Tag Archives: SEBI

BSE Startup Platform and Revised Listing norms at National Stock Exchange

Many initiatives have been undertaken in the recent years for facilitating direct listing and consequent public trading of startup securities in India. In January 2010, Prime Minister’s Task Force recommended to set up a dedicated stock exchange for small and medium enterprises[2], which eventually led to the genesis of the SME Exchanges, NSE EMERGE and BSE SME platform. In our earlier Handbook on Initial Public Offering: SMEs, we have provided an overview of various SME platforms, benefits of SME listing and SME IPOs, list of documentation and comparatives of fees.

The rationale behind boosting SME listing could be manifold, from the perspective of all stakeholders in the ecosystem, i.e. the investors, growth stage companies, and the exchanges. The biggest impetus would be the greater access to sophisticated investors and wider portfolio base and investment opportunities for investors of both ‘Main Board’ and SME Exchange Platforms. This is also attractive from the perspective of providing exit opportunities to eligible existing investor base. As mentioned by the Managing Director of NSE, Mr. Vikram Limaye, “… a lot of money has been invested in start-ups and some investors in these companies may want to exit in the next 12-14 months…it is only appropriate for them to list in India and give an opportunity for the domestic investors to participate in their growth,”[3]

However, for various reasons, the SME platforms have not taken off or seen the traction that was envisaged during their formation. The eligibility criteria of companies with less than INR 25 crore in equity capital and those which have raised less than USD 4 million in external funding have been often cited to be the most crucial one of them. Many of the Startups[4] would have already raised large amounts of external funding from the now extensive venture capital and private equity fund base. Minimum promoter holding requirement is another set back as more often than not, a post Series B or Series C entity would have a diversified capital table where the initial subscribers’ holding could be much lesser than the required norms, with investors collectively or individually holding largest single block stakes in these companies. However, these companies might still not be matured enough to have met the eligibility criteria of the traditional IPO routes for accessing capital markets.

It is in this background that discussions around revising the listing criteria for Startups started at various levels. On 27 November and 28 November 2018, BSE and NSE, respectively, released the revised norms. We have provided the details of these below.

BSE Notice No. 20181127-23 dated 27 November 2018 on Introduction of BSE “StartUp Segment”.

The applicability seems to be for “Start-up Companies” in the identified sectors of “IT, ITES, Bio-technology and Life Science, 3D Printing, Space technology, E-Commerce, Hi- Tech Defense, Drones, Nano Technologies, Artificial Intelligence, Big data, Enhance/Virtual Reality, E-gaming, Exoskeleton, Robotics, Holographic Technology, Genetic Engineering, Variable Computers Inside body computer technology and other Hi-tech based companies”.

The criteria as notified by BSE are as follows:

  • Company should be registered as start-up with Ministry of Small and Medium Enterprises / Department of Industrial Policy and Promotion (MSME/DIPP). If not registered as Start-up with MSME/DIPP then the company’s paid-up capital should be minimum Rs. 1 crore.
  • Company should be in existence for a minimum period of 2 years on the date of filing the draft prospectus.
  • Preferably there should be an investment for a minimum of 2 years (at the time of filing draft prospectus) in the Company by:
    • Qualified Institutional Buyer or QIB[5]; or
    • Angel Investors/ Accredited Investors[6]
  • Company should have a positive net-worth.
  • Company should not have been referred to National Company Law Tribunal (NCLT) under Insolvency and Bankruptcy Code, 2016.
  • No winding-up petition must have been accepted against the Company by the NCLT.
  • None of the promoters/directors of the Company must have been debarred by any regulatory agency/agencies.

However, in addition to the above, compliance with LODR requirements and Chapter IX of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 [SEBI (ICDR) Regulation] is also mandated, with respect to conditions applicable for listing of SME Companies, viz. minimum application size, number of allottees etc.

NSE Circular No. 2/2018 dated 28 November 2018 on Listing Criteria for the Technology Startups on the SME Platform.

As mentioned in the Circular, “In order to facilitate technology startups with potential growth business model, to raise equity and list on Stock Exchange, NSE has formulated a criteria for listing such technology startups. These listed companies shall be operating within the regulatory framework as specified under Chapter IX of SEBI ICDR Regulations, 2018 and LODR requirements as applicable to SME Exchange.”

