SEBI's governance reforms for Market Infrastructure Institutions (MIIs) aim to enhance transparency, accountability, and regulatory oversight. Key proposals include a structured process for the appointment, re-appointment, and termination of Key Managerial Personnel (KMPs) involving independent external agencies, the Nomination and Remuneration Committee (NRC), and SEBI. The reforms also introduce a policy for a minimum cooling-off period for KMPs and directors before joining competing MIIs, empowering the Governing Boards to tailor policies to their operational needs. These measures prioritise public interest, reduce conflicts of interest, and strengthen the governance framework for Stock Exchanges, Clearing Corporations, and Depositories.

Table of Contents 

1. Introduction
2. Compensation Disparity and Governance Structure in MIIs
3. Process for Appointment/Re-appointment and Termination of KMPs at Market Infrastructure Institutions
4. Proposed Cooling-Off Period Policy for KMPs and Directors at MIIs
5. Conclusion

1. Introduction

On November 22, 2024, SEBI unveiled a consultation paper proposing significant reforms to enhance the Market Infrastructure Institutions (MIIs) governance framework. These reforms focus on the appointment process of Key Managerial Personnel (KMPs), establishing a cooling-off period for KMPs and directors before joining a competing MII, and building greater transparency and accountability in the functioning of MIIs.

The proposed changes seek to strengthen the regulatory framework governing Stock Exchanges, Clearing Corporations, and Depositories, ensuring that these vital institutions operate with integrity, efficiency, and a commitment to public interest. Comments on the proposal are invited by December 12, 2024, allowing stakeholders to contribute to shaping these important governance reforms.

2. Compensation Disparity and Governance Structure in MIIs

Market Infrastructure Institutions (MIIs) provide essential capital market infrastructure for trading, clearing, settlement, and record-keeping of securities. They are uniquely empowered by law to regulate their members, including listed companies, Trading Members, Clearing Members, and Depository Participants. MIIs must balance their role as public utilities and first-line regulators, operating efficiently and competitively as profit-driven entities.

While the Governing Board of the MII sets the tone at the top, the culture of prioritising public interest (Verticals 1 and 2) over commercial interest (Vertical 3) must run deep at the operating level.

The SEBI observed that in some large MIIs, there is a significant disparity between the compensation of the MD and the KMPs heading Verticals 1 and 2 of the MII. These KMPs also report to the MD. The key reforms are as follows:

3. Process for Appointment/Re-appointment and Termination of KMPs at Market Infrastructure Institutions

SEBI has proposed reforms for the appointment of KMPs at Market Infrastructure Institutions (MIIs), viz., Compliance Officer (CO), Chief Risk Officer (CRO), Chief Technology Officer (CTO) and Chief Information Security Officer (CISO) or by whatever designations referred.

3.1 Appointment of KMPs at Market Infrastructure Institutions (MIIs)

As per the proposed framework, MIIs must engage an independent external agency to identify and recommend suitable candidates for appointment as KMPs in areas like compliance, risk management, technology and information security. The Agency must submit its recommendations to the Nomination and Remuneration Committee (NRC) of the MII.

Further, the NRC will evaluate the recommendations of the agency, and submit its own recommendations to the Governing Board of the MII and SEBI simultaneously. SEBI will review the NRC’s recommendations and will provide comments, if any, for the consideration of the governing board of the MII in a time-bound manner.

If no comments are received from SEBI in the prescribed period, then the Governing Board of the MII must assume that SEBI has no comments to offer. The Governing Board must decide on the appointment after considering NRC’s recommendations and SEBI’s comments, if any.

3.2 Re-appointment and Termination of KMPs at Market Infrastructure Institutions (MIIs)

As per the proposed framework, the NRC must evaluate re-appointment/termination cases and submit its recommendations to the Governing Board of the MII and SEBI simultaneously.

SEBI will review the NRC’s recommendations and will provide its comments, if any, to the Governing Board of the MII in a time-bound manner. If no comments are received from SEBI in the prescribed period, then the Governing Board of MII must assume that SEBI has no comments to offer.

The Governing Board must make the final decision for re-appointment/termination after considering NRC’s recommendations and SEBI’s comments, if any.

4. Proposed Cooling-Off Period Policy for KMPs and Directors at MIIs

The consultation paper aims to empower the Governing Board of an MII to set the policy around a minimum cooling-off period for its KMPs and directors on the Governing Board before they can join a competing MII.

Whereas no cooling-off period is prescribed for MDs and KMPs under extant regulations, there is a provision for a cooling-off period for Public Interest Directors (PIDs) as prescribed under Regulation 24(3) of Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018.

While regulations do not prescribe any cooling-off period for the MD and other KMPs, MIIs individually include a cooling-off period in their employment contracts. The Expert Working Group (EWG) recommended the introduction of a regulatory cooling-off period and suggested that this must continue to be left to the Governing Board of the respective MII to determine.

In view of the above, SEBI proposed that MII must adopt and implement a policy approved by its governing board prescribing a minimum cooling-off period for KMPs (including the MD) and their directors (including PIDs) before joining a competing MII. SEBI must no longer prescribe a cooling-off period for PIDs of an MII joining another MII.

4.1 Meaning of the Term “Competing MII”

The term “Competing MII” refers to movement from one exchange to another exchange, one Clearing Corporation to another Clearing Corporation and one Depository to another Depository.

5. Conclusion

In conclusion, SEBI’s proposed norms mark a significant step toward enhancing governance standards in Market Infrastructure Institutions (MIIs). By establishing clear and transparent processes for the appointment, re-appointment, and removal of key personnel, alongside a well-defined cooling-off period policy, these measures aim to ensure accountability and minimise conflicts of interest. Empowering the Governing Boards to design policies that align with their operational needs while safeguarding public interest strikes a thoughtful balance between flexibility and regulatory oversight. Comments may be submitted by December 12, 2024.

The post [Analysis] Market Infrastructure Institutions – SEBI’s New Governance Framework appeared first on Taxmann Blog.

SME IPO Regulations refer to the regulatory framework established by SEBI under the SEBI (ICDR) Regulations, 2018, and SEBI (LODR) Regulations, 2015, to govern the listing and post-listing compliance of Small and Medium Enterprises (SMEs) on SME Exchanges. These regulations aim to facilitate access to capital for SMEs while ensuring transparency, investor protection, and robust corporate governance. Key provisions cover areas such as minimum application size, allotment methodology, lock-in periods for promoters, restrictions on the use of issue proceeds, enhanced disclosure requirements, and the introduction of profitability and governance thresholds. SEBI periodically reviews and updates these norms to align SME practices with Main Board standards, fostering a transparent and investor-friendly ecosystem.

Table of Contents

1. Introduction
2. Increase in Minimum Application Size for SME IPOs to Align with Market Growth
3. Alignment of Allotment Methodology for Non-institutional Investors in SME IPOs with Main Board IPOs
4. Increase in Minimum No. of Allottees for SME Public Issues to Enhance Market Liquidity
5. Restriction on Offer for Sale in SME IPOs Capped at 20% of the Issue Size
6. Mandatory Appointment of Monitoring Agency for Issue Size Exceeding Rs 20 Crore
7. Proposal to Increase Lock-in Period on Minimum Promoter Contribution in SME IPOs to 5 Years
8. Reduction in General Corporate Purpose Limit for SME IPOs to Enhance Transparency and Accountability
9. Companies Converted from LLPs or Partnerships Must Exist for 2 Full Financial Years Before Filing DRHP
10. Introduction of Profitability Threshold for SME IPO Eligibility
11. Revised Fundraising Framework for SMEs Exceeding Rs 25 Crore Capital Threshold
12. Restrictions on Using SME Issue Proceeds for Promoter Loan Repayment
13. Enhanced Disclosures for SME Companies
14. Mandatory Disclosure of Merchant Banker Fees
15. Public Access to Draft Red Herring Prospectus for SME IPOs
16. Mandatory Due-Diligence Certificate for SME IPOs
17. Post-Listing Exit Opportunity for Dissenting Shareholders in SME IPOs
18. Extending RPT Provisions to SME-Listed Entities
19. Quarterly Disclosure of Board Composition and Meetings for SME Listed Entities
20. Proposal for Quarterly Reporting of Financial Disclosures by SME-Listed Entities
21. Conclusion

1. Introduction

On November 19, 2024, SEBI released a consultation paper on a review of the SME framework under SEBI (ICDR) Regulations, 2018, and the applicability of corporate governance provisions under SEBI (LODR) Regulations, 2015 on SME companies to enhance pre-listing and post-listing SME provisions.

