Implications of amendments made by SEBI to Listing Regulations, 2015

Introduction

In exercise of its powers conferred on it under the SEBI Act, 1992, in terms of its Notification No.SEBI/LAD-NRO/GN/2018/10 dated May, 9, 2018 , SEBI has put through a slew  of amendments to the SEBI(Listing Obligations and Disclosure Requirements )(LODR) Regulations, 2015 (hereinafter 'the Listing Regulations).As a precursor to the changes made , SEBI has , in this exercise ,been guided by the Report submitted to it by the Committee on Corporate Governance headed by Mr. Uday Kotak. The Committee, readers will recall, had submitted its Report in October last year. The Report was placed in the public domain and responses /suggestions were elicited from the stakeholders   on the recommendations made and the amendments made represent substantially capture the nuances of  the  recommendations made by the Committee. SEBI has,  cherry picked on the recommendations made and quite a few of the recommendations which were path breaking in nature have been given a go by. Be that as it may, the amendments proposed, when implemented, will undoubtedly usher in a more rigorous regime of  compliance  by listed companies and raise the bar as far as governance is concerned.

Before we take a deep dive on the implications on  some of the important  amendments proposed, we would point out the dichotomy which already exists as between the Companies Act, 2013( hereinafter 'The Act') and the Listing Regulations will widen further, post the amendments , such that it may perhaps  be meaningful for the Law makers to consider introducing a separate set of provisions in the Act  which would ensure  that there is a  seamless integration of the Act with the Listing Regulations.

Amendments proposed are predominantly prospective

The amendments proposed have prospective application from April, 1, 2019 , save as otherwise specifically provided. Having said that certain conceptual changes come into immediate   effect whilst some come into vogue from October, 1   2018.

'Related party' redefined

Regulation 2(zb) defines related party to mean related party as defined under Section 2(76) of the Act or under the applicable accounting standards.

The contours of the definition are being widened to cover any person or entity who belongs to the promoter or promoter group and holds 20% or more of the shareholding in the listed company.

The definition to 'promoter' and 'Promoter Group' as provided by Regulation 2(w) of the Listing Regulations shall remain unchanged.

The above extension in the definition will mean that more transactions will come within the ambit of related party transactions (RPTs) necessitating approval of the Audit Committee/the Board and the shareholders as the case may be.

It is pertinent to note that there is already a difference in the amplitude of the  definition as between the Act and the Regulations which will get further accentuated due to the  above.

Definition of 'Independent Director' made more stringent

Through a subtle insert to the existing sub-clause (ii)to Regulation16 , it has been made clear that a person who belongs to the  promoter group of the listed company cannot be an Independent director.

In addition, it is stipulated that an independent director  shall not  serve as  a non-independent director in another company on the Board of which the  non-independent director of the listed company is an independent director.

The above changes will come into force from October,1, 2018, thus  making it necessary for existing Independent directors(IDs) in listed companies to confirm as of the said date to the respective Boards, that they satisfy the additional criteria set out above. Persons being considered for appointment as IDs have also to provide declarations on the lines stated above.

The action point for company Secretaries on this is for them to modify the form of declaration to be provided by IDs by incorporating the above changes and ensure compliance by the said date.

Definition of 'Material subsidiary'-Lowering of thresholds

At present a 'material subsidiary' refers to a subsidiary of the listed company which has an income or net worth which exceeds twenty percent of the consolidated income or the net worth of the listed Company. This threshold is being reduced to ten percent which will have the effect of bringing more number of subsidiaries within the ambit of monitoring and surveillance by the Board of the Parent Company.

Definition of 'Senior Management'

The existing definition of the term is ambivalent   in that it provides the company  the flexibility  to decide as to the functionaries who shall constitute 'senior Management' and refers to those that stand in the corporate hierarchy  at a level below the level of Executive Directors who constitute  the core management team of the company .

The above term is being made specific to include the CEO/ the Managing Director/Manager and shall include the CEO/Manager who  are not part of the Board. The expression shall specifically   include the Chief Financial Officer (CFO) and the company Secretary. The fact that the Company Secretary has been included in the echelons of Senior Management should warm the cockles of the hearts of those who belong to the profession of Company Secretaries.

