The preceding quarter saw some key developments in the corporate regulatory regime with the overseas investment framework undergoing an overhaul and the RBI and SEBI issuing circulars aimed at further liberalising the investment climate as well as providing much needed clarity on several issues.

Sanjam AroraPartner

Prashant KhuranaAssociate

The developments in the previous quarter, particularly on the foreign exchange front, indicate the emergence of a new wave of reforms - easing investment related compliance and outbound mergers and acquisitions as well as enhancing governance disclosures. The regime for overseas investments for Indian residents underwent an overhaul aimed at liberalising the framework and aligning it with emerging market trends. In the same vein, the Reserve Bank of India (RBI) liberalised the framework for external commercial borrowings (ECBs). The Securities and Exchange Board of India (SEBI) also implemented a host of regulatory changes ranging from permitting investment trusts to issue and list commercial papers to including mutual fund units in the insider trading framework.

These developments signal a potential shift in regulatory outlook towards one targeted at openness, self-certification, and a cooperative resolution of concerns raised by market players.

Key Developments

  • Overhaul of the overseas investment regime for Indian residents

    Following the draft overseas investment rules released by the RBI, the central government, basis discussions with industry players and bodies corporate, finally notified on 22 August 2022 the Foreign Exchange Management (Overseas Investment) Rules 2022, the Foreign Exchange Management (Overseas Investment) Regulations, 2022 and the Foreign Exchange Management (Overseas Investment) Directions, 2022 (collectively, the New Regime). Building on the expectations set by the draft rules, the New Regime offers a far more cogent and comprehensive overseas investment framework for Indian residents, both individuals and entities.

    The changes work to align the regulatory framework with the recent trends in the market including: (i) externalisation of business to foreign locations to attract more investment; (ii) out-bound mergers and acquisitions of foreign companies with Indian subsidiaries; (iii) guarantee, indemnity and deferred consideration; (iv) increased usage of employee stock options (ESOPs) and sweat equity to incentivise workforce; (v) investment in strategic sectors and startups; and (vi) structuring of flips, particularly relevant for startups.

    Some of the key changes introduced by the New Regime are:

    • A light touch regulatory regime for passive financial investments abroad in the form of overseas portfolio investment (OPI). This distinction between financial and strategic investments reduces regulatory touchpoints and costs for smaller investments.
    • Permission under the automatic route for upto two-layer subsidiary structures. The earlier ambiguity was an impediment to ‘flips’, used particularly by start ups to better leverage the value of their intellectual property and raise financing abroad on favourable terms.
    • Relaxing the regulations governing deferred consideration and investments by Indian corporates in financial services.
    • Dispensing with the requirement to obtain RBI approval before issuing guarantees to step down subsidiaries and writing off investments.
    • Focusing on timely reporting while introducing a transparent late submission fee calculation mechanism.

    However, certain aspects of the New Regime still remain unclear. For instance, clarity is needed on whether the restrictions around step-down subsidiary would be enforced on a resident individual who initially acquired shares in a foreign company through inheritance or under an employee benefit scheme and thereafter increased his/her holding through a rights issue or capitalisation. Similarly, it is unclear if these restrictions would apply if a resident individual received further shares through a rights/bonus issue despite the initial investment being classified as OPI.

    The provisions on issuance of ESOPs merit a re-look to correct drafting anomalies. For instance, no exception has been built to the arm’s length valuation requirements for ESOPs, which technically prevents issuance at a discount. While authorised dealer banks have clarified that practically ESOPs will be permitted at a discount, correcting the drafting of requirements would help in making the process easier for those not familiar with the Indian market. Further, market trends such as issuance of restricted stock units could also be expressly incorporated as currently these are indirectly introduced through sweat equity provisions.

    While the New Regime can be described as ‘cautious liberalisation’, the effort in creating a regime that is more credible and grounded in today’s reality needs to be appreciated. However, it would have to be seen how the RBI will address some of the challenges highlighted above.

    (To read our detailed update on the New Regime, click here.)

  • Issue and listing of commercial paper by investment trusts

    In line with the RBI Commercial Paper Directions, 2017, SEBI has now permitted Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) having net worth of INR 100 crore or higher to issue and list commercial papers. REITs or InvITs may now issue listed commercial papers subject to compliance with RBI’s guidelines and within the overall permissible limits of debt issued by SEBI from time to time.

    Listed debt securities allow creditors to seek protections under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, which provides for expeditious enforcement and grants deemed constructive possession over security (particularly immoveable property) to the lenders in cases of default, reducing the need to demonstrate physical possession for enforcement of security. These benefits are typically available only to banks and financial institutions, but listing allows any holder (including individuals) to avail of these benefits.

    Listing may also increase liquidity, permitting creditors to sell their holdings to other persons and thereby reducing risk and costs involved, which can then be passed on to the borrower in the form of lower interest rates.

