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Analysis of recommendations made by SEBI appointed group for regulating related party transactions

Ramaswami Kalidas 
Updated on 18 March 2020

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Critical analysis of the Draft Report of the Working Group on related Party Transactions(RPTs)

  • SEBI had constituted in November 2019 the working group under the Chairmanship of Mr. Ramesh Srinivasan, Managing director of Kotak Mahindra Capital to review the existing policy space on RPTs under the SEBI(LODR)Regulations.
  • The Working group has submitted its draft report on January, 27, 2020 and the Report has been thrown open by SEBI to elicit public responses to the recommendations.
  • The Group has, inter alia, recommended changes in the definition of related party as also the definition of RPT apart from recommending changes in the process to be followed in the approval of RPTs.
  • The major recommendations and their implications are summarized as under:
Analysis of recommendations made by SEBI appointed group for regulating related party transactions

a) Definition of “Related Party”-Definition being widened

Related party means a related party as defined under section 2(76) of the companies Act, 2013 or under the applicable accounting standards.

It will include:

i) any person or entity who belongs to the promoter or promoter group of the listed company. As per the previous definition, any person belonging to the above group would be a related party only if in addition to being a promoter or part of promoter group, they hold 20% or more of the equity capital of the listed company.

The rationale for the above is that the Working Group has noted that a promoter may be exercising influence on the company even without having any holding in the company.

ii) any person or any entity holding directly or indirectly including holding of their relatives 20% or more in the equity capital of the reporting entity. This will mean that holdings of relatives will also be considered in determining the threshold of 20%.

b) Definition of RPT-further widened

An RPT will be one involving transfer of resources, services or obligations between:

  1. the listed company or any of its subsidiaries on the one side and a related party of the listed company or its subsidiary on the other hand or:
  2. the listed company or any of its subsidiaries and any other person or entity where the purpose and effect of the transaction is to benefit a related party of either the listed company or any of its subsidiaries.

SSuch transactions shall be construed to include a single transaction or a group of transactions.

 

Rationale for change

The working group was of the view that the present regime was insufficient to cover transactions whereby the listed company could transfer its subsidiary, whether in India or abroad and the subsidiary could thereafter transact with the related parties of the listed company and move the assets out of the consolidated entity and escape the scrutiny of sanctions under the regulations.

Implications

The need for seeking approvals for RPTs will now widen to encapsulate in addition to the present requirements ,transactions between the related parties of the listed company and its subsidiaries. Further any transaction the purpose or intent of which is to benefit a related party of either the listed company or its subsidiary will now come under the ambit of approval of the Audit committee of the Listed Company.

Exemptions

 

The Committee has recommended that the following transactions shall not be treated as RPTs:

a) issue of specified securities on a preferential basis for which necessary requirements under the SEBI(ICDR)Regulations , 2018 have been complied with and

b) the following corporate actions by the listed company which are uniformly applicable to all the shareholders in proportion to their holding

i) payment of dividend
ii) sub-division or consolidation of securities
iii) any rights or bonus issue
iv) buy- back of securities

Critique

The above exemptions are logical given that all the above corporate actions require the approval of the shareholders under specific provisions of the Act and it would be meaningless to make the company seek approvals for the RPTs arising out of the above. For instance if the Subsidiary of the listed company proposes dividend and the quantum of dividend payable to the Holding company as a shareholder, exceeds the materiality threshold prescribed in the SEBI(Listing Regulations), as there is transfer of resources as between the company and its holding company the transaction may need specific approval of the shareholders as an RPT over and above the consent of the shareholders required for declaration of dividend to all shareholders.. The holding company being a related party cannot vote on the resolution positively , being entitled to only cast a negative vote, and there is a theoretical possibility that the resolution may not be carried at the General Meeting without the support of the holding company. The listed company could end up with egg on its face if the resolution were to be defeated due to lack of adequate support. Even otherwise shareholders need to approve the dividend .Making the listed company go through with the rigmarole of seeking approval specifically for the RPT would be counter-productive and hence the proposal to grant exemptions for the above is sensible. It may well have been the case of the battle being won with the war being lost.

