SEBI Tightens Screws On Related-Party Transactions
The Securities and Exchange Board of India approved several changes to provisions pertaining to related party transactions, at its board meeting on Sept. 28. These changes will become effective April 1, 2022, a statement by the regulator said. Though first they have to be notified to be included in SEBI (Listing Obligations And Disclosure Requirements Obligations) Regulations, 2015.
Related party transactions may occur in the ordinary course of business but have often been used to benefit select parties, often promoters or those close to them, at the cost of public shareholders. Since 2013, company law and SEBI regulation have sought to govern them more tightly in order to prevent such abuses. Though in some cases, company law has been relaxed to facilitate ease of doing business, SEBI has continued to maintain higher RPT thresholds, approval standards and disclosures. These changes continue in that vein.
The SEBI board has approved to expand the definition of related party and related party transactions. They also expand the scope of shareholder approval of RPTs. Audit committee oversight has been rationalised, but only in certain cases, and disclosures made more frequent. The amendments are mostly in keeping with the recommendations of a SEBI Working Group, submitted in January 2020.
Amendments To Related Party, Related Party Transaction Definitions
The SEBI board has approved expanding the definition of related party to:
All persons/entities in a promoter group (irrespective of shareholding).
Currently any person/entity belonging to the promoter group of the listed entity and holding 20% or more of shareholding in the listed entity is deemed to be a related party.
But, as the working group had explained, a promoter may exercise control over a company irrespective of the extent of shareholding. Also, several Indian business are structured as intrinsically linked group entities that operate as a single economic unit. Hence this change was necessary to plug any gaps.
Any person/entity holding directly or indirectly a 20% stake in the listed entity in the immediately preceding year. This falls to 10% or more with effect from April 1, 2023.
The working group cited several other jurisdictions, such as U.K., that treat significant shareholders as related parties of the listed entity as they may influence company decisions.
The SEBI board has also approved amending the definition of related party transactions.
The existing definition—"related party transaction” means a transfer of resources, services or obligations between a listed entity and a related party...— was viewed as being open to abuse by complex structures or by transactions with seemingly unrelated parties, however intended to benefit related parties and the like.
Now RPTs are defined as being transactions between:
The listed entity/its subsidiaries and a related party of the listed entity/its subsidiaries.
The listed entity/its subsidiaries and any person/entity, the purpose and effect of which is to benefit a related party of the listed entity/its subsidiaries.
The working group, drawing from the recommendations of the Kotak Committee, said it was needed to regulate the consolidated entity as a whole given that often companies have multiple subsidiaries, step-down subsidiaries, associates, and joint ventures. "...it's important for boards to ensure that good governance trickles down to the entire structure," the Kotak Committee had said.
Audit Committee Approval
All related party transaction currently require prior approval of the listed company board's audit committee. Given that the new definitions capture many more transactions, the working group had recommended narrowing the audit committee approvals in certain cases.
Hence, SEBI has approved that RPTs, where the subsidiary is a party but the listed entity is not, will require the approval of the listed entity's audit committee only if certain size thresholds are exceeded.
10% of the consolidated turnover of the listed entity.
10% of the standalone turnover of the subsidiary (April 1, 2023 onwards).
Materiality Threshold And Shareholder Approval
SEBI's extant regulations mandate company boards to determine a policy on materiality of RPTs, provided that a RPT exceeding 10% of annual consolidated turnover of the listed entity shall be considered material.
All material RPTs need the prior approval of shareholders, as per SEBI regulations.
Now, partially adopting the working group's recommendations to expand the scope of shareholder approval, the regulator has approved amending the definition of material to include RPTs that cross Rs 1,000 crore or 10% of the consolidated annual turnover, whichever is lower.
To be clear, the working group had recommended materiality threshold should be amended to 5% of the annual total revenue, total assets or net worth of the listed entity on a consolidated basis or Rs 1,000 crore, whichever is lower.
More detailed disclosures of RPTs are being mandated, again in keeping with the Working Group recommendations.
Enhanced disclosures to be placed before the audit committee, provided in the notice to shareholders for material RPTs, and provided to the stock exchanges every six months.