Woman Director shall be Independent-Regulation 17(1)(a)

One of the chinks in the existing Regulations is that it simply calls for the appointment of a woman director. This requirement has been satisfied in many companies through the appointment of the spouses /female relatives of the promoter group.

A director particularly in the context of a listed company , has an important role to play and is not expected to be an ornamental piece or simply  make up the numbers. He has to make a contribution in the decision making process of the Board.

Viewed against this perspective, the stipulation that the top 500 listed Companies shall have in place at least one woman ID by April,1, 2019 is salutary. Companies which figure in the top 1000 list will follow suit by April,1, 2020.

The top500 and 1000 companies shall be determined based on their market capitalization  at the end of the immediately preceding financial year.

From the above, it follows that Companies which do not belong to the '1000 league' can continue to have woman directors who are not independent.

One is not being  merely a chauvinist while welcoming the above proposal which will provide for a more independent Board.

Minimum size of Company Boards-Regulation 17(1)(c )

The top 1000 and 2000 companies based on their market capitalization shall have a Board size comprising of   at least six directors respectively with effect from April,1 , 2019 and April 1. 2020   respectively.

Appointment of Non-executive Directors aged 75 and above shall require special resolution

The newly inserted Regulation 17(1A) contemplates that where a company proposes to either appoint or continue with the directorship of a non-executive director who has attained the age of 75 years  , approval of the shareholders by special resolution shall be necessary and an Explanatory statement shall also be appended to the notice for the meeting providing justification for the proposal.

It is pertinent to note that a non-executive director l also includes a non-independent director. The Act does not visualize   the passage of a special resolution under the above circumstances. It is only when it is   proposed to appoint a Director who has attained the age of 70 or more   in an executive capacity   that under Schedule V of the Act  a special resolution is called for.

 Further under Section 102 of the Act appointment of a non-executive director (except in case of  an appointment of ID for a second term  ) is part of ordinary business to be transacted at the AGM and does not call for an explanatory statement also.

The above provision will have the effect of making an item which is otherwise 'ordinary' under the Act 'special'- yet another instance of a disconnect between the Act and the Listing regulations.

Separation of the Office of the Chairman and Managing Director

Regulation 17(1B) provides that effective from April, 1, 2020 the top 500 companies shall have as Chairman, a non-executive director who is not related to the Managing Director or CEO of the Company.

The above requirement shall not apply to companies which do not have an identified promoter as per filings made with the Stock Exchanges.

From the above ,it follows that companies which do not figure in the top 500 list can still continue to have   as Chairman someone who is also an Executive director.

The above amendment is welcome in many ways. it is common knowledge that it is   inappropriate for the chairman of the Board to hold an executive position simultaneously. If he wears both the hats   , there would be situations where there is conflict of interest which could vitiate his judgment in business decisions. The Chairman is the stabilizing force  in ironing out situations involving conflict of interest and he should play a non-executive role.

It is also pertinent to note that  in many of the European countries in particular in Germany the established practice is to have a two- tier Board one which is non-executive and the other a working or executive board. The above move by SEBI may well be a forerunner in the future   to Board compositions of the genre prevailing in the west.

Special resolution for payment of remuneration to non-executive director beyond 50% of total remuneration paid

New Regulation 17(6) (ca) proposes that where the annual remuneration payable to a single non-executive director exceeds 50% of the total remuneration paid to all the non-executive directors , approval by special resolution has to be obtained. The details of the remuneration proposed shall also be incorporated in the approval documents. This change has obviously been provoked by the unhealthy practice in some of the listed companies to pay abnormal sums as remuneration  generally by way of profit based commission. 

Remuneration to promoter executive directors

Where the remuneration payable to Executive Directors who belong either to the promoter category or are members of the promoter group exceeds , in case there is only one such director an amount of Rupees 5 crore or 2.5 % of the net profits of the company  whichever is higher calculated as envisaged under Section 198 of the Act, and where there is more than one such director , if the aggregate remuneration to all such directors exceeds 5% of the net profits , approval of the shareholders shall be obtained by special resolution.

