The Securities and Exchange Board of India (“SEBI”) issued amendments on February 14, 2023, to the Securities and Exchange Board of India (Infrastructure Investment Trusts) Regulations, 2014 (“InvIT Regulations”) and the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”).  These are primarily governance-related requirements and apply to all infrastructure investment trusts (“InvITs”) and real estate investment trusts (“REITs”), including those planning a listing.

Some of the amendments are effective immediately and others with effect from April 1, 2023.  Those effective immediately relate to: (i) the appointment and re-appointment of auditors, the requirement to undertake a limited review of the entities whose accounts are consolidated with the InvIT or REIT; (ii) provisions for the treatment of unclaimed or unpaid distributions; and (iii) a clarification to the calculation of leverage thresholds for consolidated borrowings and deferred payments, with cash and cash equivalents being excluded from the value of the assets of the InvIT or REIT (and overnight mutual funds having maturity of one day included as cash and cash equivalents).

The amendments that are effective from April 1, 2023, relate to: (i) a clarification to the definition of change in control; and (ii) obligations and governance requirements of the investment manager of the InvIT/REIT. Certain governance requirements, generally applicable to companies in India with listed equity shares, have been made applicable to InvITs and REITs, such as eligibility of an independent director, the requirement of a woman independent director on the board of the investment manager, the quorum for a board meeting to include an independent director, minimum information required to be placed before the board, establishing a vigil mechanism (including a whistle blower policy), constituting an audit committee, nomination and renumeration committee, risk management committee and stakeholders relationship committee and submission of compliance certificates, including by the chief executive officer and chief financial officer.

While InvITs and REITs may have been following certain of these requirements, including because they had outstanding non-convertible debentures exceeding a prescribed value listed on a recognized stock exchange in India and were ‘high value debt listed entities’, each InvIT or REIT needs to examine the new requirements.  Clarity may be needed for existing unlisted InvITs with respect to the governance requirements that become applicable to such entities from April 1, 2023.

Overview of the Amendments

Governance norms

These are effective from April 1, 2023.

Certain provisions of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) have been made applicable to InvITs and REITs.  Also, unless the context otherwise implies, certain terms under the LODR Regulations would be interpreted under the InvIT Regulations and the REIT Regulations as follows: (i) “promoter” as “parties to the InvIT/REIT”, (ii) “listed entity” as the InvIT or the investment manager (in case of InvITs) and the manager (in case of REITs), (iii) “company secretary” as “compliance officer”, (iv) “executive director” as “non-independent director”, (v) “non-executive director” as “independent director”, (vi)  “board of directors of the listed entity” as “board of directors of the investment manager” and (vii) “subsidiary of the listed entity” as holding companies (“HoldCos”) and special purpose vehicles (“SPVs”) held by the InvIT or REIT.

Independent directors

Board of Directors

The current regulations require at least 50% of the board of directors of an investment manager to be independent and not be directors or members of the governing board of the investment manager of another InvIT or REIT, as applicable.  The amendments introduce the following additional provisions:

Also, the board is required to clearly set forth its recommendation in the unitholder notice for matters that require higher threshold approval under the InvIT Regulations and the REIT Regulations, i.e., where the votes cast in favor of the resolution are not less than one-and-a-half times the votes cast against the resolution.  These include matters relating to the removal, change or change in control of the investment manager, material changes in investment strategy or changes in management fees, delisting of units and matters that are not in the ordinary course of business which require unitholder approval.

Committees of the Board

The investment manager is required to constitute an audit committee, a nomination and remuneration committee, a stakeholders relationship committee and a risk management committee, as set out below.

Requirements for quorum, minimum number of meetings, terms of reference and information to be reviewed by the above committees are also prescribed.

Obligations with respect to directors, senior management and key managerial personnel

There are two different terms to consider when analyzing the regulations – key managerial personnel and senior management (the latter has been recently introduced).  The term “senior management” has been defined to mean the officers and personnel of the investment manager who are members of its core management team (excluding the board of directors), and includes the company secretary, the chief financial officer and all members of management that are one level below the chief executive officer, the managing director, whole-time director or manager (and includes the chief executive officer and manager to the extent they are not already included).  The term “key managerial personnel” has a different and slightly narrower definition under the Companies Act, 2013, and comprises the chief executive officer/managing director/manager, any whole-time director, the chief financial officer, company secretary and an officer not more than one level below the directors who is in whole-time employment and who has been designated by the board as a key managerial personnel.

Certain obligations in relation to directors, senior management and key managerial personnel are discussed below.

Further, based on Regulation 26 of the LODR Regulations as applicable to an InvIT or REIT, no employee (including key managerial personnel) or director of the investment manager or any of the parties to the InvIT/REIT, is permitted to enter into any agreement for itself or on behalf of any other person with any shareholder or any other third party with regard to compensation or profit sharing in connection with dealings in the securities of the “listed entity”, unless prior approval of the board and the public shareholders has been obtained by way of an ordinary resolution. There are also board and shareholder approval requirements, disclosure requirements and restrictions on interested persons in relation to existing and expired arrangements under these regulations.