The proposals are divided into two parts. The first part deals with provisions related to IPO at SME Exchange and conditions of migration from SME platform to Main Board post-listing. The second part deals with corporate governance norms, including post-listing disclosures by issuers listed on SME Exchange. Comments on the same may be submitted by December 4, 2024. The key proposals in detail are as follows:

2. Increase in Minimum Application Size for SME IPOs to Align with Market Growth

As per Regulation 267(2) of the ICDR Regulations, 2018, the minimum application size for Small and Medium Enterprises (SME) IPOs[1] is Rs 1 lakh. Stock Exchanges and Merchant Banks have suggested increasing the minimum application size to Rs 2 lakh per application.

Regulation 2(vv) of SEBI (ICDR) Regulations, 2018, defines a “retail individual investor” as an individual investor who applies or bids for specified securities for a value of not more than Rs 2 lakh.

SEBI observed a rise in retail participation in SME IPOs and, to safeguard the interests of smaller retail investors has proposed increasing the application size to Rs 2 lakh per application in SME IPOs.

Given the 4.5 times growth of Nifty and Sensex over the past 14 years, SEBI is also considering raising the threshold to Rs 4 lakh, in line with the market growth.

3. Alignment of Allotment Methodology for Non-institutional Investors in SME IPOs with Main Board IPOs

Presently, under ICDR norms, the allotment procedure for the non-institutional investors[2] (NIIs) category in a book-built issue for SME IPO is based on a proportional allotment that is different from the allotment procedure for NIIs in Main Board IPOs.

It was suggested that the draw of lot allotment methodology and reservation in the portion available for NIIs, as currently in place for main board IPOs, must also be extended for allocation to NIIs in SME IPOs. The proposed change will align the allocation methodology for the NII category in SME IPOs with the existing allocation methodology for the NII category in main board IPOs.

SEBI has proposed to divide the NII category into two sub-categories –

• Sub-category 1 – 1/3^rd of the allocation earmarked for NIIs must be for application sizes up to Rs 10,00,000
• Sub-category 2 – 2/3^rd of the allocation earmarked for NIIs must be for application sizes above Rs 10,00,000

4. Increase in Minimum No. of Allottees for SME Public Issues to Enhance Market Liquidity

As per Regulation 268(1) of ICDR Regulations, there is a requirement that for SME public issues to be considered successful, there must be a minimum of 50 allottees in public issues.

The investor base in India has grown significantly since 2010. The above requirement will ensure that only companies in which investors have an interest will get listed. This increased requirement will also ensure that a sizeable number of investors will also be present after listing, which will help provide liquidity in the market.

In view of the above, SEBI has proposed increasing the minimum number of allottees in SME public issues to 200.

5. Restriction on Offer for Sale in SME IPOs Capped at 20% of the Issue Size

Currently, the ICDR Regulations impose no restrictions on Offer for Sale (OFS) in SME IPOs. Stock Exchanges and Merchant Banks have suggested either completely restricting OFS or limiting it to 20%-25% of the issue size.

The SME Exchange[3] was established to support small and medium enterprises (SMEs) in accessing finance for growth. Data shows that in FY 23-24, two IPOs were entirely OFS, and in FY 24-25 (until October), one was. Additionally, of the 52 issues with both OFS and fresh issues, 30 had an OFS portion exceeding 20% of the total size.

In response, SEBI has proposed restricting OFS in SME IPOs to 20% of the issue size. It also suggests that the OFS from selling shareholders should not exceed 20% of their pre-issue shareholding on a fully diluted basis.

6. Mandatory Appointment of Monitoring Agency for Issue Size Exceeding Rs 20 Crore

As per Regulation 262 of the ICDR Regulations, 2018, a Monitoring agency must be appointed if the fresh issue size is more than Rs 100 crores for an SME issue. The monitoring agency acts as an independent agency that certifies the utilisation of proceeds and ensures that funds are used for the purposes disclosed in the offer document, thus reducing the risk of misuse or diversion. This will also bring more transparency for investors and accountability for the issuer.

SEBI has now proposed that the appointment of a monitoring agency must be made applicable to the Issuer Company if the fresh issue size is higher than Rs 20 crore.

In cases where there is no requirement for the appointment of a Monitoring Agency, there must be a mandatory requirement of a Statutory auditor’s certificate for utilisation of money raised through the public issue to be submitted to Exchange while filing the half-yearly financial statement till the issue proceeds are fully utilised. These certificates must also be submitted to the Audit Committee and the Board of the Issuer Company.

7. Proposal to Increase Lock-in Period on Minimum Promoter Contribution in SME IPOs to 5 Years

SEBI has proposed increasing the lock-in period for minimum promoter contribution (MPC) in SME IPOs to 5 years, up from 3 years. Additionally, the release of lock-in on promoters’ holdings exceeding MPC will now occur in phases: 50% can be released after 1 year, and the remaining 50% after 2 years. This phased release approach, suggested by Stock Exchanges, aims to ensure long-term commitment from promoters while gradually allowing liquidity for their excess holdings.

8. Reduction in General Corporate Purpose Limit for SME IPOs to Enhance Transparency and Accountability

SEBI has proposed reducing the General Corporate Purposes (GCP) amount in SME IPOs from the current 25% of the issue size to a maximum of 10%, with an absolute cap of Rs 10 crore. The rationale behind this change is to address concerns over the potential misuse of funds, as the GCP category allows issuers to allocate funds without specifying the exact purpose, leading to unclear usage of proceeds.

For example, in a Rs 100 crore IPO, the GCP allocation could be as high as Rs 25 crore, a significant amount that could be spent without sufficient transparency for investors. SEBI also proposed deleting Regulation 230(3), which currently permits raising funds for unspecified targets or acquisitions, to further enhance accountability and protect investors’ interests.

9. Companies Converted from LLPs or Partnerships Must Exist for 2 Full Financial Years Before Filing DRHP

As per Regulation 229 of ICDR Regulations, 2018, an issuer is eligible to make an initial public offer:

• If its post-issue paid-up capital is less than or equal to Rs 10 crore
• If its post-issue face value capital is more than Rs 10 crore and up to Rs 25 crore

Further, ICDR provides a proviso for cases where the issuer was a partnership firm or a limited liability partnership or in case an issuer is formed out of a merger or a division of an existing company, for considering their track record provided they conform to certain requirements regarding financial statements.

SEBI has proposed that in case of a company’s conversion from a Limited Liability Partnership or Partnership firm, the Company must have existed for at least two full financial years before filing DRHP. Further, the restated financial statements of the issuer company prepared post-conversion should be in accordance with Schedule III of the Companies Act 2013.

Also, SEBI proposed to have a 2-year cooling off period before SME IPO for a Company, if there is a change of promoters or new promoters have come after the acquisition of 50% or more shareholding before the filing of the draft offer document.

10. Introduction of Profitability Threshold for SME IPO Eligibility

SEBI has proposed that an issuer must be eligible to make an initial public offer (IPO) only if the issuer has operating profit (earnings before interest, depreciation and tax) of Rs 3 crore from operations for at least any 2 out of 3 financial years preceding the application.

A minimum operating profit threshold indicates that the company has achieved a certain level of profitability and is financially viable.

11. Revised Fundraising Framework for SMEs Exceeding Rs 25 Crore Capital Threshold

Under Regulation 280(2) of the ICDR Regulations, SMEs with post-issue face value capital exceeding Rs 25 crore must migrate to the Main Board. However, SMEs that do not meet the Stock Exchange migration criteria (such as 3 years of listing on the SME platform) face restrictions in raising funds that would push their capital beyond Rs 25 crore.

In response to concerns about the challenges this poses for SMEs, SEBI has proposed allowing companies that are not yet eligible for migration to raise funds without migrating to the Main Board. Once their post-issue paid-up capital exceeds Rs 25 crore, these companies must comply with the Main Board’s corporate governance and disclosure norms under LODR, including quarterly financial reporting. Migration to the Main Board will only be allowed once they meet the necessary eligibility criteria.

12. Restrictions on Using SME Issue Proceeds for Promoter Loan Repayment

The objective of SME issues is to provide necessary financing for the growth of small and medium enterprises. Allowing the repayment of loans taken by promoters, promoter groups, or related parties from the issue proceeds, whether directly or indirectly, defeats this purpose. It is suggested that such repayments should not be permitted as an object of SME issues.

13. Enhanced Disclosures for SME Companies

To enhance transparency and provide investors with detailed insights, SEBI has proposed to mandate SME companies to disclose senior-level employees across departments (e.g., Heads of Sales, Purchase, Plant, Finance, IT, etc.), including their experience. Additional disclosures should cover ESIC/EPF details, such as the number of employees registered, amounts paid, and any delays in payments over the past three years.

