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SEBI Proposes An L&T-Situation Fix To Its Buyback Regulations

SEBI intends to soften its views on buybacks for companies which have NBFC and housing finance businesses housed in subsidiaries.

Man distributes money Photographer: Dhiraj Singh/Bloomberg
Man distributes money Photographer: Dhiraj Singh/Bloomberg

In January this year, Larsen & Toubro Ltd.’s Rs 9,000-crore buyback proposal was rejected by SEBI. In SEBI’s view L&T did not meet one of the regulatory requirements for a buyback — that of debt to capital and free reserves ratio.

The requirement is that the ratio of the aggregate debt (secured and unsecured) post buyback must not be more than twice the paid-up capital and free reserves. Simply put, for a company to be able to buyback its securities, its total debt must be less than or equal to twice the sum of paid-up capital and free reserves. This is to ensure that the company has enough cash to service its debt.

The Securities and Exchange Board of India’s rejection noted that the company’s ratio post buyback would breach the regulatory threshold. SEBI’s rejection hinged on interpretation of whether the ratio is to be calculated on the basis of consolidated or standalone financials. At that time, an L&T official had told BloombergQuint that the company had applied for approval based on its standalone numbers since the regulation does not specify whether the application seeking approval for a buyback has to be based only on consolidated numbers.

Consolidated figures account for the financials of subsidiaries and group companies, while standalone figures only reflect the position of the company concerned.

Proposed Change

Experts told BloombergQuint that SEBI has historically looked at all proposals and transactions on a consolidated as well as a standalone basis. But to further clarify its stance, SEBI has proposed to amend the regulations to reflect that the consolidated statement that will also be looked at to approve a buyback application.

“SEBI has taken a view that the financial statements would be considered on a conservative basis (i.e. both standalone and consolidated basis) for evaluating the various thresholds/conditions of buyback of securities.”

Considering that the consolidated financials present the aggregate information of the company/group which is material for decision making, SEBI believes that it is in the interest of investors that the stipulated thresholds/conditions are better evaluated based on standalone as well as consolidated financials, wherever consolidated financials are required to be prepared, the regulator has explained in the discussion paper.

Experts agree with SEBI’s view.

To test any financial parameter under a regulation, it is prudent to always test the company and its subsidiaries together and not just the company alone, Manan Lahoty, partner at law firm L&L Partners, told BloombergQuint.

The value of the assets a HoldCo owns in its own balance sheet may not necessarily reflect the fair value of its subsidiaries since long-term investments are not marked-to-market. So to get a real sense of the assets and liabilities of any company you must look at the financials on a consolidated basis.
Manan Lahoty, Partner, L&L Partners

Consolidated financials give a complete picture to the shareholders and creditors of the financial status of the relevant entity and brings greater transparency at the group level. This, however, needs to applied on a case-to-case basis as it wouldn’t be fair to consider the same ratio if the subsidiary is engaged in financial services business, Moin Ladha, partner at Khaitan & Co, said.

To account for this unfairness, SEBI has now proposed to ease the buyback norms for companies whose subsidiaries are engaged in financial services businesses that inherently require taking on large debts. The financials of such subsidiaries, SEBI has proposed, need not be included in calculating the post buyback debt to capital and free reserves ratio.

Riders

The financials of subsidiaries in the NBFC and housing finance business can be excluded from the consolidated financials only if they are:

  • Regulated
  • Have issuances with AAA ratings.
  • Have debt to equity ratio of not more than 5:1 on standalone basis.

To reiterate, while calculating the post buyback debt to capital and free reserves ratio of 2:1 on a consolidated basis, subsidiaries engaged in financial services may be excluded. But the requirement that the subsidiary be ‘regulated’ is confusing, Lahoty said.

It seems like the intent of SEBI is to cover companies that are engaged in financial services business. These companies, by the nature of their business models, are expected to be more leveraged. However, referring to such companies merely as ‘regulated’ entities could lead to confusion. It could exempt any entity which is regulated by some or the other regulator — in some sense all companies are ‘regulated’.
Manan Lahoty, Partner, L&L Partners

Instead, SEBI could use the term “financial services activities regulated by financial sector regulators” to capture financial services companies regulated by autonomous regulators like Reserve Bank of India, SEBI, IRDA. This term is defined by the Department of Industrial Policy & Promotion, Lahoty said.

Besides NBFC and housing finance activities, the listed entity making a buyback application could also have a subsidiary in the infrastructure sector. Infrastructure companies too, the regulator has pointed out, have higher debts because of the nature of their business. But since they are not separately regulated, their financials must be considered to calculate the debt to capital and free reserves ratio, SEBI has proposed.