The major criteria as listed in the Circular are as follows:

  • As conditions precedent adherence must have been made to the provisions of Securities Contract (Regulation) Act, 1956; Companies Act, 2013; SEBI Act, 1992 and regulations prescribed therein.
  • Company must be incorporated in India under the Companies Act.
  • The post issue paid up capital of the company (at face value) shall not be more than Rs. 25 crores.
  • There must be a 3 years of track record of either:
    • applicant seeking listing; or
    • promoters/promoting company, incorporated in or outside India with at least 3 years of experience in the same line of business and shall be holding at least 20% of the post issue equity share capital individually or severally; or
    • Proprietary / Partnership firm and subsequently converted into a Company
  • Annual revenue of at least Rs. 10 crores and the issuer must have shown growth of at least 20% in the past one year. (Annual growth may be exhibited in the form of number of users/revenue growth/customer base)
  • Net-worth of issuer must be positive.
  • Must meet one of the following criteria:
    • At least 10% of pre-issue capital to be held by QIBs as on the date of filing of draft offer document; or
    • At least 10% of its pre-issue capital should be held by a member of the angel investor network[7] or private equity firms and such angel investor network or Private Equity Firm should have had an investment in the start-up ecosystem in 25 or more start-ups their aggregate investment is more than 50 crores as on the date of filing of draft offer document.

The criteria of minimum QIB, angel network or private equity holding is interesting as this now could give a clear pathway to the Startups from very early stages on who to raise funds from. A diligence on the investors would also become necessary in such scenarios.

  • The Company must not have been referred to the erstwhile Board for Industrial and Financial Reconstruction (BIFR).
  • No petition for winding up must have been admitted by a court against the Company.
  • No material regulatory or disciplinary action by a stock exchange or regulatory authority in the past three years must have been brought against the Company.
  • Further the following disclosures will be required to be made:
    • Any material regulatory or disciplinary action by a stock exchange or regulatory authority in the past one year in respect of promoters/promoting company(ies), group companies, companies promoted by the promoters/promoting company(ies) of the applicant company.
    • Defaults in respect of payment of interest and/or principal to the debenture/bond/fixed deposit holders, banks, financial institutions by the applicant, promoters/promoting company(ies), group companies, companies promoted by the promoters/promoting company(ies) during the past three years. In this regard, an auditor’s certificate shall also have to be provided.
    • Litigation record, the nature of litigation, and status of litigation pending against the applicant company, promoters/promoting company(ies), group companies, or companies promoted by the promoters/promoting company(ies).
    • Status of criminal cases filed or nature of the investigation being undertaken with regard to alleged commission of any offence by any of the Company’s directors and its effect on the business of the company, where all or any of the directors of issuer have or has been charge-sheeted with serious crimes like murder, rape, forgery, economic offences etc.

As may be noted, both the BSE and NSE Notice and Circular refer to the applicability of the SEBI (ICDR) Regulations.

Under Chapter IX of the SEBI (ICDR) Regulations, 2018 certain common criteria, irrespective of the SME Exchange sought to be listed in must be met. These are:

  • the amount for general corporate purposes, as mentioned in objects of the issue in the draft offer document and the offer document should not exceed 25% of the amount being raised in the issue;
  • promoters must hold at least 20% of the post-issue capital of the Company. However, if the post-issue shareholding of promoter is less than 20% then alternative investment funds, foreign venture capital investors, banks, or public financial institutions may contribute to meet the shortfall in the minimum contribution. In any case, the promoter cannot hold less than 10% of the post-issue capital;

This brings back the concerns related to minimum promoter holding as discussed above.

  • the minimum promoters’ contribution as mentioned above shall be locked-in for 3 years; any promoter shareholding in excess of the above shall be locked in for 1 year;

This could be a major concern for QIBs given their internal constraints, for instance, fund exit requirements.

  • apart from promoters’ pre-issue capital, the entire pre-issue capital held by persons other than promoters shall be locked in for 1 year, however this lock in period will not apply to share allotted to employees, shares held in an ESOP trust, and equity shares held by a venture capital fund or alternative investment fund (categories I and II) or foreign venture capital investor, provided that such equity shares must be locked in for a period of at least 1 year from the date of purchase by such investor.
  • entering into an agreement with a depository for dematerialisation of its specifies securities already issued and proposed to be issued;
  • all existing equity share capital must be fully paid up or forfeited;
  • all securities held be promoters must be in dematerialised form;

SEBI’s intent to relax listing norms for Startups seems to be in the pipeline[8] and it remains to be seen whether the realities of the Startup ecosystem are considered and reflected in the revised norms.

