Regulatory updates

Paragraph 12.19.2.10 of the Master Circular for Mutual Funds permits Indian mutual funds to inter-alia invest in units/securities issued by overseas Mutual Funds (MFs) or Unit Trusts (UTs) (together referred to as ‘overseas funds’) registered with overseas regulators. These overseas funds should meet certain investment criteria.

The Securities and Exchange Board of India (SEBI) issued a circular on 4 November 2024, to facilitate investments by Indian mutual funds in overseas funds that have exposure to Indian securities. It has provided the following:

Investment guidelines:

• Indian mutual fund schemes can invest in overseas funds that have exposure to Indian securities, provided this exposure does not exceed 25 per cent of their assets.
• All investor contributions to the overseas funds must be pooled into a single investment vehicle, with no segregated portfolios.
• The overseas funds must maintain a common portfolio, ensuring all investors have equal rights and receive returns proportional to their contributions.
• An independent investment manager must manage the overseas fund to ensure unbiased investment decisions.
• The overseas funds must disclose their portfolios at least quarterly.
• There should be no advisory agreements between Indian mutual funds and the overseas funds as this wll prevent conflicts of interest.

Breach of the 25 per cent limit:

• If the exposure to Indian securities exceeds 25per cent, Indian mutual funds have a 6-month observance period to monitor portfolio rebalancing by the overseas fund.
• During this period, no fresh investments can be made in the overseas fund.
• If the exposure of overseas funds to Indian securities remains above 25 per cent after the observance period, Indian mutual funds must liquidate their investments in the next 6 months unless the exposure falls below 25 per cent.

Non-compliance consequences:

If there has been a breach of the 25 per cent limit and if the Indian mutual funds do not liquidate their investments, then the Indian mutual fund/Asset Management Company cannot accept new subscriptions, launch new schemes, or levy exit loads on investors exiting the scheme. This circular aims to enhance transparency and ensure that Indian mutual funds can diversify their investments while maintaining regulatory compliance.

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The Securities and Exchange Board of India (SEBI) recently conducted an extensive study on royalty payments made by listed companies to their related parties over a decade (FY 2013-14 to 2022-23). The study, which analysed data from 233 companies across various sectors, uncovered several significant findings which are as follows:

Over the last decade, royalty payments by listed companies to their Related Parties (RPs) more than doubled in magnitude.

• While the royalty payments grew substantially until FY 2018-19, such payments tempered briefly post FY 2018-19, when these payments were brought under regulatory ambit by requiring majority of minority shareholders’ approval for royalty exceeding 5 per cent of consolidated turnover of the listed entities.
• When measured with turnover metric, these royalty payments do not look concerning. However, when viewed through profitability lens, the data offers a contrasting picture.
• When comparing royalty with net profit, it can be observed that, with increasing ‘royalty to RPs as per centage of Net Profit (NP)’, percentage of instances where such royalty payments exceeded total dividend went up significantly. Accordingly, as ‘royalty to RPs as per centage of NP’ increases, such royalty payments may erode the profitability of a company, eventually affecting interests of minority shareholders.

Disclosure of royalty

• Companies are not providing details with respect to the rationale and rate of royalty paid.
• Classification of royalty payment made towards the purposes of brand usage, technology know-how, etc. is not being disclosed.

Approval of RPTs

• Further, companies seeking approval of shareholders with respect to royalty payments, are not disclosing period or tenure of approval of such transactions. This is suggestive of the company seeking a perpetual approval for transactions.
• Any such transaction would require approval of shareholders, only if there is any upward revision in rate of such royalty or if there is a prospective regulation prescribing periodicity of such an approval.

