Alerts & Updates 19th Apr 2022

Foreign investment rules tweaked to relax & expand applicability of various provisions | SEBI’s relief on validity of RPT approval | Risk management framework for EGRs

Authors

Manendra Singh Partner | Mumbai
Tanvi Goyal Principal Associate | Mumbai
Ambareen Khatri Associate | Mumbai

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  • Following changes have been introduced by Ministry of Finance and SEBI

    A. Amendments to Foreign Exchange Management (Non-debt Instruments) Rules, 2019: The Ministry of Finance has amended the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules), following key amendments have been made:

    • Extension of conversion period of convertible notes to 10 years;
    • Revisions to what would constitute “equity instruments”;
    • Meaning of foreign investment in case of beneficial ownership under other laws;
    • Revisions to definition of Indian company;
    • Concept of ‘Share Based Employee Benefits’ introduced, allowing wider gamut of employee benefits under foreign exchange laws;
    • Schemes of compromise, arrangement or transfer of undertakings involving issuance of equity instruments to the existing shareholders of the transferor company resident outside India, included;
    • Clarification and alignment of definition of “real estate business”;
    • 20% sectoral cap for FDI in LIC under the automatic route

    B. Clarification on validity period of shareholders omnibus approval for Related Party Transactions (RPTs): Keeping in view the timelines prescribed under Companies Act, 2013 on holding of Annual General Meeting (AGM), SEBI has clarified that shareholders’ approval of omnibus RPTs approved in an annual general meeting (AGM) shall be valid upto the date of the next AGM for a period not exceeding 15 months. And in case, such approval was taken in any other shareholders meeting, the validity of approval will not exceed 1 year.

    C. Comprehensive Risk Management Framework for Electronic Gold Receipt (EGR) Segment: In furtherance of the framework notified by SEBI for operationalizing the gold exchange in India, SEBI has issued risk management framework that will be applicable to the EGR segment.

    D. Alignment of regulatory framework for ‘security cover’: In order to align the framework relating to “security cover”, SEBI has amended LODR Regulations to replace the term “asset cover” with “security cover”.

  • The above changes have been analysed below

    A.  Amendments to Foreign Exchange Management (Non-debt Instruments) Rules, 2019:

    The Ministry of Finance introduced following changes to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules):

    1. Extension of conversion period of Convertible Notes to 10 years: The term “convertible note” has been revised to mean an instrument issued by a startup company acknowledging receipt of money initially as debt, repayable at the option of the holder, or which is convertible into such number of equity shares of that company, within a period not exceeding ten years (earlier the time period was five years) from the date of issue of the convertible note, upon occurrence of specified events as per other terms and conditions agreed and indicated in the instrument. This will give start-ups longer duration to allow conversion of monies raised through convertible notes.

    2. Revision to what would constitute “equity instruments”:

    a) Fully paid convertible debentures / preference shares: The definition of term “convertible debenture” and “preference shares” has been revised to mean fully and mandatorily convertible debentures/ preference shares which are fully paid.

    b) Equity shares issued under other applicable laws: Equity shares issued by an Indian Company in accordance with the provisions of the Companies Act, 2013 or any other applicable law, shall include equity shares that have been partly paid, and shall be treated as “equity instruments”.

    C) Meaning of share warrants: The definition of term “share warrants” has been revised to mean those which are issued by an Indian Company in accordance with the regulations made by the Securities and Exchange Board of India, the Companies Act, 2013 or any other applicable law (earlier the provision only referred to SEBI).

    3. Meaning of foreign investment in case of beneficial ownership: The explanation to the definition of “foreign investment” has been modified to state that if a declaration is made by a person as per the provisions of the Companies Act, 2013 or any other applicable law, as the case may be (earlier there was only reference to Companies Act 2013), about a beneficial interest being held by a person resident outside India, then even though the investment may be made by a resident Indian citizen, the same shall be counted as foreign investment.

