Sebi Consultation Paper on Capital Market to Boost Public Issues

Ever since the pandemic has hit the country and our economy, the capital market’s watchdog Securities and Exchange Board of India (Sebi) has been providing various relaxations and amendments to help the market participants function and run smoothly. Significant changes have been introduced to the regulatory framework to boost the equity capital markets such as: 

• allowing promoters to acquire up to 10 per cent equity (as against 5 per cent earlier) in a single financial year without triggering open offer requirements through preferential issue of equity; 
• introduction of the innovator’s growth platform; 
• making the delisting process more transparent and efficient; 
• enhancing eligibility criteria for ‘fast track’ rights issue etc. 

To further boost the equity capital markets, Sebi has rolled out a consultation paper on Review of the regulatory framework of promoter, promoter group and group companies as per Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 on 11th May 2021 (the Consultation Paper). 

Some of the key changes proposed under the Consultation Paper are as follows:

1.    Reduction in lock-in requirements post Initial Public Offer (“IPO”) for promoters and other investors

Acknowledging the trend of the broad-based shareholding seeping into most of the Indian companies due to drastic rise in the presence of institutional investments in business, Sebi is attempting to standardise the market practices with that of the international standards by proposing the following relaxations in the lock requirements post IPO:

Current Requirement

Proposed Requirement

Minimum promoters’ contribution of 20per cent of post-issue capital (MPC)

3 years lock-in period from the date of commencement of commercial production or date of allotment in the IPO

1 year lock-in from the date of allotment in the IPO

Additional shareholding of the promoters over and above MPC

1 year from the date of allotment in IPO

6 months from the date of allotment in IPO

Pre-issue shareholders other than the promoters

1 year from the date of allotment in IPO

6 months from the date of allotment in IPO

Further, the shareholding of the promoter shall be exempt from lock-in requirement after 6 months from the date of allotment in IPO to comply with the minimum public shareholding requirement of 25 per cent.

The current stringent requirements of lock-in were introduced by Sebi to ensure that the promoters have a skin in the game. Historically, companies were more family run and private equity and institutional investors were akin to lenders of the company. To ensure that the company performs well, Sebi insisted on the promoters having a skin in the game. 

With the current regulatory framework for listing, there are adequate checks and balances under the Sebi regulations (including corporate governance requirements, monitoring requirements by third parties for utilisation of issue proceeds, penal provisions for non-compliances and misstatements in prospectus) to reduce lock-in requirements. Sebi is of the view that today the companies are much more stable and established with mature businesses before they apply for listing and their promoters have demonstrated skin in the game for several years before proposing listing.

The proposal is expected to incentivise the promoters of the companies to avail pre-IPO funding from private equities, alternative investment funds and such other institutional investors. Typically, such investors are not in favour of long lock-in periods and accordingly the proposed amendment will be a welcome move. 

2.    Reconceptualising Promoters, Promoter Group and disclosures required by Group Companies

a.        Promoter:

The concept of promoters in the Indian capital markets is peerless. The Indian company law and securities law identifies the concept of promoters and is defined under Sebi (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations) as such person(s): 

• designated as promoters in the offer document or the annual return of the company; 
• who directly or indirectly have control over the affairs of the company as a shareholder, director or otherwise; or, 
• on whose advice, direction or instructions, the board of directors of the company is accustomed to act subject to such other conditions as detailed therein.

The implication of the definition is that a person may be classified as a promoter irrespective of the holding in the company. Further, the trend in India has been that various companies are initially funded by institutional investors until their listing, subsequent to which, an exit is provided to such investors. 

Amidst the fast-moving and forward-looking economy, with a paradigm shift in the ownership structure of the company, the current definition of promoter fails to target only such persons who are in actual control of the company but continues to consider widely, persons beyond the control of the company. Further, if a person had to be reclassified to a non-promoter, then the process envisaged under the Sebi (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR Regulations) for reclassification of promoters is quite cumbersome to encourage promoters to undergo the same. Additionally, with India aligning with international standards, companies are now becoming more professionally managed, thereby the concept of promoter becoming redundant. 

