Since their introduction to the Indian investment landscape as a separate asset class in 2014, infrastructure investment trusts (“InvITs”) have emerged as an increasingly attractive vehicle for both domestic and foreign investors looking to leverage India’s (developing – but severely underexploited) infrastructure sector.
As the market for this product has grown over time (with 14 InvITs registered with the Securities and Exchange Board of India (“SEBI”) as at the time of writing this), the regulatory regime governing it – the SEBI (Infrastructure Investment Trusts) Regulations, 2014 (“InvIT Regulations”) – has also undergone significant development, which has largely been fuelled, amongst others, by two factors – one, an increasing need for sophistication in the market as it matures (for instance, originally the InvIT Regulations permitted an InvIT to leverage only up to 49% of its asset base, which was increased in 2019 to 70% (subject to compliance with certain conditions) to meet stakeholder demand for better debt raising ability for InvITs), and two, the regulator’s own learnings and unlearnings (for instance, the introduction of a largely liberal regime for private unlisted InvITs (for increased structuring flexibility), which is now being tightened steadily).
On February 14, 2023, SEBI amended the InvIT Regulations further (through the Securities and Exchange Board of India (Infrastructure Investment Trusts) (Amendment) Regulations, 2023) (“Amendment Regulations”)), to introduce a range of corporate governance and audit related prescriptions for InvITs. While the InvIT Regulations (and the InvIT market, thanks to its growing popularity with foreign investors) already did develop a relatively robust corporate governance framework/ practice over time (with continuous disclosure requirements, interested party voting restrictions, credit rating requirements, etc.), the additional prescriptions – which are discussed in detail below – are a step towards making this investment avenue even more safe, qualitative, and attractive in the long term for different investor classes in and outside the country.
Background to the Amendment Regulations
The InvIT Regulations, further to an amendment in 2017, had permitted InvITs whose units are listed on a stock exchange to issue listed debt securities. Separately, pursuant to an amendment in 2021 (through the SEBI (Listing Obligations and Disclosure Requirements) (Fifth Amendment) Regulations, 2021 (“LODR Amendment”)) to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”), certain corporate governance provisions of the LODR were made applicable on entities that have issued listed (non-convertible) debt securities (in the case of an InvIT – the applicability extended to the investment manager), the outstanding value of which is above INR 500 crores (hitherto, primarily only disclosure requirements were applicable on entities with their debt securities listed).
These provisions – at par with provisions applicable on entities that have their equity shares listed – included, amongst others, prescriptions as to a minimum number of independent directors to be appointed to the boards of eligible entities, mandatory constitution of board and other committees, formulation of codes of conduct for board and senior management personnel of such entities, policies for determination of material subsidiaries and related party transactions, etc. While the LODR Amendment has far reaching implications (which we have not discussed in this article) – particularly in the context of investment structures such as InvITs, some of these provisions would not appear to be relevant, given the LODR (and the corporate governance mandate it contains) is aimed at regulating corporates and not collective investment vehicles. For instance, the LODR Amendment provided that independent directors of relevant listed entities shall not be entitled to stock options; however, given that the InvIT Regulations do not even contemplate a framework for stock options, this provision would be redundant in the context of InvITs. Several other provisions, including with respect to material subsidiaries, approval of unitholders for appointment of independent directors (in the context of InvITs, to the board of the investment manager) or recommendation of fees/ compensation to directors of the investment manager of the InvIT, etc., also do not find relevance in the context of InvITs (and similar structures).
Accordingly, following representations from market participants highlighting the incompatibility between an InvIT’s setup and the application of the LODR Amendment; and ‘considering that the governance provisions would involve a set of relationships between the InvIT, its Investment Manager, board of directors of Investment Manager, unitholders and other stakeholders and taking into account the structure of InvIT, amounts of funds raised by InvIT and participation of retail investors’, SEBI – in its meeting of December 20, 2022 approved the agenda to amend the LODR and InvIT Regulations to: (i) carve out certain provisions of the LODR which are not directly applicable on an InvIT; and (ii) introduce separate corporate governance norms, in line with ones applicable on listed companies, but tuned to be relevant in the context of InvITs, irrespective of whether any debt security has been issued by them. Following the meeting, SEBI issued the SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2023, on January 17, 2023 which, amongst others, withdrew the applicability of corporate governance norms introduced by the LODR Amendment, in the context of InvITs.