Authors: Ms. Sohini Mandal and Mr. Avaneesh Satyang

[1]BSE Circular dated November 27, 2018: Available at https://www.bseindia.com/markets/MarketInfo/DispNewNoticesCirculars.aspx?page=20181127-23

NSE Circular dated November 28, 2018: Available at http://nseindia.com/content/circulars/SME39509.zip

[2] As defined and categorized under the Micro, Small & Medium Enterprises Development (MSMED) Act, 2006

[3] Yuvraj Malik, “NSE in talks with Sebi to tweak start-up listing norms”, as reported in https://www.livemint.com/Companies/giHdsfq86vtiPzngwlQSqL/NSE-in-talks-with-Sebi-to-tweak-startup-listing-norms.html on 2 March 2018

[4] As registered with DIPP under the Startup India Action Plan

[5] As defined in Regulation 2(ss) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018: includes venture capital fund, alternative investment fund, scheduled commercial bank, foreign portfolio investor, et al.

[6] The concept of accredited investor is found in US securities law, which is similar to angel investors in India, only persons meeting the minimum net-worth criteria, professional experience and expertise requirements are recognised as accredited investors.

[7] By angel investor networks, the notice makes reference to angel funds, which are a sub-category of category-I alternative investment funds registered with SEBI, and angel investors are persons who propose to invest in angel funds and meet the net-worth, expertise, and experience criteria as specified under the SEBI (AIF) Regulations, 2012.

[8] PTI News, “SEBI To Relax Listing Norms For Startups, Rename it ‘Innovators Growth Platform’”, as reported in https://www.bloombergquint.com/markets/sebi-to-relax-listing-norms-for-start-ups-rename-it-innovators-growth-platform#gs.U99GjHQ on 9 December 2018

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Case Study: SEBI Settlement Order in the Matter of SREI Multiple Asset Investment Trust (a Category II AIF)

In this post, we look into the Adjudicating Officer’s (“AO”) Order dated November 29, 2017, in the matter of SREI Multiple Asset Investment Trust (“Fund”) and SREI Alternative Investment Managers Limited (“Investment Manager”) and the way the matter proceeded further, leading finally to a settlement on July 25, 2018 under the SEBI (Settlement of Administrative and Civil Proceedings) Regulations, 2014. The AO’s order cannot be considered to be conclusive because of the subsequent settlement order. However, a review of the entire saga provides some insight into how the Securities and Exchange Board of India (“SEBI”) interprets relevant provisions of the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”).

Factual Matrix and Issues Raised before the AO:

The Fund had launched a scheme which was to primarily focus on financing brownfield assets which carries a lower execution risk as compared to greenfield assets. The following issues were dealt with in the proceedings before the AO;

  1. The Fund, instead of making investments of the amount raised from the investors, had gone on to grant loans to several entities, allegedly in breach of the AIF Regulations.
  2. Out of the investible corpus of the Fund, amounts in excess of 25% of the investible corpus were given to investee companies on two occasions, allegedly another breach of the investment conditions prescribed in the AIF Regulations.
  3. The Fund had acted in contravention of the decision of the investment committee of the Fund, and also had failed to follow the investment strategy as specified in their private placement memorandum.
  4. The Investment Manager failed in maintaining the minimum continuing interest of INR 5 crore in the Fund mandated in the AIF Regulations.

Summary of the AO’s order:

In the foregoing paragraphs the arguments on behalf of the Fund/Investment Manager and the reasoning adopted by the AO are summarized:

Issue 1: The defence taken by the Fund/Investment Manager was that the private placement memorandum of the Fund clearly stated that it was the Fund’s investment strategy to invest in forms of finance/loans to various companies. Further, the AO pointed out that the fund was registered as Category II AIF which included a “debt fund” that invests primarily in debt and debt securities. Thus, the Fund was not in contravention of Reg. 2(1)(b) of the AIF Regulations in giving loans as per its investment strategy.

Issue 2:  Reg. 15(1)(c) of the AIF Regulations require the investment commitment to not be more than 25% of the investible corpus of the Fund. According to the Fund, on the alleged date of investment (i.e. June 29, 2015), the investment commitment was indeed only 25%. However, post the investment (i.e. July 9, 2015), due to redemption of units of the Fund and distribution to investors, the total corpus of the Fund fell, and resultantly the investment commitment rose to about 28%. It was argued that since this was just an after-effect of the redemption of units, this was not an infringement of the said regulation. However, the AO ruled that the defence was inadmissible as they themselves had admitted to the investment being in excess of the 25% threshold post July 9, 2015.

