[Adnan Danish and Zaier Ahmad are penultimate year BA LL.B. (Hons.) students at National Law Institute University, Bhopal ]
Following the Union Budget for the fiscal year 2023-24, an Expert Committee was established under the chairmanship of Mr. S.K. Mohanty, a former Whole Time Member of the Securities and Exchange Board of India (‘SEBI’). The Committee’s mandate was to review the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the ‘LODR Regulations’) and the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (the ‘ICDR Regulations’) with the aim of facilitating the ease of doing business. This Committee’s primary role was to review these regulations and identify ways to make doing business easier. SEBI, in a press release dated October 4, 2023, invited suggestions from the public and regulated entities to simplify, ease, and reduce the cost of compliance under various SEBI regulations, including the ICDR & LODR Regulations. The Expert Committee, after thorough deliberations, compiled a report with interim recommendations to facilitate ease of doing business under these regulations. These recommendations were made public through a consultation paper and an addendum published on the SEBI website on January 11, 2024, and February 2, 2024, respectively. Fast-forward to May 17, 2024, SEBI amended the ICDR Regulation in lines with the consultation paper.
Key Proposals and Changes
The ICDR Amendment 2024 has brought about several significant changes. One of the key proposals made in the consultation paper issued in January 2024 was to allow non-individual shareholders to contribute to the minimum promoters’ contribution (‘MPC’) without being identified as promoters. The MPC concept, which secures 20% of the post-issue capital held by promoters or other permitted shareholders for a period ranging from 18 months to 3 years from the date of allotment in the initial public offer, was designed to address situations where promoters’ holdings get diluted over time. A 5% threshold was established for non-individual shareholders to ensure that significant shareholders remain invested in the company post-listing. This would ensure that such shareholders continue to remain invested in the company post-listing providing comfort to public investors. The proposal also included a provision for promoter group entities to meet the shortfall in MPC without being identified as promoters, providing flexibility for issuers with identifiable promoters who do not have sufficient equity share capital for MPC. However, for issuers without identifiable promoters, the requirement for MPC does not arise and they are permitted to undertake an initial public offering (‘IPO’) under ICDR Regulations without any MPC requirement. Following the amendment in May 2024, proposals in the consultation paper are have taken shape as applicable law.
Further, the proposal to include equity shares received from the conversion of fully paid-up compulsory convertible securities (‘CCS’) for the purpose of MPC was met with majority agreement from commentators on the consultation paper. They suggested that the conversion should be mandated after filing of draft red herring prospectus (‘DRHP’) but before the red herring prospectus (‘RHP’), providing flexibility to shareholders if the IPO is not pursued further. Under the erstwhile ICDR Regulations, CCS held for more than one year prior to the filing of the DRHP were not considered for inclusion towards MPC. The recent amendment has made CCS held for more than a year prior to filing of the DRHP eligible for MPC, provided full disclosures of the terms of conversion are made in the DRHP and they are converted into equity shares prior to filing of the red herring prospectus. This amendment brings parity between eligibility of shares for offer for sale (‘OFS’) and equity shares required for MPC.
The proposal further suggested that changes in the estimated issue size should be based on the amount in rupee value, as it impacts the objects of the issue. The recent amendment clarified that for a fresh issue any change in the estimated issue size by more than 20% would trigger a refiling of the DRHP. On the other hand, for an offer for sale (OFS), the change is determined based on the unit value, allowing a 50% change without refiling. This provides certainty to issuers and selling shareholders. Further, in the amendment, the regulations relating to “security deposit” have been omitted, and the minimum days for which the bidding can be extended in case of force majeure, banking strike or similar circumstances has been revised from “three working days” to “one working day”.
Redefining Minimum Promoter Contribution
SEBI has taken a significant step towards enhancing the ease of doing business by harmonizing the provisions of the ICDR Regulations. This move echoes practices seen in the United States (‘US’), where the Securities and Exchange Commission (SEC) does not mandate minimum promoter contributions and lock-in requirements. Instead, these are commonly enforced through underwriting agreements associated with IPOs. In the US market, these stipulations typically impact majority shareholders (those owning more than 50% of voting shares), principal shareholders (owning over 10%), and 5% shareholders. The US stock market, known for its maturity and highly developed ecosystem, benefits from the sophisticated investment acumen of both individual and institutional investors. These investors are well-equipped with market knowledge and investment skills, contributing to a dynamic investment landscape. In contrast, the rapidly developing Indian market necessitates a balanced regulatory approach that fosters a fair playing field for both investors and companies. By the recent reforms, SEBI is paving the way for a more inclusive and market-driven solution. This adjustment not only aligns Indian practices with global standards but also enhances the market’s attractiveness to a broader range of investors, thereby supporting its continued growth and evolution.
One of the key amendments SEBI has introduced is allowing non-individual investors to contribute up to 10% of the MPC. This move is a game-changer, aligning Indian practices with global standards and making the market more attractive to a broader range of investors. The adjustment is particularly advantageous for start-ups and new-age tech companies, which often go through multiple funding rounds before listing their equity shares on stock exchanges. These rounds can dilute promoters’ holdings, making it challenging to meet the mandated MPC.
However, this amendment is not without its complexities. The inclusion of non-individual shareholders to bolster the promoters’ stake could dilute the promoters’ control and influence, potentially shifting the power dynamics within the firm. Institutional investors and other non-individual shareholders, while typically not involved in daily operations, wield substantial influence over a company’s strategic direction. This influence is especially significant in areas like major investments, corporate governance, mergers and acquisitions, restructuring efforts, and executive management changes. The potential for conflicts of interest also increases, particularly if these non-individual shareholders have diverse business interests. Their substantial sway could influence decisions in ways that may not always align with the long-term vision of the original promoters.
Another noteworthy amendment is the inclusion of convertible cumulative preference shares (CCPS) held for more than one year before filing the DRHP towards the MPC. The terms of conversion must be specified in the DRHP, and the CCPS must be converted into equity shares before the RHP is filed. While this provision offers additional flexibility, it comes with its own set of risks. CCPS can be converted into equity shares at a predetermined conversion price declared in the DRHP. However, if the company’s financial performance deteriorates after the conversion terms are declared but before the CCPS are actually converted, the conversion price might become unfavorable for the promoter. For example, if CCPS were initially issued at a conversion price of ₹100 per share, and the company’s financial health declines, causing the market price of equity shares to fall below ₹100, the promoter would still be obligated to convert the CCPS into equity shares at the predetermined price. This scenario could result in a financial loss for the promoter due to the unfavourable conversion terms.
Conclusion
SEBI’s amendments reflect a careful balancing act between fostering a fair investment environment and encouraging market growth. By broadening the ambit of the minimum promoter contribution to include non-individual investors, SEBI is paving the way for a more inclusive and market-driven solution. This not only aligns Indian practices with international standards but also enhances the market’s attractiveness to a broader range of investors, supporting its continued growth and evolution. However, these changes also bring significant considerations regarding corporate governance and decision-making within companies. As the power dynamics shift with the inclusion of non-individual shareholders, the market will need to remain vigilant to ensure that these new influences do not disrupt the strategic alignment and long-term goals of companies. In conclusion, SEBI’s reforms represent a forward-thinking approach to modernizing India’s capital markets. By learning from global practices and tailoring them to the unique needs of the Indian market, SEBI is not just enhancing the ease of doing business but also laying the groundwork for a more robust and inclusive investment ecosystem.
– Adnan Danish & Zaier Ahmad
