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SEBI's IFSC Guidelines, Less 'Distress', Quick Disclosures! Capital Markets Sandeep Parekh | Partner
Pragyan Patnaik | Associate
25 March, 2015

  1.  SEBI Budget for 2015-16

    The Board approved the budget, along with the following policy initiatives that may be taken during the FY 2015-16:

    •    Extensive use of technology to ease the investing process in the securities market, e.g., e-IPO, Aadhaar based e-KYC, etc.
    •    Proactive steps to address the financing and listing needs of start-ups with measures like Institutional Trading Platform (ITP), crowd funding, etc. or a separate carve out for them in the ICDR Regulations.
    •    Collaborate with other agencies, empanel more Resource Persons and greater use of social media to enhance investor education and awareness efforts.
    •    Upgrade SEBI website to improve interface of investors and other stakeholders.
    •    Streamline the enforcement process to ensure uniformity and improve internal efficiency of enforcement proceedings.

    Finsec Comment:In light of the greater powers which have been bestowed on SEBI it is seeking to play a larger role and help young entrepreneurs raise funds. SEBI aims to increase retail participation in the capital market, instead of largely relying on domestic and overseas institutions. These long overdue changes will improve the functioning of the securities and investment market. 

    It may be noted that SEBI had released a discussion paper “Revisiting the capital raising process”, proposing the submission of ASBA applications through DPs and RTAs and removal of physical bid-cum-application forms by providing investors the option to fill and sign forms on digital platforms provided by the broker/SCSB/DP/RTA. With regard to non-ASBA bids, the discussion paper proposes a faster mechanism to collect the money from investors through a web based electronic transfer platform viz. NACH provided by the National Payments Corporation of India.

    II.    SEBI Guidelines for International Financial Services Centre

    The Board approved the SEBI (International Financial Services Centres) Guidelines, 2015, following the announcement in the Union Budget 2015-16 on Gujarat International Finance Tec-City (GIFT). The guidelines would regulate financial services relating to securities market in an IFSC created under Section 18(1) of the Special Economic Zones Act, 2005 and matters connected therewith or incidental thereto. 

    •    The entities operating in IFSC will be governed by the overall framework of securities regulations, with certain carve outs as specified in the guidelines.
    •    Indian and foreign stock exchanges, clearing corporations and depositories can set up subsidiaries to undertake the same business in IFSC, subject to certain relaxed norms on shareholding and net worth, etc. Stock exchanges can establish clearing corporations in IFSC. All entities in IFSC will need to comply with the IOSCO principles, Principles for Financial Market Infrastructures (FMIs) and such other governance norms as may be specified by SEBI. SEBI registered intermediaries or recognized intermediaries of foreign jurisdiction can operate as securities market intermediaries through a subsidiary or joint venture company.
    •    The guidelines, inter alia, allow domestic and foreign companies to issue depository receipts and debt securities in IFSC, subject to the Foreign Currency Depository Receipts Scheme, 2014 and the SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2009.  Further, the guidelines provide for listing and trading of equity shares issued by companies incorporated outside India, depository receipts, debt securities, currency and interest rate derivatives, index based derivatives and such other securities as may be specified by SEBI. Non Resident Indian, foreign investors, institutional investors, and Resident Indian eligible under FEMA may participate in IFSC.
    •    Mutual Funds and Alternative Investment Funds constituted in IFSC can invest in securities listed in IFSC, securities issued by companies incorporated in IFSC and securities issued by foreign issuers.
    •    SEBI will be issuing guidance notes or circulars specifying norms and relaxations for implementation of the guidelines. 

    Finsec Comment: The Gujarat International Finance Tec-City (GIFT City), has come up near Ahmedabad and is expected to be the first such centre in India. The proposed norms will help set up capital market infrastructure in such centres with relative ease and lead to greater capital market activities. The guidelines allow foreign firms to raise capital with the designated zone via depository receipts and debt securities. Further, stock exchanges can undertake business with relatively low levels of capital. For instance, a stock exchange can be set up with Rupees 25 crore capital, as against the normal requirement of Rupees 100 crore (though this will have to be raised to Rupees 100 crore within 3 years). Initial capital requirement for a clearing corporation will be Rupees 50 crore, as against the current norm of Rupees 300 crore, which needs to be achieved in three years. The rule restricting ownership of exchanges also seems to be relaxed allowing both credible Indian and foreign exchanges to set up wholly owned subsidiaries in the GIFT City. They have been given 3 years to meet the norms on shareholding and demutualisation. GIFT City, given its infrastructure and cost advantage, will help bring tens of billions of dollars worth of financial services that currently goes to locations outside India, such as the considerable amount of rupee and equity derivatives trading taking place in centres like Singapore and Dubai. However there has to be clarity on issues relating to taxation of these entities operating in the financial special economic zones. Besides the tax regime, there has to be close coordination between the government of India, RBI and SEBI for this important venture to succeed. 