Issue 3: According to the minutes of the investment committee of the Fund, and also as mentioned in the Fund’s private placement memorandum, the Fund had decided on the range of interest rates it would charge on their loans (14-16%), and also decided what the corpus of investment for each investee under the scheme would be (INR 50 crore–INR 200 crore). The Fund/Investment Manager took the defence that these ranges were only indicative in nature, and it was not intended that they would be strictly bound by them. However, the AO cited Paragraph 2(c) of SEBI’s Circular No. CIR/IMD/DF/7/2/2015 dated October 1, 2015 which prescribed that all managers shall carry out all the activities of the AIF in accordance with the placement memorandum circulated to all unit holders and amended from time to time in accordance with AIF Regulations and circulars issued by SEBI. It was decided that terms of the private placement memorandum must be complied with without any deviation, unless amended following the due process of law.

The AO here tried to propagate strict compliance of SEBI’s 2015 Circular to safeguard the interests of the investors. However, reference may be made to SEBI’s Circular No. CIR/IMD/DF/14/2014, dated June 19, 2014 which at Paragraph 2(b) states that only in cases of material deviations from the placement memorandum, the manager is bound to provide an exit to the investors. The investors are to be informed of any changes post-facto and are not bound to take prior approval. The strict compliance with placement memorandum that the AO’s order demands needs careful consideration, therefore.

Issue 4: Under Reg. 10(d) of the AIF Regulations, an Investment Manager is required to have a continuing interest in the Fund of not less than 2.5% or INR 5 crores (whichever is lower) in the form of investment. The defence taken was that the contribution of the Investment Manager reduced to INR 3.13 crore after some of its contribution was repaid to it as an investor of the Fund. The AO however decided that the continuing interest requirement had no exception and must be complied with at all times.

Developments after the AO’s order:

Interestingly, regarding the AO’s decision on whether the Fund could give out loans, the final settlement order dated July 25, 2018 published by SEBI indicates a different conclusion. The settlement order was prepared in consultation with the High-Powered Advisory Committee (HPAC) of SEBI. According to the said settlement order, a new show-cause notice dated February 2, 2018 was issued to the Fund for using the investible corpus for the purpose of giving loans.

Further, the Fund and Investment Manager were required to provide an undertaking by way of an affidavit, confirming that they would stop granting loans, the amounts given as loans shall be taken back and, in the future, there will be no loan activity. The reasoning for such conclusion is not captured in the settlement order.

Our Suggestions based out of the matter:

The AO’s order exhibits the strict nature of compliance demanded by SEBI with respect to AIFs in general. The following key suggestions are provided for all Funds and Investment Managers:

  1. It is highly advisable that appropriate protections through indemnities and limiting liabilities are provided in the fund documents for trustees, managers, or settlors. Furthermore, adequate insurance policies to protect the downside from such statutory penalties is also highly recommended.
  2. In light of the strict compliance demanded from the provisions of the private placement memorandum, it becomes increasingly important to draft them with extra attention to the investment strategies that will be adopted and to leave ample flexibility for the manager to execute the same.
  3. The order also reinforces focus and importance of regular monitoring of all regulatory compliances.

Sources:

  1. Order of the Adjudicating Officer, dated November 29, 2017: https://www.sebi.gov.in/sebi_data/attachdocs/nov-2017/1511951662889.pdf
  2. Order of the Securities Appellate Tribunal, dated May 4, 2018: http://sat.gov.in/english/pdf/E2018_JO2017373.PDF
  3. SEBI’s Settlement Order, dated July 25, 2018: https://www.sebi.gov.in/enforcement/orders/jul-2018/settlement-order-in-respect-of-srei-multiple-asset-investment-trust-and-srei-alternative-managers-limited-_39703.html
  4. SEBI’s Circular No. CIR/IMD/DF/14/2014, dated June 19, 2014: https://www.sebi.gov.in/legal/circulars/jun-2014/guidelines-on-disclosures-reporting-and-clarifications-under-aif-regulations_27118.html
  5. SEBI’s Circular No. CIR/IMD/DF/7/2/2015 dated October 1, 2015: https://www.sebi.gov.in/legal/circulars/oct-2015/guidelines-on-overseas-investments-and-other-issues-clarifications-for-aifs-vcfs_30772.html

Authors: Mr. Avaneesh Satyang and Ms. Sohini Mandal

Enhanced disclosure requirements for Credit Rating Agencies

SEBI vide its circular dated 13 November 2018 has tightened the norms for Credit Rating Agencies (CRAs) by enhancing the levels of disclosures required to be made by the CRAs under the SEBI (Credit Rating Agencies) Regulations, 1999 (CRA Regulations). As per the recent circular, the following changes have been brought about:

  1. Under an earlier circular dated 1 November 2016, SEBI had prescribed the standard format for press releases put out by CRAs regarding rating action. Now, specific disclosures must be made in the press release;
    • with respect to rating factors where support from a parent/group/government entity is expected, the name of such entities and the rationale for such expectation to be mentioned.
    • when subsidiaries or group companies are consolidated to arrive at a rating, the names of all such companies, along with the extent of consolidation and rationale for the same to be disclosed.
  2. The above-mentioned press release must also contain a specific section on ‘Liquidity’ with parameters like liquid investments or cash balances, access to unutilised credit lines, liquidity coverage ratio, adequacy of cash flows for servicing maturing debt obligation, etc.
  3. Disclosure of any linkage to external-support for meeting near term maturing obligations must also be made by CRAs.
  4. CRAs may review their rating criteria with regard to assessment of holding companies and subsidiaries in terms of their inter-linkages, holding company’s liquidity, financial flexibility and support to the subsidiaries, etc.
  5. In monitoring of repayment schedules, CRAs to analyse the deterioration in the liquidity conditions of the issuer and also take into account any asset-liability mismatch.
  6. CRAs may treat sharp deviations in bond spreads of debt instruments vis-à-vis relevant benchmark yield as a material event.
  7. CRAs to publish their average one-year rating transition rate over a 5-year period, on their respective websites, calculated as the weighted average of transitions for each rating category, across all static pools in the 5-year period. This shall be adhered during the half-yearly internal audit of the CRAs under the CRA Regulations.
  8. CRAs to furnish data on sharp rating actions in investment grade rating category to Stock Exchanges and Depositories for disclosure on website on half-yearly basis, within 15 days from the end of the half-year (31st March/ 30th September).

Link to source:

https://www.sebi.gov.in/legal/circulars/nov-2018/guidelines-for-enhanced-disclosures-by-credit-rating-agencies-cras-_40988.html

Fund Formation: On-Shore and Off-Shore Structures

Global interest in the LP (Limited Partner) ecosystem, for investments in India focused businesses, is at an all-time high. According to recent surveys, about 108 India focused private equity firms are in the market looking to raise funds. The first half of the year 2018 has been characterized by large value deals as pension funds, sovereign funds and global buyout funds have increased their India exposure (Source: Economic Times).

The positive regulatory changes have influenced the investor preference for pooling of funds both on-shore and off-shore for investing in India focused businesses. Some of the significant statutory/legislative revisions/clarifications, brought in over the last couple of years, are as follows:-

  • Liberalization of foreign direct investment (FDI) in the home-grown alternative investment funds (AIFs) sector in 2015, which now allows 100% investment in AIFs through the automatic route, as opposed to the prior FIPB approval requirement.
  • Down-stream investments by AIFs with FDI is now deemed as foreign investment, only if neither the sponsor nor the manager nor the investment manager is Indian ‘owned and controlled’. This has led to an opening up of choices for many FDI taking AIFs and have also taken away the mandatory obligation of complying with the pricing guidelines for any downstream investment.
  • Clarification issued by the Central Board of Direct Taxes (CBDT) that dividend distribution by off-shore companies with respect to underlying Indian assets would not result in a tax liability since it does not result in indirect transfer of shares.
  • Clarification brought in through the Finance Act, 2017, that indirect transfer tax provisions would not be applicable for capital assets held directly or indirectly by way of investment in Category I or Category II FPIs.
  • Opening up of FDI in limited liability partnerships LLPs and taking away minimum capitalization requirements for investment advisory businesses in March 2017.

[Source: RBI Notifications, CBDT Circular No. 4/2015 and the Paragraph 4 of the Finance Act, 2017]

These changes have led us to consider and advise on various unified as well as co-investment fund structures. Each such structure requires evaluation from compliance and taxation perspective. A very high level overview of some of these structures are given below:-

Direct Investment by an Off-Shore Fund. Also known as a pure off-shore structure, this where an off-shore investment pooling vehicle can pool and directly invest into India portfolio companies, as FDI, FPI or FVCI investment. Few things to be kept in mind for this structure would be:-

  • Spread of LP appetite for India/non-India focused investment;
  • Permanent establishment connotation if the off-shore investment manager is being advised by an Indian investment advisor;
  • Advantage of not having to mirror every investment decision of Indian investment manager.

