India has been one of the fastest-growing economies in the world in recent years. Over time, it has also proved to be one of the most resilient global markets and, during the past 12 months, the stock markets have been trading at the highest level for several years.
i Financial year 2017–2018
There was a significant increase in the capital market activity in India during the 2017–2018 financial year (Fiscal 2018), both in the number of companies accessing the primary market and the amount mobilised. As many as 231 companies accessed the primary market, raising 1,102.69 billion rupees through public and rights issues of equity and debt instruments, as compared to 134 companies raising 621.35 billion rupees during Fiscal 2017.2
Within the public issue market, 201 companies3 made initial public offerings (IPOs) of equity shares, partly convertible debentures or fully convertible debentures, raising 836.84 billion rupees. Listed companies raised 214 billion rupees through issues of shares to their shareholders on a rights basis.4 The vast majority of capital raised during Fiscal 2018 was through private placement by listed companies5 (1,267.29 billion rupees).6 A number of promoters (i.e., the principal shareholders) of listed companies also availed of offer for sale (OFS) through stock exchange mechanisms to raise an aggregate 170.85 billion rupees.
Unlike the equity markets, there was a significant dip in the domestic debt market. Public issues on the debt front registered a 82.36 per cent decrease in Fiscal 2018 compared to Fiscal 2017, raising 51.73 billion rupees. Similarly, listed bonds issued on a private placement basis aggregated 5,991.47 billion rupees,7 a decrease of 6.49 per cent from Fiscal 2017.
ii General introduction to the legal framework for capital markets
The principal statutes governing capital markets in India are the Companies Act, 2013 (the Companies Act), the Securities Contract Regulation Act, 1956 (SCRA), the Securities and Exchange Board of India Act, 1992 (the SEBI Act) and the various rules and regulations made thereunder. Investments in the Indian securities markets by non-resident investors are governed by the Foreign Exchange Management Act, 1999 (FEMA). The Reserve Bank of India (RBI), India's central bank, regulates foreign investment through various regulations and notifications.
The Companies Act is the fundamental statute that empowers a company to issue securities. It is a recently enacted legislation that has, for the most part, replaced the Companies Act, 1956.
Until recently, the Companies Act, unlike its predecessor, contained detailed provisions regulating various aspects of capital markets, which unfortunately resulted in a multiplicity of rules and regulations. Illustratively, unlike the Companies Act, 1956, a company proposing to make an IPO of its shares or convertible securities, in addition to complying with the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 20098 (the SEBI ICDR Regulations), was also required to comply with the Companies (Prospectus and Allotment of Securities) Rules, 2014 (the Allotment Rules), which stipulated various additional disclosures, including details pertaining to the source of funds of the promoter's contribution to the IPO. These additional disclosure norms made compliance more onerous and cumbersome. However, the Companies Act was amended on 7 May 2018 to eliminate the disclosure requirement under both the Companies Act and the Allotment Rules.
Nevertheless, the Companies Act continues to stipulate the penalties for untrue statements or material omissions made in a prospectus, which are stringent, and include, in certain instances, mandatory imprisonment. Despite the stringent nature of the penalties under the Companies Act, investors have generally sought recourse against errant companies under the SEBI framework.
In addition to public offers, the Companies Act also regulates the private placement of securities (i.e., issues of securities to up to 200 persons other than qualified institutional buyers9 (QIBs) and employees entitled to shares under a stock option scheme). The exemption to QIBs and employees was not available under the Companies Act, 1956, which provided that any issue of securities to more than 49 persons would be deemed to be a public issue.
SCRA and SEBI Act
The SCRA governs the establishment and functioning of the stock exchanges and their members, and prescribes the criteria for the listing of securities. In addition, it prescribes listing requirements, including stipulating minimum public shareholding norms, and regulates contracts in securities.
The SEBI Act established the Securities and Exchange Board of India (SEBI) as the securities market regulator to protect the interests of investors in securities and to promote the development of the securities market. SEBI is also vested with the powers of a civil court to resolve capital market disputes.