There is some clarity required under the amendments.  For example, the term “listed entity” has been replaced with the terms “investment manager and the InvIT, as applicable” under the new InvIT Regulations, but it includes only the manager and not the REIT under the REIT Regulations.  Therefore, whether the securities of the REIT (e.g., its units) are covered will need to be clarified. References to public shareholder approval may also require clarity.

Additional compliance requirements

Requirements in relation to secretarial audit, submission of compliance certificates and corporate governance reports have been introduced, as set out below:

Changes to the definition of “change in control”

This change will be effective from April 1, 2023.

Under the current regulations, the definition of ‘change in control’ under the InvIT Regulations and the REIT Regulations in relation to bodies corporate (which includes a company) refers to the definition of control under the Companies Act, 2013.  For entities other than bodies corporate, this definition refers to a change in the ‘controlling interest’ of the entity, with ‘controlling interest’ defined as a direct or indirect interest to the extent of more than 50% of voting rights or interest in such entity.

Pursuant to the amendments, ‘control’ for bodies corporate whose shares are listed on any recognized stock exchange is to be construed with reference to regulations framed under the SEBI takeover regulations. For unlisted bodies corporate, control continues to refer to the definition under the Companies Act, 2013.  For entities other than bodies corporate, change in control now includes change in ‘legal formation’ or ownership, in addition to a change in controlling interest.

Limited review of HoldCo/SPV accounts and appointment of auditors

Pursuant to the amendments, the statutory auditor is required to undertake a limited review of the accounts of all entities whose accounts are consolidated with the accounts of the InvIT or the REIT, in accordance with applicable accounting standards.  While this provision is similar to the corresponding provision applicable to listed companies under the LODR Regulations, under those regulations the SEBI has also issued detailed procedures and formats for such review and specifically clarified for listed companies that the audit and limited review of components that are consolidated with the parent company will be undertaken by the respective auditors of such components.  Accordingly, a similar clarification may be required under the InvIT Regulations and the REIT Regulations.

The amendments have also clarified that the investment manager may appoint an individual or firm as the statutory auditor who will hold office from the date of the unitholder meeting where the auditor is appointed until the conclusion of the sixth unitholder meeting thereafter.  The investment manager is not permitted to appoint or re-appoint as the auditor (i) an individual, for more than one term of five consecutive years; and (ii) an audit firm, for more than two terms of five consecutive years.  Further, a cooling-off period of five years has been prescribed for auditors that have completed their term for re-appointment as auditors in the same InvIT or REIT.

These provisions are in effect from the date of the amendment.

Clarifications for calculation of leverage thresholds

Under the regulations, consolidated borrowings and deferred payments, net of cash and cash equivalents, are not permitted to exceed prescribed percentages of the value of the InvIT/REIT assets (70% for InvITs and 49% for REITs, subject to certain conditions). For purposes of calculation of these thresholds, the amendments clarify that (i) overnight mutual funds, characterized by their investments in overnight securities and having maturity of one day, will be considered cash and cash equivalents; and (ii) the amounts of cash and cash equivalents is required to be excluded from the calculation of the value of the InvIT/REIT assets.

These provisions are in effect from the date of the amendment.

Treatment of unclaimed or unpaid distributions

The InvIT Regulations and the REIT Regulations did not provide for the treatment of unclaimed or unpaid distribution amounts.  Pursuant to the amendments, amounts remaining unclaimed or unpaid out of distributions declared by InvITs or REITs are required to be transferred to the Investor Protection and Education Fund constituted by the SEBI, in such manner as may be specified by the SEBI.

These provisions are in effect from the date of the amendment.

Conclusion

The InvIT Regulations and the REIT Regulations historically followed a lighter touch approach to regulation, including with respect to governance norms.  However, with the reduction in minimum investment, trading lots and increased retail participation, increased governance requirements are being introduced for InvITs and REITs.

In the past, there has been ambiguity with respect to the applicability of the LODR Regulations and additional compliances for InvITs and REITs that were high value debt listed entities.  These amendments clarify this issue.  However, certain additional clarifications may be needed from the SEBI on the recent amendments, as discussed above.  All InvITs and REITs (including those proposing to register or list) need to review the new amendments. Clarity may also be needed for existing unlisted InvITs with respect to the governance requirements that become applicable to such entities.

This update has been authored by Sandip Bhagat (Partner), Pratichi Mishra (Partner) and Dhanush Dinesh (Associate). They can be reached at [email protected], [email protected] and [email protected], respectively, for any questions. This update is intended only as a general discussion of issues and is not intended for any solicitation of work. It should not be regarded as legal advice and no legal or business decision should be based on its content.

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