  • The Companies (Corporate Social Responsibility Policy) Amendment Rules, 2022

    On 20 September 2022, the Ministry of Corporate Affairs notified the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2022 (Amendment Rules) amending the Companies (Corporate Social Responsibility Policy) Rules, 2014 (Principal Rules). Key changes introduced by the Amendment Rules are:

    • A company with unspent Corporate Social Responsibility (CSR) funds (as allocated in the Unspent Corporate Social Responsibility Account) is now required to constitute a CSR Committee comprising its board of directors.
    • Companies which cease to meet the criteria for applicability of CSR under the Companies Act, 2013 (net worth of at least INR 500 crore or turnover of at least INR 1000 crore or net profit of at least INR 5 crore during the immediately preceding financial year) can now immediately dispense with related compliance requirements. Previously, this could only be done after at least three financial years had passed from the company ceasing to meet the criteria.
    • Companies with more than INR 10 crore in outlay on CSR obligations in three immediately preceding financial years need to undertake an independent impact assessment of their expenditure and place such reports before their board of directors for consideration.

    These modifications have eased compliance requirements (and thereby costs) for most companies. The introduction of impact assessment, while an additional cost, should result in better utilisation of funds in keeping with the intent of CSR provisions.

  • SEBI circular for portfolio managers

    With effect from 20 September 2022, SEBI, through its Portfolio Managers (Amendment) Regulations, 2022, has mandated prudential limits on investments in associates/related parties of portfolio managers as under.

    Security Limit for investment in a single associate/related party (as % of clients' assets under management) Limit for investment across multiple associate/related party (as % of clients' assets under management)
    Equity 15% 25%
    Debt and Hybrid Securities 15% 25%
    Equity + Debt and Hybrid Securities 30%

    Further, a complete prohibition on investments in unrated securities of associates/related parties has been introduced. Clients are now permitted to refuse permission or specify lower limits for investment in securities of related parties by the portfolio manager.

    The changes grant greater authority to clients over investment decisions made by the portfolio manager. This is likely to reduce conflict of interest in the market. However, the impact will depend on the investment options available with clients since a limited market for debt and equity investments reduces the practical effectiveness of such disclosures.

  • Foreign Portfolio Investors Advisory Committee

    SEBI has constituted a Standing Committee to provide recommendations and advise on policy matters relating to Foreign Portfolio Investors (FPIs), for facilitating FPI investments. The terms of reference of the Committee are broad, suggesting that an overhaul may be on the cards. FPI is a critical route for investments into India, particularly for debt investments as it provides several relaxations from an exchange control perspective. These relaxations often translate into enhanced monetary returns for investors. Changes to the FPI route therefore will be a key event for market players.

  • Inclusion of mutual fund units within the insider trading framework 

    In a move that upends long-established jurisprudence on insider trading, SEBI on 8 July 2022 proposed including trading in mutual fund units within the purview of the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations). The consultation paper (PIT Consultation Paper) proposed a host of regulatory tweaks and changes to the PIT Regulations such as the inclusion of a new chapter, and amendment of terms and definitions to include mutual fund units. 

    In line with the proposed framework, on 30 September 2022, SEBI approved the proposal to include a new chapter in the PIT Regulations, which shall contain mutual fund-specific definitions of unpublished price sensitive information (UPSI) and generally available information, among other changes. Any person associated with the mutual fund having direct or indirect access to UPSI or any immediate relative of such person, officials or employees will now be subject to the PIT Regulations. A code of conduct shall also be put in place to govern designated persons with respect to mutual funds, and reporting requirements will be instated to monitor transactions in mutual funds by designated persons.  

    SEBI’s grouse with the current insider trading regime is spelt out in the PIT Consultation Paper – key personnel of fund houses redeeming their personal holdings in the fund houses’ schemes upon the receipt of insider information. The move has received mixed reactions from market participants, with many expressing concerns about the excessive stifling of investment opportunities for designated persons. However, SEBI hopes that its decision will curb the abuse of insider information in mutual funds and has tried to balance the competing interests of regulatory scrutiny and unitholder convenience.

  • RBI circular on external commercial borrowings policy

    On 1 August 2022, RBI issued a circular to liberalise the framework governing external commercial borrowings (ECBs) under the Foreign Exchange Management (Borrowing and Lending) (Amendment) Regulations, 2022. This follows an earlier press release on Liberalisation of Forex Flows dated 6 July 2022. The key changes introduced through this circular are:

    • increase in the automatic route limit for ECBs from USD 750 million or equivalent to USD 1.5 billion or equivalent; and
    • increase in the all-in-cost ceiling for ECBs, by 100 basis points, for borrowers of investment grade rating from Indian Credit Rating Agencies.

    These relaxations would be available for ECBs to be raised till 31 December 2022.

The trend emerging from the above is encouraging since it demonstrates the openness of various regulators to market response and sensitivities. Over the next quarter, we look forward to further clarity on the overseas investment regime, the findings of the FPI advisory committee, and potential extension of the temporary benefits offered by RBI on ECBs. Additionally, the Ministry of Corporate Affairs has been engaged in a long-drawn project to decriminalise provisions of India’s corporate law regime – further clarity is awaited on the changes in the Companies Act, 2013 and associated rules brought about by this process.

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