a look through basis. | Prior to availing benefits available to QIBs | Refer Note 2 below for existing investments & Note 3 for proposed investments.Manager to provide confirmation to SE or lead manager or merchant banker on this. |
| 2 | Benefits designated for QBs | Under SARFAESI Act | If an investor, or investors belonging to the same group, contribute(s)50% or more to the corpus of the scheme. | Same as above | Prior to making any investments or availing benefits | Refer Note 2 below for existing investments & Note 3 for proposed investments. |
| 3 | RBI regulated lenders/ entities ever-greening their stressed loans/ assets & circumventing RBI norms | RBI norms on Income Recognition, Asset Classification, Provisioning and Restructuring of stressed loans/ assets | (a)whose manager or sponsor is an entity regulated by RBI; or,(b)that has investor(s)regulated by RBI who:(i)individually or along with investors of the same group contribute(s) 25% or more to the corpus of the scheme; or(ii) is an associate of the manager/ sponsor of the AIF;(iii) has majority or veto power [by itself, or through its representatives/ nominees] in voting over decisions of the investment committee set up by the manager to approve investment decisions of the scheme.Note: where investor is an AIF or fund set up in IFSC or outside India, criteria check to be carried out on a look through basis. | Refer Note 4. | Prior to making any investments, to avoid indirect investment by RBI regulated lender/ entity. | Refer Note 2 below for existing investments & Note 3 for proposed investments. |
| 4 | Investment from countries sharing land border with India | FEMA (NDI) Rules, 2019 | Where 50% or more of the corpus of the scheme is contributed by investors (a)who are citizens of/are from/are situated in a country which shares land border with India; or(b)whose beneficial owners, as determined in terms of Rule 9 (3) of the PMLA (Maintenance of Records) Rules, 2005, are citizens of/are from/are situated in a country which shares a land border with India. | If the proposed investment would result in the scheme holding 10 % or more of equity/equity-linked securities issued by the company (on a fully-diluted basis), the manager to check details stated in the previous column, by collecting information on the country of investors and their beneficial owners. | Prior to making any investment | Refer Note 2 below for existing investments & Note 5 for proposed investments. |
Note 1: same group’ shall mean ‘related parties’ and ‘relatives’ as defined in SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.
Note 2:
For Sr nos 1 to 3: DD requirement is applicable for existing investments too, held by AIF schemes as on October 8, 2024:
- If DD check not satisfactory – details of investment to be reported to AIF’s custodian on or before April 07, 2025, in the format as per Annexure 1 of the circular;
- If DD check satisfactory – AIF manager to submit an undertaking to AIF’s custodian on or before April 07, 2025.
For Sr no. 4: Reporting is required to be made for existing investments held by AIF schemes as on October 8, 2024 if the scheme holds 10% or more of equity/ equity-linked securities on a fully-diluted basis, to AIF’s custodian on or before April 07, 2025 in the format prescribed by SFA.
Note 3:
Consequence of not satisfying requirements of DD checks specified by SFA for proposed investments in case of Sr nos 1 to 3:
- Such investor or investor group to be excluded along with necessary disclosure in the private placement memorandum (PPM); or
- Investment cannot be made.
Note 4:
Note 5: Details of investment, which would result in the scheme holding 10% or more of equity/ equity-linked securities on a fully-diluted basis, to be reported to the custodian within 30 days of investment, in the below format specified by SFA.
DD requirement – one-time or ongoing?
As discussed in the SEBI BM Agenda, the purpose of the due-diligence check is to prevent facilitation of any circumvention of provisions of financial sector regulators, which cannot be a time specific check. An entity who intends to circumvent can design the structure in such a way that, at a later date post investment, it acquires the units of AIFs post investment, such as buying the units of an existing investor or by acquiring control over the existing investor entity, as per prior arrangement. Accordingly, it has been indicated that due diligence around investors and investments will be an ongoing one.
Applicability of DD – prospective or retrospective?
As per the SEBI circular this is applicable for existing and prospective investments. Refer Note 2 above.
Obligations of Custodian to the AIF
- Information received from AIFs under Note 2 to be furnished to SEBI on or before May 7, 2025.
- Information received from AIFs in terms of Note 4 above on a monthly basis to be compiled and reported to SEBI within 10 working days from month end.
Power of AIF to exclude an investor
As per SEBI Circular, in cases where the outcome of DD is not satisfactory, in that case the AIF will either have to exclude the investor or investor group or abstain from making the proposed investment.
Dealing with power to exclude an investor, in April 2023 SEBI had issued ‘Guidelines with respect to excusing or excluding an investor from an investment of AIF that empowered an AIF to excuse its investor from participating in a particular investment in the following circumstances:
Figure 1: Circumstances to excuse an investor of AIF
Conclusion
The present amendment and SEBI Circular lays an onerous burden on the AIF, manager and KMP of the AIF and the manager. The DD requirement has become effective from October 8, 2024 and applies to existing investments as well. The AIFs have an actionable of evaluating the existing investments in the scheme in the light of the present amendment and ensure reporting in next 6 months. The obligation of on-going due diligence will result in a compliance burden, but is justified given the intent of law as “quando aliquid prohibetur ex directo, prohibetur et per obliquum” i.e. things that cannot be done directly should not be done indirectly either. AIFs will continue ‘trust, but verify’ using the DD standards for due diligence. The trustee/ sponsor of the AIF is required to ensure that compliance status of this amendment is reported to SEBI in the ‘Compliance Test Report’ prepared by the manager in terms of Chapter 15 of Master Circular for AIFs.