Further, a site visit report prepared by the Merchant Banker should form part of the due diligence report and be included in material documents for inspection in the offer document. These measures will improve the overall quality of disclosures and provide investors with comprehensive information about the company’s operations and employee strength.

14. Mandatory Disclosure of Merchant Banker Fees

To ensure transparency and align with the purpose of providing SMEs with an alternative fundraising mechanism, SEBI has proposed that Merchant Banker fees, regardless of form, name, or purpose, must be disclosed in the Red Herring Prospectus (RHP). Currently, there is no requirement to disclose issue-related expenses, and it has been observed that Merchant Banker fees sometimes exceed 30-40% of the issue size, undermining cost-effectiveness for SMEs.

15. Public Access to Draft Red Herring Prospectus for SME IPOs

For Main Board IPOs, Regulation 26 of ICDR Regulations mandates making draft offer documents public for 21 days, with announcements in English, Hindi, and regional newspapers inviting comments. This requirement is currently absent for SME IPOs when filing the DRHP.

To enhance transparency and enable public participation, SEBI has now proposed that the DRHP of SME IPOs filed with stock exchanges be made available to the public for comments for at least 21 days. The DRHP must be hosted on the websites of stock exchanges and lead managers, with a public announcement made in one English, Hindi, and regional language newspaper, inviting comments.

16. Mandatory Due-Diligence Certificate for SME IPOs

In Main Board IPOs, merchant bankers must submit a due diligence certificate at the time of the draft offer document, i.e., at the time of DRHP. SEBI has proposed that merchant bankers submit a due diligence certificate to the stock exchanges when filing the DRHP for SME IPOs.

17. Post-Listing Exit Opportunity for Dissenting Shareholders in SME IPOs

Regulation 59 of the ICDR Regulations provides a post-listing exit for dissenting shareholders in main board IPOs due to changes in objects or contract terms. Still, such provisions are not currently available for SME IPOs.

SEBI has now proposed to introduce provisions in the SME chapter, similar to Regulation 59 of the ICDR, to allow post-listing exit for dissenting shareholders in cases of changes to objects or contract terms stated in the offer document.

18. Extending RPT Provisions to SME-Listed Entities

SEBI has proposed that the provisions related to related party transactions (RPTs) under Regulation 23 of the LODR Regulations should also apply to SME-listed entities, with exceptions for those with a paid-up capital of up to Rs 10 crores and net worth up to Rs 25 crores.

This would align SME RPT norms with those of Main Board listed entities, providing stricter approval and disclosure requirements to prevent risks like fund siphoning through related parties. However, for SME entities, the materiality threshold for shareholder approval of RPTs should be based on transactions exceeding 10% of annual consolidated turnover, rather than the higher Rs 1000 crore threshold.

19. Quarterly Disclosure of Board Composition and Meetings for SME Listed Entities

Regulation 27 of the LODR Regulations mandates that Main Board-listed entities submit a quarterly compliance report, including details on board composition, attendance, and meeting specifics. However, this requirement does not currently apply to SME-listed entities. It is proposed that SME-listed entities should also disclose the composition and meeting details of their Boards of Directors and committees.

This would enhance governance, increase transparency, and enable better monitoring by stock exchanges, analysts, and investors. The requirement would apply to SME entities with paid-up capital exceeding ₹10 crore and net worth exceeding ₹25 crore, with disclosures to be made quarterly in XBRL format, harmonising the disclosure practices with Main Board listed entities.

20. Proposal for Quarterly Reporting of Financial Disclosures by SME-Listed Entities

Currently, SME-listed entities must submit their shareholding pattern, statement of deviation(s) or variation(s), and financial results on a half-yearly basis, whereas Main Board entities submit them quarterly. SEBI has proposed that SME-listed entities should align with Main Board entities by submitting these reports quarterly. This would ensure more timely updates on financial health and fund utilisation, enhancing transparency and consistency in disclosures.

21. Conclusion

In conclusion, these proposed changes to the SME framework under SEBI (ICDR) and (LODR) Regulations aim to enhance transparency, strengthen governance and build investor confidence in SME IPOs and listed entities. By aligning SME norms with those of Main Board companies, introducing stricter disclosure and compliance requirements, and addressing concerns related to fund use, governance and investor protection, SEBI seeks to create a stronger and more transparent system for SMEs, supporting their steady growth while ensuring fair opportunities for investors.

[1] As per Regulation 2(zi) of SEBI (LODR) Regulations, 2015, SME means an entity that has issued specified securities in accordance with provisions of Chapter IX of SEBI (ICDR) Regulations, 2018

[2] Regulation 2(jj) of SEBI (ICDR) Regulations, 2018

[3] Regulation 2(ddd) of SEBI (ICDR) Regulations, 2018

The post [Analysis] SEBI Proposes Enhancements to the SME IPO Framework | A Detailed Overview of the New Regulations and Their Impact appeared first on Taxmann Blog.

The recent amendment to the definition of Unpublished Price Sensitive Information (UPSI) by the Securities and Exchange Board of India (SEBI) aims to clarify and expand the events covered under the SEBI (Prohibition of Insider Trading) Regulations, 2015. SEBI's proposed changes align the UPSI definition with significant events and thresholds listed in Schedule III of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR), covering aspects like changes in ratings, fundraising, management control agreements, fraud or defaults by key personnel, forensic audits, and significant regulatory actions. This broader definition seeks to standardize compliance for listed entities, enhance transparency, and protect investor interests by ensuring timely disclosure of price-sensitive information.

Table of Contents

1. Introduction
2. Background and Rationale
3. Current Definition of UPSI
4. Key Proposals from SEBI
5. Conclusion

1. Introduction

On November 9, 2024, the Securities and Exchange Board of India (SEBI) released a consultation paper proposing a review of the definition of Unpublished Price Sensitive Information (UPSI) under the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations). The proposals aim to enhance clarity, certainty, and uniformity in compliance for listed companies by aligning the UPSI definition with key events and thresholds outlined in Regulation 30 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

2. Background and Rationale

According to SEBI’s observations, listed entities inconsistently classified events as UPSI. Many companies adhered strictly to Regulation 2(1)(n) of PIT Regulations, omitting potentially sensitive events outlined in Regulation 30 of the LODR Regulations that impact market prices. SEBI’s study noted various gaps in defining UPSI, which affected uniform compliance and transparency. Therefore, the consultation paper proposes amendments to ensure compliance that aligns with PIT and LODR regulations.

 3. Current Definition of UPSI

PIT Regulations define UPSI as follows:

As per Regulation 2(1)(n) of SEBI (PIT) Regulations, 2015, unpublished price sensitive information” means any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to affect the price of the securities materially and shall, ordinarily including but not restricted to, information relating to the following:

• financial results;
• dividends;
• change in capital structure;
• mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions;
• changes in key managerial personnel.

4. Key Proposals from SEBI

The proposals put forth by SEBI’s Working Group (WG) and informed by public feedback aim to update the UPSI list to include specific events and information types. These proposals cover material events categorized under Schedule III of LODR, ensuring they are addressed in the UPSI framework.

 5. Conclusion

The proposed amendments to the UPSI definition under SEBI’s PIT Regulations represent a proactive step toward achieving greater clarity and consistency in regulatory compliance for listed entities. By aligning UPSI events with the material events outlined in Schedule III of the LODR, SEBI aims to enhance transparency, protect investor interests, and establish a standardized compliance framework across industries.

The post [Analysis] SEBI’s New UPSI Definition – Key Amendments for Transparency in Insider Trading appeared first on Taxmann Blog.

External confirmation in audits refers to audit evidence obtained directly from a third party in response to the auditor's request. This type of confirmation is used to verify the accuracy of specific financial information, such as account balances, transactions, and legal matters, as represented in a company's financial statements. Due to its independence and objectivity, external confirmation is considered one of the most reliable forms of audit evidence, enhancing the credibility of the audit and reducing the risk of errors or misstatements.

Table of Contents 

1. Introduction
2. What Constitutes Audit Evidence?
3. Case Study – Audit Evidence Failure and Its Consequences
4. Importance of Complying with Audit Standards
5. Understanding External Confirmation in Audits
6. Why External Confirmation is a Valuable Audit Tool?
7. Different Types of External Confirmation
8. Challenges in Obtaining Reliable External Confirmation
9. Audit Standards for External Confirmation
10. Case Example – External Confirmation in Action
11. Conclusion – Enhancing Audit Quality with Audit Evidence

1. Introduction

The integrity of a financial statement audit is built upon the foundation of audit evidence. It is the information used by auditors to form an opinion on whether the financial statements of an entity are free from material misstatement. Externalconfirmation  stands out as a particularly valuable and reliable source among the various types of evidence gathered during an audit. This article delves into the role of audit evidence in financial audits, focusing on using external confirmations to gather reliable and relevant evidence.

