The Securities Exchange Board of India ("SEBI") has, in its meeting held on December 28, 2021, approved certain changes to the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018, amended ("SEBI ICDR Regulations") that largely affect public offerings, preferential issues by listed companies, and to some degree, rights offerings. Pursuant to this meeting, SEBI has issued a press release 1 ("SEBI PR"), summarizing these decisions. Most of these changes had previously been included in two consultation papers dated November 16, 2021 2 ("Public Offer Consultation Paper") and November 26, 2021 3 ("Preferential Allotment Consultation Paper") that sought public comments on some of the policy changes for primary markets. In addition to the above, as per the SEBI PR, SEBI has also approved certain other changes, including several procedural changes, to other securities laws dealing with mutual funds, AIFs and FPIs. However, this note will only focus on the changes to the SEBI ICDR Regulations.
2. KEY UPDATES TO PUBLIC OFFERS
The key changes approved by SEBI are provided below. While there are several changes specified in the SEBI PR, there are two material changes affecting use of proceeds and size of offer for sale that are very relevant for new age technology companies ("NATCs") and private equity funds looking to exit in an initial public offer ("IPO").
2.1 Changes linked to use of proceeds
2.1.1 Acquisition of unidentified targets
Last year the Indian capital markets space saw a series of public offers by NATCs, and such transactions are only expected to grow in volume in the coming years. NATCs tend to be asset-light and typically grow their businesses through acquisitions and strategic investments instead of traditional capex. As a result, the use of IPO proceeds for these NATCs is, to a large extent, to fund their inorganic growth initiatives. While using public offer proceeds for acquisition of a specific and identified target is not a new concept, a number of NATCs that have filed their offer documents recently have instead preferred a 'blind pool' for acquisitions without identifying targets. Such an object is often only justified based on historic acquisitions by the NATC and its strategy for selecting future targets. Some of these NATCs have allocated as high as 50% issue proceeds to such 'blind pool' acquisitions.
While SEBI has acknowledged the need for this flexibility to address the business models of the NATCs and has even cleared a few IPOs with use of proceeds for 'blind pool' acquisitions, it has also expressed need for restricting the 'blind pool' object. Accordingly, under the new changes, use of proceeds for future inorganic growth without an identifiable target and for general corporate purpose ("GCP") will together be capped at 35% of the total proceeds raised. GCP refers to a group of identified purposes that don't have specific amounts attributed to each purpose, but collectively cannot exceed 25% of the amount raised by the issuer. Further, the use of proceeds for future inorganic growth, without considering GCP, will also be restricted to 25%. These limits will not apply in case the acquisition or investment is made in an identified target, with relevant disclosures in the draft offer documents and the offer documents. For perspective, in IPOs filed or launched in 2021, the average portion of the proceeds allocated for 'blind pool' acquisitions by NATCs (based on certain assumptions) was around 30%, whereas the average portion allocated to 'blind pool' acquisitions together with the GCP was around 50% (again based on certain assumptions).
2.1.2 Monitoring of use of issue proceeds
The SEBI PR makes further changes that affect use of proceeds and their monitoring. Where the issue size is over INR 1,000 million, the existing provisions under the SEBI ICDR Regulations 4 require issuers to appoint a monitoring agency to monitor and prepare reports on the utilization of issue proceeds. However, the monitoring requirement was only to the extent of 95% of the proceeds from the issue, excluding GCP. However, in light of the size of GCP (in absolute monetary terms) in recent transactions, SEBI now intends to extend the monitoring requirement to 100% of the proceeds from the issue, including GCP. The monitoring agencies will now have to also submit these reports to the audit committee of the issuer on a quarterly basis instead of annually.
While currently, the SEBI ICDR Regulations allow scheduled commercial banks ("SCBs") and public financial institutions ("PFIs") to perform the role of monitoring agencies, the SEBI PR seems to suggest that now the role of monitoring agency will be instead performed by credit rating agencies ("CRA"). While the intention could be to add CRAs to the list of entities qualified for this role, we will need to see the language of the amendment to understand the scope of this change. Interestingly, the Public Offer Consultation Paper only discussed the change on including GCP within the scope of the monitoring agencies' report, without dealing with the other changes which have now been approved.
Furthermore, while the SEBI PR has highlighted these changes for public issues, these are also conceptually relevant for rights issues by listed companies in India. We will have to wait till the amendments are notified to see the extent of their applicability.
These changes will be applicable to all draft offer documents filed on or after the amendments to the SEBI ICDR Regulations are notified in the official gazette. While the amendments have not been notified, there could be regulatory expectation to start following these policy changes from now.
2.2 Offer for sale in public offers by issuers without track record
As per the Public Offer Consultation Paper, for issuers without an identifiable promoter, SEBI intended for certain larger shareholders (holding more than 20%) ("Significant Shareholders") to have some skin in the game post listing, and had therefore suggested a limit on the size of the exit by such significant shareholders to 50% of their pre-IPO shareholding. This restriction is intended for public offers made pursuant to Regulation 6(2) of SEBI ICDR Regulations, i.e., where the issuer does not meet the prescribed track record thresholds for its assets, net worth and operating profit, to further reduce the risk to public subscribers to the IPO. There was also a suggestion of a six month lock-in on the post-offer shareholding of these Significant Shareholders, even if such shareholders happen to be from the exempted category of venture capital funds, alternate investment funds and foreign venture capital funds.