The above changes have been obviously triggered off by the nefarious tendency  of some of the listed companies to remunerate their promoter executive directors excessively in comparison  to the general trend of remuneration in the organization. The amendments are therefore appropriate.

Having said this, we need to ponder over the question whether the requirement of a special resolution is an adequate deterrent. The answer is obviously   no   since the promoter groups may well  have the required voting power to pull the resolution through.

What would have provided  further muscle to the  to the amendment is to have  disentitled the promoter group from voting in the matter as such payments would belong to the genre of related party transactions. In such a case the  will  of the 'majority of the minority' would prevail. The threshold prescribed under Regulation 23 for seeking shareholder approval for RPTs is  much too high for roping in payments of the above nature and SEBI would have had to prescribe a much lower threshold for the above payments.

Cap on number of directorships

Regulation 17A seeks to set a cap on the number of listed companies with which a person could be associated as director. The maximum number (including Alternate Directorships)shall not exceed eight by April,1,2019 and 7 by April,1, 2020.The Act only provides for a cap of 10 directorships in public companies.

An Independent Director shall not serve as an ID in more than seven companies which is also the existing ceiling.

Any person holding the position of MD/WTD in a listed company shall not be an ID in more than three companies.

Nomination and Remuneration Committee to meet at least once

Regulation 19 as amended sets out that the Quorum for the above Committee shall be a minimum of two directors or one-third of the total strength whichever is greater with at least one ID being present.

It is also proposed that the Committee shall meet at least once a year. The Committee has , notwithstanding the above,  to meet at least once a year to recommend to the Board the remuneration of Directors ,KMPs and other Senior personnel as also for carrying out the performance evaluation of directors.

Scope of functioning of Stakeholders Relationship Committee widened

As the existing Regulations do not set out the composition of the Committee  , it is proposed that the Committee shall consist of at least three members of which one member shall be an ID.

The amendment also  contemplates that the Committee shall  engage itself in 'various matters of interest' as opposed to its present limited mandate of regulating 'the mechanization of redressal of grievances'. With this end in mind the amendments envisage that the Committee should enlarge its activities to encompass the following areas:

a)resolution of grievances of security holders in respect of  complaints relating to transfer/transmission, non-receipt of annual reports, dividend etc.

b) review of measures taken for effective exercise of voting rights by members. The trigger for this is obviously the fact that response of members to the evoting process so far has been lukewarm.

c) review of adherence to the service standards in respect of various services rendered by Registrars and Share Transfer Agents(RTAs).

d) review of measures taken to reduce the quantum of unclaimed dividends and ensuring timely receipt of dividend warrants, statutory notices etc.

Risk Management Committee –to be set up by top 500 Companies

At present only the top 100 Companies need to set up the above Committee. This requirement shall stand extended to the top 500 Companies. In addition, it is stipulated that the Committee shall review measures taken towards cyber security.

The Committee shall meet at least once a year.

Amendments relating to Related party transactions(RPTs)

Regulation 23 is being amended to the effect that the Company's policy with regard to RPTs should contain clear threshold limits for authorization as approved by the Board. The policy shall also be subject to review by the Board once in three years.

The existing threshold for seeking shareholder approval for RPTs is being revised in respect of transactions involving payments to a related party with respect   to brand usage or royalty .Such payments will have to be approved by shareholders only where the amount payable to the related party exceeds 2% of the consolidated annual turnover of the company. The amendments do not  provide  any insight as to what constitutes a payment for Royalty. It is important to point out that in the Report submitted by the Kotak Committee to SEBI, payments for royalty, brand or technical fees to the parent company/promoters  are covered(Reference Para 5 of the Committee's Report under Chapter V). Considering the above, the question to ponder is whether any payment to a related party for technical fees can be brought within the ambit of the term  'Royalty'.

Another interesting amendment on this issue is that as per the existing Regulations where the transaction value exceeds the prescribed threshold and thus becomes a material transaction, the related parties are required to abstain from voting. Regulation 23(4) is being amended to state that the related parties shall  'not vote to approve the relevant transaction' which implies that the related parties can either choose to abstain from voting or choose to vote against the transaction.