2. What Constitutes Audit Evidence?

As per SA 505, “Audit Evidence” is the information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based. Audit evidence includes information in the accounting records underlying the financial statements and information obtained from other sources.

Thus, the auditor must obtain sufficient and appropriate evidence to support their opinion on the financial statements. The reliability of the evidence depends on the source and nature, with direct evidence, such as external confirmation, generally being more reliable than indirect evidence, such as client representations. Audit evidence comes from a variety of sources and can be classified into different types:

• Physical Evidence – Tangible items that can be inspected (e.g., inventory count).
• Documentary Evidence – Written or electronic records substantiating transactions (e.g., invoices, contracts).
• Testimonial Evidence – Information gathered from discussions with management or staff.
• Analytical Evidence – Data obtained through analytical procedures, such as ratios or trend analysis.
• External Evidence – Information from independent third parties, such as banks, customers, or suppliers.

3. Case Study – Audit Evidence Failure and Its Consequences

An order from the NFRA emphasises the need to obtain sufficient and appropriate audit evidence. In the said case, the auditor failed to obtain sufficient appropriate audit evidence relating to trade receivables even though 100% of the trade receivables were unsecured without any provision for doubtful debts and formed a material part of the Balance Sheet (52.89%).

Following a detailed investigation, the NFRA found that the auditor failed to exercise due diligence while performing the audit of financial statements, particularly in relation to the audit of trade receivables. This failure was substantiated by the non-creation of the provision of doubtful debts, which showed that the audit procedures were not performed in accordance with the prescribed standards of the Institute of Chartered Accountants of India (ICAI). As a consequence of the violations, the regulatory body imposed the following penalties and actions:

• A monetary fine of ₹5,00,000 for non-compliance with auditing standards.
• A one-year suspension of the engagement partner from serving as an auditor or internal auditor or from conducting audits of financial statements or internal audits for any company or body corporate.

4. Importance of Complying with Audit Standards

The penalties and corrective actions imposed in this case remind all professionals in the field to comply with the established guidelines and safeguard the interests of stakeholders relying on accurate and truthful financial statements. Obtaining audit evidence is crucial because it enables the auditor to form an accurate opinion, ensures compliance with professional standards, helps detect material misstatements or fraud, and strengthens the overall quality and credibility of the audit process. The audit’s integrity and value would be significantly compromised without sufficient and appropriate audit evidence.

Continuing with the sources of audit evidence, external confirmation is a particularly reliable method, as it offers independent verification from third parties, thereby reinforcing the authenticity and objectivity of the evidence. The article’s next section will explore how audit evidence can be gathered through external confirmation.

5. Understanding External Confirmation in Audits

As per SA 505, “External Confirmations” is defined as audit evidence obtained by the auditor from a third party in response to a direct request. It is used to verify the accuracy of information presented in financial statements, such as balances, transactions, or other specific financial data. External confirmations are considered one of the most reliable sources of audit evidence, as they provide independent, external validation of the assertions made by the client. The confirmation may be in written responses, electronic communications, or other documented forms from the third party. External confirmations are most commonly used to verify:

• Account Balances – Confirming the balances of third parties’ receivables, payables, or cash.
• Transactions – Verifying specific transactions with customers or suppliers, such as sales or purchases.
• Legal Matters – Confirming ongoing or potential litigation details with the company’s legal advisors.
• Debt Agreements – Verifying terms of loan agreements with lenders or financial institutions.

6. Why External Confirmation is a Valuable Audit Tool?

External confirmation is highly regarded in audits because it comes from an independent source, making it more trustworthy than internal documents that could be influenced or altered. The reliability of the third-party provider, whether a bank, customer, or supplier, adds credibility to the confirmed information, ensuring that it is more objective and accurate.

External confirmations are especially useful when auditing high-risk areas where management may have incentives to misstate financial information. For example, confirming the accuracy of accounts receivable balances helps auditors assess whether the company’s reported assets are valid and whether customers are likely to pay their debts.

7. Different Types of External Confirmation

External confirmation can take various forms, and auditors typically choose the method based on the nature of the information being confirmed and the level of assurance required.

• Positive Confirmation – These require the recipient to respond to confirm the information. Positive confirmations are particularly useful when there is a high risk of error or fraud, e.g. account receivable confirmation.
• Negative Confirmation – In contrast, negative confirmations request the recipient to only respond if they disagree with the information provided. These are generally used when the risk of misstatement is lower, for example, when confirming accounts payable.
• Blank Confirmation – These are a variation of positive confirmations where the third party is asked to provide the balance or other information rather than confirming what has been sent by the auditor.

8. Challenges in Obtaining Reliable External Confirmation

Although external confirmation is highly valuable, it comes with certain challenges and limitations, including:

• Non-responses – A lack of response from third parties can undermine the effectiveness of external confirmation. This is particularly problematic when confirmations are used to verify significant balances.
• Misstatements or Errors in Responses – While third-party confirmations are generally reliable, they may still contain errors or be incomplete. Auditors need to critically assess the reliability of the responses.
• Cost and Time – External confirmation can be time-consuming and costly, especially when dealing with large numbers of third parties. It may also involve delays in receiving responses, which can impact the audit timeline.
• International Considerations – When auditing entities with international operations, auditors may encounter difficulties obtaining external confirmations from foreign parties due to language barriers, different legal systems, or time zone differences.

 9. Audit Standards for External Confirmation

• International Standards on Auditing (ISA 505) – Under ISA 505, External Confirmations auditors must send external confirmations to obtain sufficient and appropriate audit evidence. The standard highlights the importance of using external confirmation procedures when they effectively obtain evidence.
• PCAOB –In the United States, the PCAOB (Public Company Accounting Oversight Board) also provide guidelines in Auditing Standard (AS) 2301, AS 2310, and AS 2410 on using external confirmation as part of the audit process. The PCAOB’s guidance on external confirmation stresses the importance of obtaining sufficient, reliable, and appropriate audit evidence to support the auditor’s opinion. The auditor must consider the nature and risk of the accounts being confirmed, select appropriate procedures, assess the reliability of responses, and document all steps in the process. Failure to do so may lead to a misstatement or failure to detect fraud, which could result in a modified audit opinion.

10. Case Example – External Confirmation in Action

An order from the NFRA emphasises the importance of obtaining appropriate audit evidence through external confirmation. In this case, the auditor failed to obtain sufficient appropriate audit evidence relating to trade receivables, trade payables and supplier advances. The auditor obtained no external confirmations of bank balances and third-party balance confirmations.

During its investigation, the NFRA determined that the auditor had committed professional misconduct and, exercising its authority, imposed the following penalty:-

• Monetary penalty of Rs. 2,00,000/- (Two Lakhs Rupees) on the engagement partner
• Debared the engagement partner and the auditor firm for two years from being appointed as an auditor or internal auditor or from undertaking any financial statements or internal audit of the functions and activities of any company or body corporate.

11. Conclusion – Enhancing Audit Quality with Audit Evidence

In conclusion, an audit’s integrity and quality heavily rely on the sufficiency and appropriateness of audit evidence. Audit evidence not only supports the auditor’s opinion but also ensures compliance with professional standards, aids in detecting misstatements or fraud, and enhances the credibility of the audit process. Among the various sources of audit evidence, external confirmation stands out as a particularly reliable method. By obtaining independent verification from third parties, external confirmation reinforces the objectivity and authenticity of the information, reducing the risk of errors and fraud. However, its effectiveness depends on careful planning, execution, and overcoming potential challenges such as non-responses or errors in the confirmation process. When used effectively, external confirmation significantly strengthens the audit process, ensuring auditors can provide stakeholders with a more accurate, transparent, and trustworthy financial picture.

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High-Value Debt Listed Entities (HVDLEs) are listed entities with an outstanding value of non-convertible debt securities of ₹500 crore or more. SEBI classifies these entities based on their debt holdings to apply specific corporate governance norms that ensure transparency and accountability. The designation of HVDLEs helps streamline regulatory focus on significant debt issuers, aligning their compliance requirements with their impact on the debt market and investor protection.

