A new regulatory outlook

(Managing partner, Finsec Law Advisors)

In its board meeting held on December 20, 2022, the Securities and Exchanges Board of India approved a slew of proposals. A few changes are analysed below.  

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Changes to buyback regulations

Under the existing mechanisms for buyback of shares through the exchange, per Sebi, market participants faced two major challenges. First, one shareholder’s entire trade could get matched with the purchase order placed by the company and in turn, deprive other shareholders of the opportunity to avail the benefit of the buyback. Second, the six-month window provided to complete the buyback could create artificial demand, resulting in exaggerated prices, and preventing efficient price discovery.

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Thus, Sebi is phasing out of the stock exchange mechanism of buybacks and introducing a separate window on stock exchanges for undertaking buyback. The proposal for easing the restrictions for the tender offer route was also approved, through which the requirement for filing a draft letter of offer has been done away. The period for the tendering of shares and payment of consideration to the shareholders will be reduced. Sebi has also increased the minimum utilisation of the amount earmarked for buyback from 50% to 75%.

While the removal of the stock exchange mechanism was not recommended, Sebi may have taken away a transparent method of buyback that may have required some revisions to make it more efficient. It has been argued the stock exchange approach ensures that businesses are not “overpaying” for stocks. The argument that the company’s offer gets matched with a specific seller is merely an efficient use of the anonymous market which values the highest price for the seller transparently. If the highest bidder is a single person, her winning the bid is evidence of the fairness of the process.

Norms strengthening governance of MIIs

Institutions such as stock exchanges, clearing corporations, and depositories that form the backbone of any securities market are considered as market infrastructure institutions (MIIs). As MIIs perform various regulatory responsibilities and simultaneously work towards generating profit, they are subjected to higher governance standards. In November 2022, Sebi released a report of the Committee on Strengthening Governance of MIIs that proposed a slew of changes to enhance the governance standards of MIIs. In this meeting, Sebi approved certain recommendations to bring in greater transparency and accountability in the functioning of MIIs.

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MII functions have been divided across three verticals—critical operations; regulatory, compliance and risk management; and business development. Further, each core function of the MII should be headed by a designated key management person (KMP), with the KMPs of the first two verticals being at par in hierarchy with those of the third. Sebi has also approved revision in the performance assessment requirements of MIIs and has stated that internal evaluation of functioning of MIIs and their statutory committees will take place annually. Further, external evaluation is to be done by an independent entity every three years. Sebi also approved the proposal regarding the mandatory appointment of public interest directors, with background and expertise in technology, law and regulatory, finance and accounts and capital markets, and the removal of a KMP shall be on the basis of the recommendation of the nomination and the renumeration committee. 

These amendments would not only strengthen governance standards of MIIs but also increase market confidence and deter malpractices. Measures such as the optimal utilisation of resources and classification of functions could ensure a reasonable balance between the dual role of MIIs as business enterprises and front-line regulators, especially now that the regulatory and risk management verticals have been prioritised. Moreover, enhanced reporting requirements and periodic assessments would prevent any future governance lapses, enhance transparency, and ensure timely risk management. In addition, it would be useful to think of creating a regulatory framework for alternate marketplace for certain products like with online bond platforms.

Amendments to NCS regulations

Against the backdrop of enhanced climate commitments worldwide and the growing relevance of sustainable finance, Sebi approved the proposal for revising the framework governing green debt securities in India—the Sebi (Issue and Listing of Non-Convertible Securities) Regulations, 2018. The categories of green debt securities that can be issued are pollution prevention and control and circular economy adapted products. Sebi also approved issuance of coloured bonds as sub-categories of green debt securities. For instance, blue bonds would be issued for projects facilitating the sustainable use of oceanic resources and yellow bonds for solar energy-related initiatives.

The inclusion of additional categories will enhance the overall accessibility of the green bond market in the long term and harmonise the framework with international principles, while the subcategorisation of green bonds will encourage investments in emerging areas of the economy such as data centres and circular economy and will help in the development of the Indian green bond market. These changes will also contribute to India’s efforts towards transitioning to a low-carbon economy.

Execution-only platforms (EoPs)

Sebi has approved the proposal to establish a framework for EoPs for entities aiming to offer ‘execution-only’ services in direct plans of mutual funds. These platforms would be registered as investment advisers or stock brokers, and therefore be required to comply with the extensive regulatory norms applicable to such entities. The new framework will provide these platforms the option to seek registration either as an agent of an asset management company with registration with AMFI or as an agent of investors with a limited stock broking license. Norms regarding key issues including investor protection measures, cyber security requirements, service pricing, and grievance redressal, would be notified in the coming months.  The introduction of a dedicated regulatory framework will provide these entities with guiding principles better suited to their nature of activities and reduce undue compliance burdens.

Sebi has also approved a proposal to designate certain brokers which handle a large number of clients, a large amount of client funds, and large trading volumes as qualified stock brokers, that will be subjected to enhanced governance standards. These will be introduced subsequently.

These changes will benefit all stakeholders, and further investor confidence in the markets and market institutions with enhanced governance mechanisms.

(Co-authored with Mihir Deshmukh and Anirudh Sood, associates, Finsec Law Advisors)