Regulation 23(9) is being introduced to take effect from the half year ending March,31,2019, to the effect that the company shall provide to the Stock Exchanges  within 30 days from the publication of its financial results(both standalone and consolidated)for the above half year, the details of related party transactions on a consolidated basis in the format prescribed in the relevant accounting standards and also put up the details on the company's website.

'Material Subsidiary' to include overseas Subsidiary

As per Regulation 24(1) at least one ID of the listed Holding Company shall be nominated on the Board of an unlisted material subsidiary. At present this requirement applies only for an Indian unlisted material Subsidiary. This requirement is being widened to cover even an unlisted overseas Subsidiary which satisfies the materiality threshold.

It is pertinent to note that for the purposes of this Regulation the threshold for being a material subsidiary shall continue to be 20% or more of the consolidated income or net worth of the Holding Company.

We have observed earlier that SEBI has amended the definition of 'material subsidiary' in Regulation 16(1)(c )to mean one whose turnover or net worth exceeds 10% of the consolidated turnover or net worth of the Holding Company.

Notwithstanding the above, the requirement of placing an ID on the Board of the unlisted Subsidiary only when it has to be considered 'material' as per the threshold stated in Regulation 24(1) above.

Secretarial Audit-Regulation 24A

The requirement of Secretarial Audit shall apply to every listed company and its unlisted material subsidiary from the financial year ending March 31, 2019.

It may be clarified that for the purpose of this Regulation, a material subsidiary as per definition given in Regulation16(1)(c ) above,would mean one whose turnover or net worth exceeds 10% of the consolidated turnover or net worth of the Holding Company.

No Alternate Director for ID

Effective from October,1, 2018 no person can be appointed as an alternate Director for an Independent director.

Revised declarations from IDs as to their independence

Regulation 25(8) has been introduced  in terms of which it will be necessary for the IDs to make a declaration at the first Meeting of the Board which shall take place after April,1,2019 to the effect that he meets with the criteria of independence as per Regulation 16(1)(b)referred to hereinabove and that he is not aware of any circumstance or situation which exist or maybe reasonably anticipated that could impair or impact his ability to discharge his duties with an objective independent judgment and without any external influence.

Such a declaration has to be provided by the ID at the first meeting held in the financial year and the Board  shall take on record such declarations after ascertaining the veracity thereof.

Directors and Officers(D and O)Insurance for IDs

In terms of Regulation 25(10) it will be necessary for the top 500 Companies to undertake D and O Insurance for the IDs which shall be effective from October,1, 2018 .The quantum and risks to be covered shall be as determined by the Board.

Disclosure of end use of funds raised through preferential allotment/QIPs

New Regulation32(7A) postulates that it would be necessary for a company to disclose in its Annual Report end use of funds raised through preferential allotments  or Qualified Institutional Placements (QIPs)until such time the funds are fully utilized.

Additional disclosure requirements in Financial Statements

Several changes have been proposed under Regulation33 which will ensure that the Company shall make additional disclosures as prescribed while providing its Quarterly /annual financial statements to the Stock Exchanges which are summarized as under:

• Where a company has subsidiaries it will be obligatory for the company to provide the consolidated financial statements .The option presently available under Regulation33 (3)(b)to intimate to the Exchange whether or not the company shall be additionally submitting quarterly consolidated financial results in the first quarter of the year will no longer be available effective from April,1,2019.
• The quarterly and year to date results shall be subjected to either a limited review or to audit by the company's Auditors.
• A cash flow statement (both standalone and consolidated  )shall be submitted along with the half yearly results.
• In case of consolidated statements it must be ensured that at least 80% of the consolidated revenue, assets and profits have been either audited or limited reviewed.
• While disclosing the results for the last quarter of the financial year the aggregate effect of material adjustments made in the results of that quarter which pertains to the earlier quarters shall be disclosed by way of a note.
• Limited review of the audit of all the companies whose accounts are to be consolidated with that of the listed company shall be undertaken by the Statutory Auditors as per AS21.

Annual Report to be sent to Exchanges simultaneous with dispatch to members

Regulation 34 provides that the company's Annual Report should be sent to the Exchanges not later than the day on which dispatch of the Report to shareholders commences. Additionally the Report shall also be hosted on the Company's website. This requirement is in contrast with the present requirement of furnishing the Report to the Exchanges  within 21 days from the conclusion of the AGM.