Our other resources:
Some relief in RBI stance on lenders’ round tripping investments in AIFs
– Team Finserv | finserv@vinodkothari.com
The Reserve Bank of India on 19th December 2023 issued a notification[1] imposing a bar on all regulated entities[2] (REs) with respect to their investments in AIFs. We had covered the same in our earlier write-up. The Circular has already created some bloodshed as several banks took a hit in their Q3 results. Though late, yet welcome, the RBI has now come with some relief by a March 27 2023 circular. The following Highlights are based on the original circular, as amended by the March 27th circular :-
What has the RBI done?
- Prohibited all regulated entities (REs), including banks, cooperative banks, NBFCs and All India Financial Institutions from making investments in Alternative Investment funds (AIFs), if the AIF has made any investment in a “debtor company”, other than by way of equity shares of the debtor company. Hence, if the AIF has made investment by way of bonds, structured capital instruments, etc., issued by a debtor company, the bar as above will apply.
- Debtor company means a company in which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months
- The bar applies immediately, that is, effective 19th Dec 2023. No further investments to be made.
- If investments already exist, the RE shall exit within 30 days, that is, by 18th Jan., 2024. Hindsight clearly shows that for most regulated entities, there was no way to cause exit, as AIF investments are evidently illiquid. Hence, most regulated entities took a hit on their P/L.
- Further, if an RE has made an investment in an AIF, and the AIF invests in a debtor company, the RE shall make an exit within 30 days.
- Investment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ subject to full deduction from RE’s capital funds. See further discussion on priority distribution model below.
What was the intent?
- Since several REs have affiliated AIFs, routing the money through AIFs to borrowers might have led to ever greening. That is, the AIF would invest the money into a debtor company, and consequently, the debtor company would keep its account as a performing asset. In essence, the AIF was acting as a stopover in the process of round tripping of the money back to a debtor company, from where it will be used to pay off the lender.
What will be the impact of the Circular?
- Most of the larger REs have affiliated AIFs. Flow of funds to them from the RE would stop completely.
- The sweep of the circular is wide and non-discriminatory. Not only affiliated AIFs, but any AIF in general will be dried of funding from REs. While the bar is only for those AIFs which have invested in “debtor companies”, it will be practically tough for REs to avoid overlapping investments. Given the severe implications of a breach, compliance-sensitive REs will avoid investing in AIFs.
- There is an immediate disinvestment pressure on AIFs, as there may be overlapped investments. AIFs’ assets are mostly illiquid – ensuring exit to RE investors may be tough. In many cases, there are lock-in restrictions as well.
- Not only has the RBI expressed concerns, SEBI also issued a consultation paper for enhancement of trust in the AIF ecosystem, citing use of AIFs for regulatory arbitrage. See our write up on the SEBI proposals.
Direct or indirect investments:
- As the Circular is driven by concerns of round-tripping, widening the circuit by creating more stop-overs does not help. For example, if a lender invests in an AIF, which invests in an intermediate entity, which in turn invests in a debtor entity, the trail of the money is clear. Likewise, the lender may be making an indirect investment in an AIF.
- However, where there is no round-tripping of the money to a “debtor company”, there should be no concern. For example, if a lender makes a loan to an entity, where an AIF of the group has also made investments, there is no flow of money from the lender to the AIF, for the purpose of the downstream investment by the AIF into the debtor company.
Investments through mutual funds and FOFs exempt:
- The 27th March circular exempts instances where investments are made by lenders into mutual funds or FoFs, and those in turn have some exposure in either an AIF or in a debtor entity.
Priority distribution model or structured AIFs
- In addition to the concerns on downstream investments by AIFs in debtor companies, the RBI also had concerns on the so-called structured AIFs or AIFs with a distribution waterfall. Whether AIFs can at all have a priority distribution waterfall is currently under SEBI examination and SEBI has stopped AIFs from using structured distribution schemes (by way of accepting fresh commitment or making investment in a new investee company) . However, several existing schemes have such models.
- If a lender makes an investment in the subordinated units of a structured AIF scheme such investments will get deducted from the regulatory capital of the lender. The March 27 circular now clarifies that the deduction will be equally from Tier 1 and Tier 2 capital. Further, it also clarifies that the subordinated exposures in the AIF schemes could be in the form of subordinated exposures, including investment in the nature of sponsor units.
Concern areas
- Ideally, the bar should have been limited to affiliated AIFs. Affiliated AIFs could have been defined appropriately – for example, a related party, or where the investment manager, or sponsor is a related party of the RE. Extending the bar to all AIFs is quite far from the intent of the circular – which is, admittedly, to curb evergreening. It is difficult to see how unrelated AIFs can be used by an RE to evergreen, as investment decisions of these AIFs are not exercised by the investors.
- Ideally, the bar should have been limited only to Cat 1 and Cat 2 AIFs. Cat 3 AIFs, widely known as hedge funds, typically play in equity long/short strategies, or do other leveraged trades. REs find such investment a useful way to diversify their funds into hedge funds. Hedge fund investments are common by institutional investors all over the world; an outright curb on these investments by REs is, once again, beyond the stated intent. Notably, given the wide range of investments that Cat 3 AIFs make, avoiding an overlap with the RE’s borrowers will be quite impractical.