The SEBI PR however has expanded on this proposal to make the following changes:
- Size of offer for sale by Significant Shareholders in a public offer made pursuant to Regulation 6(2) of the SEBI ICDR Regulations cannot exceed 50% of their pre-issue shareholding in the issuer. The SEBI PR does not make a distinction between promoter run companies and professionally managed companies. As a result, even promoter run companies looking to make an offer under Regulation 6(2) will be subject to these limits and lock-in. It is possible that the amendment will clarify this position.
- Shareholders other than Significant Shareholders can sell only up to 10% of the 'pre-issue shareholding of the issuer'. There seems to be some confusion on the way this has been drafted in the SEBI PR and since this was not a part of the Public Offer Consultation Paper, it is unclear as to what is the policy rationale behind this change. One rational way to read this is to mean that each non-Significant Shareholder can sell up to 10% of the share capital of the issuer. However, we await specific amendment language for clarity on this point.
- The SEBI PR is silent on proposed changes in the Public Offer Consultation Paper on the additional post-issue lock-in requirement for Significant Shareholders. Even though there is already a post IPO lock in for all pre-IPO shareholders, the SEBI PR is silent on whether lock in extended for exempted categories of venture capital funds, alternate investment funds and foreign venture capital fund, when they happen to be Significant Shareholders.
These changes will also be applicable to all draft offer documents filed on or after the amendments to the SEBI ICDR Regulations are notified in the official gazette. As above, while the amendments have not been notified, there could be regulatory expectation to start following these policy changes from now.
2.3 Issue price determination
SEBI has mandated that minimum price band range should be at least 5% of the floor price, to address the more recent trend of very narrow price bands that defeat the purpose of having a price band range.
This change will apply to all issues opening on or after the amendments to the SEBI ICDR Regulations in this regard are notified in the official gazette. This proposed change could be an operational challenge for transactions where the amendments to the SEBI ICDR Regulations are notified after the publication of the price band but before the issue opens. It would be advisable for SEBI to make this applicable only in case the amendment is notified prior to the publication of the price band. However, there could be regulatory expectation to start following these policy changes from now.
2.4 Extension of lock in for anchor investors
The Public Offer Consultation Paper had proposed extending the lock in period for not less than 50% of the anchor investors from 30 days to 90 days, with a view to boost investor confidence. SEBI also sought views on whether there should be a reservation for anchor investors who agree to the new longer lock-in period.
SEBI has extended the lock-in period from 30 days to 90 days for 50% of anchor investors in a public issue for all issues opening on or after April 1, 2022. The SEBI PR, however, is silent on the reservation.
2.5 Allocation among non-institutional investors
SEBI has bifurcated allocations to be made to the non-institutional investor ("NII") category, which now requires one third of the NII portion to be reserved for NIIs with application size between INR 0.2 million and INR 1 million, and the rest for NIIs with application size over INR 1 million. SEBI has also mandated that allotment in the NII category be undertaken on the basis of 'draw of lots', as is currently applicable for retail investors. This is also a new change not previously addressed in the Public Offer Consultation Paper.
This bifurcation will have to be followed for all book built issues opening on or after April 1, 2022.
3. UPDATES TO PREFERENTIAL ALLOTMENTS BY LISTED COMPANIES
SEBI has also approved certain changes to preferential allotments by listed companies, as highlighted below, which follow the proposals outlined by SEBI in the Preferential Allotment Consultation Paper. These changes will come in force for preferential allotments where the relevant date is after the date of notification of the amendments to SEBI ICDR Regulations.
3.1 Floor price determination
SEBI has reduced the look back period for determining the floor price for all preferential issues. For frequently traded securities, the look back period has been reduced from 26 weeks/two weeks to 90 days/10 days, or as per any stricter provision in the articles of association of the issuer company. For infrequently traded securities and in transactions where there is change in control or allotment of more than 5% of the post-issue diluted capital, SEBI now mandated that the floor price be supported by a valuation report by a registered independent valuer. In case of change in control, a committee of independent directors will also be required to provide a rational and recommendation for the preferential issue, including its pricing.
3.2 Lock-in provisions
SEBI has sought to align the lock-in provisions following a preferential allotment with the changes made recently for public issues 5. The lock-in requirement for promoters has been changed to:
- For allotment up to 20% of the post issue share capital will be reduced from three years to eighteen months;
- For allotment over 20% of the post issue share capital will be reduced from one year to six months.
Similarly, non-promoter shareholding lock-in for allotment has been reduced from one year to six months.
3.3 Other additional changes
SEBI has also approved the following changes:
- Aligning it with the requirements of public offers, pledge of the locked-in shares by promoters can be done if such pledge is a term of loan granted by financial institution to the issuer or its subsidiary to finance one or more of the objects of the preferential issue.
- Preferential issue with consideration 'other than cash' will be permitted only in case of share swaps backed by a valuation report from an independent registered valuer.
- Issuer must seek in principle approval from stock exchanges for the preferential issue on the same day as dispatch of notice for general meeting to their shareholders.
4. INDUSLAW VIEW
While these changes are extensive and will have an impact on companies looking to access public markets, especially NATCs or professionally managed companies, we will have to wait for the amendments to be notified to access what specific changes are brought in. Hopefully the amendments will address some if not all of issues highlighted above, including the applicability of limits on OFS for promoter driven companies, or how it will impact both significant as well as small shareholders.
1. SEBI Press Release no. 38/2021 dated December 28, 2021
2. SEBI consultation paper on "Review of certain aspects of public issue framework under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018" dated November 16, 2021
3. SEBI consultation paper on "Review of provisions related to Preferential Issues Guidelines under Chapter V of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018" dated November 26, 2021
4. Reg. 41 of SEBI ICDR Regulations
5. Changes pursuant to Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) (Third Amendment) Regulations, 2021, w-e-f 13.08.2021
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