Table of Contents

1. Introduction
2. Introduction of a Separate Chapter for Corporate Governance Norms in LODR Regulations for ‘High-Value Debt Listed Entities’
3. Relaxation in the Threshold for Identification of ‘HVDLEs’ for Applicability of Governance Norms
4. Introduction of Corporate Governance Compliance Report in XBRL Format
5. Introduction of Sunset Clause for Applicability of Corporate Governance Norms
6. Introduction of Business Responsibility and Sustainability Report for HVDLEs voluntarily
7. Relaxation for HVDLEs Which are Not Companies as per Companies Act, 2013
8. Relaxation with Regard to the Constitution of the Nomination and Remuneration Committee
9. Relaxation with Regard to the Constitution of the Risk Management Committee and Stakeholders Relationship Committee
10. Upfront Disclosure of the RPT Amount in Offer Documents by the Issuer at Time of Issuance of NCS
11. Inclusion of HVDLE Directorships in Overall Board Limit for Listed Entities
12. Proposal to Consider HVDLEs for Computing Maximum Limit of Committees a Director Can Act as a Member or Chairperson
13. Conclusion

1. Introduction

SEBI has released a consultation paper dated October 31, 2024, on reviewing the provisions of LODR Regulations relating to corporate governance norms for ‘High-Value Debt Listed Entities’. The objective of the consultation paper is to seek public comments on the proposals related to the review of provisions of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, pertaining to corporate governance norms for High-Value Debt Listed Entities (HVDLEs). The comments on the same may be submitted by September 6, 2024. The key proposals in detail are as follows:

2. Introduction of a Separate Chapter for Corporate Governance Norms in LODR Regulations for ‘High-Value Debt Listed Entities’

Presently, Regulations 15 to 27 of the LODR Regulations contain corporate governance norms that have been approached from an equity perspective and may not be fully relevant from the perspective of debt-listed entities. Out of 812 debt-listed entities as of March 31, 2024, 264 (33%) entities are both equity and debt-listed, whereas 538 (66%) entities are only debt-listed.

SEBI has proposed introducing a separate chapter for HVDLEs comprising all provisions relating to corporate governance norms and carving out only those that differ from equity-listed entities in a separate chapter. This facilitates ease of reference for HVDLEs to adhere to corporate governance norms.

2.1 Meaning of ‘High-Value Debt Listed Entities’

Listed entities having an outstanding value of listed non-convertible debt securities of Rs 500 crores and above are referred to as ‘High-Value Debt Listed Entities’ (HVDLEs).

3. Relaxation in the Threshold for Identification of ‘HVDLEs’ for Applicability of Governance Norms

Currently, corporate governance norms are applicable based on the outstanding value of listed non-convertible debt securities, and an entity is identified as HVDLE as and when it hits the threshold of Rs 500 crore.

SEBI has proposed increasing the listed outstanding non-convertible securities threshold for identifying a debt-listed entity as HVDLE from Rs 500 crore to Rs 1000 crore.

4. Introduction of Corporate Governance Compliance Report in XBRL Format

SEBI observed from the filings made by HVDLEs on the websites of stock exchanges that the filings are made in uniform formats. In most cases, they are made in PDF format, which hampers readability and monitoring of clause-wise compliance by stock exchanges. Hence, it is proposed to specify that quarterly compliance reports, as specified in Regulation 27(2) of the LODR Regulations, must be in XBRL format.

Further, in the case of reporting for corporate governance compliance, SEBI has proposed harmonizing the format for HVDLEs with the format specified for equity-listed entities.

5. Introduction of Sunset Clause for Applicability of Corporate Governance Norms

Currently, Regulation 3(3) of the LODR Regulations provides that the corporate governance norms shall continue to apply to an HVDLE even when the outstanding amount of listed non-convertible debt securities falls below the specified threshold of Rs. 500 crores.

However, there is no specified period for which an HVDLE shall continue to comply with such provisions once the outstanding amount of listed non-convertible debt securities falls below the specified threshold of Rs. 500 crores.

To address the issue for HVDLEs, SEBI has proposed the following –

• Once the corporate governance norms become applicable to an HVDLE, they must remain applicable until the value of outstanding listed debt securities reduces and remains below the specified threshold for three consecutive financial years.
• Suppose the value of outstanding listed debt securities of the entity increases in the subsequent years and the listed entity hits the specified threshold. In that case, it has to ensure compliance with the provisions within two quarters, i.e. 6, months and disclosures of such compliance may be made in the corporate governance compliance report.

6. Introduction of Business Responsibility and Sustainability Report for HVDLEs voluntarily

Regulation 34(2)(f) of the LODR Regulations mandates that the top 1000 listed companies (by market capitalization) provide disclosures as per the Business Responsibility and Sustainability Report (BRSR).

To inculcate the practice of good governance at par with equity listed, HVDLEs may voluntarily comply with the requirements of publishing BRSR.

7. Relaxation for HVDLEs Which are Not Companies as per Companies Act, 2013

Certain entities such as NABARD, SIDBI, NHB, and EXIM Bank raise funds from the bond market through the issuance of debt securities. These institutions are governed by the specific Acts passed by Parliament and not governed by the Companies Act 2013.

These Acts lay down the governance structure, including the composition of the Board, appointment, removal, and other terms and conditions. Thus, these entities specifically need approvals from the Government or Regulatory bodies concerning the appointment of directors and other related aspects.

SEBI has proposed specifying a similar carve-out for HVDLEs that are not companies, similar to what is provided for equity-listed entities.

8. Relaxation with Regard to the Constitution of the Nomination and Remuneration Committee

Regulation 19 of the LODR Regulations mandates the constitution of the Nomination and Remuneration Committee (NRC) as part of corporate governance norms.

To avoid the constitution of multiple committees by HVDLEs, SEBI has proposed that the board of directors of an HVDLE may either choose to constitute NRC or may ensure that the functions of NRC as specified in Regulation 19(4) of the LODR Regulations are delegated and discharged by the Audit Committee.

9. Relaxation with Regard to the Constitution of the Risk Management Committee and Stakeholders Relationship Committee

Regulation 21 of the LODR Regulations specifies that the Board of Directors must constitute a Risk Management Committee (RMC). In contrast, Regulation 20 of the LODR Regulations mandates the listed entity to constitute a Stakeholders Relationship Committee.

To avoid the constitution of multiple committees by HVDLEs, SEBI has proposed that the board of directors of an HVDLE may either choose to constitute RMC/SRC or may ensure that the functions of RMC/SRC as specified in Regulation 21(4) and Regulation 20(4) of the LODR Regulations are delegated and discharged by the Audit Committee.

10. Upfront Disclosure of the RPT Amount in Offer Documents by the Issuer at Time of Issuance of NCS

Regulation 23 of the LODR Regulations specifies the regulatory requirements pertaining to related party transactions (RPTs), including forming a policy on the materiality of RPTs, prior approval of the audit committee for all RPTs, and prior approval of shareholders for material RPTs.

SEBI has proposed that the issuer, at the time of issuance of non-convertible securities (proposed to be listed), may provide a declaration upfront in the offer document regarding the amount (percentage of issue size) of RPT the issuer proposes to undertake over the tenor of the proposed non-convertible securities (NCS).

Further, the issuer must declare upfront in the offer document the debt-equity ratio, debt service coverage ratio, internet service coverage ratio, and such other financial/non-financial covenants that will be maintained by the issuer over the tenor of non-convertible securities. The debenture trustee must monitor such ratios, including covenants.

11. Inclusion of HVDLE Directorships in Overall Board Limit for Listed Entities

Regulation 17A of the LODR Regulations specifies that a person must not be a director in more than seven listed entities. Further, a person must not serve as an independent director in more than seven listed entities.

However, extant regulations exclude HVDLEs while counting the number of directorships held by a person. As a consequence, a person may hold directorships in many HVDLEs, which would not be counted for the purpose of the limits.

SEBI has proposed including directorships in HVDLEs along with directorships in equity-listed entities when counting the number of directorships held by a person in listed entities. Further, to give sufficient time to all the listed entities to ensure compliance with the provision, a period of six months or a period of time till the next AGM is held may be provided.

12. Proposal to Consider HVDLEs for Computing Maximum Limit of Committees a Director Can Act as a Member or Chairperson

Regulation 26 of the LODR Regulations provides a maximum cap on the number of committees a director can act as a member or chairperson across all listed entities. While determining the number of such listed entities, HVDLEs are excluded.

To ensure that directors devote adequate time to listed entities, including HVDLEs and in the interest of investor protection, SEBI has proposed that HVDLEs (along with equity-listed companies) must be considered for computing the maximum limit of committees, a director can act as a member or chairperson.

13. Conclusion

The proposed norms aim to strengthen corporate for High-Value Debt Listed Entities by introducing specific provisions that enhance transparency, accountability and compliance. Through measures such as creating a separate governance chapter, raising the threshold for HVDLE identification, aligning reporting standards, and ensuring balanced board commitments, SEBI seeks to simplify governance practices and promote consistent oversight. These initiatives collectively enhance investor protection and strengthen the stability of the debt market.

The post [Analysis] SEBI’s Corporate Governance for High-Value Debt-Listed Entities (HVDLEs) appeared first on Taxmann Blog.