SEBI may, in the interests of investors or the securities market, either suo motu or on a complaint, investigate any matter concerning a listed company, its promoters or any other person, and may take action against such persons – for example, levy penalties, prohibit persons from accessing the capital market, suspend a company's securities from trading on the stock exchanges or even sentence offenders to imprisonment.
The appellate authority from a SEBI ruling is the Securities Appellate Tribunal (SAT). The Supreme Court of India is India's highest judicial authority and the court of final appeal.
Historically, SEBI has been extremely protective of retail investors, mostly as a result of the lack of investor awareness in India. SEBI's regulatory policy continues to be centred on the protection of retail investors.
Apart from adjudication of disputes, SEBI also has a concept of 'informal guidance', a process through which any person who has a question regarding the interpretation of the law relating to capital markets or who wishes to get SEBI's affirmation to any proposed transaction may write to SEBI seeking guidance or clarification. SEBI then responds in writing with its views. While the views given by SEBI are informal and do not establish precedent, they do indicate the regulator's perspective.
SEBI ICDR Regulations
The SEBI ICDR Regulations, inter alia, govern the public issue and private placement of equity share and convertible securities issued by listed or to-be-listed companies in India. The regulations prescribe, inter alia, the eligibility criteria for a company proposing to list its equity shares or convertible securities, the disclosures to be made in an offer document, lock-in of such securities and the pricing guidelines applicable to listed companies for making a private placement of securities.
The offer document for a public issue must be filed with SEBI for its observations and the issue may open for subscription only on receipt of SEBI's clearance.
SEBI (Issue and Listing of Debt Securities) Regulations
The SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (the SEBI ILDS Regulations) provide an enabling framework for the listing of non-convertible debt securities in India. Under these regulations, the listing of non-convertible debt securities issued to the public is mandatory. Privately placed non-convertible debt securities may also be listed by complying with the regulations.
The SEBI ILDS Regulations provide for disclosures in the offer document that are identical for the listing of debt securities by issue to the public or on a private placement basis. Juxtaposed with the SEBI ICDR Regulations, under the SEBI ILDS Regulations, the offer document for an issue of debt securities does not require clearance from SEBI.
SEBI (Listing Obligations and Disclosure Requirement) Regulations
The SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015 (the SEBI Listing Regulations) provide the broad principles governing disclosures obligations and corporate governance norms to be followed by listed companies. The SEBI Listing Regulations also list, inter alia, the provisions for reclassifying promoters of a listed company, mandatory disclosure of related party transactions, and disclosure of events or information that may be material or price sensitive.
The law relating to investment in the Indian securities markets by non-resident investors is governed by the FEMA, which empowers the RBI to formulate rules and regulations in respect of foreign exchange transactions. The government acts through the Department of Industrial Policy and Promotion of the Ministry of Industry and Commerce, which formulates the policy on foreign investment.
II the YEAR IN REVIEW
Some of the key developments in the Indian capital markets during Fiscal 2018 are discussed in this Section.
i Developments in the capital markets
SEBI has strengthened the corporate governance framework towards enhancing transparency in operations of listed companies, while simultaneously expanding the investment avenues available to foreign investors. Some of the salient developments are outlined below.
Strengthening the corporate governance regime
In a step towards enhancing the standards of corporate governance of listed companies in India, SEBI has set up a committee to advise on issues such as improving safeguards and disclosures pertaining to related party transactions, ensuring independence in the spirit of independent directors, and disclosures and transparency related issues. The committee recommended a host of immediate and long-term solutions to address existing challenges and gaps in the extant corporate governance framework. The key recommendations were that:
- at least half the board of directors of listed companies comprise independent directors;
- listed companies undertake, at least once a year, a formal programme to update the board of directors on changes in the applicable law, regulations and compliance requirements;
- listed companies formulate a group governance policy to ensure transparency in the governance of a listed company on a consolidated level;
- listed companies execute an access-to-information agreement with counterparties, including promoters and nominee directors to ensure symmetry in information dissemination;
- SEBI be empowered to act against auditors and other third-party fiduciaries in cases of gross negligence and fraud; and
- SEBI be empowered to grant leniency and offer protection to whistle-blowers.
