03 May 2016

3rd Annual Roundtable of Finsec Law Advisors

Finsec Law Advisors and the Association for Development of Securities Market (ADSM) proudly hosted its third roundtable on the 29th of April 2016. This year the focus was on Institutional Investors.  We were also happy to team up with Institutional Investor Advisory Services India Limited (IiAS) and the event was solely sponsored by BSE Ltd.

Investor protection is as crucial for sophisticated institutional investors as for retail investors. Although the tenets of investor protection may differ in range and tenor, an active and informed institutional investor not only safeguards its interests better but can also contribute towards better corporate governance and shareholder value.

The objective of the Roundtable was to bring together financial market experts and
decision makers within the industry and academia for an active, face-to-face discussion on key issues faced by institutional investors in the Indian capital market. The Roundtable, though moderated, took place without a centre of gravity and the wisdom from the discussions will result in an approach papers on issues discussed, which will be shared with policy makers.

01 March 2016

Budget 2016: Financial sector reforms – another day

I have a piece in today's Financial Express on the missed opportunities for capital formation and investment in the budget 2016-17. Attached below is the full piece:

The Budget 2016-17 charts out an ambitious goal as far as farm support and decentralisation up to the panchayat level. The results of that would only be visible only if the various schemes are implemented without excessive leakages.
What is disappointing is the treatment of investments and capital in the Budget. This Budget is unlikely to unleash the powerful and beneficial forces of capital raising and entrepreneurship. So, what are the five areas of concern from the perspective of capital formation?
First is the long-awaited reform in the taxation of alternative investment funds that invest in listed securities. Currently, they neither get the benefit of a passthrough nor do they get the benefit of long-term capital gains available to an investor who invests directly in listed securities. The illogical lack of such benefit means that a person investing in Infosys or other listed stock will pay 0% capital gains tax if held for a year, but if the same investor were to invest through the Sebi-registered AIF, he would pay upwards of 35% tax and harassment for paying even more. This could have been a major source of investment from domestic savers who underinvest.
Second, people were expecting a reform to foreign investment in stock exchanges, which has increased from 5% cap per investor to a 15% cap. From a control perspective, foreign investors would not be interested in such an increase, which raises their capital investment but restricts their ability to control the domestic exchange any further. A 5% control is quite similar to a 15% control in terms of ability to change management. So increasing investment will not look inviting.
Third, the concept of taking away the double taxation for dividend for high net worth investors and promoters means that there is now triple taxation. One, when the company pays corporate tax, two when the company pays dividend distribution tax and three when the investor pays tax. This may be sound rich bashing, but is poor policy for capital formation and investment.
Fourth, public banks are to be capitalised by only Rs 25,000 crore. The NPAs, the real quantum of which is a matter of conjecture, but by all estimates well in excess of that figure will restrict the ability of banks to lend purposefully. Particularly to the infrastructure sector and to the corporate sector in general.
Finally, the many recommendations of the Justice Srikrishna financial sector committee, with two exceptions, have not been announced for implementation. The two sought to be implemented on resolution of financial firms and monetary policy committee were both opposed by many.

22 February 2016

Alternate exchanges

I appeared on The Firm show of CNBC, India discussing the area of alternate exchanges. Here is the link to the show.

17 February 2016

10 December 2015

Exit option to shareholders on change of objects of fund raising in IPO

I have a piece on the Firm website where I discuss the consultation paper on exit being provided to dissenting shareholders where public offer proceeds have not been applied towards the disclosed object. I argue that the Companies Act provision which provide an exit option to shareholders where objects are modified is unwholesome in its application and is wholly wealth destructive for genuine shareholders. Some punters may make some money in the short term in some cases, but broadly everyone loses. Below if the full piece and here is the link to the original article:

"Punters versus The Real Economy
SEBI has come out with a consultation paper on exit being provided to dissenting shareholders where public offer proceeds have not been applied towards the disclosed object.

To provide a brief context, sections 13 and 27 of the Companies Act, 2013 provide that where a company has raised money from the public, and wishes to use part of the funds towards an object not originally stated in the prospectus, then such change of object must be permitted by shareholders by way of a special resolution. In addition, dissenting shareholders are to be provided an exit by the promoters of the company in terms of regulations of SEBI.

The basic premise of the Companies Act in the two sections is that a change of objects for use of funds raised is by itself a dubious activity. It also seems to protect shareholders from such a change by guaranteeing them money back. On the face of it, this does not sound wrong at all. If a company has raised money for a purpose, it must use it for that purpose. But the reality is quite different from the optics.

