In its recent board meeting on March 29, 2023 the Securities and Exchange Board of India (SEBI or the Regulator) approved a slew of proposals in relation to existing securities laws. Some of the approved decisions are highlighted below:
I. Framework surrounding Environmental, Social and Governance (“ESG”) Norms
- ESG Disclosures:
Currently, the Business Responsibility and Sustainability Report (BRSR) is required to be published as a part of ESG Disclosures. However, it is very extensive and the compliance with it is difficult for companies. Thus, SEBI has introduced the concept of a ‘BRSR Core’, which would have 49 key performance indicators forming the essence of ESG norms. They would be detailed and quantifiable, so that there is objectivity and comparability. Further, the companies would be required to provide a reasonable assurance on the accuracy in their reporting.
Furthermore, disclosures for entities forming a part of the supply chain of the company, as per certain thresholds, will also be specified. The glide path for the implementation of these measures has also been provided.
- ESG Ratings:
SEBI has tried to take an approach of adopting the minimum standards instead of prescribing any particular framework. Further, SEBI has recommended modifications to the ESG framework for its application in India. It would likely recommend the relevant standards for the same as well. Further, ratings based on the ‘BRSR Core’ parameters, the Core ESG Rating, has been made applicable.
- ESG Investing:
Different measures like minimum investment of at least 65% of AUM in entities which are giving assurances on core BRSR, third party assurance and certificates by board of AMCs, increased disclosures of scheme documents, disclosure of voting decisions, publication of case studies and introduction of a new scheme category, among others, have been approved.
This framework would help in establishing an entire eco-system around the ESG norms and help in attracting funds towards companies which are taking initiatives towards sustainability, social welfare and good governance.
- Framework for ESG Rating Providers:
SEBI has provided for the ESG rating providers to provide ratings based on transparency, without any conflict of interest and based on reasonable assurance. The framework would be incorporated in the SEBI (Credit Rating Agencies) Regulations, 1999. The framework recommended in the consultation paper was comprehensive and in line with the Regulations prescribed for credit rating agencies, drawing inspiration from the2008 financial crisis.
SEBI has taken cognizance of the importance of ESG ratings in the investment world and accordingly paved a rationalized glided path for disclosures by way of by listed companies and establishing regulatory framework for ESG rating agencies to avoid conflict of interests and providing reasonable assurances to the investor community.
II. ASBA-like Facility for Trading in Secondary Market: Options to Investors
SEBI approved the broad framework for Application Supported by Blocked Amount(ASBA)-like facility for investors of secondary market trading. Accordingly, the investors will now be able to block funds in their bank account for trading in secondary market, instead of transferring them upfront to the trading member, thereby providing enhanced protection of cash collateral. Under the model approved by SEBI, the funds will remain in the account of the investor but will be blocked in favour of the Clearing Corporation (CC) till the expiry date of the block mandate or till block is released by the CC, whichever is earlier. The CC can debit funds from the client account, limited to the amount specified in the block. SEBI has decided that this ASBA-like facility shall be optional for investors as well as stock brokers.
The facility is expected to bring in more efficiency in the secondary market ecosystems and could go a long way to protect investors’ funds and assets from being misused by the trading member as they would no longer be in the custody of the broker. The investors could also benefit from the reduced burden on them to transfer the funds to the stock broker as well as the interest accrued on the funds in their savings account as the money is not being transferred to the broker, but merely being blocked in the same account.
SEBI’s move to provide this facility at the option of the investor is laudable since the same can run parallelly to the existing mechanism to cater for any contingencies. However, in making this facility optional for the stock broker, it is unclear whether such a move would be fruitful since the ASBA-like facility threatens the broker’s earning mechanisms, thus disincentivising it to provide the same to its clients.
III. Upstreaming and Safeguarding of Clients’ Funds Placed with Stock Brokers/Clearing Members
To ensure that clients’ funds are not retained by stockbrokers or clearing members, the Board approved a proposal to introduce a regulatory framework on upstreaming of clients’ funds by stock brokers and non-bank clearing members (CM) to clearing corporations (CC) on End of Day basis. As per this model, the stock brokers will place the clients’ entire funds with the CM with segment wise, Unique Client Code wise allocation of collateral. The CM would in turn place these funds with the CC, allocated against the concerned client, which shall be marked as cash collateral against the respective clients. Surplus funds received by stockbrokers from clients are withdrawable on an immediate basis and therefore, these should be deposited with the CC on an “as is” basis.