    4. Revision to definition of “Indian company”The term “Indian company” which is presently defined to mean a company incorporated in India, the following definition has been substituted to include within its ambit body corporates established by or under Central or State Acts:

    “Indian company” means a company as defined in the Companies Act, 2013 or a body corporate established or constituted by or under any Central or State Act, which is incorporated in India;

    Note: (i) It is clarified that reference to ‘company’ or ‘investee company’ or ‘transferee company’ or ‘transferor company’ in these rules also includes a reference to a body corporate established or constituted by or under any Central or State Act.

    (ii) It is further clarified that if the term ‘Company ‘ or ‘Indian company’ or ‘Investee company’ or ‘transferee company’ or ‘transferor company’ is qualified by a reference to a company incorporated under the Companies Act, 2013 such term shall mean a company incorporated under the said Act but not a body corporate.

    (iii) It is also clarified that ‘Indian company’ does not include a society, trust, or any entity, which is excluded as an eligible investee entity under the FDI Policy.”

    5. Concept of ‘Share Based Employee Benefits’ introducedThe concept of “Share Based Employee Benefits” has been introduced and Rule 8 has been revised to allow Indian companies to issue equity instruments under “Share Based Employee Benefits”.

    “Share Based Employee Benefits” has been defined to mean issue of equity instruments to employees or directors or employees or directors of the holding company or joint venture or wholly owned overseas subsidiary or subsidiaries who are resident outside India, pursuant to Share Based Employee Benefits schemes formulated by an Indian Company.

    6. Clarification on the meaning of “subsidiary”: It has been clarified that the term “subsidiary” shall have the same meaning as is assigned to it in the Companies Act, 2013, as amended from time to time.

    7. Compromise/arrangement/division of one or more Indian company: Rule 19 permitted transferee company to issue equity instruments to the holders of transferor company subject to certain conditions, where a merger or amalgamation of two or more Indian companies has been approved by the National Company Law Tribunal (NCLT). This has been modified to include in addition to scheme of merger or amalgamation, scheme of compromise or arrangement or transfer of undertaking of one or more Indian company to another Indian company or involving division of one or more Indian company.

    Further, it has been clarified that Government approval shall not be required in case of mergers and acquisitions taking place in sectors under automatic route.

    8. Clarification and alignment of definition of “real estate business: The term “real estate business” has been modified as follows, and is aligned with the definition provided under “Construction Development: Townships, Housing, Built-up infrastructure” in which 100% foreign investment is permitted under automatic route:

    Explanation: For the purpose of this rule, “real estate business” means dealing in land and immovable property with a view to earning profit from there and does not include development of townships, construction of residential or commercial premises, roads or bridges, educational institutions, recreational facilities, city and regional level infrastructure, townships, real estate broking services and Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations 2014 and earning of rent or income on lease of the property, not amounting to transfer.

    9. 20% FDI under automatic route for LIC: A new sub-sector for Life Insurance Corporation of India (LIC) has been inserted. Foreign investment upto 20% in LIC has been permitted under automatic route, subject to certain conditions as mentioned therein. Amongst other conditions, such investment in LIC will be subject to the provisions of the Life Insurance Corporation Act, 1956, as amended from time to time and such provisions of the Insurance Act, 1938, as amended from time to time, as are applicable to LIC.

    The aforesaid amendment has been made vide the Foreign Exchange Management (Non-debt Instruments) (Amendment) Rules, 2022 released by the Ministry of Finance dated April 12, 2022 (available here).

    B. Clarification on validity period of shareholders omnibus approval for Related Party Transactions (RPTs)

    In relation to RPTs, presently, Regulation 23(3)(e) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations) provides that an omnibus approval granted by the audit committee shall be valid for a period not exceeding one year and shall require fresh approvals after expiry of one year. Further, Regulation 23(4) of the LODR Regulations requires shareholders’ approval for material RPTs. Under Companies Act, 2013, Section 96(1) specifies that the time gap between two Annual General Meetings (AGMs) cannot be more than fifteen months.

    In order to facilitate listed entities to align their processes to conduct AGMs and obtain omnibus shareholders’ approval for material RPTs, SEBI has clarified the following:

    • Approval at AGM: The shareholders’ approval of omnibus RPTs approved in an AGM shall be valid upto the date of the next AGM for a period not exceeding 15 months.
    • Approval at general meeting other than AGM: In case of omnibus approvals for material RPTs, obtained from shareholders in general meetings other than AGMs, the validity of such omnibus approvals shall not exceed 1 year.