SEBI subsequently amended the SEBI Listing Regulations, on 9 May 2018. In view of the plethora of changes introduced by the amendment, SEBI has ensured that most of changes will be effective from 1 April 2019.
To ensure greater transparency in the deployment of the issue proceeds, SEBI reduced the threshold for the mandatory appointment of a monitoring agency to any offer exceeding 1 billion rupees (excluding the OFS portion, if any).10
Online filing of offer documents
As part of SEBI's 'go green' initiative and to facilitate operations, SEBI has introduced an online system for filings related to public issues, rights issues, institutional placement programme, schemes of arrangement, takeovers and buybacks.11 Subsequently, from 1 April 2018, SEBI has mandated that the offer and other related documents must be filed only through the online system.
Compensation to retail individual investors
Under the extant public issue process, retail individual investors are mandatorily required to subscribe through the application supported by blocked amount (ASBA),12 which has substantially reduced complaints pertaining to refunds. To deal with instances when an applicant fails to get an allotment of securities and, in the process, suffers an opportunity loss because of a failure on the part of a self-certified syndicate bank to submit bids or process the ASBA application, for example, SEBI has prescribed a policy for compensating investors in these circumstances.13
Foreign portfolio investments
The SEBI (Foreign Portfolio Investors) Regulations, 2015 have been amended to prohibit the issue or transfer of offshore derivatives instruments (ODIs) to resident and non-resident Indians and to entities that are beneficially owned by such persons. Further, SEBI has also prohibited FPIs from issuing ODIs with derivatives as underlying,14 except where the derivative positions taken by the issuer company of an ODI is for hedging the equity shares held by it, on a one-to-one basis. Further, existing ODIs with derivatives as underlying, where the benefit of the exception is not available, must be liquidated on the date of maturity of the ODI instrument or by 31 December 2020, whichever is earlier.
To counter the potential effects of the truncation of the ODI regime, investment limits by FPIs in government securities have been enhanced from 2,751 billion rupees to 3,015 billion rupees. Further, in response to an appeal by the industry, SEBI also eased certain operational norms for FPIs by:
- discontinuing the need for prior SEBI approval for a change in local custodian or designated depository participant; and
- permitting FPIs operating under the multiple investment managers structure to appoint multiple custodians.
SEBI has also broadened the scope of entities that can be registered as FPIs by expanding the list of entities that are eligible to be registered as broad-based funds and sovereign wealth funds.15
International financial services centres
In 2015, SEBI put in place guidelines for setting up international financial services centres (IFSCs) in India.16 The SEBI (International Financial Services Centres) Guidelines, 2015 provided an enabling regulatory framework for the registration and conduct of securities market activities in IFSCs.
In continuation of its efforts to make IFSCs more attractive, SEBI has facilitated participation by FPIs and other eligible foreign investors (EFIs) by doing away with additional due diligence requirements for registration of FPIs and easing the due diligence requirements in the case of EFIs. In addition, SEBI expanded the bouquet of securities that can be traded on the stock exchanges in IFSCs to include derivatives on equity shares of a company incorporated in India, subject to prescribed position limits. Of course, SEBI approval will be required prior to the securities being made available for trading. FPIs are now also permitted to participate in non-agricultural commodity derivative contracts where the transaction is denominated in a foreign currency. The contracts must be settled in cash, based on a settlement price determined on an overseas exchange.
The SEBI Takeover Regulations require promoters of a company to disclose details of their encumbered shares, including non-disposal undertakings (NDUs)17 executed by promoters with respect to the shares held by them. Though the depository system in India provides a mechanism for recording pledge transactions between the lenders and borrowers, currently there is no such mechanism for recording NDUs. SEBI, via a Circular,18 directed the depositories to develop a framework for more detailed disclosures of NDU arrangements. Subsequently, the National Securities Depositories Limited and Central Depositories Services (India) Limited, the depositories in India, amended their by-laws and business rules to stipulate a mechanism for recording NDUs.