Further, any pay-out request by clients made prior to 6 pm are to be honoured by the broker, CM and CC within the same day. In terms of the brokerage and other charges, the stock broker has to now perform client wise daily reconciliation and deduct only the required respective brokerage and statutory charges prior to upstreaming of clients’ funds to CC at end of the day. The contract note sent to clients must mention all the relevant charges levied to the client.
The approved framework will aid in mitigating fund-related risk and misuse of investors’ funds by any intermediary by mandating daily upstreaming of all investor funds from stock-brokers and CMs to CCs. The framework will be implemented in two phases and shall not be applicable to Bank-Clearing Members including Custodians that are banks, and for proprietary funds of stockbrokers/clearing members in any segment.
IV. Prevention and Detection of Fraud or Market abuse by stock brokers
SEBI had released a consultation paper on February 07, 2023 for providing that intermediaries should have a mechanism to prevent fraud and market abuse. Different measures have been approved by SEBI for the said purpose for stockbrokers. Some of them include the senior management of the stock broker being held responsible, robust automated trade surveillance system being executed, reporting of suspicious trading activities and having a whistle blower policy without any retribution. An indicative list of common fraudulent activities and measures to counter them is also provided.
It is based on the industry best practices being followed by the stock brokers, from the on-boarding of the client like KYC processes to the execution of trades in unusual patterns. It will help in eliminating common fraud and market abuse practices.
V. Regulatory Framework for Index Providers
SEBI approved the introduction of a regulatory framework for index providers. The salient features of the framework include, mandatory adherence to the ‘Principles for Financial Benchmarks’ released by the International Organization of Securities Commissions (IOSCO) to promote the reliability of market indices, ensure quality and set out governance mechanisms; having a minimum net worth of Rs. 25 crores; having a minimum track record of 5 years of index administration OR two employees each having an experience of a minimum of 5years of conducting the business of an index provider; having an oversight committee for the review of existing index design, proposed changes to index methodology, examination of whether the said methodology reflects the description of the index and supervision over audit results and implementation of observations; etc.
While proposing a regulation for all index providers basis the location of the users of the index concerned, the Board Meeting decision does not delineate whether users that are unknown to index providers would also be considered for the determination of applicability. Further, subjecting foreign index providers to regulation and a minimum net worth requirement may directly impact Indian investors’ ability to access low-cost investment products, such as index funds or exchange traded funds.
VI. Framework for “Corporate Debt Market Development Fund” Backstop Facility for specified Debt Funds
The creation of a ‘Corporate Debt Market Development Fund (“CDMDF”) was first ideated by SEBI in 2020 after high-profile defaults rocked the domestic debt market. It is a welcome move to boost liquidity in uncertain and challenging times such as major defaults or COVID-19, where default percentages had risen to about 4.5%.The fund would be established in the form of an AIF with different AMCs contributing a certain amount, with SBI Mutual Fund in charge of the AIF. The access to the fund would be in proportion to the contribution made by the AMCs.
It would not only boost investor confidence but also the provide corporates which don’t have the resources to mitigate rollover risk in the repayment of these bonds through re-issuance. Providing this liquidity to the market would help in preventing price crashes of bonds and provide an impetus to the growth of the corporate bond market.
VII. Role and Obligations of Mutual Fund Trustees and Board of AMC
SEBI identified the core responsibilities of the Trustees of MFs, for these core responsibilities, they should conduct an independent assessment and due diligence for matters such as assessing the fairness of fees and expenses charged by the AMC, undue influence by sponsor, associates, mis-selling to increase AUM, valuation of the AMC, etc. While Trustees would have to devote their time and attention to fulfilling their core responsibilities, it was proposed that Trustees may rely on audit firms, legal firms etc to carry out due diligence on behalf of the trustees for matters pertaining to policy of empanelment of stock broker by the AMC, assessing whether the AMC is managing the operations of MF independently from other activities, etc. Further, the structure of the trustee was proposed to be changed from the Board of Trustees structure to the Corporate Structure. Other proposals include enhancing the accountability of the board of AMC, constitution of a “Unitholder Protection Committee” under the AMC Board, among others.
While the proposal to highlight the core responsibilities of the Trustees is good, it is advisable that “valuation of securities”, particularly of debt securities should be included in the core responsibilities. Further, the list of responsibilities of Trustees for which third party fiduciaries can render their services could also be expanded to include responsibilities such as keeping a check on the conflict of interest that could arise between the associates of the AMC and the unitholders, ensure that there is no mis-selling to increase the assets under management and valuation of the AMC, etc.