AAs the proposal to exempt such corporate actions from the ambit of shareholder approval is only prospective, it follows that no action can be taken in respect of transactions of the above genre which may have gone through in the past without being subjected to specific approval of the shareholders, in relation to the holding company.

Additional compliance requirements to be ensured

Due to the widening up of the definition of related party , the listed company shall have to map the related parties of the subsidiary also. Further the purpose of the transaction has to be analysed to see whether it benefits any of the related parties of the listed company or the subsidiary company .If this is so, the transaction will have to be brought in for the approval of the Audit committee.

c) Reduction in threshold for materiality for seeking shareholder approval

At present ,where the value of a related party transactions exceeds 10% of the consolidated turnover or total assets or net worth of the listed company, consent of the shareholders has to be taken by the listed company as the transaction would be considered as a “material related party transaction”.

Proposal

The Group has recommended lowering of the existing threshold for seeking shareholder approval as under:

If the value of the transaction exceeds rupees one thousand crores or 5% of the total revenues, or total assets or net worth on a consolidated basis as per the last audited Accounts, approval will be needed. The net worth criteria shall not be applicable where the net worth on a consolidated basis is negative.

Replacement of the criteria of consolidated turnover by the consolidated total revenue and the reduction in the threshold would mean that many more transactions could come within the ambit of the materiality threshold.

d) Approval of the Audit committee-Proposed additional requirements

In respect of a transaction in which the subsidiary of the listed company is a party but the listed company is not a party thereto, approval of the Audit Committee will be necessary only if the value of the transaction exceeds 10% of the total revenue or total assets or net worth of the subsidiary whichever is lower on a standalone basis for the immediately preceding financial year. The net worth criteria shall not apply where the net worth of the subsidiary is negative.

No approval of the Audit committee of the listed company shall be needed where the subsidiary company is listed and it is by itself obliged to comply with the requirements of Regulation 23 and other provisions relating to corporate governance.

For transactions between the unlisted subsidiaries and the listed subsidiary, it would be adequate if the approval of the Audit Committee is obtained prior to entering into the transaction.

e) No requirement for approval of the listed holding company for RPTs in which listed subsidiary is a party - Regulation 23(4)

In the case of a material related party transaction which involves only its listed subsidiary and the holding company is not a party thereto, no approval has to be obtained from the shareholders of the holding company ,if the listed subsidiary is required to comply with the requirements of Regulation 23 and other provisions of the listing regulations. In such a situation it would be necessary only for the listed subsidiary to seek the approval of its shareholders for the subject RPT.

For transactions between the unlisted subsidiaries and the listed subsidiary for value exceeding the specified threshold, approval of the shareholders of the listed subsidiary would be sufficient. No approval would be needed from the shareholders of the listed holding company.

f) Exemption from approval for transactions between wholly owned subsidiaries of the listed holding Company-Regulation 23(5)

Transactions between two wholly owned subsidiaries of the listed holding company shall not be subject to approval of the shareholders of the holding company subject to the condition that the Accounts of both the subsidiaries are consolidated with that of the holding company and presented to the shareholders of the holding company.

g) Reporting RPTs to Stock Exchanges-Regulation 23(9)

At present listed companies are required to provide a report to the stock exchanges on a consolidated basis particulars of RPTs within thirty days from the date of publication of the half yearly financial results in the format prescribed in the Accounting standards and also upload the information on the website.