    The above clarification has been issued by SEBI vide circular dated April 8, 2022 (available here)

    C. Comprehensive Risk Management Framework for Electronic Gold Receipt (EGR) Segment

    SEBI released a comprehensive risk management framework for EGR segment, some of the key requirements under the framework are as follows:

    Change Explanation
    Liquid assets The liquid assets of the member deposited with clearing corporations (CCs) shall, at all times, be adequate to cover the following:

    • MTM (Mark to Market) Losses: Mark to market losses on outstanding settlement obligations of the member.
    • VaR Margins: Value at risk margins to cover potential losses for 99.9% of the days.
    • Extreme Loss Margins: Margins to cover the expected loss in situations that lie outside the coverage of the VaR margins.
    • Any other margins as may be prescribed.

    Other provisions related to the aforesaid, reporting, verification of margins is provided in detail in the circular.

    Rationalization of imposition of fines The stock exchanges and CCs, in all segments to devise a standard framework for imposition of fine on the trading member/ clearing member for incorrect/false reporting of margin collected from the clients.
    Risk Reduction Mode CC to ensure that the stockbrokers and clearing members are mandatorily put in risk-reduction mode when 90% of the member’s collateral available for adjustment against margins gets utilized on account of trades that fall under a margin system including crystalized losses.
    Settlement of funds
    • The funds to be settled on gross basis at member level.
    • CC to empanel clearing banks based on various financial and operational criteria.
    • Clearing members to open single settlement account with any of the clearing banks.
    Settlement of EGR
    • Settlement of EGR shall be on T+1 rolling basis.
    • Transactions to be settled on gross basis at the clearing member level and netting to be done at client level.
    • Members will be required to maintain account with depositories including a pool account.
    • Members to provide specific delivery instructions in favour of the CC on the settlement day.
    • The delivering member to complete delivery instructions for transfer of EGR to Clearing Pool Account on settlement day by the specified pay-in time.
    • The depositories will credit the receiving members’ pool account/client’s beneficiary account in accordance with the pay-out instructions received electronically from Clearing Corporation on the settlement day by the specified pay-out time.
    Settlement Guarantee Fund, Default Waterfall and Stress Testing CC to maintain a separate core settlement guarantee fund (Core SGF) for the EGR segment. The minimum corpus of SGF to be INR 10 crores.

    The detailed risk management framework laid done by SEBI for the EGR segment has been provided under the SEBI circular dated April 11, 2022 (available here).

    D. Alignment of regulatory framework for ‘security cover’

    SEBI, in its board meeting held on February 15, 2022 (available here) had approved the amendment to SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations) for alignment of regulatory framework for ‘security cover’. Accordingly, SEBI has amended Regulation 54 of the LODR Regulations and has replaced the term “asset cover” with “security cover”.

    Further, the amended Regulation 54(1) now provides that in respect of listed non-convertible debt securities, the secured listed entity is required to maintain 100% security cover or higher security cover as per the terms of offer document/ information memorandum and/or Debenture Trust Deed, sufficient to discharge the principal amount and the interest thereon (prior to amendment the regulation only provided for principal amount) at all times for the non-convertible debt securities issued.

    The aforesaid amendment has been made vide the SEBI (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2022 dated April 11, 2022 (available here).

    We trust you will find this an interesting read. For any queries or comments on this update, please feel free to contact us at insights@elp-in.com or write to our authors:

    Manendra Singh, Associate Partner –ManendraSingh@elp-in.com ;
    Tanvi Goyal, Principal Associate –TanviGoyal@elp-in.com;
    Ambareen Khatri, Associate- AmbareenKhatri@elp-in.com

Disclaimer: The information provided in this update is intended for informational purposes only and does not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein. This update is not intended to address the circumstances of any particular individual or corporate body. There can be no assurance that the judicial/ quasi-judicial authorities may not take a position contrary to the views mentioned herein.