In view of the above it is proposed under the Consultation Paper to replace the concept of ‘promoters’ with ‘persons in control’. 

The above proposal seems to have received a mixed reaction from the market. While some believe the proposal may reduce the current vigilance that is there on promoters, others believe it is a step forward aligning towards international standards. Needless to mention, the proposal may have a ripple effect on other Sebi regulations. 

The other Sebi regulations recognises the concept of promoters and casts duties and obligations on them pertaining to periodic disclosures, holding persons responsible in case of any breach and non-compliance etc. Concurrently, this will require changes in not only Sebi regulations but also other norms under the Companies Act, Insurance Regulatory and Development Authority of India etc. Thus, the views of all the concerned regulatory bodies will have to be considered.

b.    Promoter Group:

In cases where there is an investor (being an individual, body corporate, group of individuals and/or companies or combinations thereof) that has invested in multiple companies and holds more than 20 per cent of the equity share capital of such companies (Investee Companies), then such Investee Companies are said to be a part of the promoter group by the virtue of 2(1)(pp)(iii)(c) of the ICDR Regulations. It is proposed to delete regulation 2(1)(pp)(iii)(c).

The Sebi regulations cast obligations on the issuing company to make disclosures in its offer document relating to the Investee Companies forming a part of the promoter group. Primarily, such Investee Company maybe totally unrelated to the issuing company. This leads to increasing the burden on the issuer to make detailed disclosures in the offer document of unrelated companies on account of having a common investor without adding any benefit to the investor. A narrower definition will reduce disclosure requirements of non-material entities on issuer and ensure investors are provided with requisite material information.

c.    Group Companies:

If an issuing company has entered into related party transactions with other companies during the period for which the financials are disclosed in the offer documents, then such other companies are considered to be as ‘group companies’ of the issuing company as per the ICDR Regulations. Further, any other company may also be designated as a group company if it is considered material by the board of issuer company. 

Under the ICDR Regulations, a company applying for listing requires to disclose the following details:

• name of the group companies
• details of registered address
• business description 
• financial statements of such group companies for the previous 3 years 
• details pertaining to outstanding litigations etc. 

The issues arising with the definition of “group companies” are:

• Private equity and institutional investors may get classified as group companies. Accordingly, their disclosures would have to be disclosed in the offer document.
• Details of related party transactions are included in the offer document. 
• Such disclosures as currently required to be made by the group companies are not applicable subsequent to listing as a requirement either in LODR Regulations or in Sebi (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and thus prove to be unproductive for the investors.

Considering the financial details of such group companies can be accessed from their website, it is proposed that only their names and address be disclosed in the offer document.

The above amendment will not only avoid detailed disclosures about companies which may be immaterial to the investors of the issuing company, but also lead to synchronisation between the pre-listing disclosures and post-listing framework.

Conclusion

The proposals introduced under the Consultation Paper are a welcome move and are expected to boost the equity capital markets and pre-IPO funding. This in turn will align India with international standards. The said proposals shall not only reduce the disclosure burden on the companies, but from the perspective of the small and retail investors, these changes will help in making the offer document more condensed, thereby enabling the investors to make informed decisions with relevant information.

Considering the shortened life span of business and investments, from the perspective of the promoters and that of the institutional investors, these changes will help in recycling capital for productive usage, if early exit opportunities are envisaged. 

It would be worth noting that statistically, over a period of time, the overall promoters’ shareholding has taken a dip while there has been an increase in the overall strategic investors. Thus, while attempting to substitute the concept of promoters with that of persons in control, this new definition would need to be worded cautiously to include only such persons who are in actual control of the company and not beyond, to reflect the essence of the proposed objective.

Further, these proposals will require consequent changes to be reflected in other Sebi regulations and norms governing the capital markets. Sebi will be required to deliberate over the proposals with other regulators to ensure uniformity in the applicable law and accordingly bring about amendments to its regulations. 

The authors are partner and associate, Juris Corp

DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.