Building Trust and Transparency: SEBI's Policy Updates

The Securities and Exchange Board of India (‘SEBI’), in its board (‘Board’) meeting held 18.12.2024, approved several regulatory reforms designed to enhance transparency, safeguard investor interests, and streamline market operations - giving effect to proposals in various consultant papers issued this year. These changes reflect SEBI’s efforts to align with global best practices and put in place adequate guardrails for Indian capital markets.  These changes will impact various sectors, from tightening Small and Medium Enterprises (‘SME') IPO frameworks to enhancing mutual fund regulations.

This article covers some of the major changes that have been approved. 

Fixing the SME IPO Framework

A revamped framework has been introduced for SMEs accessing public markets. These changes follow various instances of diversion of funds raised and inflation of financials pre-IPO through related party transactions:

1. Financial Stability as a Pre-Requisite. To ensure only financially sound SMEs with a proven track record access public funds, SEBI now mandates that SMEs must have achieved Earnings Before Interest, Taxes, Depreciation, and Amortization (‘EBITDA’) of ₹1 crore in any two of the three previous financial years. This requirement, applicable at the time of filing the Draft Red Herring Prospectus (‘DRHP’), filters out speculative ventures and brings credibility to SMEs participating in IPOs.

2. Transparent Use of Funds. Allocation for General Corporate Purpose (‘GCP’) has been capped at 15% of the funds raised or ₹10 crores, whichever is lower. Additionally, funds raised through IPOs can no longer be utilized to repay loans taken by the company’s promoters or related parties. These measures direct proceeds toward productive business activities, rather than obscure purposes. 

3. Limits on Stake Sale. SEBI has introduced restrictions on the sale of promoter and shareholder stakes during SME IPOs to prevent premature exits and ensure accountability. Under the revised framework, promoters and selling shareholders can divest only up to 50% of their holdings, and the offer-for-sale (‘OFS’) component cannot exceed 20% of the total issue size. These measures are designed to require that promoters retain a significant stake in the business, and align with the company's growth and alignment with investor interests.

4. 21-Day DRHP Review Period for Investors. SEBI now mandates that the DRHP for SME IPOs, once filed with the stock exchanges, must be made publicly available for a 21-day review period. During this time, stakeholders, including investors, can provide comments and raise concerns regarding the DRHP. To ensure broad accessibility, issuers are required to make a public announcement in newspapers, accompanied by a QR code linking to the document. 

5. Strict Oversight on Related Party Transactions (RPTs). Related Party Transaction (‘RPT’) norms applicable to Main Board-listed entities have been extended to SME-listed entities. RPTs will be classified as material if they exceed 10% of the company's annual consolidated turnover or ₹50 crores, whichever is lower. This change brings listed SMEs in line with larger corporations where significant transactions are subject to rigorous scrutiny including approvals by audit committees & shareholders, and disclosure in corporate governance reports, financial statements & stock exchanges. 

   
   

NSE’s Circular on Additional SME Listing Criteria: Following the 18 December 2024 SEBI Board meeting, the National Stock Exchange of India (‘NSE’) on 19 December 2024 issued a circular adopting additional eligibility criteria for companies seeking in-principle approval to list on NSE Emerge. The criteria have been made applicable to all DRHPs filed on or after 19th December 2024. Existing listing quality checks by NSE will continue alongside the new criteria to maintain prudential standards.

Tighter Rules for Merchant Bankers

Merchant Bankers (‘MBs’) play an essential role in the financial ecosystem, managing IPOs, underwriting, and mergers. However, challenges such as conflicts of interest, inadequate oversight, and regulatory lapses prompted SEBI to undertake a review of the SEBI (Merchant Bankers) Regulations, 1992 (‘MB Regulations’). The MB Regulations provide for the framework of registration of Merchant Bankers, eligibility, activities undertaken, etc. SEBI has consequently approved inter alia the following amendments to MB Regulations:

1. Focus on Core Activities. To ensure that merchant bankers prioritize their primary permitted activities, SEBI will now mandate that merchant bankers, other than banks and public financial institutions, limit their operations to core activities such as IPO management, underwriting, and mergers and acquisitions. Non-core activities, such as lending or mutual fund management, must be hived off into separate legal entities with distinct branding within two years. These separated entities may carry out activities not regulated under MB Regulations, including by sharing resources with the MB on an arm’s length basis without sharing any legal liability with the latter. This structural segregation ensures that merchant bankers remain focused on their regulated activities and reduces the risk of operational conflicts.