VIII. Review of Regulatory Framework for Sponsors of a Mutual Fund
Over the past few years, private equity players (PEs)have been allowed to act as sponsors of real estate investment trusts, in the insurance industry, etc. PEs have significant capital which can be invested to drive innovation and growth, consequently leading to constructive competition in the MF industry. With a view to enable the entry of PEs into the MF industry, SEBI has proposed an alternate-eligibility-criteria wherein a sponsor would have to capitalize the AMC in a manner, that the positive liquid net worth of the AMC is not less than Rs. 150 Crores. In addition to this, the minimum positive liquid net worth would have to be Rs. 100 Crores and the AMC would have to maintain such net worth till it has profits for five consecutive years. Further, the minimum capital contributed and minimum sponsor stake of 40per cent would have to be locked-in for a period of five years.
While, on one hand, SEBI’s proposal to make the MF industry more inclusive is laudable, however, on the other hand, the networth-based eligibility criteria prescribed by SEBI defeats this purpose by invariably erecting high entry barriers for interested players.
Further, SEBI had observed that as MFs mature, AMCs acquire self-sufficiency and maturity in running its operations in the interest of the unitholders, thereby gradually reducing the sponsors’ obligations. Considering this, SEBI has proposed for a reduction of ownership of the sponsor in the AMC over time from the current requirement of 40 per cent and has floated the idea of a self-sponsored AMC without any sponsor. A reduction of the sponsor’s stake in the AMC will pave way for other significant shareholders, bringing in strategic guidance, inclusivity, and good talent to fuel growth and innovation in the MF industry. Overall, SEBI’s proposals will go a long way in achieving fresh capital injection, encouraging and fostering competition and innovation, enabling new players to enter the MF space and providing an exit option to sponsors of AMCs.
IX. Amendments to SEBI (Listing Obligations and Disclosure Requirements) Regulations to facilitate more comprehensive and timely disclosures.
Listed companies are required to ensure adequate and timely disclosure of material information/events to investors to maintain transparency and fairness in the market. However, there has been an increase in complaints received by SEBI regarding non-compliance, inadequate or delayed disclosures by companies.
Broadly, SEBI has decided to i) expand the list of deemed material events that have to be mandatorily disclosed; ii) provide different timelines for disclosure of events and iii) curtail the discretion that is presently enjoyed by companies in determining whether a particular information/event would be material enough to be disclosed to the public.
- Introduction of a quantitative threshold to determine materiality of events:
A quantitative threshold to determine the materiality of events with respect to information/events which do not fall in the category of deemed material events. Events whose threshold value or expected impact in terms of value is more than the lower of either 2% of turnover, or 2% of net worth, or 5% of the 3 year average of the absolute value of profit/loss after tax, as per the last 3 audited financial statements of the company, will have to be disclosed.
- Reduced timelines for disclosure
Disclosures for material events for which decision has been taken in the meeting of board of directors have to be made within 30 minutes of the conclusion of the board meeting; and disclosures for material events emanating from within the listed entity are to be made within 12 hours.
This decision appears to disregard the fact that material events may require time to be identified and thereafter escalated from the ground-level employees to the compliance officer for appropriate action. A drastic time constraint such as the one proposed may lead to hasty disclosures with redundant information being disclosed or material information being left out.
- Verification of Market Rumors
The Board approved the proposal mandating verification, confirmation, denial or clarification, as the case may be, of market rumors by the top 100 listed entities by market capitalization effective from October 01, 2023 and by the top 250 listed entities with effective from April 01, 2024.
We are of the view that this may lead to premature disclosures or leakage of trade secrets and may hamper ongoing business negotiations of companies. Further, it is impossible for entities to keep a tab on every rumor surrounding them and to outrightly confirm or deny such rumors at the same time. If implemented, the ambit of 'mainstream media' should be defined to provide clarity on which platforms, print media and news broadcasting channels would fall within its scope.
- Strengthening corporate governance at listed entities by empowering shareholders
SEBI observed that a listed entity has to ensure equitable treatment of all shareholders. In pursuance of this, the following decisions were taken by the board to protect the interest of minority shareholders:
- Shareholders should give their approval once in every 5 years for any special right(existing/proposed) granted to a shareholder of to a listed entity. Such special rights shall be renewed every 5 years on approval of the other shareholders.