Observations of proxy advisors

• Royalty payments had little correlation to profits or revenue over the years.
• Significant royalty is being paid to parent companies by listed companies, despite the listed company themselves spending significantly on adding value to the parent brand (like advertisements, brand promotion, etc.).
• Cash outflows to RPs can take many forms, other than royalty or brand payments- like management fees, technology fees, etc. which are not within the ambit of royalty from regulatory perspective and quantum of such payments can be uncomfortably large.
• Shareholders don’t have information on royalty rates applicable to fellow subsidiaries in other geographies for the purpose of comparison.
• Some royalty-paying companies pay less than 5 per cent to more than one RP without requiring shareholders’ approval, while the cumulative payment to all RPs together is much in excess of the regulatory threshold.

Matters that require policy discussion

• Should policy on materiality of royalty payments be reviewed by linking it to a profitability threshold?
• Should definition of payments to related parties be more standardized and encompassing, to include both royalty and other payments?
• Whether stipulating separate thresholds for each component of royalty payment enables shareholder to develop an informed opinion on the royalty payable?
• Should the regulation be amended so that the threshold applies to cumulative royalty pay-out to multiple RPs?
• Should there be any additional regulatory requirements for loss-making royalty payers?
• Should companies that skip dividend payments but pay royalty, or pay more royalty than dividends be subject to enhanced scrutiny from shareholders?
• Whether the resolution seeking shareholders’ approval for royalty payments should have a validity period?
• Should the royalty agreements between the royalty-paying company and its parent company or concerned RP contain relevant sunset provisions, reflecting the principle that such payments are not meant to be perpetual?
• Should royalty agreements also factor in the spends done by the royalty-paying company towards brand promotion, R&D expenditure, etc. for due offsets?
• Should there be a change in approval of royalty payments?
• Streamlining Disclosures with respect to royalty and brand payments?

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The SEBI (Buy-Back of Securities) (Second Amendment) Regulations, 2024, effective from 20 November 2024, introduced several significant changes to the existing buy-back regulations² Securities and Exchange Board of India (Buy-Back of Securities) Regulations, 2018
• 3. Schedule II: Requires disclosure of relevant details and the potential impact of subsisting obligations.
• Schedule III:
• Schedule IV: :

1. Computation of entitlement ratio: If any member of the promoter or promoter group declares their intention not to participate in the buy-back, their shares will not be considered when calculating the entitlement ratio.
2. Terminology adjustments: The word record date under Regulation 17(ii) of the buyback regulations is substituted by the word as date of public announcement, accordingly buy-back offer would open not later than four working days from the date of public announcement.
3. Subsisting obligations: The regulations previously barred companies from issuing any shares or securities until the expiry of the buy-back period. The amendment allows companies to discharge existing obligations through the conversion of warrants, stock options, sweat equity, or preference shares into equity shares within this period. These obligations and their potential impact must be disclosed in the public announcement.
4. Disclosure requirements: Corresponding amendments have been made in schedules II, III and IV ³ • 3. Schedule II: Requires disclosure of relevant details and the potential impact of subsisting obligations.
   • Schedule III: : The cover page of the Letter of Offer should include the entitlement ratio for small and general shareholders and provide a web link for shareholders to check their entitlement
   • Schedule IV: Adds a requirement to disclose the relevant details and potential impact of subsisting obligations .

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The SEBI issued a circular on 26 November 2024, introducing changes to the valuation methodology for repurchase (repo) transactions by mutual funds. This circular aims to standardise the valuation methodology for all money market and debt instruments to prevent regulatory arbitrage. Previously, repo transactions with a tenor of up to 30 days were valued on a cost-plus-accrual basis.

The new regulation mandates that repo transactions, including tri-party repos (TREPS) with a tenor of upto 30 days would be valued on a mark-to-market basis.

Further, valuation of all repo transactions (except for overnight repos) and all money market and debt securities (not just those with residual maturity of over 30 days) would be obtained from valuation agencies⁴ If security level prices given by valuation agencies are not available for a new security, it may be valued at the purchase yield/price on the date of allotment/purchase. .

Amendments have been made in the Master Circular for Mutual Funds.

The provisions of this circular would come into effect from 1 January 2025.

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