EXECUTIVE SUMMARY
The Securities and Exchange Board of India (SEBI) has on 14 January 2022 notified an amendment to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations), bringing into effect inter alia certain changes approved by SEBI at its board meeting held on 28 December 2021 to the provisions governing preferential issues of securities by listed companies, including tweaks in the determination of the floor price in such issues. These changes are seen to be a response to the controversy that arose earlier in 2021 involving a preferential issue that had been approved by the board of PNB Housing Finance Limited (PNBHFL), which had been challenged at the time by SEBI, and had reached the Supreme Court of India (SC) before PNBHFL finally called off the transaction.
BACKGROUND
In May 2021, the board of directors of PNBHFL had approved a preferential issue of shares and share warrants worth INR 4,000 crore to certain investors including the Carlyle Group, pursuant to which Carlyle would have acquired control over PNBHFL, at a price which though compliant with the then applicable pricing requirements under the ICDR Regulations was below the prevailing market price.
This transaction came under scrutiny at that time, on the grounds inter alia that a change of control at a material discount to the prevailing market price was against the interests of the minority shareholders and was in violation of PNBHFL’s articles of association (AOA), which provided that the price for any preferential issue would need to be determined by the valuation of a registered valuer. SEBI had thereafter directed PNBHFL not to consider the preferential issue until an independent valuation was done by a registered valuer, and the matter placed afresh before the board. Upon appeal, the Securities Appellate Tribunal (SAT) returned a split verdict which was appealed before the SC, but before a definitive decision was pronounced, PNBHFL chose to cancel the transaction.
With a view to settling the position on the matter, SEBI had issued a consultation paper in November 2021 seeking public comments on modifications to the provisions governing preferential issues under the ICDR Regulations, which were then approved at its final board meeting of 2021.
KEY AMENDMENTS – PRICING METHODOLOGY
The ICDR Regulations prescribe a floor price for preferential issue of frequently traded shares, which was formerly based on the average of the weekly high and low of the volume weighted average price (VWAP) of the shares during the 26 weeks and 2 weeks preceding the relevant date for the issue. This has now been amended to the higher of (x) the VWAP for the (i) 90 trading days and (ii) 10 trading days preceding the relevant date, and (y) the price as calculated in accordance with any valuation methodology that is set out in the AOA of the issuer.
Notwithstanding any provisions on valuation methodology for preferential issues in the issuer’s AOA, if the preferential issue is for more than 5% of the post-issue fully diluted share capital (to the same person or persons acting in concert) or may result in a change in control, then a valuation report from an independent registered valuer would be required, which would also be considered when arriving at the floor price. Where the preferential issue would lead to a change in control, the valuation report must also provide a computation for a control premium, which is over and above the floor price. Further, if the preferential issue may result in a change in control, then a committee of independent directors would be required to provide a reasoned recommendation on the issue together with comments on all aspects of the issue, including pricing. The voting pattern of this committee would need to be disclosed publicly.
OTHER KEY AMENDMENTS
The trading lookback period for being eligible to be allotted securities in a preferential issue has been reduced from 6 months to 90 trading days, i.e., a person who has sold or transferred any equity shares of the issuer during the 90 trading days prior to the relevant date for the preferential issue would not be eligible to participate in such issue.
Qualified institutional buyers that are either promoters or have certain existing shareholder rights in the issuer, including any veto right or director nomination right, would not be eligible to participate in a preferential issue.
The lock-in period for securities issued on a preferential basis has been reduced to bring it in line with the revised lock-in periods notified by SEBI earlier in 2021 for public offers, i.e., the lock-in for allotment to promoters up to 20% of the post-issue share capital stands reduced from 3 years to 18 months, and the lock-in for allotment to promoters in excess of 20% and to any non-promoters stands reduced from 1 year to 6 months. The lock-in on any pre-issue shareholding of the allottees has also been reduced from 6 months to 90 trading days. Promoters would be permitted to pledge their locked-in shares as security for loans by certain categories of financial institutions, provided such loan is sanctioned to the issuer or any of its subsidiaries for the purposes of financing one or more of the objects of the preferential issue and conditional upon creation of such pledge.
SEBI has also decided to limit non-cash consideration that may be given for preferential issues only to share swaps backed by a valuation report from an independent registered valuer. Issuers would now be required to apply for in-principle approval from stock exchanges on the date of dispatch of notice to the shareholders of the general meeting for approving a preferential issue.
TAKEAWAYS
According to SEBI’s press release following its board meeting where the amendments were approved, the revised provisions would be applicable to all preferential issues where the relevant date is after the notification in the official gazette. However, the gazette notification provides that these amendments have come into force upon their publication, and so in the absence of a clarification from SEBI would appear to be applicable to all subsequent preferential issues, regardless of their relevant date.
One of the points of contention in the PNBHFL controversy was the stipulation in PNBHFL’s AOA that the price for any preferential issue would need to be determined by the valuation of a registered valuer, and whether a certificate confirming compliance with the floor price under the ICDR Regulations based on the preceding 26 weeks / 2 weeks VWAP would fulfil such stipulation. PNBHFL had questioned SEBI’s jurisdiction to direct a listed company to follow its AOA, which SEBI has now sought to resolve by mandating that if an issuer’s AOA provides for pricing in a preferential issue, then such provision would need to be considered in addition to the market price.
Given that companies that propose to make an initial public offer typically undertake the exercise of amending their AOA in order to align them with the requirements for listed companies, it would be advisable for such companies to carefully review the provisions dealing with preferential issues, and decide whether post-listing, the pricing for a preferential issue should be based entirely on the prevailing market price as per the ICDR Regulations, or if the AOA should contain more bespoke requirements.
The impact that the changes to the pricing provisions for preferential issues under the ICDR Regulations will have on the pricing guidelines under the Foreign Exchange Management (Non-debt instruments) Rules, 2019 (NDI Rules) remains to be seen. The NDI Rules provide that the price for transfers of listed shares between residents and non-residents would be based on the price at which a preferential issue can be made under the ICDR Regulations. With pricing under the ICDR Regulations now contingent on provisions in the listed company’s AOA as well as whether the transaction involves a change of control or more than 5% of the listed company’s share capital, it is hoped that the government or the Reserve Bank of India, both of which are in charge of administering the NDI Rules, provide clarity on how the proposed amendments to the ICDR Regulations will need to be read when determining the pricing for transfers of listed shares under the NDI Rules.