Soft copy of Annual Report can be sent to members whose mail IDs are registered with Depositories

The amendment proposed to Regulation 36 is most welcome as it would enable the company to provide soft copies of the company's Annual Report additionally to those members whose email IDs are registered with the Depositories ,apart from those whose IDs are registered with the company. This will mean that the company can hope to reduce the number of hard copies of the Annual Reports to be printed. This move will give a further fillip to the green initiative movement launched by  the Govt.

Additional disclosures for appointment of Auditors

Regulation 36(5) stipulates that  in the notice proposing the appointment of Auditors disclosures as under shall be provided in the Explanatory Statement appended to the Notice for the Meeting:

a) to state the fees proposed to be paid along with the terms of appointment. In case appointment of a new auditor is proposed  , material change in the fees payable as compared with the previous Auditor is to be provided along with the rationale for such change.

b) basis of recommendation for appointment including details in relation to and credentials of the Auditors  proposed to be appointed.

Complying with the above requirements will give rise to certain practical difficulties in the light of the requirements contained in the Act on the above.

Firstly, in compliance with Section 139(2) of the Act every listed company is required to appoint Statutory Auditors for a term of five consecutive years. The requirement of seeking ratification of such appointments from the shareholders has also been done away with by the Companies (Amendment) Act, 2017.Companies are  not therefore expected to appoint auditors and fix their remuneration at the anniversary of every AGM.

Secondly, although the Act empowers the shareholders to fix the remuneration of the Auditors, generally this power is delegated by the members to the Board since the Board is in a better position to evaluate the fees payable. The board is guided by the recommendation of the audit Committee as contemplated under Section 177 of the Act. Expecting the shareholders to articulate on the fees payable to the Auditors is a retrograde step .

Thirdly, appointment of Auditors being part of ordinary business to be transacted at the AGM ,it is not necessary to provide an Explanatory Statement for this purpose unless the appointment is to fill up a casual vacancy.

For the above reasons, it is earnestly submitted that SEBI comes up, before the proposal comes into effect, with certain modifications to integrate it seamlessly with the Act.

Reduction in time lines for holding AGM

Regulation 44(5) provides that the top 100 Companies shall hold their AGMs within five months from the close of the financial year. This proposal also runs contrary to the prescription contained in the Act.

What would have been more   appropriate is to have reduced the timelines for all listed companies.

One way  live webcasting of AGM proceedings

Regulation 44(6) postulates that the top 100 companies shall provide   the facility of one-way  live web cast of their AGMs.

This requirement shall apply for AGMs of the above category of Companies held on or after April,1, 2019.

To ensure that a standardized procedure is followed by all companies impacted SEBI may consider provision of some ground rules nearer the time of implementing the above requirement.

Additional  disclosures on company website

Regulation 46(2) contemplates that information to the members shall be provided under a separate section of the website.

Effective from October,1, 2018, companies shall provide updated credit ratings for all outstanding instruments as and when there are any revisions.

The audited Accounts of all the subsidiaries of the company shall also be hosted on the website within 21 days from the date of the AGM of the company.

Widening the role of the Audit Committee

Through changes in Part C of Schedule II to the Regulations, the Audit committee shall be given the responsibility to review the utilization of loans and/or   advances from/investment by the holding company in the subsidiary which exceeds Rupees 100 Crores or 10% of the asset size of the Subsidiary whichever is lower including existing loans/advances/investments existing as on the date on which the above provision comes into force.

• The Nomination and Remuneration Committee shall in addition to its existing responsibilities , recommend to the Board the remuneration payable to the senior management.

Disclosure of Events to Stock Exchange without application of materiality test-Part A of Schedule III read with Regulation 30

The following information shall be provided to the Stock exchanges:

a) In case of resignation of auditor, detailed reasons for their resignation shall be provided  within 24 hours from the time of receipt of the reasons from them.

b) In case of resignation of Independent directors  , within seven days from the resignation , the information shall be furnished to the Stock exchanges with the detailed reasons therefore as provided by the ID. The intimation shall also contain a confirmation from the ID that there are no material reasons other than those provided.