Indirect Investment through a Unified or Master-Feeder Structure.  The on-shore fund pools investments from Indian investors and the off-shore fund pools investments from global investors and the off-shore fund becomes one of the investors of the on-shore fund, by executing a contribution agreement. Advantages could be as follows:-

  • Indian investors can overcome liberalized remittance scheme (LRS) or overseas direct investment (ODI) or round tripping related restrictions;
  • For global investors, it is easy to invest through an off-shore structure as that helps in operational ease of not having to obtain PAN registration for each investor, not having to report each individual investment with RBI;
  • Global investors still get to benefit from the various Direct Tax Avoidance Agreements (DTAA). For example, continued tax benefits for sale of debentures, lower withholding tax rate of 7.5% for interest income, as available to Mauritius investors under the India-Mauritius DTAA.
  • The investment manager gets to pay on the management fee and carry allocation on the entire fund at the on-shore level.

Co-Investment Structure. This is where, typically, the investment management of the on-shore and the off-shore funds are handled by different entities, in the respective jurisdictions. Advantages would be as follows:-

  • The off-shore fund need not necessarily participate in every investment made by the on-shore AIF.
  • The investment spread between the 2 entities could be decided on a case to case basis, depending on availability of funds.

Taxation from an ‘Association of Persons’ perspective, in India, needs to be carefully thought through while adopting this structure and it is suggested to have completely separated investment committees and managements from this aspect.

Disclaimer: Fund structuring is complex matter that requires a case to case evaluation of investor-base, investor jurisdiction spread, taxation at each investor level, demonstration of level of substance and permanent establishment. The purpose of this article is to disseminate information only and readers are requested to seek profession advice shall for any individual requirement.

M&A through Share Swap/Stock Swap Arrangements

Introduction

A share swap arrangement signifies issuance of a share in exchange for a share rather than remittance of cash consideration. Share Swap arrangements occur when shareholders’ ownership of the target company’s shares is exchanged for shares of the acquiring company as part of any restructuring.

For instance, two companies, A and B, come together to form company C. If the two companies enter into a Share Swap Arrangement, the shareholders of company A can be given shares of company C for every share of company A that they owned. A similar arrangement can be made for company B as well. Now, if such an arrangement occurs between companies wherein the Indian parties are shareholders of the Indian company and the other company is a foreign company, the arrangement would attract both regulations prescribed under the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (the ODI Regulations) and the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 (the FDI Regulations).

Share Swap arrangements can be useful mechanisms to raise investment in the case of an externalisation plan. Externalisation plans involve promoters of Indian entities moving their holding entities outside India (in case more information about externalisation is required, refer to our article on externalisation schemes, which can be accessed at https://novojuris.com/2018/06/24/ externalisation-many-Indian-startups-are-choosing-to-have-their-holding-entity-outside-india/).

In such scenarios, both FDI Regulation and ODI Regulations become applicable owing to the fact that there is a transfer of shares of an Indian company to a person resident outside India and there is an acquisition of shares of a Foreign Company by a resident Indian in the manner. Therefore, an adherence with the applicable FDI Regulation and ODI Regulation is required for the share swap arrangements.

Implications under FDI Regulations

The FDI Regulations would be applicable in the case of a share swap arrangement where any one company to the transaction is non-resident and the transaction becomes eligible to be governed by the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 and Foreign Direct Investment policy (“FDI Policy”) issued by the Department of Industry Policy and Promotion every year. A key thing that has to be kept in mind is that as per the FDI Regulation, the price of shares offered should not be less than the fair market value of shares valued by SEBI registered Merchant Banker.

Reporting Requirements

The FDI policy provides primarily for two types of reporting mechanisms:

  1. one through the filing of an FC-TRS (Foreign Currency- Transfer of Shares) Form by the Indian company which becomes applicable in the case of transfer of shares, where one party is a non-resident and another one being a resident Indian; and
  2. second being through the filing of an FC-GPR (Foreign Collaboration- General Permission Route) Form by the Indian company which becomes applic`able in the case of allotment of-of shares by an Indian Company to a person resident outside India.

General permission has been granted to non- residents to acquire shares from Indian shareholders under swap arrangement, provided that the price of shares offered is not less than the fair market value of shares valued by SEBI registered Merchant Banker. However, in the case of share swap arrangement between the entities whose sector is under Government approval route, prior approval would be required.

Implications under ODI Regulations

As mentioned above, the ODI Regulations would be applicable in the case of a share swap arrangement where any one company to the transaction is non-resident. In case of share swap arrangement under externalization, the shareholders of Indian company who are resident Indians would acquire shares of the foreign company in exchange for their shares of the Indian company. The share swap arrangement under the ODI Regulations would fall under the automatic route unless otherwise prescribed under FDI Regulation. The arrangement would also be subject to the sectoral caps and entry mechanisms as applicable under the FDI Regulation and approvals from the relevant ministries.

