SEBI Pauses Expansion of Takeover Rules to Cash-Settled Derivatives

The Securities and Exchange Board of India (SEBI) is unlikely to pursue expansion of takeover regulations to include single-stock cash-settled derivatives, as per a Moneycontrol report. It has been determined that the planned changes were premature and will upset the current regulatory framework. Although SEBI was proactive in creating safeguards against future risks.

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The Reason Behind SEBI's Proactive Approach

SEBI was attempting to redefine shares under takeover regulations in a way to include derivatives that have been created as a result of voting rights attached to shares - This would include 'risk instruments' and 'contracts for Differences'. The current regulations require disclosure of shareholding that equals 5% or more; however, cash-settled positions are not transparent to the public and create an opportunity for individuals and corporations to have economic exposure without disclosing it to the public. 

SEBI sought to avoid this risk and prevent wider market adoption by creating a regulatory framework to address it. To achieve this, SEBI analysed examples of similar situations from around the world.

Comparisons to Global Examples

As an example, in Europe, the Porsche-Volkswagen situation is indicative of a similar pattern where a large number of derivative positions were created. That gave a person who owned those derivatives the ability to create a secret stake in a public company without disclosure under European law. Further, it caused European regulators to change the framework of their regulations. 

The SEC has taken an approach to create a system requiring companies to disclose their derivative product-based exposures that are above certain thresholds in order to prevent people and organisations from using stealth methods to acquire positions. The UK Takeover Code is very similar to the U.S. approach, but it provides for "interests in securities" to be clearly defined and disclosed to eliminate the remaining loopholes that exist.

Panel's Recommendation: Defer for Targeted Fixes

The Takeover Panel concluded the expansion was pre-emptive and would create unnecessary complexity in regulation. In its opinion, increased monitoring of derivative prominence should take place prior to broadening the scope of the definitions, allowing for custom regulations as the instruments develop. Control of a company pursuant to the provisions of the SEBI Rules is determined by the number of shares owned and the voting power of each shareholder; however, with derivatives, an entity can exert economic control over a target entity, regardless of whether it has a voting right.