Real estate insolvency under the Insolvency and Bankruptcy Code (IBC) refers to the legal process of addressing the financial distress of real estate companies unable to meet their debt obligations. Under the IBC, real estate firms facing insolvency enter the Corporate Insolvency Resolution Process (CIRP), where their assets and operations are managed by an appointed Resolution Professional (RP) to formulate a plan for debt resolution. Homebuyers, now recognised as financial creditors, participate in this process alongside other creditors through the Committee of Creditors (CoC). The IBC's framework for real estate insolvency aims to protect the interests of all stakeholders—particularly homebuyers and creditors—by facilitating structured resolutions and reducing prolonged litigation in real estate projects.

Table of Contents

1. Introduction
2. Inclusion of Land Authorities as Special Invitees in CoC Meetings for Real Estate CIRPs
3. Mandatory Reporting of Pre-Insolvency Land Allotment Cancellations for Enhanced CoC Decision-Making
4. Enhancing Allottee Associations’ Participation in Real Estate Insolvencies through Flexible Eligibility and Deposit Requirements
5. Proposal for Uniform Application of 8% Interest Rate in Homebuyers’ Claims and Voting Shares
6. Representation of Large Creditor Classes through Facilitators
7. Dissemination of CoC Meeting Minutes to all Creditors in Real Estate Projects
8. Proposal for Allowing of Transfer of Ownership of Completed Units During CIRP with CoC Approval
9. Conclusion

1. Introduction

On November 07, 2024, the Insolvency and Bankruptcy Board of India (IBBI) released a discussion paper addressing crucial issues within real estate insolvency cases under the Insolvency and Bankruptcy Code (IBC). This initiative seeks to enhance efficiency in the Corporate Insolvency Resolution Process (CIRP) for real estate companies, especially by integrating perspectives from various stakeholders, such as homebuyers, land authorities, and insolvency professionals, in a more structured manner. Below is an overview of the major proposals and issues addressed in the paper:

2. Inclusion of Land Authorities as Special Invitees in CoC Meetings for Real Estate CIRPs

3. Mandatory Reporting of Pre-Insolvency Land Allotment Cancellations for Enhanced CoC Decision-Making

4. Enhancing Allottee Associations’ Participation in Real Estate Insolvencies through Flexible Eligibility and Deposit Requirements

5. Proposal for Uniform Application of 8% Interest Rate in Homebuyers’ Claims and Voting Shares

6. Representation of Large Creditor Classes through Facilitators

7. Dissemination of CoC Meeting Minutes to all Creditors in Real Estate Projects

8. Proposal for Allowing of Transfer of Ownership of Completed Units During CIRP with CoC Approval

9. Conclusion

In conclusion, the IBBI’s proposals aim to streamline and enhance the real estate insolvency process under the IBC, ensuring greater stakeholder engagement and more efficient resolutions. These reforms seek to balance the interests of all stakeholders, reduce litigation, and provide smoother resolution processes, ultimately promoting a more effective and transparent real estate insolvency framework.

The post [Analysis] IBBI’s Proposals to Streamline Real Estate Insolvency Under IBC – Key Reforms and Insights appeared first on Taxmann Blog.

SEBI's regulations on overseas mutual funds allow Indian mutual funds to invest in foreign securities, including overseas mutual funds or unit trusts, within specific guidelines. Issued as part of SEBI's Master Circular on Mutual Funds, the rules set limits on exposure to Indian securities (capped at 25% when investing abroad) and require compliance with conditions like independent management and public disclosure. These regulations enhance transparency, protect investor interests, and promote portfolio diversity by providing Indian mutual funds access to global markets while ensuring prudent oversight and risk control.

Table of Contents

1. Introduction
2. Investment Scope for Overseas Mutual Funds and Unit Trusts
3. Key Highlights of the Circular
4. Implications for Mutual Funds and Investors

1. Introduction

On June 27, 2024, the Securities and Exchange Board of India (SEBI) issued the ‘Master Circular on Mutual Funds,’ which permits mutual funds to invest in overseas securities, including those in foreign mutual funds or unit trusts. Subsequently, on November 4, 2024, SEBI introduced additional regulations for Indian Mutual Funds investing in overseas Mutual Funds or Unit Trusts (MF/UTs). These regulations are designed to streamline the process of overseas investment, enhance transparency, and allow Indian Mutual Funds to broaden their investment portfolios. This regulatory update was informed by discussions with the Mutual Fund Advisory Committee, various industry stakeholders, and a public feedback period.

2. Investment Scope for Overseas Mutual Funds and Unit Trusts

As per Para 12.19.2.10 of the Master Circular on Mutual Funds, the units or securities issued by overseas Mutual Funds or Unit Trusts that are registered with foreign regulators are authorized to invest in:

• Specified overseas securities;
• Real Estate Investment Trusts (REITs) that are listed on recognized overseas stock exchanges;
• Unlisted overseas securities are subject to a maximum of 10% of their net assets.

3. Key Highlights of the Circular

3.1 Investment Guidelines

Indian Mutual Fund schemes can allocate up to 25% of their portfolio to Indian securities when investing in overseas Mutual Funds or Unit Trusts (MF/UTs). This guideline is designed to provide opportunities for global investment while maintaining a deliberate and moderate exposure to Indian securities.

3.2 Conditions for Overseas MF/UTs

To protect investors, SEBI has introduced stringent conditions for investments in overseas MF/UTs:

• Pooling – Investments must be consolidated into a single vehicle, prohibiting side vehicles or segregated portfolios.
• Pari-passu Rights – All investors should receive returns proportional to their investments, ensuring equal treatment.
• Independent Management – Overseas MF/UTs should be managed by independent fund managers to prevent conflicts of interest and ensure unbiased decision-making.
• Public Disclosure – These funds are required to publicly disclose their portfolios quarterly to maintain transparency for investors.
• No Advisory Agreements – Prohibiting advisory agreements between Indian Mutual Funds and overseas MF/UTs to avoid conflicts of interest and ensure fairness.

3.3 Breach and Compliance Monitoring

SEBI has established guidelines to monitor and address any breaches in the 25% exposure limit to Indian securities:

• Observation Period – If an overseas MF/UT’s investment in Indian securities exceeds 25%, six months is allowed for monitoring and rebalancing.
• Investment Restrictions – No new investments are permitted during this period until the exposure is reduced below 25%.
• Mandatory Liquidation – If the rebalancing is not achieved within the observation period, Indian Mutual Funds must divest their holdings in the non-compliant MF/UT within an additional six months. If the exposure is corrected during the liquidation period, forced liquidation can be avoided.

3.4 Penalties for Non-Compliance

Failure to adhere to the rebalancing requirements within the specified timeframe will lead to significant consequences for Indian Mutual Funds/AMCs, including:

• Subscription Suspension – Temporary halt on new subscriptions to the affected schemes.
• Prohibition on New Schemes – Restrictions on launching new schemes.
• Exit Load Waiver – Remove exit fees for investors wishing to withdraw from the non-compliant scheme.

4. Implications for Mutual Funds and Investors

The recent SEBI circular facilitates greater global investment opportunities for Indian mutual funds, introducing diversity and potential growth to investor portfolios. By enforcing clear guidelines prioritising transparency and investor safety, this initiative enables Indian funds to access international markets effectively while maintaining prudent oversight of domestic investments.

The cap of 25% on exposure to Indian securities in overseas funds ensures that investments are not overly concentrated in the Indian market, thereby minimizing risk and promoting a more balanced growth potential. These regulations underscore SEBI’s dedication to fostering a stable and well-regulated investment environment, aiding mutual funds in offering their investors security and growth prospects.

The post [Analysis] SEBI Regulations on Overseas Mutual Funds – New Guidelines for Global Investments appeared first on Taxmann Blog.

A Financial Guarantee Contract (FGC) is an agreement where one party, known as the guarantor, promises to fulfil the payment obligations of a borrower or debtor in the event of default. This contract safeguards lenders, ensuring that they will receive payment even if the original debtor cannot meet their obligations. FGCs are typically classified as financial liabilities under accounting standards, such as Ind AS 109, where they are recognised at fair value upon issuance. Depending on the arrangement, FGCs may involve premiums or be provided at no charge, especially in cases between related parties, like parent and subsidiary companies.

Table of Contents

1. Financial Guarantee Contracts under Ind AS Framework
2. Financial Guarantee Contracts under the AS framework
3. Conclusion

A Financial Guarantee Contract (FGC) is a formal agreement where one entity, the issuer, promises to fulfil the payment obligations of a specified debtor should they default. This agreement serves as a safety net for lenders or creditors, ensuring reimbursement in cases of non-payment. This document elaborates on the treatment of financial guarantees under Indian Accounting Standards (Ind AS) and Accounting Standards (AS).

