Explained: Why companies are worried over SEBI norms on related-party transactions

A bunch of companies led by the engineering and construction major Larsen & Toubro Ltd want the capital markets regulator to change its proposed rules around transactions between related parties, saying they will increase compliance costs and delay decision-making processes. 

Along with the likes of L&T, industry lobby group the Confederation of Indian Industry want the Securities and Exchange Board of India (SEBI) to scrap the mandatory shareholder approval for deals beyond Rs 1,000 crore ($134 million). Instead, they say that the existing rule of 10% of annual turnover should prevail even after the new rules kick in on April 1.  

When and why did SEBI propose changes?

SEBI tightened rules around transactions between group firms, founders and related entities in November last year, in a bid to curb siphoning of funds by founders and ensure better corporate governance. 

The regulator tightened the norms after alleged irregularities were observed in the case of some companies including DHFL and Fortis Healthcare Ltd. The regulator set up a working group in November 2019 to strengthen regulatory norms and later notified the amendments for implementation from April 2022.

What sorts of entities typically get into such related-party transactions?

Typically, listed companies, along with founders and entities related to large shareholders and the owners themselves, get into such transactions. 

So, what has L&T said exactly?

“The recent proposals announced by SEBI makes compliance quite tedious and complicated particularly for large companies,” a Bloomberg report cited L&T’s Chief Financial Officer, R. Shankar Raman, as saying. 

“Thresholds should have had a linkage to the size of the company, say in terms of turnover. Approaching shareholders on multiple occasions in the course of the year for approval is not efficient time wise and business wise,” Raman said, according to the report. 

How does SEBI seek to define a related party in its new rules?

Under the new rules, SEBI said the related party will be any person or entity belonging to the promoter or promoter group of the listed entity.

Besides, any person or any entity, directly or indirectly (including with their relatives), holding 20% or more of the holding in the listed entity during the preceding fiscal and 10 per cent or more with effect from April 1, 2023, will be considered as a related party.

What other changes has SEBI proposed?

SEBI has proposed changes to the process followed by a company's audit committee for approval of related parties that are material. Further, there will be a format for reporting of related parties to the stock exchanges.

Prior approval of the shareholders of the listed entity will be required for material related-party transactions having a threshold of lower than Rs 1,000 crore or 10% of the consolidated annual turnover of the listed entity.

An approval of the audit committee will be required for all related party transactions and subsequent material modifications as defined by the audit committee.

In addition, approval will be needed for related-party transactions where the subsidiary is a party but the listed entity is not a party. This is subject to a threshold of 10% of the consolidated turnover of the listed entity and 10% of the standalone turnover of the subsidiary from April 1, 2023.

Also, the transaction between the listed entity or its subsidiaries and any other entity that is aimed to benefit a related party will be considered a related-party transaction.

SEBI said enhanced disclosure of information related to related-party transactions will be placed before the audit committee. The disclosure will be provided in the notice to shareholders for material related-party transactions.

In addition, such disclosure needs to be made to the stock exchanges every six months in the format specified by SEBI within 15 days from the date of publication of financial results.