- Practical implementation of this circular, if at all a RE invests in an AIF, will be quite tough. AIFs will have to share their potential investment list, which will be against any investment manager’s choice. Assuming there is an overlapped investment, the RE will have to exit within 30 days, which will create liquidity issues for AIFs, in addition to challenging the lock-in restrictions.
- Most of the regulated entities took a provision in the 3rd quarter. The 27th March circular of the RBI gives some relief by saying that the provision will be required only to the extent of the downstream investment in a debtor entity.
In our view, there is a need to review the regulatory mechanism for AIFs, as currently, AIFs are being used as instruments of regulatory arbitrage.
[1] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12572&Mode=0
[2] Commercial Banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks), Primary (Urban) Co-operative Banks/State Co-operative Banks/ Central Co-operative Banks, All-India Financial Institutions, Non-Banking Financial Companies (including Housing Finance Companies)
Other articles related to the topic:
- Trust, but verify: AIFs cannot be used as regulatory arbitrage (updated on October 9, 2024)
- FAQs on Specific Due Diligence of investors & investments of AIF
- RBI bars lenders’ investments in AIFs investing in their borrowers
- AIFs ail SEBI: Cannot be used for regulatory breach
- SEBI’s standard approach, standardising valuation for AIFs
- Comparison between non-deposit accepting NBFC – Investment and Credit Company (NBFC-ND-ICC), Core Investment Company (CIC) and an Alternative Investment Fund (AIF)
- Snippet on credit of existing & issue of new units of AIFs in demat form
- SEBI amends framework for Large Value Funds
SEBI approves uniform approach for market rumour verification, eases on-going compliance requirement for listed companies, eases norms for IPO/ fund raising, AIFs, relaxes requirement for FPI & extends timeline for HVDLE on March 15, 2024
The Promise of Predictability: Regulation and Taxation of Future Flow Securitization
Dayita Kanodia | Executive | finserv@vinodkothari.com
The most reliable way to predict the future is to create it
– Abraham Lincoln
Surely, Lincoln did not have either securitisation or predictability in mind when he wrote this motivational piece; however, there is an interesting and creative use of securitisation methodology, to raise funding based on cashflows which have some degree of predictability. In many businesses, once an initial framework has been created, cashflows trickle over time without much performance over time. These situations become ideal to use securitisation, by pledging this stream of cashflows to raise funding upfront. Surely, traditional methods of on-balance-sheet funding fail here, as there is very little assets on the balance sheet.
Read more →Securing the Beat: Tuning into Music Royalty Securitization
Dayita Kanodia | finserv@vinodkothari.com
“Music can change the world”
–Ludwig van Beethoven
This quote by Beethoven remains relevant today, not only within the music industry but also in the realm of finance. In the continually evolving landscape of finance, innovative strategies emerge to monetize various assets. One such groundbreaking concept gaining traction in recent years is music royalty securitization. This financial mechanism offers investors a unique opportunity to access the lucrative world of music royalties while providing artists and rights holders with upfront capital.
The roots of this innovative financing technique can be traced back to the 1990s when musician David Bowie made history by becoming the first artist to securitize his future earnings through what became known as ‘Bowie Bonds’. This move not only garnered attention but also paved the way for other artists to follow suit. Bowie Bonds marked a significant shift in how music royalties are bought, sold, and traded.
As per the S&P Global Ratings[1], the issuance of securities backed by music royalties totaled nearly $3 billion over the two-year span 2021-22. The graph below shows a recent surge in issuance of securities backed by music royalties.
Data showing the growth of Music Royalty Securitization
This article discusses music royalty securitization, its mechanics, benefits, challenges along with implications for the music industry.
Understanding Music Royalties:
Before exploring music royalty securitization, it’s essential to understand the concept of music royalties. In the music industry, artists and rights holders earn royalties whenever their music is played, streamed, downloaded, or licensed for use. These royalties are generated through various channels, including digital platforms, radio, TV broadcasts, live performances, and synchronization licenses for commercials, movies, and TV shows. However, it’s important to note that artists only earn royalties when their music is utilized, whether through sales, streaming, broadcasting, or live performances.
As a result, the cash flows from these royalties being uncertain are received over time and continue to be received for an extended period. Consequently, artists experience a delay in receiving substantial amounts from these royalties, sometimes waiting for several years before seeing significant income.
The Birth of Music Royalty Securitization:
Securitization involves pooling and repackaging financial assets into securities, which are then sold to investors. The idea is to transform illiquid assets, such as mortgage loans or in our case, music royalties, into tradable securities. Music royalty securitization follows a similar principle, where the future income generated from music royalties is bundled together and sold to investors in the form of bonds or other financial instruments.
Future Flows Securitization:
Music royalty securitization is a constituent of future flows securitization and therefore before discussing the constituent, it is important to discuss the broader concept of future flows securitization.