The world of economics and the competitive landscape for almost every company is a slippery slope. Oil at $100 a barrel versus oil at $37 in a matter of just over a year can make entire industries highly uncompetitive, where they were previously profitable. And of course conversely, many companies would find the dip in oil prices a big bonanza, so that they would like to enter into a business which was previously unattractive. For a company, the price of oil is merely one of the hundreds of variables which make their business viable or unviable. The reality is that these variables, much as we like predictability, vary on a daily basis. Whether it is input costs, change of regulations, number of competitors or many other unforeseen factors.

Now imagine a company which had raised funds for a particular project, say deep sea oil discovery in 2013 or a beer factory in Kerala in 2014. Now imagine what such a company would be looking at in 2015. Funds were raised for a project which has now become unviable because of change in competitive features or regulatory changes. If the oil drilling is done the cost of extraction (say) would exceed the sale price by 30% and in the second case sale of beer locally would be banned and transport costs would ensure that sale outside the state would be unviable.

Now imagine what the promoters of the company would do with the funds raised, assuming that only a small part of the funds raised had actually been invested in the two projects. They can do one of the two things a) continue with the projects and watch the shareholder money go down a certain black hole, but with no liability on the promoters/managers. b) discontinue the project and attempt to invest in a viable sector, but seek shareholder approval and give them an exit option out of the personal funds of the promoters. Clearly, the incentive will be to take the first option given the new Companies Act. Equally clearly, this is a bad outcome for the company, the shareholders and for economy.

While the SEBI discussion paper seems to understand some of the issues, it only subtly talks about them and recommends statutory change. SEBI as a creation of the statute of course rightly does not challenge the statute itself. But, someone ought to- in the national interest. This law is unwholesome in its application and is wholly wealth destructive for genuine shareholders. Some punters may make some money in the short term in some cases, but broadly everyone loses. We really need a discussion paper on the existence of the statutory provisions more than a discussion paper on the logistics of the SEBI norms for providing the exit option to dissenting shareholders."

(Attached is SEBI’s Discussion Paper on “Exit Offer to Dissenting Shareholders)

14 September 2015

We need independence with accountability in financial regulators

I have a face-off opinion piece in today's Business Standard on improving accountability of financial regulators. Independence without accountability is dangerous. Below is the full piece and here is the link to the piece:

Under the new Companies Act, a director is independent, if she is a person of integrity, possesses relevant expertise, and one who is not a promoter besides other requirements
It would be interesting to view the independence of financial regulators by trying to view it through the prism of how directors are considered independent. Under the new Companies Act, a director is independent, if she is a person of integrity, possesses relevant expertise, and one who is not a promoter besides other requirements. There is also a term limit for each independent director. Most importantly, there are also several accountability standards applicable to independent directors.

A more blunt definition of independence for financial regulators would be that it is independent of the government and independent of the politics and politicians who might seek to influence its behaviour. From the perspective of the second definition, the financial regulators are highly independent.

Based on the first definition, the answer is more nuanced. Broadly, all financial regulators possess high integrity, relevant expertise and experience and are relatively uninfluenced by the government. The Reserve Bank of India (RBI)'s hawkish stance on the monetary policy, for instance, is evidence of that. Top leadership of the regulator has terms, usually three to five years and that keeps limits on their power.

However, the integrity of the regulators has a missing twin. And that is accountability. Not only is accountability weak with some financial regulators but this lack of accountability often flows from the over-confidence of its integrity and expertise. The classic example of this weak accountability is the way payment bank licences were handed out as if alms were distributed.
In a rule of law country, if eligibility of standards is set, it cannot be open to give a licence only to some people who meet the standards. It must be given to all who qualify. The only reason RBI can get away with it is because hardly anyone suspects foul play. The award is wrong but it is also objective and uninfluenced by politics or money.
Similarly, Sebi's investigations are carried out with a gun on the head of witnesses asked to furnish information in a day or even half a day. These excesses are tolerated, but we do need independence coupled with accountability for true independence of regulators.

21 August 2015

Related Parties - Listing agreement versus Companies Act, 2013

My colleague and I have a piece on The Firm website on the inconsistencies of listing agreement with Companies Act with respect to Related Parties  and reforms which are required to be done by SEBI.
The full piece is copied below.

The Companies Act, 1956 (“Companies Act”) and the Listing Agreement both set out different requirements for related party transactions (“RPT”). While the former applies to all companies, the latter applies only to listed companies. 