1. Financial Guarantee Contracts under Ind AS Framework

Treatment of Financial Guarantee Contracts under Ind AS within the Ind AS framework, financial guarantee contracts are classified as financial liabilities. According to Ind AS 109, which governs financial instruments, a financial guarantee is a contract that imposes a financial obligation to either deliver cash or another financial asset or swap financial assets under specific conditions. Essentially, an FGC represents a unique form of financial liability where the issuer commits to cover a debt obligation of another party in instances of default.

Types of Financial Guarantee Contracts:

• Financial Guarantees to Related Parties – This category includes guarantees provided to entities like associated companies, subsidiaries, or holding companies where the guarantor does not receive a premium. An example is a parent company issuing a guarantee for a loan taken by its subsidiary.
• Financial Guarantees to Unrelated Parties – These guarantees involve a premium paid to the guarantor. For instance, a company might issue a financial guarantee on behalf of a purchaser to a seller and receive a premium in return.

Regardless of these distinctions, both financial guarantees types are classified as liabilities under Ind AS 109.

1.1 Initial Recognition of Financial Guarantee Contracts

Upon issuance, financial guarantee contracts are initially recognised at their fair value. When these guarantees are issued to unrelated parties, such as in an arms-length transaction, the fair value is typically equivalent to the premium received for issuing the guarantee. However, Ind AS 109 does not specify a formula for calculating the fair value of financial guarantee contracts (FGCs) provided to related parties.

To address this gap, the Ind AS Transition Facilitation Group (ITFG) has proposed several methods for estimating the fair value of financial guarantees issued to related parties:

• Approach 1 – One method could involve determining what an unrelated, independent third party would charge for a similar guarantee.
• Approach 2 – Another method might estimate the fair value based on the present value of the difference in interest or other similar cash flows that would occur if the loan were not guaranteed.
• Approach 3 – A further method may calculate the fair value by estimating the present value of the probability-weighted expected cash flows that could arise from the guarantee.

1.2 Subsequent Recognition of Financial Guarantee Contracts

After initial recognition, the issuer of the financial guarantee contract (FGC) must measure it at the higher of:

• The amount is determined based on lifetime expected credit losses. This measurement reflects any significant increase in credit risk, indicating a higher likelihood of the debtor defaulting since the FGC was first recognised.
• The initially recognised amount (i.e., fair value) is adjusted for the cumulative amount of income recognised under the principles of Ind AS 115, where applicable.
  If the carrying amount of the FGC exceeds its initially recognised value, any excess is recognised as an impairment loss.

1.3 Presentation of Financial Guarantee Contracts under the Ind AS framework

Under the Ind AS framework, specifically Schedule III, financial guarantee contracts are categorised and presented as “Other Financial Liabilities” on the balance sheet within the larger grouping of “Financial Liabilities.” This section also encompasses contingent considerations, derivative contracts, and financial guarantees. The categorisation aids in clear financial reporting and ensures stakeholders have a detailed view of the entity’s financial commitments. The discussion also includes a case study involving a parent company that issued a financial guarantee to a bank on behalf of its subsidiary, illustrating the practical application of these accounting principles.

2. Financial Guarantee Contracts under the AS framework

In the Accounting Standards (AS) framework, no specific standard exclusively addresses financial instruments such as financial guarantees. However, these guarantees are generally treated under AS 29, Provisions, Contingent Liabilities, and Contingent Assets. Under AS 29, a contingent liability is defined in two ways:

• A possible obligation that arises from past events, the existence of which will be confirmed only by the occurrence (or non-occurrence) of one or more uncertain future events not wholly within the control of the entity.
• A present obligation that arises from past events but is not recognised because:

1. 1. It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
   2. The amount of the obligation cannot be measured with sufficient reliability.

Given that a financial guarantee’s enactment depends on the uncertain event of a debtor’s default, it is classified as a contingent liability under AS 29. Such liabilities are not recognised on the balance sheet. Instead, they are disclosed in the notes to the financial statements unless the probability of the obligation becoming a reality is deemed remote. This ensures transparency and provides stakeholders with a clear understanding of potential financial impacts that may not yet have been realised.

2.1 Recognition of the contingent liability

are not recognised on the balance sheet within the financial statements; however, they must be disclosed in the notes unless the probability of resource outflow is deemed remote. Should the chance of an outflow be considered more likely than remote, the entity is required to provide a concise description of the nature of each contingent liability in the notes to the financial statements, along with any information available about the potential financial impact.

For Example:

“Company A” (the parent company) offers a financial guarantee to a bank for a loan taken by its subsidiary, “Company B.” This arrangement stipulates that should “Company B” fail to repay the loan, “Company A” would be obliged to fulfil the payment obligations.

Under the Accounting Standards (AS) framework, this arrangement positions “Company A” in relation to the financial guarantee as follows:

• Possible Obligation – The guarantee creates a potential obligation for “Company A,” as there exists a scenario in which “Company A” might have to pay if “Company B” defaults.
• Uncertain Event – The requirement for “Company A” to make any payment is contingent upon whether “Company B” defaults on the loan, a future event filled with uncertainty. The obligation will only materialise if and when “Company B” fails to meet its repayment responsibilities.
• Not Within Company A’s Control – The potential default by “Company B” is beyond “Company A’s” direct control. For instance, despite potential financial support or interventions from “Company A,” it cannot guarantee the financial solvency of “Company B” or ensure its loan repayments.

Although no monetary transfer has occurred yet, “Company A” must acknowledge the potential obligation arising from the financial guarantee. This recognition categorises the guarantee as a contingent liability—a potential obligation triggered by an uncertain future event not entirely within the company’s control.

3. Conclusion

Financial Guarantee Contracts (FGCs) are addressed distinctively under the Indian Accounting Standards (Ind AS) and Accounting Standards (AS) frameworks. In the Ind AS 109 context, FGCs are categorised as financial liabilities, where they are initially recognised at fair value. Their subsequent measurement takes into account expected credit losses or retains the initial fair value, with impairment losses recognised if deemed necessary. Conversely, under the AS framework, FGCs are treated as contingent liabilities. They are not recorded on the balance sheet but must be disclosed in the financial statement notes unless the likelihood of an outflow of resources is considered remote.

Both accounting frameworks are designed to reflect potential obligations stemming from financial guarantees transparently. However, they diverge in their approaches to the recognition and measurement of these obligations, tailored to align with their respective underlying principles and standards. This ensures that financial statements provide a comprehensive view of an entity’s financial health and obligations.

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Mediation for operational creditors under the Insolvency and Bankruptcy Code (IBC) is a proposed dispute resolution process that allows operational creditors to attempt settlement with corporate debtors before filing for insolvency under Section 9. This initiative, introduced by the Insolvency and Bankruptcy Board of India (IBBI), aims to resolve disputes related to payment defaults, quality of goods, and contractual issues through a mediator rather than directly proceeding to court. If mediation is unsuccessful, a non-settlement report is attached to the application, simplifying the adjudication process. This approach reduces judicial caseload, enhances efficiency, and offers a cost-effective resolution path for operational creditors.

Table of Contents

1. Problem Statement & Challenges in Section 9 Applications
2. Proposal for Mediation
3. Impact
4. Invitation for Public Comments

On November 4, 2024, the Insolvency and Bankruptcy Board of India (IBBI) published a discussion paper that puts forward a proposal for introducing mediation as an initial step for operational creditors (OCs) before they file an insolvency application under Section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC). This proposal aligns with the Expert Committee’s recommendations on the ‘Framework for the use of Mediation under the IBC’ and the Indian Institute of Insolvency Professionals of ICAI (IIIPI). Both bodies have advocated for a pre-institutional mediation step to resolve disputes early on.

1. Problem Statement & Challenges in Section 9 Applications

Applications under Section 9 often face consistent challenges, predominantly stemming from conflicts between OCs and Corporate Debtors (CDs) over issues such as:

• Disputes related to the quality or performance of goods and services delivered.
• Contractual disputes are allegations of non-compliance with the terms agreed upon by either party.
• Disagreements over the amounts due, including set-off claims.

Such disputes frequently lead to protracted legal proceedings and place an undue burden on the judicial system. Data from the Adjudicating Authority (AA) up to April 2024 reveals that out of 21,466 Section 9 applications, only 3,818 were admitted, reflecting a high rate of pre-admission settlements. Moreover, the AA is mandated to conduct hearings before deciding on an application, a process that is often lengthy. Mediation is proposed as a beneficial tool to alleviate these disputes between OCs and corporate debtors early on and facilitate quicker admissions by the AA.