- Introduction of new provisions in order to regulate such sale, disposal and lease of any undertaking of the company. These provisions would require entity to disclose the object and commercial rational behind the sale, disposal or lease to the shareholders, acquire approval of majority of public shareholders, etc.
- All directors appointed to the board of a listed entity need to go through periodic shareholders’ approval process. This shall substantially address the concerns around grant of board permanency by listed entities to certain selected persons.
- Streamlining timelines for submissions of first financial results by newly listed entities:
Regulation 33 of the LODR Regulations states the timelines within which listed entities have to submit their financial results. In cases when companies get listed close to the timeline prescribed for submission of financial results, they would be required to announce the first financial results within a very short period of time post listing. Since the financial results are price sensitive information, such disclosures immediately post listing may have large impact on the company’s share price. For this reason, the board decided that a time period of 15 days may be provided for newly listed entities for disclosure of first financial results.
- Timeline to fill up vacancy of directors:
Regulation 17(1) and Regulation 25(6) of the LODR Regulations, specifies the composition of board of directors for the listed entity and timeline within which an independent director who resigns or is removed should be replaced. However, there is no timeline prescribed for filling up vacancies of independent directors for reasons other than resignation and removal and further, there is no timeline for filing up vacancies for directors other than independent directors. Given the importance of the role of directors, SEBI decided that a new provision wherein any intermittent vacancy of a director shall be filled up in not less than 3 months from the date of vacancy.
X. Changes to the SEBI (Issue of Capital and Disclosure Requirements)Regulations, 2018 (“ICDR Regulations”) for transparency and streamlining processes.
- Underwriting process for public issues
There are two kinds of underwriting which take place for any issue: ‘soft’ and ‘hard’. Soft underwriting pertains to technical rejections, whereas hard underwriting is related to underwriting for under-subscription due to shortfall in demand. Currently, the ICDR framework does not differentiate between the two and there is no disclosure requirement for the underwriting agreements to the investors.
Thus, SEBI has approved in the board meeting to amend the ICDR Regulations to bring in a change, introducing a difference between underwriting done for technical and under-subscription reasons. Further, it has also proposed to disclose the underwriting agreements to the public at the time of filing the red-herring prospectus, specifying the nature of the agreement.
-Pre-conditions for announcing bonus issue by a listed entity and its issuance in demat form
Some issuers were announcing bonus issues even when they had not received in-principle approval of listing from SEBI and trading approval from stock exchanges. It becomes an issue for future issuances as well as there is a mismatch in issued and listed shares. Therefore, the in-principle approval has been approved as a precondition for a bonus issue. Further, since almost 99% of bonus issues are made in the demat mode, it has been made mandatory for all bonus issues to be made in a dematerialized form only.
XI. Proposal for introduction of the concept of General Information Document (GID) and Key Information Document (KID), mandatory listing of debt securities of listed issuers and other reforms under the NCS Regulations
SEBI observed that issuers spend a lot of time, effort and cost in preparing voluminous/comprehensive placement memoranda for multiple issues in the same year and this acts as a deterrent for the securities market. Thus, to do away with multiplicity in filing of placement memoranda and to promote ease of doing business, SEBI proposed to introduce the concept of General Information Document (GID) and Key Information Document (KID).
A GID shall contain the information and disclosure specified in the schedule and shall be filed during first issuance with the stock exchanges and will have a validity for the period of one year. Any subsequent filings within the validity period would require only a KID to be filed with the stock exchange which shall contain the material changes.
Further, to bring in parity and ensure standardization in the process, it was proposed that a common schedule be issued to mandate disclosure of the various expenses incurred in the issuance of debt securities and non - convertible redeemable preference shares, whether issued on private placement basis or through a public issue process, in terms of the NCS Regulations and circulars issued.
These proposals will facilitate ease of doing business by saving time cost and effort. Further, this decision bridges the information gap between disclosures in a private placement document and a public issue document. With the recent increase in the number of investors registering on online bond platforms to buy bonds, it is imperative that there is no information gap and the debt issuances are made in a more efficient manner.
XII. Compliance Period for Large Corporates to meet their Financing Needs
The requirement for Large Corporates to meet their financing needs from debt markets through issuance of debt securities to the extent of 25% of their incremental borrowings were made applicable on a ‘comply or explain’ basis until a contiguous block of two financial years. SEBI has now decided to extend this ‘comply or explain’ period to a contiguous block of three years.