    III.    Conversion of Debt into Equity by Banks and Financial Institutions

The Board approved a proposal, prepared in consultation with RBI, to relax the applicability of certain provisions of the SEBI (ICDR) Regulations, 2009 and the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 to the conversion of debt into equity of listed borrower companies which are in distress, by the lending institutions. The relaxation in pricing will be subject to, the allotment price being in accordance with a prescribed fair price formula and not being less than the face value of shares. Other requirements would be available if conversions are made as part of the proposed Strategic Debt Restructuring (SDR) scheme of RBI. This measure seeks to revive such listed companies and make it simpler for lending institutions to acquire control over the company while restructuring, thereby benefitting all stakeholders.

Finsec Comment: Currently, banks can convert debt into equity in case of bad loans, however there are regulatory issues with regard to distressed listed companies. Under the existing regime, the pricing of conversion of such debt/loan of troubled companies into equity is computed on a minimum price of the 26-week average or 2-week average price of the stock, with the date of CDR approval being treated as the reference date. The relaxation of norms for conversion of the distressed loans of listed companies into equity by banks and financial institutions would help lenders, especially many public sector banks, which have an alarming rate of bad debts/ non-performing assets, to improve their balance sheets. Instead of the existing market pricing formula, SEBI has opted for a fair price mechanism for conversion. However, there is a minimum floor price of par value, which may act as a dampner for many highly distressed situations. This ought to be done away with in a future reform. The easier conversion norms for lenders converting loans of distressed companies into equity will benefit banks and financial institutions since they were converting at a price that was often higher than the market price making the turnaround impossible or very costly. This may result in an increase in corporate debt restructuring. An exemption from the open offer requirement would also help banks change management and control of a badly run company without the costly and often impossible open offer requirement imposed on such banks.

IV.    Review of Continuous Disclosure Requirements for Listed Entities 

SEBI reviewed the requirements relating to disclosures being made by listed entities on a continuous basis to help investors make well informed investment decisions. The Board approved the following changes to the proposed SEBI (Listing Obligations and Disclosure Requirements) Regulations:

•    A listed entity shall disclose all events/ information, first to stock exchange(s), as soon as reasonably practicable and not later than 24 hours of occurrence of event/ information.
•    The outcome of board meetings shall be disclosed within 30 minutes of the closure of the meeting of Board of Directors.
•    In addition to the current requirement of making disclosure at the time of occurrence and after the cessation of the event, updation of disclosure on material developments shall be made on a regular basis, till such time the event/ information is resolved/ closed with explanations wherever necessary.
•    The listed entity shall disclose on its website all material events/ information and such information shall be hosted for a minimum period of 5 years and thereafter as per the archival policy of the listed entity, as disclosed on its website. 
•    The listed entity shall disclose all events/ information with respect to its material subsidiaries.
•    The listed entity shall provide specific and adequate reply to queries of stock exchange(s) pertaining to rumours and may on its own initiative, confirm or deny any reported information to the stock exchange(s).
•    The listed entity shall determine whether a particular event/ information is material, based on the following criteria:
>    the omission of an event/ information, which is likely to result in discontinuity/ alteration of publicly available information; or result in significant market reaction if the said omission came to light at a later date;
>    if the event/ information is considered material in the opinion of the Board of Directors of the listed entity.
•    The Board of the listed entity shall frame a policy for determination of materiality, which shall be disclosed on its website.
•    Rationalization, consolidation, enhancement and categorization of existing list of events into two parts:
>    events which are by nature material i.e., those that necessarily require disclosure without any discretion by the listed entity;
>    events which shall be considered to be material as per the guidelines for materiality, as specified by SEBI.
•    SEBI to specify an indicative list of information which may be disclosed upon occurrence of an event.

Finsec Comment: SEBI noticed that the existing level of discretion given to listed companies to decide which events are material or price sensitive, based on a broad list of material events provided under the Listing Agreement led to voluntary and inadequate disclosures by the listed companies in the securities market. In a measure to strictly monitor compliance with disclosure or listing guidelines, SEBI seeks to convert the same into regulations, whereby non-compliance will be met by strong penal action.  While the move aims to benefit investors and provide them with complete information, it may result in disclosures of a lot of unnecessary information which may not be material, relevant or required for public dissemination. Such disclosures may at times result in loss of trade secrets and interference with confidentiality. Further, companies may find it difficult to ascertain within a day whether an event/ information is required to be disclosed under the vague tests of materiality proposed to be introduced by SEBI. It should be clarified that merely because an information is material, does not impose an obligation to disclose it. Such a requirement would give away a lot of the competitive advantage and intellectual property of a company.