In addition to the above, SEBI also approved an agenda in the meeting, to introduce certain audit related provisions to the InvIT Regulations, basis recommendations of its Hybrid Securities Advisory Committee, which it had constituted on June 16, 2022, in order to provide recommendations, inter-alia, on development and regulation of primary and secondary markets of Hybrid Securities.
The Amendment Regulations (effective upon notification, other than with respect to the amendments to definitions (control, independent directors, senior management, etc.)) and provisions regarding obligations of investment manager (which become effective on April 1, 2023)) have been issued directly on the heels of the SEBI meeting of December 20, 2022, and as approved by SEBI in the said meeting, introduce a relatively elaborate corporate governance and audit related framework under the InvIT Regulations. The amendments are summarised below:
Governance Provisions – Effective from April 1, 2023
- Definition of ‘control’: The definition of ‘control’ under the InvIT Regulations referred to the term as defined under the Companies Act, 2013, in case of a company or a body corporate; and a change in controlling interest (direct or indirect interest of more than 50% of voting rights or interest), in any other case. The LODR Amendment (to the extent it applied on InvITs) referred to the term as defined under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SAST”).
In order to streamline the definition across various regulations, and considering that the scope of the term under the LODR Amendment may not cover the various unlisted or non-body corporate parties to an InvIT (or may not even be relevant in their context – for instance, in the case of trustees, change in control is defined under the Securities and Exchange Board of India (Debenture Trustees) Regulations, 1993), the Amendment Regulations have redefined the term to refer to the SAST or Companies Act, 2013, in the case of listed or unlisted body corporates or companies, respectively, and change in legal formation, ownership or ‘controlling interest’, in any other case.
- Independent Directors and Senior Management: SEBI has introduced definitions of ‘independent director’ (in line with the LODR) and ‘senior management’ setting out elaborate and broad eligibility criteria for qualifications and standards for ‘independent directors’ (to be appointed to the board of directors of the investment manager – see below) and ‘senior management’ (being core management team of the investment manager, excluding the board of directors, and members one level below the CEO, managing director, manager or whole time director, and the CEO (in case they are not on the board)), and specifically the CFO and compliance officer of the investment manager).The InvIT Regulations in their current form have a simpler test of independence i.e., the concerned independent director should not be an independent director on the board of directors of the investment manager of another InvIT.
While this is a welcome move, the applicability of the definition (wider than under the LODR), to ‘parties to the InvIT’, may require clarity from a practical standpoint. For example, trustees of InvITs – who in the case of most InvITs, are institutional unrelated parties – are now within the ambit of the definition. Given that in certain cases, the independence criteria are required to be tested even at the holding/ associate company level of such entities (a test which should not be relevant in the context of unrelated trustee entities), may lead to logistical challenges in implementation.
Board related prescriptions: The board of directors of the investment manager is required to comprise of at least 6 directors, one of which would be a woman independent director (as opposed to the previous requirement of half of the board being independent). Quorum for meetings is prescribed as higher of 1/3rd of the total board strength or 3 directors, including at least one independent director. Additional obligations have been built in with respect to the board of directors to review compliance reports, and clearly setting our recommendations to unitholders for certain unitholder vote items.
A list of minimum information to be placed before the board of directors has also been prescribed, in a welcome move. In line with the provisions applicable to listed companies, the list covers items such as budget and operating plans, overview of meetings and financial performance, information on recruitment and remuneration of senior officers, accidents and regulatory actions, defaults, liability claims, material sales, etc.
- Applicability of LODR: Certain provisions of the LODR have been made applicable with suitable revisions of terms to accommodate the InvIT structure. For instance, the term ‘listed entity’ under the LODR is redefined to include the InvIT or its investment manager (as applicable). Similarly, terms such as ‘promoters’ (now ‘parties to the InvIT’), company secretary (now ‘compliance officer), executive director (now ‘non-independent director’), etc. have been revised to fit into the context of InvITs. Curiously, no clarification has been provided with respect to the term ‘shareholders’ under the LODR and its analogous usage under the InvIT Regulations (this term has been used, for instance, in respect of voting for appointment, removal and re-appointment of independent directors, under the LODR).