It is proposed that the information relating to RPTs shall be submitted to the stock Exchanges along with the publication of the half yearly financial results. It is also clear that the format for disclosure shall be prescribed by SEBI.

h) Documents and information to be provided to shareholders while seeking approval

New Regulation 36(6) is being proposed to provide that while seeking approval of the shareholders for the RPTs the listed company will be called upon to make the following additional disclosures in the explanatory statement attached to the notice for the general meeting:

a) A summary of the information provided to the audit committee relating to the proposed transaction while seeking its recommendation.
b) Recommendation of the Audit committee along with its justification as to why the transaction would be beneficial to the interest of the company.
c) Where the transaction involves provision of loans, inter-corporate deposits, advances or investments made or given to the subsidiary company complete details as regards the terms and conditions thereto shall be provided.
d) Whether the approval granted to the transaction by the Audit Committee was unanimous.
e) Confirmation that where a report has been obtained from an External Agency regarding valuation or any other aspect relating to the transaction , the same shall be available for inspection by shareholders leading up to the date of the general meeting.
f) The percentage of the counterparty’s annual total revenue, total assets and net worth which is represented by the value of the proposed RPT.
The provision of the above information in the notice is voluntary.
g) Any other information which may be relevant relating to the transaction.

i) Mandatory review of RPTs by Audit Committee

The following information shall be mandatorily provided by the Management to the Audit Committee to enable it to take a decision on RPTs:

i) Type of transaction, material terms and particulars of the transaction.

ii) Name of the related party ,and its relationship with the listed company ,or its subsidiary including the nature of its interest (financial or otherwise).

iii) Tenure of the Transaction .The transaction cannot be open ended and should be for a specific tenure.

iv) Value of the proposed transaction. An upper limit should be provided and in case of recurring transactions, the aggregate value and period in which the limit will be exhausted should be provided.

v) The percentage of the company’s annual total revenue on a consolidated basis which is represented by the value of the proposed transaction. If transaction is with a subsidiary, the value of the transaction as a percentage of the subsidiary’s standalone revenue for a year shall be indicated.

vi) Where transaction involves provision of any loan , inter-corporate deposits , advances or investments made or given the following information has to be provided additionally;

a) sources of funds for the subject transaction.
b) for providing the inter corporate loans, if any borrowings shall be resorted to, the details thereof shall be provided.
c) terms and conditions , tenure of loan, rate of interest, whether the loan is secured or unsecured .If secured, the nature of the security.
d) the purpose for which the loan shall be used by the ultimate beneficiary to the RPT.
e) justification as to why the transaction would be in the interest of the company.
f) a copy of the valuation or any other external report on which reliance has been placed by the Management.
g) percentage of the counterparty’s annual total revenues , total assets and net worth which is represented by the transaction. The disclosure of this information is voluntary .
h) any other relevant information.

vii) The Committee shall also be apprised of the status of long term RPTs with an age more than one year or recurring RPTs on an annual basis.

j) Disclosures in the Annual Report

The company's annual Report shall contain the following additional disclosures:

a) Disclosure on RPTs.
b) Corporate governance Report
c) Disclosure of loans and advances which are in the nature of loans to firms/companies in which directors are interested by name and amount outstanding for the listed company and its subsidiaries.

Other disclosures as per the existing Schedule V to the Listing Regulations will continue.

Need for change in format of Directors’ disclosure of interest (MBP1) recommended due to extended definition of "Related party" under listing Regulations

AAs the definition of a related party as per the listing regulations is much wider than the definition contained in Section 2(76)it is suggested that listed companies should make modifications in the format of disclosure provided by directors in MBP 1 to capture relationships/interest in terms of the extended connotation to the term in the Listing Regulations.

Conclusion

The recommendations of the working group if accepted in entirety by SEBI will mean that the procedure associated with seeking approval of RPTs shall become much more tenuous than ever before. There will be dissemination of more information and a higher degree of transparency .The Audit committee shall exercise greater vigilance where it comes to approving RPTs. The mandatory requirement of providing disclosure as enumerated above to the Audit Committee is most welcome. It is imperative that directors are asked to provide their disclosures in form MBP 1 by listed companies to map their interest in entities in line with the extended connotation to the term “Related Party” as per Ind. AS 24.

The proposed changes will no doubt raise the bar as far as transparency and corporate governance is concerned by some notches. Corporates that have taken advantage of the loopholes which are sought to be plugged will have retrace their steps and fall in line with a more sophisticated regime of governance which augurs well for the future. It remains to be seen to what extent the recommendations of the working group are accepted by SEBI.


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