Future flows securitization involves the securitization of future cash flows derived from specific revenue-generating assets or income streams. These assets can encompass a wide range of future revenue sources, including export receivables, toll revenues, franchise fees, and other contractual payments, even future sales. By bundling these future cash flows into tradable securities, issuers can raise capital upfront, effectively monetizing their future income. Future flows securitization differs from the traditional asset backed securitization by their very nature as while the latter relates to assets that exist, the former relates to assets that are expected to exist. There is a source, a business or infrastructure which already exists and which will have to be worked upon to generate the income. Thus, in future flows securitization the income has not been originated at the time of securitization. The same can be summed up as: In future flow securitization, the asset being transferred by the originator is not an existing claim against existing obligors, but a future claim against future obligors.
Mechanics of Music Royalty Securitization:
Music royalty securitization involves packaging the future income streams generated by music royalties into tradable financial instruments. The process begins with the identification of income-generating assets, which are then bundled into a special purpose vehicle (SPV). The SPV issues securities backed by these assets, which are sold to investors. The revenue generated from the underlying music royalties serves as collateral for the securities, providing investors with a stream of income over a specified period.
The process of music royalty securitization typically involves several key steps:
Asset Identification: Rights holders, such as artists, record labels, or music publishers, identify their future royalty streams eligible for securitization.
Valuation: A valuation is conducted to estimate the present value of the anticipated royalty income streams. Factors such as historical performance, market trends, and artist popularity are taken into account.
Selling the future flows: The future flows from royalties are then sold off to the Special Purpose Vehicle (SPV) to make them bankruptcy remote. The sale entitles the trust to all the revenues that are generated by the assets throughout the term of the transaction, thus protecting against credit risk and sovereign risk as discussed later in this article.
Structuring the Securities: These future cash flows are then structured into securities. This may involve creating different tranches with varying levels of risk and return.
Issuance: The securities are then issued and sold to investors through public offerings or private placements. The proceeds from the sale provide upfront capital to the rights holders.
Revenue Collection and Distribution: The entity responsible for managing the securitized royalties collects the revenue from various sources which is then distributed to the investors according to the terms of the securities.
Importance of Over-collateralization:
Over-collateralization is an important element in music royalty securitization. In music royalty securitization and in all future flows transactions in general, the extent of over-collateralization as compared to asset backed transactions is much higher. The same is to protect the investors against performance risk, that is the risk of not generating sufficient royalty incomes. Over-collateralization becomes even more important since subordination structures generally do not work for future flow securitizations. This is because the rating here will generally be capped at the entity rating of the originator.
Why go for securitization ?
Now the question may arise as to why an artist or a right holder of a royalty has to go for securitization of his music royalties in order to secure funding. Why cant he simply opt for a traditional source of funding ? The answer to this question is two folds:
Firstly, the originator in the present case generally has no collateral to leverage and hardly there will be a lender willing to advance a loan based on assets that are yet to exist.
Secondly even if they are able to obtain funding it will be at a very high cost due to high risk the lender perceives with the lending.
Music royalty securitization, could be his chance to borrow at a lower cost. The cost of borrowing is related to the risks associated with the transaction, that is, the risk the lender takes on the borrower. Now, this risk includes performance risk, that is the risk that the work of the originator does not generate enough cash flows. While this risk holds good in case of securitization as well, it however takes away two major risks – credit risk and sovereign risk.
Credit risk, as divested from the performance risk would basically mean that the originator has sufficient cash flows but does not pay it to the lender. This risk can be removed in case of a securitization by giving the SPV a legal right over the cash flow.
Sovereign risk on the other hand emanates only in case of cross-border lending. This risk arises when an external lender gives a loan to a borrower whose sovereign later on in the event of an exchange crises either imposes a moratorium on payments to external lenders or may redirect foreign exchange earnings. This problem is again solved by giving the SPV a legal right over the cash flows from the royalties arising in countries other than the originator’s, therefore trapping cash flow before it comes under the control of the sovereign.
The lack of these two types of risks might reduce the cost of borrowing for the originator; thus making music royalty securitization a lucrative option.
Accounting Treatment:
As discussed, there is no existing asset in a music royalty transaction. In terms Ind AS 39, an entity may derecognize an asset only when either the contractual rights to the cash flows from the financial asset have expired or if it transfers the financial asset. However, here asset means an existing asset and a future right to receive does not qualify as an asset in terms of the definition under Ind AS 32.
Accordingly, the funding obtained through the securitization of music royalties should be shown as a liability in books as the same cannot qualify as an off-balance sheet funding.
Regulatory Framework in India:
It is crucial to discuss the applicable regulatory framework on securitization currently prevalent in India and whether music royalty securitization would fall under any of these:
- Master Direction – Reserve Bank of India (Securitization of Standard Assets) Directions, 2021(‘SSA Master Directions)
- SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008 (SDI Framework)
- Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
While the SSA Master Directions primarily pertain to financial sector entities, and will not directly apply to this domain; however, there exists a possibility that the securitization of music royalties could fall under the purview of SEBI’s SDI Framework.
The same has been discussed in detail in the artcile- The Promise of Predictability: Regulation and Taxation of Future Flow Securitization
Benefits of Music Royalty Securitization:
Music royalty securitization offers a range of benefits for both investors and rights holders:
Diversification: Investors gain exposure to a diversified portfolio of music royalties, potentially reducing risk compared to investing in individual songs or artists.
Steady Income Stream: Music royalties often provide a stable and predictable income stream, making them attractive to income-oriented investors, such as pension funds and insurance companies.
Liquidity: By securitizing music royalties, rights holders can access immediate capital without having to wait for future royalty payments, providing liquidity for new projects or business expansion.
