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SEBI: Representation highlighting issues relating to related party in Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2021
SEBI: Representation highlighting issues relating to related party in Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2021

December 30, 2021

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As you may be aware, SEBI notified the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) (Sixth Amendment) Regulations, 2021 (Amendment Regulations) on November 9, 2021, which are effective from April 1, 2022. The Amendment regulations bring in several key changes in the SEBI LODR Regulations pertaining to related party transactions. Some of these changes are a welcome step to improve the overall corporate governance regulatory framework.

However, there are issues which are onerous to comply and may create unintended practical challenges for companies, thereby impacting ease of doing business in India. In this regard, we have made a submission to SEBI on December 30, 2021 highlighting the following issues:

DEFINITION OF RELATED PARTY

a) Before introduction of Amendment Regulations, the definition of related party under SEBI LODR Regulations included “any person or entity belonging to the promoter or promoter group and holding 20% or more shareholding in the listed entity”. However, now, the requirement of 20% shareholding has been removed. This implies that all promoters (irrespective of their shareholding) will now be covered within the scope of related party. As a result, it will become onerous for the company to identify and track transactions undertaken by all promoters or promoter group entities.

Suggestion: Reinstate earlier provisions to prescribe a minimum percentage of shareholding by any person or entity forming part of promoter/ promoter group for deeming them as related party (instead of including all person or entity who are part of promoter or promoter group). In order to tighten corporate governance framework for promoters/ promoter group, SEBI may prescribe 10% shareholding (instead of 20% provided earlier) for considering promoter/ promoter group as related party.

b) Further, w.e.f. from April 1, 2023, any person or entity holding 10% or more shareholding in listed entity will be regarded as related party (instead of 20%). It is important to note that there are several provisions under the Companies Act, 2013 and SEBI regulations wherein the criteria of 20% has been prescribed to trigger the concept of material/ substantial from a control perspective. On similar lines, shareholding by any person or entity should continue to be at 20% or more of the equity shareholding, to deem such person as related party even after April 1, 2023.

Suggestion: Retain the cap of 20% equity holding by any person or entity other than promoter/promoter group, even after April 1, 2023, to deem such person or entity as related party.

c) Second proviso to Regulation 2(1)(zb) excludes units issued by mutual funds from the definition of related party. Similar to mutual funds, private equity investors also invest in a company with no intention to control or run the operations of a company. Considering such investors as related parties will increase the compliance burden. Hence shareholding by private equity investors should be excluded from the definition of related party.

Suggestion: Investment by private equity should be excluded from the definition of related party.

d) Further, in most subsidiaries, directors are appointed by the parent company on the board of subsidiaries and such directors are employees of either the parent company or subsidiary company. These directors do not have any shareholding and considering them as related parties will complicate the approval process for Related party transactions, even for payment of salaries to such employees by the parent/subsidiary company. It is relevant to note that Rule 9 of Companies (Meetings of the Board and its Powers) Rules, 2014 provides that every director who has interest in a proposed contract or arrangement and holds 2% in the body corporate directly or indirectly, shall disclose such interest at the meeting of the Board in which the contract or arrangement is discussed and shall not participate in such meeting.

Suggestion: Exclude directors of subsidiaries who are employees of parent/ subsidiary company from the definition of related party, unless they hold shares/voting rights in parent/ subsidiary beyond a prescribed percentage (say 2%).

DEFINITION OF RELATED PARTY TRANSACTION

a) As per Regulation 23(2), approval of Audit Committee of listed entity is required to be taken prior to undertaking each Related Party Transactions (RPT). This is cumbersome as the subsidiary will have to wait for the approval to be accorded, before it can proceed to enter into such transaction. In a large conglomerate, the number of subsidiaries can be huge. This would impact efficiency of operations. It may also result in loss of operational or time-competitive opportunities for the subsidiary, as the parent company’s Audit Committee meeting happen once in a quarter, thereby impacting ease of doing business in India.

Suggestion: Amend Regulation 23(2) to provide that approval of Audit Committee of the listed company, for transactions where parent listed company is not a party, will be required only for transactions between related party, which are not on arms-length price or are not in the ordinary course of business.

b) Further, transactions like issuance of Employee Stock Option Plans (ESOPs), Stock Appreciation Rights (SARs), redemption of securities, remuneration or revision of remuneration of director or Key Managerial Persons (KMP) of the Company or subsidiary, etc. have separate mechanism under the Companies Act, 2013 as well as SEBI regulations. Including the above within the definition of RPT will increase compliance burden for the company. Hence, such cases should be excluded from the purview of RPT.

Suggestion: In the list of exclusions provided under Proviso b) to Regulation 2(1)(zc), include frant of ESOP, SARs, shares issued upon cona) Explanation to Regulation 23(1): The reference of INR1000 crores to determineversion or redemption of securities and temuneration or revision of remuneration of directors or KMP of the parent company or subsidiary.

POLICY ON MATERIALITY OF RELATED PARTY TRANSACTIONS

a) In November 2019, Ministry of Corporate Affairs deleted the monetary threshold to obtain shareholders’ approval for material RPTs under Companies Act, 2013 with a view to liberalise the RPT regime. Prescribing a minimum monetary threshold of INR 1000 crores under SEBI LODR Regulations will create inconsistencies with Companies Act provisions.

Suggestion: The reference of INR1000 crores to determine materiality should be removed.

b) Further, linking the threshold as a percentage of consolidated turnover of the listed entity is subjective and may differ in case of different subsidiaries. Hence, the threshold should be linked with annual turnover of respective companies, rather than linking it with annual turnover of the listed entity.

Suggestion: The percentage to determine materiality should be capped at 10% of annual consolidated turnover of the company (and not on annual consolidated turnover of the listed company).

We hope you will find the update useful. We will keep you posted on further developments in this regard. 


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