Options on commodity futures
In a bid to attract institutional investors, facilitate hedging, enhance liquidity and deepen the commodity derivative market, SEBI prescribed a product design and risk management framework for permitting a trading in options contract with commodity futures as its underlying, subject to, inter alia, the following conditions:
- The underlying of the options contract must be a commodity future that is one of the top 5 future contracts in terms of trading turnover, subject to minimum threshold levels.
- On exercise, the options position would devolve into an underlying futures position.19
As a pilot, SEBI permitted the stock exchanges to launch options with futures contracts as underlying, for only one commodity, with the prior approval of SEBI. Subsequently, the Multi Commodity Exchange of India Limited and the National Commodity and Derivatives Exchange, India's leading commodity derivative exchanges, introduced trading in options with future contracts.
ii Cases and dispute settlement
SEBI's order in the matter of Price Waterhouse (PW) – by which SEBI, inter alia, prohibited entities from practising as chartered accountants in India under the PW banner and from directly or indirectly issuing any certificate of audit of listed companies for a period of two years (the SEBI Order) – attracted a significant amount of interest from commentators as to whether SEBI has jurisdiction to take such actions.20 The SEBI Order considered the role of PW, in its capacity as auditor, in financial irregularities and misstatements in the financial statements of Satyam Computer Services Limited21 (Satyam) from 2001 to 2008. The SEBI Order held, inter alia, that:
- there was gross negligence on the part of the PW entities while carrying out the audit of Satyam;
- there was total abdication by the PW entities of their duty to follow the minimum standards of due diligence and care expected from a statutory auditor;
- the PW entities made fraudulent misrepresentation by giving material representations in their certifications without any supporting documents and these were detrimental to the public investors at large who rely on the said certifications to make their investment decisions; and
- the directions must extend to the audit firms forming part of the PW network.
Consequently, SEBI prohibited 11 Indian chartered accountancy firms affiliated with PW and two partners at those firms from issuing any certificates of audit of listed companies or any compliance certificates for listed companies and intermediaries registered with SEBI for a period of three years from 1 April 2018, in the case of the partners, and for two years, in the case of the entities. The SEBI Order also directs the PW entities to disgorge the audit fees which they earned in their capacity as the auditors of Satyam. The PW entities have preferred an appeal against the SEBI Order before the SAT and the matter is presently pending.
Although not a first in the Indian jurisprudence, the SEBI Order reiterates that an auditor is required to apply an attitude of professional scepticism in his or her audit and notes that the duty of an auditor transcends beyond what is visible to the naked eye. It appears from the SEBI Order that SEBI intends to tighten the regulatory oversight on professionals linked to the securities market, by enforcing the statutory liability that such professionals have towards the persons who rely on their reports.
iii Stock exchanges and central counterparties
India's stock exchanges, in addition to facilitating the issue and sale of securities, are a key medium for the dissemination of information pertaining to listed companies. They follow a T+2 settlement cycle. The stock exchanges are governed by the SCRA and are empowered to make and enforce rules, regulations and by-laws to regulate their operations.
The BSE Limited (BSE) and the National Stock Exchange of India Limited (NSE), one of Asia's oldest stock exchanges, have nationwide trading terminals and are the primary stock exchanges in India.
Gujarat International Finance Tec-City (GIFT IFSC) is India's first IFSC. A stock exchange and a clearing corporation, both promoted by the BSE, have been granted recognition by SEBI for a period of one year. Further, two entities promoted by the NSE have been granted in-principle approval for setting up a stock exchange and a clearing corporation in the GIFT IFSC.
iv Developments in financial year 2018–2019 (Fiscal 2019)
During the first quarter of Fiscal 2018, 43 companies raised an aggregate of 55.68 billion rupees through IPOs and two companies raised an aggregate 1.5 billion rupees through rights issues.22
Some of the regulatory developments in the financial year 2018–2019 (Fiscal 2019) are briefly discussed below. The impact of some of these amendments is yet to be ascertained.
