On August 21, 2019, India’s securities market regulator, the Securities and Exchange Board of India (the “SEBI”), introduced a plethora of changes to Indian securities laws and regulations. This update discusses the key changes.
Background
In recent months, a multitude of factors including, inter alia, the ongoing trade tensions between the US and China, a slowdown of India’s growth rate, the shadow bank liquidity crisis and the introduction of a higher tax surcharge on institutional investors in India’s financial budget for 2019-20, caused foreign investors to pull out of Indian equity markets. Given India’s need to attract investment to revitalize its economy, the SEBI has sought to ease compliance norms and make India a more attractive investment destination while seeking to provide support to domestic market participants.
Simplification of the framework for Foreign Portfolio Investors (“FPIs”)
On March 26, 2018, the SEBI had constituted a working group to analyze and recommend changes to India’s FPI framework.The working group published its report on May 24, 2019.The SEBI has now implemented many of the changes proposed in the report.
- Funds could not be registered as FPIs if they did not have at least twenty (20) investors, and in which, no single investor held more than 49% of the shares or units. Recognizing that this requirement prevented a number of funds from entering the Indian market, the SEBI has scrapped this criterion. In our view, doing away with the broad based criteria will open up the FPI route to a wider base of investors and is likely to stimulate higher investment.
- FPIs were divided into three (3) categories on the basis of their risk profile, which depended on the manner in which the FPI was regulated in its own country. Consequently, the best regulated FPIs were categorized as Category I FPIs. In a bid to simplify this, the SEBI has decided to categorize FPIs into two (2) categories only, and the basis of the classification will be clarified in due course.
- A multiple investment manager (MIM”) structure had to obtain multiple FPI registrations despite the fact that the MIM was a single legal entity. Moreover, for each such registration, and periodically thereafter, the entity was required to provide substantial KYC information. The SEBI has simplified the registration requirement for MIM structures and has done away with multiple registrations. This will, in our view, substantially reduce the timelines for registering additional accounts under a MIM structure.
- A bank or a resident of a country whose central bank was not a member of the Bank for International Settlements was not eligible for FPI registration. The SEBI has now permitted central banks who are not members of the Bank for International Settlement to register as FPIs. This is a positive move as central banks are essentially state-backed entities, who are low risk, long-term investors.
- The SEBI will now recognize entities established in the International Finance Service Center, Gift City, Gujarat (the “IFSC”) as entities who have satisfied the jurisdiction criteria for registering as an FPI.
- The SEBI has eased KYC norms and simplified documentation requirements. In our view, given that the FPIs already undergo the KYC process with their global custodians, simplifying the KYC requirements in India will make the process of registration far less cumbersome.
- The SEBI has allowed FPIs to transfer their unlisted, suspended or illiquid securities to an onshore or offshore investor by entering into off-market transactions. Given that the ability of investors to easily liquidate their investments is often an important criteria while opting for an investment, in our view, this change is likely to reassure prospective investors.
SEBI permits mutual funds to invest in unlisted non-convertible debentures (“NCDs”)
On June 27, 2019, the SEBI issued a press release under which mutual funds were not permitted to invest in listed NCDs. However, the SEBI has now reversed this. Accordingly, a mutual fund will be permitted to invest up to 10% of its debt portfolio in unlisted NCDs, subject to such NCDs offering monthly coupons and being rated by the designated agencies. This flip-flop by SEBI is to ensure more liquidity to companies who are unable to tap bank funding easily. However, the risks of these types of transactions are high, and mutual fund investors will have to assess the quality of the NCDs owned by the fund house.
Rationalization of buy-back restrictions
Currently, listed companies, apart from notified companies, are under an obligation to maintain a post buy-back debt-to-equity ratio of at least 2:1. Recognizing the need for easing these norms in light of the debt crisis, the SEBI has relaxed the post buy-back debt-to-equity restrictions in relation to the companies associated with non-banking financial companies (the “NBFCs”) and housing finance companies (the “HFCs”). Now, while such conglomerates must maintain a post buy-back debt-to-equity ratio of 2:1 on a standalone basis, they may exceed the 2:1 ratio on a consolidated basis. At the same time, however, such companies must ensure that their post buy-back debt-to-equity ratio on a consolidated basis does not exceed 2:1 after excluding their associated NBFCs and HFCs, and that the excluded NBFCs and HFCs do not exceed a ratio of 6:1 on a standalone basis.
In our view, given that an increasing number of NBFCs and HFCs have been accumulating debt as a consequence of the instability caused by the IL&FS crisis and the subsequent economic slowdown, the debt-to-equity ratio for their group companies has been skewed disproportionately. This move will provide welcome relief to such companies, who will now be able to initiate buy-backs without being hindered by the debt of their group companies.
Rating agencies to have more teeth
Credit Rating Agencies (“CRAs”) must add in the rating agreement with their clients a clause granting them explicit consent to obtain details of the clients’ borrowings and repayments, from statutory or non-statutory authorities, or from the clients themselves.
In our view, this decision is important, because it will give more teeth to the CRAs and will force them to be more accountable. CRAs will now have to be more proactive in analyzing debt transactions.
SEBI introduces the “informant mechanism”
The SEBI has approved an amendment to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (the “Insider Trading Regulations”) to implement the informant mechanism and to provide for the creation of an Office of Informant Protection (the “OIP”). The OIP will be responsible for analyzing the veracity of information received from informants and to determine whether the informant is to be awarded for the information. Further, the mechanism also envisions a protection apparatus to protect the identity of the informant while exempting the information provided from the purview of the Right to Information Act, 2005. The amendment also gives the SEBI powers to initiate action against informants providing frivolous and vexatious information.
SEBI approves migration from the Innovators Growth Platform (the “IGP”)
Recently, the SEBI had revamped the Institutional Trading Platform by easing the requirements for listing of eligible start-ups and renaming it as the IGP.In a further boost, the SEBI has approved the proposal for entities listed on the IGP to migrate to the main board as regular trading members.The eligibility requirements for such migration will include, inter alia, (i) a minimum listing period on the IGP of one (1) year; (ii) a minimum shareholding of at least two hundred (200) shareholders at the time of making application; (iii) a profitability/net worth track record of three (3) years or at least 75% of its shareholding being held by qualified institutional investors; and (iv) a minimum promoter contribution of 20%, which would be locked in for three (3) years.
Our Comments
In the wake of domestic market witnessing strong foreign outflows, the foregoing changes will create a greater incentive for investment while also reassuring investors of the SEBI’s commitment towards a stable market environment. By easing compliance norms for FPIs and permitting mutual funds to invest in unlisted NCDs, the SEBI has sought to increase the liquidity in the Indian market. Allowing start-ups to migrate to the regular trading platform will provide a further stimulus to the start-up industry while the introduction of an informant mechanism to the Insider Trading Regulations will complement SEBI’s goal of timely identification of insider trading incidents. Combined with the government’s rollback of the tax surcharge on overseas investors, these changes will reassure market participants that India’s regulators are willing to accommodate their demands. However, given the current macro-economic factors in play, it remains to be seen whether these changes provide enough impetus to the Indian economy.