Risk Mitigation: Securitization allows rights holders to transfer the risk of fluctuating royalty income to investors, providing a hedge against market uncertainties and industry disruptions.
Challenges and Considerations:
While music royalty securitization presents compelling opportunities, it also poses certain challenges and considerations:
Market Volatility: The music industry is subject to shifts in consumer preferences, technological disruptions, and regulatory changes, which can impact the value of music royalties.
Due Diligence: Thorough due diligence is essential to assess the quality and value of music assets, including considerations such as copyright ownership, market demand, and revenue potential.
Potential Risks:
- Market Risk: Changes in consumer behavior, technological advancements, or regulatory developments could impact the value of music royalties.
- Legal Risk: Disputes over ownership rights, copyright infringement, or licensing agreements could lead to litigation and financial losses.
- Concentration Risk: Investing in a single music catalog or genre exposes investors to concentration risk if the popularity of that catalog or genre declines.
- Cash Flow Variability: While music royalties can provide steady income, fluctuations in streaming revenues or changes in licensing agreements may affect cash flow stability.
- Reputation Risk: The success of music royalty securitization depends on the ongoing popularity and commercial success of the underlying music assets. Negative publicity, controversies, or declining relevance can adversely affect investor confidence and returns.
Implications for the Music Industry:
While music royalty securitization presents exciting opportunities, it also raises certain considerations for the music industry:
Artist Empowerment: Securitization can empower artists by providing them with alternative financing options and greater control over their financial destiny.
Industry Evolution: The emergence of music royalty securitization could reshape the traditional music business model, fostering innovation and collaboration between artists, labels, and investors.
Way Forward
Music royalty securitization offers a compelling investment opportunity for investors seeking exposure to the lucrative music industry. By securitizing future royalty streams, music rights owners can unlock liquidity while providing investors with access to a diversified portfolio of music assets.
As the music industry continues to evolve, music royalty securitization is likely to play an increasingly prominent role in the financial landscape, providing new avenues for capital deployment and revenue generation. It has the potential to transform the rhythm of creativity into the melody of investment opportunity.
See also our article on:
[1] https://www.spglobal.com/ratings/en/research/articles/240220-abs-frontiers-music-royalty-securitizations-are-getting-the-band-back-together-13003585
[2] https://incometaxindia.gov.in/Pages/acts/income-tax-act.aspx
[3] https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=12165
[4] https://www.sebi.gov.in/sebiweb/home/HomeAction.do?doListingAll=yes&search=Securitised%20Debt%20Instruments
[5] https://www.indiacode.nic.in/bitstream/123456789/2006/1/A2002-54.pdf
AIFs ail SEBI: Cannot be used for regulatory breach
Vinod Kothari | corplaw@vinodkothari.com
The alternative investment management industry in India works in the form alternative investment funds (AIFs), a SEBI-regulated vehicle. Most of the PE, VC funds, and hedge funds in India work in this mode.
AIFs have recently been at the receiving end of regulatory flak. RBI had expressed concerns on use of AIFs by regulated lenders for evergreening, and prohibited regulated entities from making any investment in such AIFs as have investments in their borrowers.
Now, SEBI, vide a Consultation Paper dated 19th January heaped a bunch of similar concerns, and required AIFs to affirm that the AIF or investments therein are not being used for regulatory breaches. These concerns, SEBI says, are a result of an ongoing thematic check on the AIF industry, and SEBI says it has already detected at least 40 cases, involving AUM over Rs 30000 crores, where the structure was used to create dents in existing financial regulations.
Based on Data relating to activities of Alternative Investment Funds (AIFs)
The AIF industry has demonstrated steady growth in recent years. As of September 2023, the assets under management (AUM) of AIFs have surged to 3.88 lakh crores, a substantial increase from the 13,000 crores recorded in September 2015. [See Graph above].
Read more →LEAP to listing: India permits direct listing of shares overseas through IFSC
MCA & MOF notify rules for the same
– Vinita Nair & Prapti Kanakia | corplaw@vinodkothari.com
January 25, 2024 (Updated on August 31, 2024)
Indian companies were permitted to raise funds from overseas either pursuant to issue of depository receipts listed overseas or having the non-residents subscribe to issuances made in India or by way of borrowing overseas. As an initiative to provide an avenue to access global capital markets, GoI had announced the decision to ease the raising of foreign funds in order to boost foreign investment inflows, unlock growth opportunities, and offer flexibility to Indian companies to raise funds. Consequently, an enabling provision for direct listing of prescribed class of securities on permitted stock exchanges in permissible foreign jurisdictions was inserted vide Companies (Amendment) Act, 2020 in Section 23 of Companies Act, 2013 (‘CA, 2013’), that deals with permissible modes of issue of securities, vide notification dated September 28, 2020, and made effective from October 30, 2023. Thereafter, the Ministry of Corporate Affairs (‘MCA’) notified Companies (Listing of equity shares in permissible jurisdictions) Rules, 2024 (‘LEAP Rules’) effective from January 24, 2024. As listing of shares abroad will result in raising funds from Persons Resident Outside India (PROI), Ministry of Finance (‘MoF’) notified FEMA (Non-Debt Instruments) Amendment Rules, 2024 amending FEMA (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’) with effect from January 24, 2024. SEBI is also expected to roll out the operational guidelines for listed companies to list their equity shares on permitted stock exchanges.[1]
Additionally, FAQs on direct listing scheme (FAQs) have also been rolled out on January 24, 2024. Further, two of the key recommendations of the working group report on Direct Listing of Listed Indian Companies on IFSC Exchanges submitted in December 2023 were to notify the rules under Section 23 (3) and (4) of CA, 2013 and notify necessary amendments in NDI Rules to permit cross-jurisdiction issuance and trading of equity shares of Indian companies on IFSC exchanges.
