Sweeping reforms to India’s securities regulations

Background

Late last month, the Securities & Exchange Board of India (SEBI) took several key decisions in its board meeting, including:

• the introduction of a gold exchange framework;
• the establishment of a social stock exchange;  
• stricter norms for related party transactions; and
• relaxed criteria for delisting and superior voting rights framework. 

This update discussed the key changes and analyses their impact on India’s securities market.

Framework for a gold exchange

In an attempt to create a regulated system for gold trading, SEBI has approved the framework for a gold exchange and introduced the SEBI (Vault Managers) Regulations, 2021.

• The functioning of the exchange will involve:

• deposit by the investor of physical gold to the vault manager and its conversion into Electronic Gold Receipts (EGRs);
• the trading of EGRs on the stock exchange; and
• the conversion from EGRs into physical gold on withdrawal by investor.  The EGRs are to be surrendered and subsequently extinguished once the investor withdraws the physical gold.

• EGRs will fall within the purview of “securities” and will have the trading, clearing, and settlement features similar to any other security.

• EGRs can be traded in a separate segment on any recognized stock exchange.

• EGRs will be fungible, i.e., gold deposited against one EGR can be withdrawn against another EGR, subject to same contract specifications. 

• EGRs will also be interoperable, i.e., gold deposited with one vault manager can be withdrawn from another vault manager at the same or different location.

• A vault manager will be a body corporate incorporated in India having a net worth of INR500 million, who will be responsible for accepting, safekeeping and withdrawal of the gold, creation of EGRs, periodic reconciliation of the underlying gold with the records of the depository, and grievance redressal.

Trading in gold is now permissible and is a step in the right direction.  Perpetual validity, fungibility and inter-operability of EGRs ensures greater flexibility to investors, reduced costs, and less time consumption.  Though SEBI has allowed stock exchanges to determine EGR denominations, subject to its approval, more clarity is awaited on this issue by way of a final amendment.  Investors might have apprehensions in relation to transit risks and the hassle associated with physical delivery of gold, but overall this will provide more liquidity to an otherwise illiquid asset class.

Introduction of a social stock exchange (SSE)

SEBI has approved the creation of a SSE, which can be a separate segment in any existing stock exchange.

• The SSE will allow social enterprises (like (i) Non-Profit Organisations (NPO); (ii) and For-Profit Social Enterprises) to raise funds and engage in eligible social activities.

• NPOs can register with the SSE to raise funds through instruments such as equity, zero coupon zero principal bonds, mutual funds, and social impact funds.

• The nomenclature of ‘social venture funds’ under SEBI (Alternate Investment Funds) Regulations, 2012, will be changed to ‘social impact funds.’  The minimum corpus requirement for a social impact fund has been reduced from INR200 million to INR50 million.

• A capacity building fund with a corpus of INR1 billion shall be raised from stock exchanges and development agencies such as NABARD and SIDBI.

Creation of the SSE will legitimize contributions towards social activities.  The corporate governance norms and disclosure requirements of the SSE will enhance transparency and socio-economic development objectives.  Reducing the corpus requirements of social impact funds is beneficial and will certainly attract more investments.

Amendments to the delisting framework

As per Regulation 7(4) and 7(5) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, if the shareholding of an acquirer exceeds the maximum permissible non-public shareholding, i.e., 75% pursuant to an open offer, the acquirer is currently required to reduce the shareholding to 75% within twelve (12) months and becomes ineligible to make a delisting offer until twelve (12) months from the date of completion of the offer period. 

• Under the amended regulations, if an acquirer crosses 75% shareholding pursuant to an open offer and does not get delisted, the acquirer will have an additional twelve (12) months to delist the company.  If unsuccessful, the acquirer must bring down the shareholding to 75% within twelve (12) months of the end of the delisting period.

• The delisting price will include a premium over and above the open offer price.

• If the delisting is successful pursuant to the 90% threshold being met, the existing shareholders will receive the delisting price.  If the 90% threshold is not met, the existing shareholders will receive the takeover price.

• If the acquirer holds more than 75% stake pursuant to an open offer and prefers to remain listed, the acquirer may either choose to proportionately reduce the shares under a share purchase agreement and open offer to reduce the shareholding to 75% or reduce it to 75% within twelve (12) months as prescribed under Securities Contract (Regulation) Rules, 1957.

The additional twelve (12) months given to the listed entities to delist is certainly a relaxation in the right direction and will provide leeway to listed entities.  Further, the amendment resolves the contradictory directions previously existing in the regulations.

Stricter norms for related party transactions

SEBI has approved amendments to SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, and has introduced stringent norms for related party transactions (RPTs), which will be effective from April 1, 2022.

• Related parties will now include all promoter and promoter group entities irrespective of shareholding.  Any person who, directly or beneficially, holds 20% or more equity shares in the listed entity (10% or more with effect from April 1, 2023) will also be a related party.

• Scope of RPTs have been expanded to transactions with persons who are not related parties but where the intent of the transaction is to benefit a related party.

• Prior mandatory approval of shareholders will be required for material RPTs with a threshold of INR10 billion or 10% of the consolidated annual turnover of the listed entity, whichever is lower.

• Approval of the board’s audit committee will be required for all RPTs and material alterations.

• Enhanced disclosures in relation to notice of material RPTs to shareholders, and disclosure to stock exchange within fifteen (15) days, and consequently on the same day, of submission of half yearly financials.

The expanded definition of RPTs will bring a check on fraudulent corporate transactions.  However, enhanced disclosure requirements will also increase the compliance burden for companies.

Unwinding the eligibility criteria for superior voting rights

As per Regulation 6(3) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, equity shares with superior voting rights (“SVR”) can be issued to promoters of companies that are intensive in use of technology.  The SEBI has announced certain changes to the eligibility criteria for such promoters

• The SVR shareholder, as an individual, must not have a net-worth of more than INR10 billion, excluding the ordinary or SVR shares held by the individual in the company, as opposed to INR5 billion earlier.

• SVR equity shares will now be required to be held for at least three (3) months prior to filing of a red herring prospectus, as opposed to six (6) months earlier.

The relaxation in eligibility norms for SVR shareholders in respect of net-worth and holding period will incentivize greater issuance of such shares.  At the same time, the existing checks and balances in the framework, including, coattail provisions and sunset clauses, must be effectively implemented to protect against misuse of the voting rights.

Appreciable trends in ESOP regulations

SEBI has consolidated SEBI (Issue of Sweat Equity) Regulations, 2002, and SEBI (Share Based Employee Benefits) Regulations, 2014, into a single regulation, i.e., SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 which is applicable with effect from August 13, 2021.

• The definition of “employee” in relation to the Employee Stock Option Plan (ESOP) now includes non-permanent employees.

• Instant relief to be provided to the employee or the employee’s family in the event of death or permanent incapacity, and the requirement of minimum one (1) year lock-in period and minimum vesting period has been waived off for all share benefit schemes.

• Relief has been given to companies that fail to clear their excess inventory by increasing the recovery gap to two (2) years from one (1) year.

The new regulations broaden the scope of employees who can avail ESOPs and extend the share-based employee benefits to employees who work exclusively for the company or any of its associate, subsidiary, or other group companies, as against earlier regulations that benefitted only permanent employees.  This will increase employee participation in the company and in the public markets, which on the evidence of recent trends, can lead to wealth generation for employees.

Rahul Datta is an associate with Majmudar & Partners since 2018.