Disclosures in Financial results

As regards audit qualifications which are not quantifiable, the Management shall mandatorily make an estimate which the Auditor shall review and report.

In respect of matters which are sub-judice or on matters such as going concerns, no estimates need to be provided .The Management needs to provide the reasons which the Auditors shall review and report suitably.

Additional disclosures in  annual Report and in 'Management Discussion  and Analysis'(MD &A)Section of Directors' Report

In the Section on 'Related party disclosures', the company shall provide details of transactions entered into with any person belonging to the promoter group who holds 10% or more in the capital of the company in the format prescribed in the relevant Accounting standards.

Where there is a change of 25% or more in the following ratios, the details should be provided along with the reasons for such variations:

(i) Debtors turnover

(ii) Inventory turnover

(iii) Interest coverage ratio(iv)current ratio(v)Debt Equity Ratio(vi)operating profit margin(%)(vii)Net profit margin(%) or such sector specific ratios as applicable.

Details of any change in return on net worth as compared to the previous year shall also be stated with the reasons for such variation.

Additional disclosures in Corporate Governance (CG)Report

Apart from the existing details, the following additional information shall be provided in the CG Report for the year ending March 31, 2019 and beyond:

a) Names of the other companies in which the director of the company is a director and the category of such directorship.

b) A matrix which sets out the core skills/competencies which should be possessed by Directors in the context of the company's business as identified by the Board  and those actually available with the Board. This information shall be provided for the year ending March,31,2019.

c) From FY 2020-21 the company shall disclose the names of the directors who possess such skills/competencies.

d) Confirmation that the IDs, in the opinion of the Board, fulfill the criteria of independence as per the Regulations and are independent of the management.

e) Detailed reasons for resignation of the IDs who have resigned before the completion of their terms with a confirmation from the director that there are no material reasons other than those provided by the company.

f) details of any revisions in credit ratings for any fund mobilization programme both in and outside India.

g) Details of utilization of funds raised through preferential allotments/QIPs.

h) a certificate from the practicing Company Secretary in confirmation that the directors are not disqualified or debarred by SEBI, the MCA or by any other statutory body.

i) where the Board has not accepted any recommendations of any Committee required for approval by the Board, the details are to be provided.

j) total fees paid by the company and its subsidiaries to Statutory Auditors for various services on a consolidated basis. Payments made to all entities in the network firm/network entity of which the Statutory Auditors are a part shall also be provided.

Non-mandatory recommendations

Vide its circular dated May,10, 2018 SEBI has also stipulated that certain recommendations of the Kotak Report, apart from what have been stated above , have also been accepted by it. These are non-mandatory in nature and are summarized below:

a) Disclosures on Board Evaluation

The disclosure on the above may cover the following matters:

i) Observations of board evaluation carried out for the year

ii) Previous years' observations and actions taken

iii) Proposed actions as on observations for the current year.

b) Group Governance Unit

Where the company has a number of unlisted Subsidiaries   , governance of such companies may be monitored through either a dedicated group governance Unit or Committee which shall comprise of Board members. The Board may also establish a strong and effective group governance policy.

The decision to set up the above Committee and have a group governance policy shall be taken by the Board.

c) Medium and long term strategy

As part of the Management Discussion and Analysis Section of the Board's Report , the company may articulate on its medium term and long term strategy within the limits set by its competitive position , based on a time frame decided by the Board.

The Board may also articulate a clear set of long term metrics which are specific to the company's long term strategy to enable appropriate measurement of progress.

Conclusion

We have made a comprehensive analysis of the amendments proposed. Where considered appropriate, the implications of the changes have been analyzed. The gamut of compliances to be ensured by companies will undergo a quantum leap once the amendments are set in motion. There will be greater transparency and dissemination of more information in the public domain which will insulate the stakeholders. The level of governance will undoubtedly move up by a few notches. Corporate India has to rise up to the occasion and embrace both in substance as also inform the amendments proposed so that corporate governance is not allowed to degenerate into a pedantic ' ticking the box' exercise.