Presently, both the LEAP Rules as well as NDI Rules have notified International Financial Services Centre in India (‘Gift City’) as the permissible jurisdiction and India International Exchange and NSE International Exchange (‘IFSC Exchanges’) as the permissible stock exchange. International Financial Services Centres Authority (‘IFSCA’) had issued the IFSCA (Listing) Regulations, 2024 effective August 29, 2024 (‘IFSC Regulations’) however, in the absence of enabling provision under CA, 2013 and NDI Rules, Indian companies were unable to undertake listing of securities abroad.
In this article we provide an overview of the regulatory regime and deal with the procedural aspect.
Regulatory regime for listing securities in IFSC
Chapter X of the NDI Rules permits investment by a permissible holder subject to conditions specified in Schedule XI. Schedule XI inter-alia provides the permissible mode of issuance, eligibility conditions for a permissible holder and Indian companies, obligations of the companies and requirements relating to voting rights and pricing.
LEAP Rules prescribe the eligibility norms for unlisted public companies and procedural aspects in relation to timeline and form for filing the prospectus, complying with Indian Accounting Standards post listing etc.
The IFSC Regulations provide the general conditions w.r.t the principles and eligibility criteria for issuer, specific eligibility criteria for IPO, procedural requirements in case of an entity freshly listing on IFSC exchanges (Chapters I, II, III) and also norms for secondary listing of specified securities (Chapter V). Chapter VI deals with listing of special purpose acquisition companies (SPAC). Comparison of the requirements under IFSC Regulations vis-a-vis under ICDR Regulations is enclosed as Annexure 1.
Mode of Listing
Companies can raise the funds either by issuing fresh capital or by offering the existing shares. In the latter case, the existing shareholders tender their shares. Both the methods are allowed under LEAP Rules & NDI Rules for listing the equity shares on IFSCA exchanges.
Figure 2: Mode of listing
Para 2 of Schedule I to NDI Rules prohibits certain sectors for investment, meaning the company engaged in prohibited sector is not allowed to raise foreign funds[2]. The same conditions are applicable in case of listing in IFSC either by way of fresh issuance/offer for sale. Eg. Nidhi company is a prohibited sector and therefore the nidhi company cannot list its equity share in IFSC.
Further, Schedule I to NDI Rules prescribes sectoral caps which are required to be complied by the public Indian company at the time of direct listing. Refer Cap on Foreign Funds for further details.
Companies ineligible to list in IFSC
NDI Rules, LEAP Rules, and IFSC Regulations provide certain eligibility criteria for companies intending to list the specified securities on permissible stock exchanges. The same are discussed below:
Companies ineligible under LEAP Rules
LEAP Rules are applicable to both unlisted public companies and listed public companies, however, the eligibility criteria under LEAP Rules are applicable to unlisted public companies only. Rule 5 of LEAP Rules provides that the following companies shall not be eligible for listing the equity shares in IFSC;
Figure 3: Companies ineligible under LEAP Rules
Companies ineligible under NDI Rules
Para 3 of Schedule XI to NDI Rules provides the eligibility criteria for direct listing. Para 3(1) & 3(3) is applicable to unlisted public companies and para 3(1) & 3(2) is applicable to listed companies. The eligibility conditions are based on the type of issuance i.e. fresh issuance or offer for sale.
In case of fresh issuance, the following companies are ineligible:
Figure 4: Companies ineligible under NDI Rules, in case of fresh issuance
Most of the conditions above are similar to those provided in Reg. 5, 61, 102, etc. of SEBI (ICDR) Regulations, 2018 (‘ICDR Regulations’) except for the ineligibility arising on account of inspection or investigation under CA, 2013. Chapter XIV of CA, 2013 deals with the requirements relating to inspection, inquiry, and investigation. The Registrar of Companies is empowered to carry out inspection in terms of Section 206 of CA, 2013 and on the basis of the outcome of the same or for other reasons specified in Section 210, the Central Government may order an investigation. In case of inspection or investigation, it is likely that the same may continue for a longer period without any tangible outcome. In such cases, this restriction will act as a deterrent for the companies eligible otherwise. Additionally, reg. 5 (2) of ICDR Regulations, an issuer is not eligible to make an initial public offer if there are any outstanding convertible securities or any other right which would entitle any person with any option to receive equity shares of the issuer. There is no such similar restriction under IFSC Regulations.