2. Avoiding Conflicts of Interest. ​​To mitigate potential biases, SEBI has prohibited MBs from leading managing public offerings of companies where their directors, key managerial personnel, or their relatives hold more than 0.1% of the company’s equity or shares worth ₹10,00,000, whichever is lower. While merchant bankers can still participate in the marketing of such issues, their involvement in core management roles is restricted. 

3. Revised Categorization Based on Net Worth and Activities. SEBI has introduced a tiered categorization for merchant bankers to align their operational scope with their financial capacity:

   1. Category 1: Requires a net worth of ₹50 crores and is allowed to undertake all permitted activities. 

   2. Category 2: Requires a net worth of ₹10 crores and can undertake all permitted activities, except managing equity issues on the Main Board. 

4. Enhanced Risk Management in Underwriting. SEBI has capped the underwriting exposure of MBs to a maximum of 20 times their liquid net worth. This measure is designed to prevent over-leveraging, which can create systemic financial risks, and to ensure that MBs maintain a stable and well-capitalized underwriting environment.

5. Other Governance Enhancements. Revenue benchmarks have been mandated for MBs to retain their licenses, subject to certain exceptions:

   1. Category 1 merchant bankers must have generated cumulative revenues of at least ₹25 crores over three immediately preceding financial years.

   2. Category 2 merchant bankers must have achieved cumulative revenues of at least ₹5 crores over the same period.

Additionally, Compliance Officers for MBs are now required to hold a law degree or be qualified as a Company Secretary, with a minimum of two years of post-qualification experience. 

Simplifying the rules for REITs and InvITs

The SEBI Board approved various proposals for ease of doing business for Real Estate Investment Trusts (‘REITs’) and Infrastructure Investment Trusts (‘InvITs’):

1. Permitting the inter-se transfer of locked-in units within sponsor group entities to simplify sponsor group structuring.

2. Clarifying the definition of "common infrastructure" in the REIT regulations.

3. Allowing REITs and InvITs to invest in interest rate derivatives for hedging purposes, subject to compliance with RBI guidelines.

4. Providing a three-month timeline for filling vacancies in the board of directors.

5. Allowing REITs and InvITs to invest in unlisted equity shares, limited to companies providing property management, maintenance, housekeeping, or project management services for the trust's assets.

6. Restricting investments to liquid mutual fund schemes with a credit risk value of at least 12 and classified under Class A-I in the potential risk class matrix.

Expanding the roles and responsibilities of trustees to ensure more defined oversight and better protection of unitholders’ interests.

Stricter oversight of Mutual Funds and NFOs

The Board approved amendments to the SEBI (Mutual Funds) Regulations, 1996 (‘MF Regulations’) to delineate the timelines for the deployment of funds when collected by Mutual Funds (‘MFs’) at the time of New Fund Offers (‘NFOs’). 

1. 30-day Timeline for Fund Deployment. From the earlier 60-day period, SEBI will now mandate that Asset Management Companies (‘AMCs’) deploy funds raised through NFOs within 30 days, adhering to the scheme's specified asset allocation. This ensures that funds are not left idle and are utilized efficiently to meet the objectives of the scheme. If the AMC fails to deploy funds within the stipulated time frame, investors will have the option to exit the scheme without incurring any exit load. This change has been made to ensure that AMCs only raise funds that they can deploy in a reasonable frame of time given that open-ended funds can accept investor subscriptions at a later time as well as the then prevailing NAV. This change was earlier discussed in the Consultation paper released on October 30, 2024. 

2. Addressing Mis-Selling Practices. To curb the mis-selling of MFs, during scheme switches, distributors will now be entitled only to the lower of the two commissions available for the schemes involved in the transaction.

Mandates Accountability for AI Usage by Regulated Entities 

In an important step, the Board has approved the proposal to amend the Securities and Exchange Board of India (Intermediaries) Regulations, 2008, Securities Contracts (Regulation) (Stock Exchanges and Clearing   Corporations) Regulations, 2018, and the Securities and Exchange Board of India (Depositories and Participants) Regulations, 2018, covering the usage of Artificial Intelligence (‘AI’). While AI holds transformative potential for enhancing efficiency, productivity, and decision-making in the industry, its adoption also brings risks such as data breaches, biased outputs, and non-compliance with legal standards. 