V.     SEBI (Issue and Listing of Debt Securities by Municipality) Regulations, 2015 

The Board approved the SEBI (Issue and Listing of Debt Securities by Municipality) Regulations, 2015, thereby providing a regulatory structure for the issuance and listing of debt securities/ bonds by Municipalities. The proposed regulations provide for public issuance and listing of privately placed municipal bonds and disclosure requirements for prospective issuers. The regulations are in line with the Government of India guidelines for issuance of tax-free bonds by Municipalities.  The regulations will facilitate investors to make informed investment decisions in relation to the bonds issued by such entities.  Some of the features of these regulations are:

•    Only revenue bonds can be issued in a public issue, while private placements can entail general obligation bonds or revenue bonds.
•    Issuers’ contribution for each project shall not fall short of 20 per cent of the project costs, which shall be contributed from their internal resources or grants.
•    Mandatory credit rating, which needs to be investment grade rating in case of public issuances.
•    Minimum tenure of 3 years.
•    Municipality should not have defaulted in repayment of debt securities or loans obtained from Banks/ Financial Institutions, during the previous 365 days.
•    Municipality should not have had negative net worth in any of the last 3 preceding financial years.
•    Banks/ Financial Institutions will be appointed as monetary agencies who will inter alia make periodic reports.

Finsec Comment: SEBI had published a concept paper titled “Proposed regulatory framework for issuance of debt securities by Municipalities” based on the report of the CoBoSAC. The proposed regulations therein permits either the ULB itself or a subsidiary of the ULB created in the form of a corporate municipal entity to undertake the issuance of general obligation bonds or revenue bonds. These guidelines for municipal bodies to raise money from the market will attract large institutional investors and pave way for municipal bonds for infrastructure projects in urban areas. Safeguards have been prescribed to protect investors, such as the issuer should not have a negative net worth and should have an investment grade rating. Revenue bonds will be the only kind of municipal bonds that can be issued through a public offering, as they are serviced by revenues from a particular project or a specific set of projects and, hence, provide greater safeguards to investors. The funds raised can be used only for the projects that have been specified in the offer document. They shall have a separate escrow account for servicing them with the earmarked revenue from the projects. The appointment of monitoring agencies will help keep the public and investors updated on a timely basis as to how the bonds are being serviced and will help to ensure compliance. The proposed regulations provide a clear mechanism for undertaking the issuance of municipal bonds and may play an important role in improving the regulatory conditions that presently hinder such issuances. Unlike government securities, these are not risk free bonds and therefore may not be suited for retail or unsophisticated participants who may assume them to be risk free.

VI.    Amendment to SEBI (Mutual Funds) Regulations, 1996, regarding managing/ advising of offshore pooled funds by local fund managers

As per extant requirements a domestic fund manager can manage an offshore fund, only if, (i) the investment objective and asset allocation of the domestic scheme and the offshore fund are same, (ii) at least 70 % of the portfolio is replicated across both the domestic scheme and the offshore fund, and (iii) the offshore fund should be broad-based i.e., there should be at least 20 investors with no single investor holding more than 25 % of corpus of the fund, etc. Otherwise, a separate fund manager needs to be appointed for an offshore fund. The Board has decided to remove the aforesaid restrictions for managing offshore funds, belonging to Category-I FPIs and appropriately regulated broad-based Category-II FPIs, by a local fund manager who is managing a domestic scheme. 

Finsec Comment: SEBI’s proposal is well-intended and would help domestic fund houses manage greater foreign capital. With the recent Budget announcement that the presence of the domestic fund managers in India will not considered the offshore fund as having a permanent establishment in India, such a measure will help domestic fund managers to effectively manage offshore funds. However certain problems may still remain, for instance, the relationship and transaction between the foreign fund and domestic fund manager may have transfer pricing implications. A higher income may flow to the Indian entity carrying out the fund management activities. The structure may be hit if it appears that the arrangement lacks commercial substance and was primarily designed to secure tax benefits. Generally, investors would prefer that the entity managing the fund is located closer to the jurisdiction in which the asset is present for better management of the asset and associated risks. From a commercial substance perspective, the presence of the fund manager in India may not be a sound justification for an offshore fund.

*This article originally appeared in The Firm.

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