The following companies are ineligible, in case of offer for sale by existing shareholders:
Figure 5: Companies ineligible under NDI Rules, in case of offer for sale
Companies Ineligible under IFSC Regulations
Companies incorporated in India/IFSC/foreign jurisdiction are allowed to list on IFSC Exchanges, however, the issuer, any of its promoters, controlling shareholders, directors or existing shareholders offering shares should not be
- debarred from accessing the capital market; or
- a wilful defaulter; or
- a fugitive economic offender
Further, Regulation 9 of IFSC Regulation prescribes certain eligibility criteria for listing such as operating revenue, minimum market capitalization, PBT, etc. (Refer our article IFSC Gateway to Global Access for Indian unlisted companies to understand the conditions in detail). Hence, the entities that are not ineligible as per LEAP Rules, NDI Rules, and IFSCA Regulations and fulfilling the eligibility criteria of IFSC Regulation can list its equity shares in IFSC Exchanges.
Permissible holder
Para 2 of Schedule XI to NDI Rules provides the eligibility criteria for the permissible holders of equity shares listed on permissible stock exchanges. Any Person Resident Outside India (‘PROI’) can be a permissible holder. Thus, an Indian resident cannot hold such shares, however a non-resident Indian can hold such shares (FAQ no. 15 & 16). The said conditions are also applicable to a beneficial owner.[3]
Where a holder is a citizen of a country which shares land border with India, or an entity incorporated in such a country, or an entity whose beneficial owner is from such a country, they can hold equity shares of such a public Indian company only with the approval of the Central Government.
To ensure that the investor is aware of the above conditions of the permissible holders, the Indian company is required to indicate the same in its offer document issued while raising funds in Gift City.
Voting rights on such equity shares will be exercised directly by the permissible holder or through their custodian pursuant to voting instruction only from such permissible holder.
As per RBI Master Directions – Liberalized Remittance Scheme (LRS) investments in IFSCs in securities except those issued by entities or companies in India (outside IFSC) were permitted. RBI Circular dated July 10, 2024 permits availing of financial services or financial products[4] (which inter alia includes securities)within IFSC. However, this cannot be construed to override the eligibility of ‘permissible holder’ prescribed under NDI Rules.
Investment Limit for permissible holder
A permissible holder can invest upto the limits prescribed for foreign portfolio investors i.e. less than 10% of the total paid-up equity capital on a fully diluted basis. That means one single investor can hold less than 10% of the equity share capital on a fully diluted basis of the public Indian Company.
Manner of Purchase/Sale
A permissible holder is allowed to pay the purchase/subscription consideration either to a bank account in India or deposited in a foreign currency account of the Indian company held in accordance with the FEM (Foreign currency accounts by a person resident in India) Regulations, 2015, as amended from time to time.
In case of a sale, the consideration may be remitted out of India or can be credited to the bank account of the permissible holder maintained in accordance with FEM (Deposit) Regulations, 2016 i.e. NRO/ NRE/ FNCR/ SNRR account.
Cap on Foreign Funds
Schedule I to NDI Rules provides the sectoral caps, i.e. the maximum foreign investment permissible in a particular sector. The said conditions are to be complied in case of listing on permitted stock exchanges as well since, listing on IFSC will result in raising funds from PROI. Accordingly, amounts offered to PROI in permissible jurisdiction along with equity shares held in India by PROI should be compliant of the sectoral cap. The aggregate amount held by PROI should not exceed the limits prescribed.
Further, wherever Government approval is required under Schedule I, the same shall be obtained while raising funds from permitted foreign exchange. Eg. in case of print media, foreign investment upto 26% is permitted under government route, therefore a company engaged in print media business can raise only upto 26% from permitted stock exchanges after obtaining requisite approval.
Also, the company has the option of receiving the funds either in the bank account maintained in India or in the foreign currency account maintained outside India. Indian companies are allowed to keep funds in the foreign currency account maintained with the Bank outside India, until its utilization or repatriation to India.
Pricing of Equity Shares
Para 6 of Schedule XI to NDI Rules provides for pricing of equity shares to be listed on the permitted stock exchange. LEAP Rules does not prescribe any pricing conditions.
Figure 6: Pricing of equity shares
Other actionable
- The unlisted public company is required to file the prospectus in form LEAP-1 with ROC within a period of seven days after the same has been finalised and filed in the permitted exchange.
- Post listing, the company will be required to prepare the financial statements as per Ind AS in addition to any other accounting standard, if applicable.
- The Indian company will be required to report to RBI through AD Banks in form LEC (FII) about the purchase/subscription of equity shares listed on IFSC Exchanges.[5]
Direct listing overseas v/s depository receipts
Issuance of depository receipts is governed by Depository Receipt Scheme, 2014 read with FEMA NDI Rules and SEBI’s framework for issue of depository receipts. The regime is different from the issue of ADR/ GDR and listing on overseas exchanges.
- While the Scheme provided for any Indian company being eligible to issue depository receipts, SEBI restricted the eligibility to issue only by ‘a company incorporated in India and listed on a recognised stock exchange in India’. Therefore, unlisted entities are not eligible to issue depository receipts.
- Mode of listing of DRs are similar to present regime i.e. fresh issuance or OFS of permissible securities.
- There are 8 permissible jurisdictions for ADR/GDR issuance[6] as compared to just IFSC in case of direct listing.
- The concept of permissible holder for depository receipts is similar to permissible holder in the context of direct listing (discussed above) such that residents are not eligible to hold the same even as a beneficial owner. In case of depository receipts, even NRIs are ineligible to invest. However, as clarified by SEBI vide circular dated December 18, 2020 issue of DRs to NRIs is permitted pursuant to share based employee benefit schemes which are implemented by a company in terms of SEBI (Share Based Employee Benefits) Regulations 2014[7] and pursuant to a bonus issue or a rights issue;
- The norms relating to pricing and voting rights are also on similar lines in both cases.