1. Applicability. These amendments will cover all SEBI-regulated entities, including Market Infrastructure Institutions (‘MIIs’), registered intermediaries, AMCs, and managers of pooled investment vehicles. These entities are required to take sole accountability for the deployment and impact of AI tools in their business activities and investor services, irrespective of the scale or scope of the AI adoption. This includes both tools developed internally or sourced from third-party technology providers.

2. Privacy, Security, and Data Integrity. Entities must ensure the privacy, security, and integrity of investor and stakeholder data, including fiduciary data maintained throughout the operational processes. 

The Board further noted that the regulated entities shall be solely responsible for compliance with applicable laws in force, possibly hinting at compliance with intellectual property and other laws which have a bearing on AI tools, to prevent negligence, misuse, and unethical practices.

Enhancing Corporate Governance

SEBI has approved amendments to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR Regulations’), to enhance corporate governance norms for High-Value Debt Listed Entities (‘HVDLEs’). The key provisions are as follows:

1. Revised Threshold for Identification of HVDLEs. The threshold for identifying HVDLEs has been raised from ₹500 crores to ₹1,000 crores, aligning it with the criteria specified for large corporations.

2. Introduction of a Separate Chapter in LODR Regulations. A dedicated chapter on corporate governance norms for entities with only debt-listed securities has been introduced, along with a sunset clause. This aims to improve ease of reference.

3. Increased Flexibility in Committee Composition. HVDLEs will have greater flexibility in the composition of the Nomination and Remuneration Committee (‘NRC’), Risk Management Committee (‘RMC’), and Stakeholder Relationship Committee (‘SRC’).

4. Ceiling on Directorships and Governance Standards

   1. HVDLEs will be counted when calculating the ceiling on the number of directorships, memberships, or chairperson-ships held by directors in listed entities, ensuring directors can devote adequate attention to each listed entity.

   2. However, the ceiling will not apply to directorships arising from ex-officio positions due to statutory or contractual obligations for Public Sector Undertakings (‘PSUs’) or Public Private Partnership (‘PPP’) entities.

5. Material RPTs

   1. For HVDLEs where shareholding is concentrated with one or a few related-party shareholders, material RPTs will require a No-Objection Certificate (‘NOC’) from the Debenture Trustee, obtained after approval from debenture holders.

   2. The NOC must precede shareholder approval. If withheld, the transaction will not proceed to shareholders for consideration.

   3. This provision will apply to RPTs undertaken by HVDLEs from 1 April 2025.

6. Voluntary Business Responsibility and Sustainability Reporting (BRSR). HVDLEs are encouraged to adopt BRSR voluntarily to promote good governance practices on par with equity-listed entities.

Relaxation for PPP Entities. Entities established under the PPP model are granted similar relaxations as PSUs regarding the composition of directors under the LODR Regulations.

Enhanced Surveillance of Trading Platforms

To enhance regulatory clarity, amendments to the definition of Unpublished Price Sensitive Information (‘UPSI’) under Regulation 2(1)(n) of the SEBI (Prohibition of Insider Trading) Regulations, 2015, by enhancing the illustrative list by covering 17 additional events from the 27 material events outlined under Regulation 30 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. 

Further, to enhance the Ease of Doing Business (‘EODB’), the amendments align UPSI identification with the threshold limits specified under Schedule III of the LODR Regulations. This ensures that only material events meeting specified criteria are classified as UPSI, reducing ambiguity and focusing attention on significant developments. For events originating outside a company’s control, SEBI has introduced greater reporting flexibility allowing companies to update their structured digital database within two days and no longer requiring them to implement mandatory trading window closures for such events. 

Our view

These regulatory updates aim to create a more structured and accountable financial ecosystem. These measures address critical governance challenges, improve risk management practices, and accommodate the rapid adoption of technology in financial markets. Market participants must assess the implications of these changes on their operations and compliance strategies to ensure adherence and leverage the opportunities presented by the new framework. SEBI’s ongoing recalibration of regulations underscores efforts toward sustainable growth in India's capital markets while safeguarding the interests of all stakeholders. Businesses and investors alike should remain vigilant in adapting to these shifts.

Authors Kushank Sindhu and Nishika Godha can be reached on kushank.s@sigmachambers.in and nishika@sigmachambers.in