Success stories from India’s stock exchange reforms

Authors: Poonam Singh, NITIE and Vikas Kumar, Azim Premji University

As New Delhi was brought to a standstill in 2021 by protests that forced the rollback of farm law reforms, the Mumbai-based Securities and Exchange Board of India (SEBI) introduced tighter regulations governing related party transactions (RPTs). The successful implementation of these regulations highlights the importance of inclusive deliberations, gradualism and alignment with other domestic regulations and international best practices.

An RPT is an arrangement between two parties who are engaged with each other for the transfer of resources, services or obligations, irrespective of whether a price is charged. While RPTs are a means through which controlling owners can expropriate wealth from minority shareholders, they can be beneficial if they substitute internal markets. The substitution could result in cost savings, increased efficiency and optimal utilisation of resources. To harness these benefits, RPTs need to be regulated but should not be banned.

Despite existing regulations in India, including the 2013 Companies Act and the 2015 Listing Obligations and Disclosure Requirements (LODR), RPTs remain an area of concern. Several unreported instances of noncompliance have come to light, including cases involving India’s largest private airline, a leading pharmaceutical company and major non-banking financial companies.

In 2021, SEBI amended the LODR to improve the regulation of RPTs, tightening reporting guidelines and expanding the definition of ‘related party’ to cover promoters with any level of shareholding. The revised definition now also includes any person or their relatives holding at least 20 per cent in shares from April 2022, a threshold which will drop to 10 per cent in 2023.

The definition of RPT has also broadened to include transactions undertaken with the intention of benefitting related parties, whether directly or indirectly. The SEBI has introduced a new standard for determining the materiality of transactions for shareholder approval, adding US$13 million (Rs 1000 crore) to the initial threshold of 10 per cent of the listed entity’s consolidated annual turnover.

A range of stakeholders was included in the reform process, reflecting the growing maturity of the SEBI. A draft report was initially prepared by a working group comprised of representatives of regulators, stock exchanges, capital market firms and investors. The draft was released to the public to invite comments, which informed the SEBI amendments.

Over the years, RPT reforms have ensured greater convergence with domestic regulations and international best practices, improving the effectiveness of their implementation. Contrary to global standards, regulations in India did not mandate the approval of RPTs by an independent organ of the listed company. But after the 2013 Companies Act was amended, the SEBI has progressively increased the scrutiny of listed companies and their promoters through the audit committee. Recognising the Indian context of widespread crossholding across listed entities and subsidiaries, the SEBI has also extended RPT regulations to involve unlisted subsidiaries of listed entities. Similarly, given the concentrated promoter holding in Indian companies, the SEBI has brought RPTs by promoters under the ambit of regulation.

The reform process has been gradual. RPT regulations were amended in 2013, 2015, 2018, 2021 and again in April 2022. Deliberations around the latest reforms began when the SEBI formed a working group on 4 November 2019. The amendments were formally introduced on 9 November 2021, after lengthy consultation, public scrutiny and board discussions. The new regulations will become operational in two steps in April 2022 and April 2023.

Since 1 April 2022, the timeline of disclosure of an RPT has been compressed from 30 days to 15 days after the biannual publication of consolidated and standalone financial results. Effective from 1 April 2023, this disclosure will need to be made on the date of publication of the financial results. Likewise, the threshold shareholding that necessitates reporting will drop from 20 to 10 per cent.

The inclusive and transparent process of consultation, followed by phased implementation with advance notice, allows stakeholders to better understand the changes. It also ensures the SEBI will not unilaterally and abruptly change the rules of the game, improving the effectiveness of regulations and reducing the cost of enforcement.

But there are still gaps in the revised regulations. The audit committee is left to determine what constitutes ‘material modification’, which could be a source of subjectivity. There is also some conflict between overlapping regulations, with the SEBI defining materiality in terms of turnover and the Companies Act defining it in terms of net worth. Finally, according to the SEBI, an RPT is a transaction with the ‘purpose and effect’ of ‘benefitting a related party of the listed entity or any of its subsidiaries’, though it is unclear how this will be evaluated by the audit committee.

Despite its shortcomings, the SEBI’s success in continuously improving regulations draws attention to the cumbersome experience of parliamentary reforms in post-liberalisation India. Although the debt, labour, land and agricultural markets have languished in the absence of timely reforms, equity markets have grown, and the regulations governing them under the SEBI have improved dramatically. The recent RPT regulations show how an inclusive and gradual process is key to the successful implementation of reforms — lessons that can inform parliamentary reforms.

Poonam Singh is Associate Professor at National Institute of Industrial Engineering, Mumbai.

Vikas Kumar is Associate Professor at Azim Premji University, Bengaluru.

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