The applicable provisions of LODR include board of director related obligations (including requirement for the board of directors (of investment manager) to meet a minimum number of times in a year, have plans in place for orderly succession, have a code of conduct in place, etc.), restrictions on employees from entering into profit/ upside sharing agreements with respect to their dealings in securities (of the InvIT), formation audit/ nomination and remuneration/ stakeholders relationship / risk management committees provisions, and obligations in respect of independent directors and senior management. Given that the LODR also prescribes restrictions on maximum number of committee memberships/ chairmanship that a director (of a listed entity) can undertake, further clarity may be required in respect of the applicability of this restriction to directors of investment managers, which are typically unlisted.
Provisions allowing protection to independent directors, being (i) that independent directors shall be held liable only for acts of omission or commission occurring with their knowledge, consent or connivance, or where the director has not acted diligently; and (ii) with respect to directors’ and officers’ insurance also become applicable.
- Vigil Mechanism: Obligations have been cast on the investment manager to formulate a vigil mechanism, including a whistle blower policy, the functioning of which shall be reviewed by the audit committee.
- Compliance Reports: Provisions have been introduced with respect to issuance of a compliance report by a practicing company secretary to stock exchanges within 60 days of the end of a financial year. Separately, the investment manager (signed either by the compliance officer or the CEO) is required to submit a quarterly compliance report on corporate governance to stock exchange within 21 days of each quarter. Additionally, the CEO, CFO and compliance officer are required to annually provide a compliance certificate in a prescribed format to the board of directors of the investment manager.
Audit Related Provisions – applicable from February 14, 2023
- In line with conditions applicable on listed entities, a new regulation 6A has been introduced which provides that an investment manager cannot appoint or re-appoint an individual as auditor for more than a single term of 5 consecutive years or any audit firm for more than two terms of 5 consecutive years.
- A new sub-regulation (e) has been introduced to regulation 12(2), which prescribes that the auditor will have to undertake a limited review of the audit of all the entities or companies whose accounts are to be consolidated with the accounts of the InvIT.
While the existing InvIT Regulations read with circulars issued thereunder mandated that the auditor appointed for an InvIT shall carry out a limited review, they did not specifically require that the statutory auditor undertake a limited review of audit of all the entities/ companies whose accounts are to be consolidated with the InvIT (and thus, it was not unusual for InvITs and their portfolio entities to have different auditors, so far).
- It has also been clarified that any amount remaining unclaimed or unpaid out of the distributions declared by a InvIT will be transferred to SEBI’s ‘Investor Protection and Education Fund’.
- Basis representations by market participants to the effect that cash available with InvIT (or its SPVs) are usually invested in liquid mutual funds as a temporary utilization, and hence, liquid mutual funds must be considered as cash and cash equivalents for computation of leverage – the Amendment Regulations prescribe that investments by InvITs in overnight mutual funds, having maturity of a single day shall be treated as cash and cash equivalents. Further, to compute the percentage of leverage of InvITs correctly, cash and cash equivalents are prescribed to be excluded from the value of assets of an InvIT.
The Amendment Regulations – in setting out a separate and specific corporate governance regime for InvITs are a welcome step by SEBI in the right direction, i.e., towards streamlining and simplifying the regulatory space for investment vehicles such as InvITs.
The one-size-fits-all approach, initially adopted by the regulator through the LODR Amendment, to generally apply a governance regime tailored for one asset class on another, would have only created ambiguity in its application in the long run (and hampered the viability of both asset classes). While the Amendment Regulations merit further clarifications in certain areas, the quick measures taken by SEBI to course correct show the regulator’s willingness to marry its objective of making the Indian securities market increasingly safer, sophisticated and in line with global best practices, with the stakeholders’ ease to function in these markets (particularly in the context of InvITs, which have witnessed ever increasing participation from marquee private equity firms and sovereign funds) – a very attractive proposition for anyone looking at India (and specifically the Indian infrastructure sector) for long term and sustained growth, and return on investments.