INDIA – SECURITIES LAW UPDATE
The Securities and Exchange Board of India (the “SEBI”) actively monitors the Indian securities and commodities markets, and has been implementing new regulations based on market practices. Some of the more important SEBI circulars issued recently have been discussed in this update.
SEBI tightens disclosure norms for credit rating agencies
In the aftermath of the IL&FS crisis, the SEBI has prescribed enhanced disclosure standards for Credit Rating Agencies (“CRAs”). Among others, CRAs must now:
- disclose the liquidity position of a company by highlighting parameters like liquid investments, liquidity coverage ratio, adequacy of cash flows, etc.
- monitor sharp deviations in bond spreads against the relevant benchmark yield.
- analyze the deterioration of the liquidity conditions of an issuer, while monitoring its repayment schedules and taking into account any asset-liability mismatches.
- disclose the names of the subsidiaries that were taken into consideration and also provide the rationale for this, if the rating is assigned either on the assumption of cash inflow or on the basis of consolidation of subsidiaries.
- disclose their average one-year rating transition rates over a five-year period and their performance on the websites of stock exchanges and depositories.
Disclosures of a company’s financial situation, cash flows, funds infusion and the ability to repay debt will help investors in making an informed decision whether to invest in a company or not and will prevent an over-reliance on ratings. Giving a proper rationale for the rating will increase accountability, and disclosure of the CRAs track record will also help investors assess the quality and trustworthiness of the CRA.
India’s Supreme Court on the definition of “CONTROL”
Recently, in Arcelormittal India Pvt. Ltd. v. Satish Kumar Gupta & Ors (the Essar Steels insolvency case), while adjudicating on the eligibility of a resolution applicant under Section 29A of the Insolvency and Bankruptcy Code, 2016 (the “IBC”), the Supreme Court (the “SC”) adopted the definition of “control” as interpreted by the Securities Appellate Tribunal (the “SAT”) in M/s. Subhkam Ventures (I) Private Limited v. SEBI (the “SAT Order”). The SC observed that the term “control” denotes “proactive power” as opposed to “reactive power,” and held that “control” refers to de facto control, which means positive control over management or policy decisions and not a mere power to block special resolutions of a company.
Interestingly, when the SAT Order was appealed by the SEBI before the SC, the SC concluded the appeal by stating that the definition of “control” in the SAT Order should not be treated as a precedent and would only apply to the Subhkam Ventures case. However, with the SC now adopting the same definition of “control” in the context of the IBC, it remains to be seen whether the ArcelorMittal ruling will become trite law and resolve the debate on what constitutes “control” under Indian securities law.
SEBI caps expenses of mutual funds and mandates disclosures
The SEBI has released a circular to bring transparency in the expenses levied by mutual funds (“MFs”), and to reduce portfolio churning and mis-selling. It has prescribed that all scheme-related expenses shall necessarily be paid from the scheme only (within the regulatory limits) and not from the books of Asset Management Companies, their associates, sponsors, trustees or any other entities. The circular also seeks to disincentivize fruitless “churning” of MF investments from one MF to another by doing away with upfronting of commissions and moving all regular-plan distributors to an “all trail” model. However, the SEBI has allowed upfronting of trail commissions in case of inflows through systematic investment plans (“SIPs”) to new investors (to be identified through their Permanent Account Numbers) up to 1% over a three (3) year period. The circular also provides that in case of misuse of the exception given for SIPs, the provision will be discontinued and appropriate action will be taken against the errant participant.
Besides, the circular also bans the practice of “passing back” commissions by distributors to investors, and prescribes a framework for transparency in the total expense ratio of MF schemes, limiting the additional incentives for B-30 (the non-metro) Indian cities based on inflows from individual retail investors. On disclosures relating to scheme performance, the SEBI has directed MFs to disclose the performance of all their schemes on the website of the industry body, the Association of Mutual Funds of India.
Currently, MFs pay distributors upfront commissions as high as 2% (i.e., double the commission provided in the circular), which will have to stop and which will benefit retain investors. A trail-free model will also benefit distributors if their clients stay invested in schemes for a longer period of time. Further, the performance disclosure requirement will help investors better assess a particular MF.
Foreign entities permitted to participate in commodities derivatives market
The SEBI has allowed eligible foreign entities (“EFEs”) having exposure to Indian commodity markets, to participate in the commodity derivatives segment of recognized stock exchanges to hedge their exposure. To be eligible, and EFE must have a minimum net worth of US$500,000. Further, if an EFE is registered with the SEBI as Foreign Portfolio Investor or Foreign Venture Capital Investor, it must have a clear segregation of funds, securities or commodities under each respective registration to be able to avail of this benefit.
SEBI allows an additional payment mechanism in public issues
The SEBI has decided to introduce the use of Unified Payments Interface (“UPI”) as a payment mechanism for share purchase applications in public issues by individual retail investors through intermediaries. For a smooth transition to UPI-based payment mechanism, the SEBI has proposed to bring this change in three phases starting from January 1, 2019. The UPI will permit funds to be blocked at the time of application. With the introduction of UPI as a payment mechanism, additional payment channels will become available to investors to apply in a public issue. This will increase efficiency, eliminate the need for manual intervention at various stages, and will reduce the time duration from issue closure to listing.
Uniform and detailed disclosures regarding commodity risks
The SEBI’s listing regulations require various disclosures to be made by listed entities in their annual reports. Now, listed entities will also be required to disclose their commodity risk management policy in a more transparent and detailed manner. For uniformity’s sake, the SEBI has prescribed a format in which the disclosure will have to be made.