2. Proposal for Mediation

In response to these ongoing issues, the IBBI proposes an optional mediation process that OCs might choose to engage in before proceeding with insolvency applications. Under this proposed system, a mediator would conduct mediation as per the Mediation Act, 2023. This could enable parties to address and potentially resolve their disputes without overburdening the AA. If mediation does not result in a settlement, the mediator would issue a non-settlement report, which would then accompany the OC’s application to the AA, thereby streamlining the admission process.

3. Impact

The proposed mediation framework for operational creditors before filing Section 9 insolvency applications is poised to improve the dispute resolution mechanism under the IBC significantly. By facilitating early mediation, the initiative is designed to reduce the caseload on the Adjudicating Authority, expedite resolutions, and enhance judicial resource efficiency. The proactive mediation approach is expected to bolster settlement rates, simplify the application process, and offer a more cost-effective method for dispute resolution.

4. Invitation for Public Comments

To further refine this mediation framework, the IBBI invites public feedback on the proposed mediation process and the associated draft regulations. Comments are requested to be submitted by November 24, 2024. After considering the public input, the IBBI plans to finalize and implement the regulations governing this mediation process. This initiative seeks to provide a quicker and more economical means for resolving disputes, thereby reducing the judicial burden and speeding up the insolvency resolution process for operational creditors.

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Small savings scheme irregular accounts refer to accounts in government-backed savings programs (like NSC, PPF, and Sukanya Samriddhi Yojana) that do not comply with the prescribed rules. These irregularities may include multiple accounts opened under the same scheme, accounts exceeding contribution limits, or accounts opened by ineligible individuals. The Ministry of Finance has issued guidelines to regularise such accounts by adjusting interest rates, setting refund terms, or merging accounts to ensure they align with the scheme's regulations and intended benefits.

Table of Contents

1. Introduction
2. National Savings Scheme
3. Sukanya Samriddhi Scheme
4. Public Provident Fund
5. Other Small Saving Schemes opened in the name of minor

1. Introduction

People often need more time to save for the future due to uncertainty and the personal goals they wish to achieve. The government introduced several appealing small savings schemes to encourage better saving habits and improve financial security. The Central Government manages these schemes, including the National Savings Certificate (NSC), Public Provident Fund (PPF), Senior Citizen Savings Scheme, Kisan Vikas Patra, etc.

These savings schemes offer higher interest rates and tax benefits to help individuals achieve long-term financial goals.

It came to the government’s attention that many people have opened accounts violating the prescribed rules for small savings schemes. These accounts have been marked as ‘irregular’ by the government. To manage these accounts, the Ministry of Finance has issued the following guidelines through letters:

1. F. No. 14/1/2018-NS-Part(1), dated 12-07-2024
2. F. No. 14/1/2018-NS-Part(1), dated 30-09-2024

These guidelines provide norms to regularise the accounts opened under the National Savings Scheme, Public Provident Fund, and Sukanya Samriddhi Yojana.

This article discusses the irregularities in the following accounts and guidelines issued by the Government to regularise them.

2. National Savings Scheme

The National Savings Scheme (NSS) was designed to encourage regular savings by offering secure investment options with tax benefits. It was discontinued and is no longer in operation.

The NSS was first introduced on 1st April, 1987. Under this scheme, individuals, Hindu Undivided Families (HUFs), Associations of Persons (AOPs) or Bodies of Individuals (BOIs) could deposit funds. Each depositor was allowed to open only one account, with a minimum deposit of Rs. 100 and a maximum annual contribution of Rs. 40,000.

However, the NSS 1987 was discontinued on 30th September, 1992, and a new National Savings Scheme was introduced on 1st October, 1992. Subsequently, this scheme was also discontinued on 1st November, 2002.

It was noticed that depositors had opened multiple accounts under this scheme to enjoy the benefit of higher interest rates, which was against the scheme’s rules. To resolve this irregularity, the following guidelines have been issued:

2.1 Two accounts opened before 02.04.1990

If the depositors opened two NSS accounts before 02-04-1990, the first account will earn interest at the prevailing scheme rate. The second account will earn interest at the prevailing Post Office Savings Account rate plus 200 basis points, i.e. 2% on the outstanding balance.

However, this is subject to the condition that the combined deposits across both accounts should not exceed the annual limit of Rs. 40,000. Any excess deposits in the accounts beyond this limit will be refunded without interest.

2.2 Two accounts opened on or after 02.04.1990

If the depositors opened two NSS accounts before 02-04-1990, the first account will earn interest at the prevailing scheme rate. The second account will earn interest at the prevailing Post Office Savings Account rate on the outstanding balance.

However, this is subject to the condition that the combined deposits across both accounts should not exceed the annual limit of Rs. 40,000. Any excess deposits in the accounts beyond this limit will be refunded without interest.

2.3 More than two accounts

If a depositor has opened more than two NSS accounts, no interest will be paid on these additional accounts. The principal from these extra accounts will be refunded without any interest.

2.4 No Interest after 01-10-2024

Although the NSS is discontinued, depositors are permitted to keep funds in the account until it is closed. However, these accounts will not earn any interest from 01-10-2024 onward.

3. Sukanya Samriddhi Scheme

The Sukanya Samriddhi Scheme is a government initiative designed to secure the future of a girl child by accumulating funds for her education and marriage. This scheme allows a guardian to open an account for a girl under 10 years of age. Each family can open accounts for a maximum of two girl children, with each account holder permitted to have only one account under the scheme. The Sukanya Samriddhi Scheme offers attractive interest rates and tax benefits, making it a compelling choice for parents looking to invest in their daughters’ long-term financial security.

Although the scheme does not explicitly define the term “guardian,” it follows the guidelines outlined in the Hindu Minority and Guardianship Act, 1956. Under this Act, a guardian can be the natural guardian (father or mother), a court-appointed guardian, or one designated by a will.

For unmarried girls, the father is considered the natural guardian, and the mother assumes this role after him. Stepfathers and stepmothers are not recognised as natural guardians under the Act.

3.1 Accounts opened by Grandparents

It has been observed that some accounts under this scheme are opened by grandparents. The government has clarified that grandparents cannot open a Sukanya Samriddhi account for their granddaughter if her parents are alive. However, if the grandparent is the legal guardian of the girl, they are allowed to open an account.

If a grandparent who is not the legal guardian opens the account, the account’s guardianship will later be transferred to the parents or the legal guardian.

3.2 More than two accounts opened

If more than two accounts are opened in a family, then the irregular account shall be closed by treating it as an account opened in contravention of the scheme.

However, in the following cases, the account can be opened with respect to more than two girl children provided an affidavit supported by the birth certificate of all the girl children is submitted by the guardian:

• The first order of birth resulted in triplets, and all the children were girls; or
• The second order of birth resulted in two girl children, and the first order also was the birth of a girl child. However, this exception shall be applicable if the first order of birth results in two or more surviving girl children.

4. Public Provident Fund

The Public Provident Fund (PPF) is a tax-free investment avenue which is open to all individuals. The Government had brought the scheme to encourage the saving and investment habits among the individuals.

An individual can open only one account in his name under the PPF scheme. Additionally, an individual can also open one PPF account each in the name of a minor or a person of unsound mind of whom he is the guardian (legal or natural).

4.1 Account opened in the name of a minor

A minor with a guardian can continue holding or open a new PPF account and earn the prevailing PPF scheme interest rate, currently 7.1%.

If a minor’s account is opened without a guardian, it will be classified as an irregular account. Such an account will earn interest at the Post Office Savings Account rate until the minor turns 18, making them eligible to open an account. From that point on, interest will be paid at the applicable PPF rate, currently 7.1%.

Additionally, the maturity period for this account will be calculated from the date the minor reaches adulthood and becomes eligible to open the account.

4.2 Holding more than one account

If a person has more than one PPF account, only the primary account will earn interest at the rate set by the scheme as long as the deposits stay within the annual limit. The primary account is the one selected by the investor at any Post Office or Agency Bank where they want to keep the account active.

The balance of the second account will be combined with the primary account, as long as the primary account stays within the investment limit each year. After the merger, the primary account will continue to earn interest at the current rate. Any amount over the limit in the second account will be refunded without interest.

Additional accounts beyond the primary and second accounts will earn 0% interest from the date they are opened.

4.3 Interest rate on the account held by NRI

For active NRI PPF accounts opened under the PPF Scheme, 1968, where Form H did not request the account holder’s residency status, the account holder (an Indian citizen who became an NRI while the account was active) will receive the Post Office Saving Account interest rate until 30th September 2024. After this date, the account will earn 0% interest.

5. Other Small Saving Schemes opened in the name of minor

If a small savings scheme (other than PPF and SSA) is opened in a minor’s name, it will be considered an irregular account. This account may be regularised with simple interest, calculated at the current post office savings account rate.

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