Status after listing
In case of direct listing, Indian companies would be listing its ‘equity shares’ and/or ‘convertible securities’. The Companies Act, 2013 defines the term ‘listed company’ as a company which has any of its securities listed on any recognised stock exchange. However, clause (c) of Rule 2A of the Companies (Specifications of Definitions Details) Rules, 2014 (‘SDD Rules’) provides that public companies which have not listed their equity shares on a recognized stock exchange but whose equity shares are listed on a stock exchange in a jurisdiction as specified in sub-section (3) of section 23 of the Act shall not be considered as a listed company.
Therefore, the status of an unlisted public company will not change upon direct listing and consequently, the additional compliances as applicable to a listed company under CA, 2013 will not apply to such company in view of express carve-out in terms of the SDD rules.
However, every Indian company getting its securities listed on stock exchanges in IFSC will be required to comply with Chapter XII[8] of the IFSC Regulations dealing with listing obligations and disclosure requirements, as applicable.
Minimum Public Shareholding Requirement
Securities Contracts (Regulation) Rules, 1957 (‘SCR Rules’) mandates listed companies in India to have a minimum public shareholding (MPS) of atleast 25% of each kind of equity shares.
On the requirement for minimum offer and allotment to public, Ministry of Finance vide notification dated 28th August, 2024, amended Rule 19 of SCR Rules prescribing a minimum of 10% irrespective of the post issue paid up capital (as opposed to 25% applicable to listed entities in India) for companies intending to list their securities on recognized stock exchanges in IFSC. Further, the continuous listing requirement in Rule 19A has also been amended prescribing MPS requirement of atleast 10%. In case it falls below 10% at any time, the company will be required to bring the public shareholding to 10% within a maximum period of 12 months from the date of such fall[9].
In this regard, the working group committee suggested that the public holding fulfilling the definition of public shareholding as per SCR Rules[10] should be considered towards MPS and such requirements should be complied in both jurisdictions separately to ensure free float in both jurisdictions. Basis the recommendations, the working group committee recommended making appropriate changes in the SCR Rule. In view of the aforesaid amendment, it seems that MPS norms are required to be separately maintained.
Tax incentives available to permissible holders
Non-residents i.e. permissible holders are exempt from the applicability of capital gains tax in case of transfer of foreign currency denominated equity shares of a company where the consideration is payable in foreign currency pursuant to Section 47(viiab) of Income Tax Act, 1961 read with Notification dated 5th March, 2020. Also, Securities Transaction Tax, Commodities Transaction Tax, and stamp duty in respect of transactions carried out on IFSC exchanges is exempt.
Conclusion
The initiative is quite encouraging and will benefit India Inc. in fundraising, however, the ineligibility on account of pending inspection/investigation needs to be revisited. The requirements post listing, as per IFSC Regulations are also numerous, several of them being on similar lines as provided under Listing Regulations.
[1] As per the press release by PIB.
[2] Prohibited sectors include- Lottery business, Gambling and betting, Chit funds, Nidhi company, Trading in TDR, (a) Real estate business or construction of farm houses, Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes, Atomic energy, Railway operations, Foreign technology collaborations in any form for lottery business and gambling and betting activities.
[3] Beneficial owner as defined as per proviso to sub-rule (1) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005
[4] “financial product” means—(i) securities; (ii) contracts of insurance; (iii) deposits; (iv) credit arrangements; (v) foreign currency contracts other than contracts to exchange one currency for another that are to be settled immediately; and (vi) any other product or instrument that may be notified by the Central Government from time to time.
[5] Inserted vide FEM (Mode of Payment and Reporting of NonDebt Instruments) (Amendment) Regulations, 2024
[6] 1. United States of America – NASDAQ, NYSE 2. Japan – Tokyo Stock Exchange 3. South Korea – Korea Exchange Inc. 4. United Kingdom excluding British Overseas Territories- London Stock Exchange 5. France – Euronext Paris 6. Germany – Frankfurt Stock Exchange 7. Canada – Toronto Stock Exchange 8. International Financial Services Centre in India – India International Exchange, NSE International Exchange.
[7] The onus of identification of NRIs holders, who are issued DRs in terms of employee benefit scheme, would lie with the listed company. The listed company is required to provide the information of such NRI DR holders to the designated depository for the purpose of monitoring of limits.
[8] Part A: General Obligations; Part B: Companies with Specified Securities Listed on Recognised Stock Exchanges as a Primary Listing and Part C: Secondary Listing of Specified Securities.
[9] Manner of achieving MPS has been prescribed vide SEBI Circular dated February 3, 2023.
[10]Rule 2(e) of SCR Rules defines public shareholding as equity shares of the company held by public including shares underlying the depository receipts if the holder of such depository receipts has the right to issue voting instruction and such depository receipts are listed on an international exchange in accordance with the Depository Receipts Scheme, 2014.
Provided that the equity shares of the company held by the trust set up for implementing employee benefit schemes under the regulations framed by the Securities and Exchange Board of India shall be excluded from public shareholding.
Provided that the equity shares of the company held by the trust set up for implementing employee benefit schemes under the regulations framed by the Securities and Exchange Board of India shall be excluded from public shareholding.