The Definition of Related Party
The Companies Act provides a definition for the term “related party” whereby a list of nine parameters have been prescribed to determine whether a particular entity is a related party. However, under the Listing Agreement, SEBI has prescribed additional parameters, apart from those specified in the Companies Act. Under Clause 49 (VII) (B) of the Listing Agreement, listed companies must also consider the parameters set out under the applicable accounting standards to determine whether a particular entity is a related party.  

The Indian Accounting Standard 24 (“IndAS 24”) deals with related party disclosures. Transactions with such entities will have to meet the higher standards and obligations set out in the Listing Agreement. The table below contains a comparison of the definitions of related party under the Companies Act and IndAS 24:

Section 2(76) of the Companies ActIndAS 24
(i)    a director or his relative;
(ii)    a key managerial personnel or his relative; 
(iii)    a firm, in which a director, manager or his relative is a partner; 
(iv)    a private company in which a director or manager is a member or director; 
(v)    a public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up share capital;
(vi)    any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
(vii)    any person on whose advice, directions or instructions a director or manager is accustomed to act:
(viii)    any company which is
a. holding, subsidiary or an associate company of such company; or 
b. subsidiary of a holding company to which it is also a subsidiary;
(ix)    such other person as may be prescribed;
a)    A person or a close member of that person’s family is related to a reporting entity if that person:
i.    has control or joint control over the reporting entity.
ii.    has significant influence over the reporting entity.
b)    An entity is related to a reporting entity if any of the following conditions apply: 
i.    The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).
ii.    One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
iii.    Both entities are joint ventures of the same third party.
iv.    One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
v.    The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.
vi.    The entity is controlled or jointly controlled by a person identified in (a).
vii.    A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).

The threshold prescribed under IndAS is essentially for determining disclosures and auditing. For the purpose of disclosure, the standards are of course very broad, as they ought to be.  Adding this standard to the Clause 49 standard is adding to the length of the definition and making it more burdensome, overlapping and confusing for listed entities. The definition within the Companies Act is easier to understand and adequate for the task at hand. SEBI should consider excluding the accounting standards from its definition of ‘related party’.

Voting rights of Related Parties
Under the Companies Act, the prior approval of the board of directors of a company is required for a RPT relating to any of the seven subject matters listed therein. It must be noted that rules made under the Companies Act state that directors who are interested in the RPT shall not participate in the meeting considering its approval. 

Further, the Companies Act requires prior approval of the company’s shareholders, by way of ordinary resolution, if abovementioned transactions are beyond the prescribed monetary thresholds. The Companies Act itself states that no member of the company who is a related party shall vote on such a resolution to approve any RPT, if such member is a related party. The Ministry of Corporate Affairs, vide Clarifications dated July 17, 2014, clarified that this restriction only applies to such related parties which may be related in the context of the RPT for which the resolution is being passed. As a result, other entities that fall within the parameters of related party but are not directly involved or interested in the transaction can vote on the resolution.

Under the Listing Agreement, material RPTs require the prior approval of the company’s shareholders by way of a special resolution. However, unlike under the Companies Act, it is expressly states that all entities falling under the definition of related parties shall abstain from voting irrespective of whether the entity is a party to the particular transaction or not. 

This inconsistency leads to some peculiar scenarios. We may consider a few hypothetical fact situation to highlight the issues here. Company X is attempting to enter into a transaction with Company Y, a related party. One of the directors and shareholders of Company X, Mr. A is also a related party of Company X but is unrelated to Company Y. He is opposed to the proposed transaction with Company Y as he believes it is not in the company’s interest. As per the Companies Act, Mr. X may vote during the board meeting and the shareholder resolution as he is unrelated to Company Y and is not interested in this transaction. However, under the Listing Agreement, as he falls under the category of related party, he may not participate in the meeting. As he is not directly or indirectly interested in the transaction, we are of the view that there is no reason to restrict him from exercising his vote. 

To take another example. If an independent director of Company X is also an independent director of a Mutual Fund AMC, the Mutual fund would be disbarred from voting even though the director has no interest in the issue at hand. SEBI may consider amending the provision accordingly in order to align it with the position under the Companies Act. Keeping it so broad would only restrict non interested parties (in a particular transaction) from voting and thus harm the interest of the shareholders which SEBI seeks to protect. In some cases, the harm may extend to non-interested parties opposing the vote being barred from voting. This again could not be the intention of SEBI. Restrictions should apply only where a person or its related entities are interested in that transaction.