*****A case of regulatory overload – The Hindu BusinessLine

Clipped from: https://www.thehindubusinessline.com/opinion/a-case-of-regulatory-overload/article65454133.ece

SEBI’s new related-party transaction rules will bring myriad challenges for listed entities

A tough law has been made tougher. The recently amended SEBI’s related party transactions (RPT) rules could be a nightmare for listed entities. SEBI, driven chiefly to strengthen corporate governance standards, has tightened the RPT rules.

From April 1, the already stiff rules along with ambiguous provisions of recent SEBI circulars of March 30 and April 8 will only add to woes of listed entities and their related parties.

The scope of related parties and RPT has been broadened. Now, any person (who is not a part of promoter or promoter group) but holds 20 per cent or more equity shares (this limit will be 10 per cent or more from April 1, 2023) will become a related party.

This will mean that even a financial investor in a listed entity (such as a private equity investor) holding 20 per cent or more equity will become a related party, it doesn’t matter what other rights such investor may have.

Further, any person or entity that is part of promoter or promoter group will also be a related party. In these cases, the test of 20 per cent or more shareholding will not apply.

By simply being part of the promoter group will make them related parties. In transactions where on the one hand a listed entity or any of its subsidiaries is involved and on the other a related party of the listed entity or any of its subsidiaries will also come within the ambit of RPT.

This was done to stop listed entities from using their unlisted subsidiaries to do RPT which listed entities couldn’t do themselves.

This will also cover transactions of subsidiaries in which the listed entity is not a party. Both Indian and foreign subsidiaries will be covered by this provision.

From April 1, 2023, this provision will be further tightened. It will cover transactions with any other person (not necessarily with a related party) if the “purpose and effect of the transaction is to benefit a related party” of listed entity or any of its subsidiaries. The rules do not clarify the meaning of “purpose and effect of which is to benefit a related party”.

Clarity needed

Without any definite meaning, this will be a subjective concept, open to several interpretations. While SEBI would take a conservative view; listed entities would prefer a more liberal interpretation. To avoid conflicting views and interpretations, SEBI should clarify this.

The nub of the problem in these rules is the fixed amount of turnover that is prescribed for determining material RPT. While retaining percentage-based threshold limit, that is, 10 per cent of annual consolidated turnover of a listed entity as per last audited financial statements, the rules now also provide for a fixed turnover test of ₹1,000 crore. This means any RPT that crosses the lower of these two limits will be a material RPT and that will also require prior shareholders’ nod.

The percentage rule was better and had worked well. By adding the turnover test, many routine RPT that cross ₹1,000 crore will become material RPT although they could only be a fraction of a company’s consolidated turnover. Several listed companies and industry bodies had represented to SEBI to relax this rule but these entreaties have fallen on deaf ears. SEBI did not make any relaxation.

As stated above, any RPT done by an unlisted subsidiary of a listed entity (even in cases where the listed entity is not a party) will also qualify as RPT of the listed entity. Consequently, if a RPT done by subsidiaries cross the thresholds limits, they will need to be approved by audit committee and shareholders of that listed entity.

The audit committee approval (which can now be given only by independent directors on the audit committee) will be required if the value of a RPT exceeds 10 per cent of the annual consolidated turnover of the listed entity, per the last audited financial statements. From April 1, 2023, this threshold will be reduced to 10 per cent of the annual standalone turnover of the subsidiary (and not of the listed company), as per the subsidiary’s last audited financial statements.

Omnibus approval 

SEBI’s recent circulars will further muddy the waters. SEBI’s circular of April 8 was issued to provide clarity on the period of validity of omnibus approval (that is, approval for RPT of repetitive nature or many transactions with the same related party) of shareholders for RPT which are material.

This circular provides that shareholders’ approval for an omnibus RPT approved in an annual general meeting (AGM) will be valid up to the date of the next AGM but not exceeding 15 months. However, if an omnibus approval is provided in an extraordinary general meeting, its validity will be for one year. It does not seem that it was SEBI’s intention to introduce a new concept of omnibus approval of shareholders, which till now was provided only for audit committee approval.

If SEBI had intended to introduce a concept of omnibus approval even in case of shareholders’ approvals, it should have done in a proper manner by amending the SEBI LODR Regulations, 2015 and not indirectly slipping it through a circular. Sadly, as things stand now, the language of this circular is quite ambiguous and confusing and suggests that the concept of omnibus approval of shareholders has also been introduced. Given this interpretation, it will make it tough for listed entities to get long-term contracts for 3-5 years approved. SEBI must clarify this and remove the ambiguity in the language of this circular. Similarly, the March 30 circular is badly drafted and needs clarification from SEBI.

Another big problem is that SEBI’s rules do not allow related party to vote on any RPT transaction whether or not that related party is party to that RPT.

This is hugely restrictive to not even allow a related party to vote even in those RPTs where there is no interest or conflict. This restriction must go.

India has arguably the toughest law on RPT. Further tightening it, although with the best of intention, seems to be a regulatory overload. Stringent rules will make it difficult to do business, encouraging entities to find ways to overcome them.

The writer is a partner with JSA. Views expressed are personal

Published on May 23, 2022

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