SEBI Wants To Clear The Road For White Knights

To help listed companies tide over financial stress and avoid large-scale insolvencies, the market regulator has proposed to ease the preferential allotment rules for capital raising. Listed companies, which meet the eligibility criteria, will be permitted to use this route to raise funds from entities that are not part of the promoter group.Some experts believe that the criteria companies need to meet to qualify as “stressed” needs to be made less onerous, while others say the Securities and Exchange Board of India also needs to account for situations where the incoming investor is giving promoters an exit..Eligibility Criteria: Too Stringent?.Pricing norms applicable to preferential allotment will be eased for listed companies with stressed assets. The floor price for the preferential issue will be based on the average of weekly high and low for two weeks preceding the relevant date, as per SEBI’s proposal..The regulator has acknowledged that the existing framework to determine pricing—a period of twenty-six weeks or more for frequently traded shares—is too onerous..“This large latency in pricing period especially given the deteriorating financial condition of the listed company leads to a wide gap in pricing between the price at the beginning of the twenty-six weeks and the current price when funds are required to be raised.” - SEBI Consultation Paper.If such an allotment triggers the takeover code, the investor will also get an exemption from making an open offer to public shareholders. To qualify for these relaxations, a listed company must fulfill any two of the following three conditions:.There’s been a disclosure of defaults on payment of interest/principal amount of loans from banks/financial institutions and listed and unlisted debt securities for two consequent quartersExistence of inter-creditor agreement as per Reserve Bank of India’s guidelines—an agreement between all lenders of a defaulting borrower that outlines a resolution plan.Credit rating of the listed instruments of the company has been downgraded to “D”..Overall, the concept of this exemption from both the preferential issue guidelines and the takeover regulations is welcome, Vivek Gupta, partner at KPMG India said. The trigger points, however, may be accelerated, he added.Existence of any one of these conditions is indicative of the fact that there is distress in the company—broadly, there will likely be a downgrade, a default could occur and an inter-creditor agreement might also happen. There is merit in giving this relaxation earlier in the downward spiral than wait for two conditions to be fulfilled, Gupta pointed out..The way our credit ratings work, a ‘BB-‘ credit rating is enough to give signs of distress. ‘D’ rating is given when you’re already in default. At that point, capital raising is difficult. If it’s true to say that ‘BBB’ is the last investment grade rating and below that is non-investment grade, then ‘BBB’ rating should be enough as a trigger point.Vivek Gupta, Partner, KPMG India.“We shouldn’t ideally need to wait for actual default to occur and have it continue for two quarters,” Gupta opined.But Sourav Mallik, joint managing director at Kotak Investment Banking, said relaxations proposed by SEBI are fairly substantive, and so it’s important that the bar to qualify for them is kept high..One, the intent is not to cover 60-70 percent of all stressed listed companies, and two, the regulator wants to ensure that there’s no misuse of these reliefs. By proposing conditions like presence of an inter-creditor agreement and a credit rating, SEBI is aiming to ensure that there’s at least one external benchmark that validates distress.Sourav Mallik, Joint Managing Director, Kotak Investment Banking.One can debate about whether, in the first condition, the default should happen over one or two quarters—hypothetically, if a default takes place on the first day of the beginning of a quarter, then the company has to wait for six months to use this route, Mallik said. “In today’s environment, six months is a long time and perhaps, that can be tweaked.”.Case Of Promoter Exit.Any preferential allotment that gives an investor 25 percent or more voting rights has to be approved by a majority of minority shareholders of the company..Exemption from takeover code is an important one to ensure that it’s attractive enough for investors to invest and companies under stress are able to raise funds quickly, Akila Agrawal, partner at Cyril Amarchand Mangaldas said.The requirement of majority of the minority approval is safeguard enough. Further, SEBI should also exempt control transactions from the open offer requirement, she added..Acquisition of control triggers the takeover code as well, and that too should be exempted in the prevailing circumstances. The potential investors are likely to be private equity players and control transactions are par for the course for them nowadays. So, acquisition of control should also be exempt from the open offer requirement. Akila Agrawal, Partner at Cyril Amarchand Mangaldas.Besides extending the benefit of its proposals to control transactions, SEBI also needs to account for agreements where promoters are bought out, experts said..There could be transactions, Mallik explained, where the existing promoters could also be provided an exit together with the primary infusion in the company. This begs the question whether the exemption from open offer should be extended to such situations?.The incoming investor, who is subscribing to the preferential allotment, may not want to co-exist with the existing promoter and is willing to buy him out. In this situation, public shareholders will need to be treated differently compared to where promoters aren’t getting an exit. Sourav Mallik, Joint Managing Director, Kotak Investment Banking.In such situations, there should be a level-playing field and public shareholders should be provided an exit at the negotiated price being paid to the promoter, he added.SEBI’s attempt to ease capital raising for stressed companies will need to be accompanied by a tax exemption, Gupta said. He explained that as soon as an announcement is made that there’s fresh investment coming in the company, the share price starts moving up..It’s possible that on the day the share sale happens, the market price is higher than this price. For situations like these, the revenue department will need to give an exemption under section 56(2)(x) that’s meant to address tax avoidance.Vivek Gupta, Partner, KPMG India.This section says that if shares are acquired at less than fair value, the excess amount will become taxable in the hands of the recipient.

SEBI Wants To Clear The Road For White Knights

SEBI proposals to ease capital raising via preferential allotment must be accompanied by tax exemption, experts point out.

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