XIII. Corporate Governance norms for a High Value Debt Listed Entity
Vide notification dated September 07, 2022, LODR Regulations were made applicable to HVDLEs, i.e. a listed entity which has listed its non-convertible debt securities and has an outstanding value of listed non-convertible debt securities of Rs. 500 crore and above. Such HVDLEs were determined as on March 31, 2021. The LODR regulations further states that in case an entity triggers the specified threshold during the course of the year, it shall ensure compliance with the provisions of corporate governance norms within 6 months from the date of such trigger. The said provisions were made applicable on a ‘comply or explain’ basis until March31, 2023 and on a mandatory basis thereafter. In its Board Meeting dated March 29, 2023, SEBI has decided to extend the ‘comply or explain’ period for the HVDLEs in respect of corporate governance norms (i.e. regulation 16 to 27 of LODR Regulations) till March 31, 2024.
XIV. Overhauling the Regime for Alternative Investment Funds (AIFs)
Multiple measures have been recommended to streamline and ease investing in India using AIFs:
- Valuation Policy:
There is no standardized valuation policy or approach for valuing assets of an AIF. In the consultation paper, SEBI had recommended adoption of IPEV Guidelines, which are most widely used in the industry. SEBI has also approved the eligibility criteria for the appointment of independent valuers. Further, the requirement of an independent valuer has been approved for Cat III AIFs as well for unlisted securities and listed debt securities. Lastly, taking inspiration from the MF Regulations, the investment managers have been made responsible for carrying out valuation of securities and providing adequate disclosures.
- Carrying forward units of an AIF
Currently, there are 2 options for AIFs at the time of expiry of tenure of the scheme: A. In Specie Distribution of Assets and B. Liquidation of Fund Investments, which typically happens via a distress or a fire sale. SEBI has introduced a new option, akin to a segregated portfolio of a mutual fund scheme. This would help in solving the problems of low realizations because of a distress sale.
- Investor Consent for investment in associates
To prevent conflict of interest and put the unit-holders of AIFs in charge of the decisions of an AIF,SEBI has provided for approval of 75% of investors before entering into transactions with associate entities or of schemes managed by or sponsored by the manager or sponsor or an investor who has greater than 50% of the corpus of the scheme of the AIF.
- Dematerialization of units of AIFs:
For administrative and operative ease and preventing fraud or theft of AIF units, SEBI has approved dematerialization of units of an AIF for those AIF schemes which have a corpus of more than INR500 crore.
- Eligibility Criteria for Key Investment Team of Manager and compliance officer of an AIF
For promoting fresh talent, SEBI has approved to replace the existing minimum experience requirement with a comprehensive certification requirement for the key investment team personnel of the manager of an AIF. Further, for providing clarity on the eligibility criterion for the compliance officers, SEBI has also approved certification requirements for them.
XV. Strengthening the Investor Grievance Redressal Mechanism in the Indian Securities Market by harnessing Online Dispute Resolution mechanisms
SEBI has decided to strengthen the existing complaint resolution procedure in the securities market in India by making use of Online Dispute Resolution mechanisms. SEBI stated that it may be useful to specify availability of a hybrid option (mix of online and offline), which serves to address any concern of digital divide including lack of access to suitable devices for initiating such proceedings, low internet speed, low digital literacy, etc.
Further, it was decided that all matters, irrespective of the amount of claim, shall be dealt with by a sole arbitrator and not by a panel. Additionally, the appellate arbitration system will be discontinued. These reforms will aid in reducing the costs for the parties, ease/eliminate the coordination issues in forming a panel and enable availability of a higher number of arbitrators for resolution of matters.
SEBI also decided that for sake of consistency, efficiency and effective redress of investor grievances in the securities market, it would be appropriate to require that all such grievances pertaining to specified securities market intermediaries be governed by the MII administered mediation/conciliation and failing which, the arbitration mechanism would commence. It was also decided that MIIs should partner or tie up with one or more Online Dispute Resolution institutions (ODR Institutions)for undertaking online mediation/conciliation and online arbitration process.
Making online dispute resolution possible for the investor community will truly provide wider access to justice and can provide people with the opportunity and mechanism to have speedy, cost effective and efficient resolution of grievances and disputes. Hence, this decision is welcome, as it will lead to faster processing of disputes.