Reporting Requirements

The resident Indian shareholders of an Indian company would be required to file Form ODI with the Authorised Dealer Bank for reporting the share swap arrangement. The Form is required to be submitted to the RBI within 30 (thirty) days of making the share swap.

Conclusion

From a regulatory standpoint, the key question which is not clear is whether the share swap arrangement would fall under general permission category of ODI Regulation & FDI Regulation or under the Government approval. While the respective regulations are clear that prior approval is needed only in case if the sector is under approval route as per FDI Policy and FDI Regulation. However, practically it has been seen that the Reserve Bank of India on case to case basis, has insisted upon such prior approval requirement. There is a need for better clarification or notification from the Reserve Bank of India.

Additionally, it is pertinent to note that the ODI Regulation mandates for prior approval of the Foreign Investment Promotion Board (FIPB) which has been abolished in 2017. Now, in case any such approvals are required, the proposals will be scrutinized and cleared by sector-specific departments concerned.

Authors: Mr Spandan Saxena and Mr Ashwin Bhat

Post Formation Compliance Requirements for Alternative Investment Funds (AIFs)

AIFs are privately pooled investment funds in India, typically set up in the form of a trust or a company or a body corporate or a Limited Liability Partnership (LLP). Please see our previous post to read more on a brief introduction to AIFs.

As per the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (the ‘AIF Regulations’), an AIF can be registered in one of the following three categories:

Categories Particulars Type Tenure
Category I Mainly invests in start-ups, SME’s or any other sector which Govt. considers economically and socially viable. Close Ended Determined at the time of application which shall be minimum 3 years.
Category II Private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other Regulator Close Ended Determined at the time of application which shall be minimum 3 years.
Category III Hedge funds or funds which trade with a view to making short-term returns or such other funds which are open-ended and for which no specific incentives or concessions are given by the government or any other Regulator. Open Ended or Close Ended No specific tenure

 

Reporting Mechanism

For proper adoption of the AIF regulations, 2012 the Securities and Exchange Board of India has issued the Operational, Prudential and Reporting Norms for Alternative Investment Funds vide its Circular No. CIR/IMD/DF/10/2013 dated 29 July 2013. Furthermore, in order to ensure conformity with the operational guidelines, the SEBI introduced the “Guidelines on disclosures, reporting and clarifications under AIF Regulations” vide its Circular No. CIR/IMD/DF/14/2014 dated 19 June 2014.

Following are the reporting obligations for all categories of AIF:

  1. As per Regulation 28 of the AIF Regulations, periodical reports (with respect to funds raised, net investments by the AIF, leverage undertaken if any, exposure, categories of investor, etc) shall be submitted by all AIFs to the SEBI with respect to their activity.
  2. Category I and II AIFs and Category III AIFs that do not undertake leverage shall submit a quarterly report with the SEBI as per the Annexure I.
  3. Category III AIFs undertaking leverage shall submit a monthly report with the SEBI as per Annexure II.
  4. As per the Circular No. CIRCULARSEBI/HO/IMD/DF1/CIR/P/2017/87 dated 31 July 2017 the aforementioned reports shall be submitted through the SEBI Intermediary Portal at https://siportal.sebi.gov.in
  5. Such reports shall be submitted within 7 calendar days from the end of the quarter/end of the month as the case maybe.

Further, all AIFs have to comply with the requirements of preparation of a Compliance Test Report (CTR) as laid down below:

  1. At end of financial year, the manager of an AIF shall prepare a compliance test report on compliance (an exhaustive reporting of the AIF’s activities) with AIF Regulations and circulars issued thereunder in the format as specified.
  2. In case of the AIF is a trust, the CTR shall be submitted to the trustee and sponsor within 30 days from the end of the financial year. In the case of other AIFs, the CTR shall be submitted to the sponsor within 30 days from the end of the financial year.
  3. In case of any observations/comments on the CTR, the trustee/sponsor shall intimate the same to the manager within 30 days from the receipt of the CTR. Within 15 days from the date of receipt of such observations/comments, the manager shall make necessary changes in the CTR, as may be required, and submit its reply to the trustee/sponsor.
  4. In case any violation of AIF Regulations or circulars issued thereunder is observed by the trustee/sponsor, the same shall be intimated to SEBI as soon as possible.

Apart from the aforementioned reporting requirements, Category III AIFs have to comply with certain other reporting and compliance norms.