Overhauling the SEBI ICDR Regulations
In a long overdue change, and to bring the extant regulations governing the public issue of securities in India in line with market practice and the regulatory environment, SEBI has proposed replacing the SEBI ICDR Regulations with a new set of regulations.23 The changes are expected to simplify the language and complexities used in the extant regulations, to make the regulations clearer and minimise the ambiguity in interpretation.
The key changes proposed include:
- aligning the definition of promoter and promoter group with the Companies Act;
- disclosure of only consolidated financial statements for a period of three years in the offer documents instead of the current requirement to disclose both stand-alone and consolidated financial statements for a period of five years;
- disclosure of stand-alone financial statements of the issuer company and its subsidiaries for a period of three years on the website of the issuer company and a link to the website to be disclosed in the offer document;
- disclosures pertaining to group companies to be restricted to information about related party transactions and to exclude disclosures relating to financial information and litigations of group companies;
- reducing the requirement of announcing the price band five working days before the opening of the issue to two working days; and
- permitting institutional investors to make up the shortfall of up to 10 per cent in the minimum promoter's contribution in an IPO, without being identified as 'promoters'.
SEBI's jurisdiction over fiduciaries in the securities market
As a backdrop to the SEBI Order in the matter of PW's and SEBI's intent to tighten the regulatory oversight on professionals linked to the securities market, SEBI has proposed overhauling the extant securities law to expressly empower SEBI to regulate third party fiduciaries and the engagement partners of fiduciaries who provide certificates and reports in respect to securities law.24 The term 'fiduciary' has been defined to mean any entity that is a professional or firm, or the limited liability partnership of a professional, that undertakes an assignment under securities law, and includes, but is not limited to, entities such as a chartered accountant, including a statutory auditor, company secretary, valuer and monitoring agency. The term 'engagement partner' has been defined to mean the partner, or any other person in the firm or limited liability partnership, who is responsible for the engagement or assignment and its performance, and for the report or the certificate, as the case may be, that is issued on behalf of the firm or limited liability partnership, and who has the appropriate authority from a professional body, if required.
In addition to introducing the liability of a fiduciary and its engagement partner, or both, the proposal stipulates that the fiduciary and its engagement partner, or both, while issuing certificates or reports, must (1) ensure that a certificate or report is true in all material respects, (2) exercise due care, skill and diligence and ensure proper care with respect to all processes involved in the issuance of a certificate or report, and (3) report in writing to the audit committee of the listed company, or to the compliance officer of an intermediary, or to the trustee of a pooled investment vehicle, as the case may be, of any material violation of securities laws noticed while undertaking the assignment.
While the proposed amendment in its current form should not bring legal counsel within its ambit, the emerging trend and SEBI's long-standing intent has been to bring together all entities involved in the securities market. That said, it appears unlikely that legal counsel will be brought within the ambit of these regulations any time soon.
Reclassification of shareholders
The SEBI Listing Regulations stipulates different conditions for different scenarios in which a promoter of a listed company wants to reclassify itself as a public shareholder, including (1) when a new promoter replaces a previous promoter subsequent to an open offer or in any other manner, or (2) when the entity becomes professionally managed and does not have any promoters. To simplify the process of reclassification, SEBI has proposed to amend the extant Listing Regulations to prescribe a single set of conditions applicable to all situations of reclassification of promoters as public shareholders. The proposed amendment also addresses the lacuna in the extant Listing Regulations where there are multiple and distinct parties classified as promoters, and one of them wishes to be reclassified.
