What Sebi’s recent decisions mean for the markets and investors

On June 27, the board of market regulator Sebi approved major amendments to the existing securities laws. Some of these are discussed here:

Sebi will now allow technology-based start-ups to issue share with superior voting rights (SR shares), in the ratio of minimum 2:1 and maximum 10:1. Such SR shares can only be issued to the founders / promoters holding an executive position in the company. Similarly, they have to be a part of the promoter group whose collective net worth is not more than Rs 500 crore.

As per the broad policy provided in the press release, the SR shares have to be compulsorily listed on stock exchanges after the issuer company has made a public issue. However, they cannot be transferred or encumbered. Absolute restrictions such as these may hinder the very objective of listing, i.e. free transferability.

Furthermore, enhanced rules of corporate governance and other restrictions have also been imposed to keep a check on the holders of SR shares, including norms related to protection of interests of public shareholders. The new framework is made on the lines of the model followed by countries such as the US, where the founders of start-ups can raise debt free funds and also retain control over the decision making of the company, while holding a smaller portion of its equity.

In the wake of recent events, Sebi has imposed additional restrictions and has reduced exposure limits for liquid funds. These include: reduction in the sectoral exposure limit from 25 percent to 20 percent, prohibiting investments from unlisted non-convertible debentures, commercial papers and equity shares, and mandating a security cover of at least four times for investments in debt securities with credit enhancements. Several amendments in provisions related with valuation of money market and debt securities have also been approved by the SEBI Board with a view to bring in uniformity and transparency in valuation methods.

Lately, due to the frequent events of default in repayment of debt obligations by various issuers, the MFs were being seen as an instrument of shadow lending. These norms will prevent that and permit the MFs to continue their business in a controlled environment.

The definition of the term ‘encumbrance’ under the Sebi (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 will be amended to include all agreements restricting free and marketable title to shares, pledge, lien, non-disposal undertakings, etc. Further, disclosure norms with respect to encumbrances have been made stricter and the promoters will now be required to disclose reasons for encumbrances if it exceeds 20 percent of the total share capital or 50 percent of their shareholding in the company.

These amendments have been made to increase the transparency and accountability of the promoters, in light of the recent events concerning Zee group of companies wherein the value of the security cover (in the form of pledge on promoters’ shareholding) against the debt instruments issued to various MFs had fallen down due to reduction in the underlying stock price of the group companies, adversely affecting various MFs.

The newly amended Sebi (Prohibition of Insider Trading) Regulations, 2015, effective from April 1, 2019 had provided that the trading restrictions ‘can be’ made applicable from the end of every quarter till 48 hours after the declaration of financial results. To this, the stock exchanges had clarified that the word ‘can’ be read as ‘shall’. In the board meeting, Sebi has approved the said interpretation and listed companies will now be required to close the trading window from the end of every quarter until 48 hours after declaration of the financial results, except in transactions such as, off-market inter-se transfer between insiders, pledging of shares for bona fide transactions, exercising of stock options, etc.

Considering that declaration of financial results may take about 40-45 days from the end of every quarter, implementation of this amendment would mean that the trading window will be effectively closed for around 160-180 days. This level of micro-management may be unnecessarily harsh and counter productive.