[Nikhil Javali is a 4th year B.B.A. LL.B. student at National Law University Odisha]
As real estate investment trusts (‘REITs’) and infrastructure investment trusts (‘InvITs’) gain global recognition as a powerful investment vehicle, India is taking significant strides towards aligning its REIT/InvIT regulations with global best practices. Across the world, REITs have emerged as a dominant fundraising vehicle for income-generating assets. Originating in the United States in 1960, REITs/InvITs now command a total market capitalization of US$2.4 trillion. In India, however, this investment vehicle is still in its nascent stages, with the first listed REIT in India making an entry only in 2019. Since then, the market has grown exponentially. During the fiscal year 2021-22, India witnessed a significant milestone as it achieved the highest-ever total inflows of foreign direct investment (‘FDI’), amounting to $84.8 billion. This record-breaking figure reflects the growing confidence of international investors in the Indian market and its potential for investment opportunities.
In line with this objective of streamlining the REIT/InvIT landscape in line with international practices, the Securities and Exchange Board of India (‘SEBI’), in its consultation paper dated May 16 2023, proposed that unitholders of an REIT/InvIT be given certain special rights. The recent changes proposed by SEBI seeks to put India on par with the global markets. Moreover, SEBI’s reforms are expected to attract greater investor confidence. This will also aid in aligning India’s position as a robust and attractive investment destination, encouraging more participation from institutional and retail investors alike.
In this post, I will delve deeper into the specific changes proposed by SEBI and examine their implications for REITs/InvITs in India. I will also explore the broader corporate governance concerns that may arise due to these proposed changes and point out how this might hamper the overall objective of placing the REIT/InvIT market on the global stage.
Changes Proposed by SEBI: A Boon or a Trojan Horse?
Currently, the SEBI (Real Estate Investment Trusts) Regulations 2014 (‘SEBI (REIT) Regulations’) provide in regulation 4(2)(g) that no unitholder can enjoy superior voting rights or any other rights over another unitholder of the REIT. A similar provision also exists in the SEBI (Infrastructure Investment Trusts) Regulations 2014 (‘SEBI (InvIT) Regulations’). The consultation paper released by SEBI lays out two options for changing this framework by conferring nomination rights to unitholders.
The first option envisages nomination rights to unitholders holding a minimum of 10% units in the REIT/InvIT by giving them the right to appoint one director for every 10% units held on the board of the Investment Manager/Manager (‘IM’) of the REIT/InvIT. This has been coupled with the proposal that unitholders who own lesser than 10% can join together, and a collective holding of 10% would give them nomination rights of one director on the board of the IM.
It is also relevant to note that SEBI identifies a significant drawback of this option. The consultation paper points out that the regulatory requirements outlined in the SEBI REIT and InvIT Regulations prescribe that at least half of the directors on the Board of the IM must be independent. Accordingly, the new proposal seeks to grant the right to nominate a director to any unitholder holding 10% of the units (for every 10% held). This introduces the possibility of a considerably large board. In the extreme scenario where each unitholder exercises their right to nominate a director, and assuming each unitholder holds ten percent of the units, the board size could reach a maximum of 20 directors, with 10 being independent directors and 10 nominated directors. This could lead to the board becoming excessively large, prompting concerns regarding effective governance.
Having a large board might create potential hindrances to effective communication and engagement among directors. It is important to consider that all stakeholders might not have the same interests; moreover, aligning their interests becomes even more difficult with a large board. There is also a risk of the board becoming ineffective and overly bureaucratic, ultimately resulting in delays in decision making. The real estate market is highly susceptible to changes in governments, policy changes, interest rate hikes, and the like. In such an atmosphere, effective decision making becomes the need of the hour.
The second option proposes that an IM be mandated to constitute a Unitholders’ Council (‘UC’) who would comprise of the nominees of the unitholders of the REIT/InvIT. This is similar to the current framework governing Alternative Investment Funds (‘AIFs’) and the constitution of an Investment Committee (‘IC’) that gives approval to the decisions of the AIF. The difference between the AIF framework and the current proposal for REITs/InvITs is that while constituting an IC is voluntary in nature, SEBI proposes a mandatory UC be formed under this option. Again, any unitholder holding a minimum of 10% units in the REIT/InvIT would be entitled to nominate one person to the UC. All decisions to be taken by the UC would be by simple majority.
It is also proposed that this UC include a minimum of 3 members be present. Additionally, if the UC does not manage to reach a strength of 3 members, two things can be done:
- The two members of the UC can appoint an independent director to the UC to meet the minimum strength of 3 members, or
- The UC can be given the right to nominate one director on to the board of the IM.
SEB’’s proposed framework for decision-making power in the context of REITs/InvITs involves a sequential process. In instances where the board of the IM holds decision-making authority, they will be the initial decision-making body for a given matter. Subsequently, upon approval of the matter by the board, it will be presented to the UC. In the event that the UC of the IM does not accept or approve a specific matter, it will be subjected to a voting process during a unitholders meeting. Furthermore, matters necessitating unitholder approval will encompass recommendations from both the board of the IM and the UC. Also, matters exclusively pertaining to the operational aspects of the IM, such as financials and employee compensation, will fall under the discretionary purview of the board.
While SEBI’s efforts are definitely a step towards aligning the REIT/InvIT framework with global best practices, the changes proposed have certain flaws from a broader corporate governance perspective. Firstly, the sequential process of decision-making, starting with the board of directors of the IM and subsequently involving the UC, may result in a potential imbalance of power. This could lead to a concentration of decision-making authority in the hands of the IM’s board, potentially marginalizing the influence of unitholders in the decision-making process. Moreover, clarity regarding the exact nature of decisions that can be taken jointly by the IM’s board and UC is required. This has a direct impact on investor confidence – one of the core objectives of the consultation paper that still stands unfulfilled.
Secondly, while the inclusion of recommendations from both the IM’s board and the UC is intended to give unitholders a say in the decision-making process, it may introduce complexities and conflicts. The diverse interests represented by these two could lead to discrepancies in their decision making, potentially impeding the effectiveness of the decision-making process.
SEBI’s initiatives to enhance participation of investors in REITs/InvITs are commendable. The proposed rights to unitholders demonstrate an attempt to involve key stakeholders and establish a structured process. However, to ensure robust corporate governance practices within the REIT/InvIT sector, it is imperative to address the broader concerns by striking a balance between stakeholder participation, decision-making authority, and accountability mechanisms. Only through careful consideration and refinement can the proposed framework align with global best practices and effectively safeguard the interests of REIT/InvIT unitholders.
– Nikhil Javali