Framework for enhanced market borrowing by companies
In the past few years, the Indian bond market has witnessed a substantial growth in funds raised by listed companies, as compared to funds raised through banks. For the financial year ending 31 March 2013, the ratio of funds raised by companies through banks to funds raised through the bond market was 63:37, whereas for the financial year ending 31 March 2017, the ratio was 49:51.25
In a bid to deepen and develop a liquid and vibrant bond market in India, SEBI has proposed a framework mandating listed companies, fulfilling certain stipulations, to raise 25 per cent of their borrowings through bond markets. The stipulations include the company having (1) an outstanding long-term borrowing of 1 billion rupees or above,26 (2) a credit rating of AA or above, (3) an intention to raise borrowing that has maturity of more than a year, and (4) its securities listed in accordance with the SEBI Listing Regulations. The framework is proposed to be applicable from 1 April 2019 and, from the third year of implementation, the requirement of long-term borrowing is proposed to be tested for a contiguous block of two years.
III OUTLOOK AND CONCLUSIONS
During Fiscal 2018, the Indian economy continued to be resilient, with the Indian capital markets and market indices reaching record highs. SEBI's recent reforms, more particularly easing access norms for FPIs, also augur well for the markets and are a step in the right direction towards maintaining India's robust economic growth. However, with the political instability resulting from the impending general election in Fiscal 2020, depreciation of the rupee against the US dollar and the continuing global rise in oil prices, the Indian stock market may remain uncertain and volatile, at least in the run-up to the general election. However, if past experience is anything to go by, the Indian stock market has generally gained in the year before a general election is held, which has been the case since 1989.27
1 Vishnu Dutt is a partner at Bharucha & Partners. The author would like to thank Ajai Achuthan and Mehul Jain for their assistance in the preparation of this chapter.
2 Securities and Exchange Board of India (SEBI), 'Annual Report 2017–18'.
3 Including small and medium-sized enterprises.
4 SEBI, 'Annual Report 2017–18'.
5 Including qualified institutions placements aggregating 672.57 billion rupees.
6 SEBI, 'Annual Report 2017–18'.
8 There are separate norms and regulations governing issues of debt capital and non-convertible redeemable preference shares.
9 Qualified institutional buyers include mutual funds, venture capital funds, alternative investment funds, foreign venture capital investors, certain categories of foreign portfolio investors and scheduled commercial banks.
10 SEBI (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations, 2017 dated 31 May 2017.
11 SEBI Circular dated 19 January 2018.
12 ASBA is an application for subscribing to an issue, containing an authorisation to block the application money in a bank account.
13 SEBI Circular dated 15 February 2018.
14 SEBI Circular dated 7 July 2017.
15 SEBI Circular dated 15 February 2018 and the SEBI (Foreign Portfolio Investors) (Amendment) Regulations, 2014 (last amended on 5 April 2018).
16 SEBI (International Financial Services Centres) Guidelines, 2015.
17 Non-disposal undertakings are typically undertakings given by a shareholder not to transfer or otherwise alienate the securities and are in the nature of negative lien given in favour of another party, usually a lender.
18 SEBI Circular dated 14 June 2017.
19 SEBI Circular dated 13 June 2017.
20 See https://www.business-standard.com/article/companies/sebi-order-against-price-waterhouse-has-audit-profession-in-a-tizzy-118011101562_1.html and https://www.financialexpress.com/industry/satyam-case-
21 The 'Satyam scam' remains one of the biggest securities markets scams in India, in which the books of accounts and financial statements of Satyam Computer Services Limited were allegedly manipulated to project a much healthier financial position than obtained in fact. The scam highlighted several loopholes in the corporate governance regime, such as abdication by auditors to perform their duty, fraudulent accounting, and failure of independent directors to alert the shareholders and other stakeholders of the alleged improprieties by the company and its promoters.
22 SEBI Bulletin July 2018.
23 The consultation paper dated 4 May 2018 issued by SEBI.
24 The consultation paper dated 13 July 2018 issued by SEBI.
25 The consultation paper dated 20 July 2018 issued by SEBI.
26 Excludes external commercial borrowings and inter-corporate borrowings between a parent company and its subsidiaries.