Risk Management and Compliance requirements for Category III AIFs employing leverage

Category III AIFs that employ leverage have to comply with the following risk management requirements:

  1. The AIF should have a comprehensive risk management framework along with an independent risk management function which shall be appropriate to the size, complexity and risk profile of the fund.
  2. Presence of a strong and independent compliance function appropriate to the size, complexity and risk profile of the fund. The same shall be supported by sound and controlled operations and infrastructure, adequate resources and checks and balances in operations.
  3. Appropriate records of the trades/transactions performed shall be maintained and such information should be available to SEBI, whenever sought.
  4. Full disclosure and transparency about conflicts of interest should be made to the investors. Further, how such conflicts are managed from time to time shall also be disclosed in accordance with Regulation 21 of the AIF Regulations and any other guidelines as may be specified by SEBI from time to time. The details of such conflicts shall be disclosed to the investors in the placement memorandum and by separate correspondences as and when such conflicts arise. Such information shall also be disclosed to SEBI as and when required by SEBI.

Redemption Norms for open-ended Category III AIFs

  1. The Manager of these AIFs should ensure that there is a sufficient degree of liquidity of the scheme/ fund so that it meets redemption obligations and other liabilities.
  2. The Manager shall establish, implement and maintain a liquidity management policy and process so that the liquidity of the various underlying assets is consistent with the overall liquidity profile of the fund/scheme while making any investment.
  3. The Manager shall disclose any possibility of suspension of redemptions to the investors in the placement memorandum
  4. Suspension of redemptions shall be justified by the Manager only if such suspension is in the best interest of the investors of the AIF or if such suspension is required under the AIF regulations or SEBI
  5. Operational capability shall be built by the Managers of such AIF so that redemption can be suspended in an efficient manner. No new subscriptions shall be accepted during the suspension of redemptions.
  6. The Manager shall communicate to SEBI the decision of suspension along with the reason for such suspension and the same shall be appropriately documented.
  7. The Manager shall review the suspension regularly and take all necessary steps to resume operations in the best interest of the investors.
  8. It shall be the duty of the Manager to keep the SEBI informed about the actions undertaken throughout the suspension and also the decision to resume normal operations.

Category III AIFs undertaking leverage shall have to comply with the prudential requirements (calculation of leverage, total exposure, etc) as laid down in the Circular.

Compliance requirements in case of breach of leverage limits for Category III AIFs

Category III AIFs shall ensure that adequate systems are in place to monitor their exposure so that the leverage does not exceed at any time beyond the prescribed limits. The AIF shall report to the custodian on a daily basis the amount of leverage at the end of the day (based on closing prices) and whether there has been any breach of limit. Such reporting shall be done by the end of the next working day (as per Circular No. CIR/IMD/DF/14/2014 dated 19 June 2014).

Reporting requirements in case of breach of limit:

  1. AIF shall send a report to the custodian in case of any breach of limit. The custodian shall report to SEBI providing a name of the fund, the extent of breach and reasons for the same before 10 A.M. on the next working day.
  2. A report shall be sent to all the clients stating that there has been a breach in the limit along with reason, before 10 A.M. of the next working day
  3. The AIF shall square off the excess exposure and bring back the leverage within the prescribed limit by end of next working day. However, an action may be taken by SEBI against the AIF under SEBI (Alternative Investment Funds) Regulations, 2012 or the SEBI Act.
  4. A confirmation of squaring off of the excess exposure shall be sent to SEBI by the custodian by end of the day on which the exposure was squared off.

Author: Ms. Alivia Das

Regulatory Update: SEBI- Investment by Foreign Portfolio Investors (FPI) through primary market issuances

SEBI (Foreign Portfolio investors) Regulations, 2014 (“Regulation”) mandated that the purchase of equity shares of each company by a single portfolio investor or an investor group shall be below 10 (ten) percent of the total issued capital of the company. Further the Regulation required that in case the ultimate beneficial owner(s) invest through multiple entities, such entities shall be treated as part of the same investor group and the investment limits of all the entities shall be clubbed as applicable to a single portfolio investment.

SEBI through this circular IMD/FPIC/CIR/P/2018/114 dated 13 July 2018 has ensured compliance of the above, at the time of allotment during primary market issuances. The Registrar and Transfer Agents (RTAs) shall:

  • Use Permanent Account Number (PAN) issued by Income Tax Department of India for checking compliance for a single portfolio investor; and
  • Obtain the validation from the depositories for the foreign portfolio investor who have invested in the particular primary market issuance to ensure there is no breach of the investment limit.

Further the circular also mandates for the depositories to put in place the necessary systems for sharing information with RTAs within the timelines for issue procedure, as prescribed by SEBI.

(Source: https://www.sebi.gov.in/legal/circulars/jul-2018/investment-by-foreign-portfolio-investors-fpi-through-primary-market-issuances_39539.html )