SEBI Informal Guidance: Investment Banking for State-Owned Enterprises

In order to avoid potential conflicts of interest, the various regulations issued by the Securities and Exchange Board of India (“SEBI”) provide that merchant banks cannot act in transactions involving their “associates”. This is so in public offerings, takeovers, buybacks, delisting offers and similar transactions that mandate the requirement for a SEBI-registered merchant banker. In case the shareholding in a merchant bank happens to be held ultimately by the government or a state-owned enterprise (“SOE”), a question would arise whether the bank would be precluded from acting in a transaction involving other SOEs. The SOE holding structure provides a layer of complication as the shareholdings can ultimately be traced to the government. The issue is whether it is possible to draw a line so that a government-affiliated merchant bank can act in relation to a transaction involving another government-owned entity. This question came up for consideration before SEBI in an informal guidancesought by CLSA India Private Limited (“CLSA India”), although the Government as well as the SOEs in this case involved the People’s Republic of China (“PRC”).

CLSA India is an indirect wholly owned subsidiary of CITIC Securities Company Limited (“CSCL”), which is a listed public company in the PRC. CSCL is in turn held by public shareholders (83.34%) and by CITIC Corporation Limited (“CCL”) (16.66%). CCL is the wholly owned subsidiary of CITIC Limited, which is also a public listed company in the PRC, 58.13% of whose shares are held by CITIC Group Corporation (“CGC”). CGC is an SOE whose shares are ultimately held by the Ministry of Finance, PRC.

Given these facts, CLSA India approached SEBI to seek its guidance on whether the company could act in the future as a merchant banker to transactions involving SOEs that are ultimately held by the PRC Government, although not forming part of the organization structure of CLSA. In other words, the question raised was whether the relationship described above would preclude CLSA India from acting in any transaction involving an SOEs ultimately relatable to the PRC Government. In its application, CLSA India made out a case as to why such SOEs would not by default be considered as an “associate” for purpose of determining the relationship between the parties.

SEBI responded favourably to CLSA. In doing so, it considered the definition of an “associate” under regulation 21A(1) of the SEBI (Merchant Bankers) Regulations, 1992, which includes a person:

(i) who directly or indirectly by himself or in combination with relatives, exercise control over the company or,

(ii) whose employee, officer or director is also a director, officer or employee of another company.

SEBI relied on the statements from CLSA India that both CSCL and CITIC Limited, which are the listed companies at the intermediate levels, operate “in strict compliance with the rules governing listed securities, including corporate governance requirements.” Moreover, there is no common management or control between CLSA India and an SOE entity. CLSA India has its own board of directors which is independent of any SOE entity, and it operates on its own without any influence from the PRC Government. Based on these factors, SEBI found that the facts do not indicate that CLSA India “is an associate with any SOE entity (except CITIC Group Corporation) in terms of the definition of ‘associate’ under SEBI Regulations” and that CLSA India can “act as a merchant banker for an SOE entity other than those forming part of the organization structure” of CLSA India.

In arriving at its conclusion, SEBI has adopted a purposive interpretation of the regulations pertaining to the relationship and roles of a merchant banker. The fact that CLSA India operates through decisions of its own board and that the PRC Government does not have ultimate control or influence over CLSA India turned out to the clinching factors. The existence of intermediate listed companies that are subject to strong governance requirements as well as the fact that the PRC Government does not have effective control of CLSA India (due to the presence of minority shareholdings in intermediate companies) appear to have supported the principal claim.

Although this guidance pertains to the specific facts of the case and operates in the context of SOEs that are prominent in the Chinese corporate context, it also provides insights into the nature of ownership structure and connections pertaining to SOEs in general. Given the involvement of Indian SOEs in the capital markets, similar questions could arise in the context of merchant bankers that have affiliations with the Government in India as well.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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