The Corporate & Commercial Law Society Blog, HNLU

Tag: SEBI

  • Bridging Borders: SCRR Amendment 2024 and India’s Gateway to Global Capital

    Bridging Borders: SCRR Amendment 2024 and India’s Gateway to Global Capital

    BY MANAV PAMNANI AND SHOURYA SHARMA, THIRD-YEAR STUDENTS AT NALSAR HYDERABAD AND JINDAL GLOBAL LAW SCHOOL, SONIPAT

    INTRODUCTION

    The Department of Economic Affairs, Ministry of Finance (‘MoF’), has recently amended the Securities Contracts Regulation Rules, 1957 (‘SCRR’). This Amendment attempts to make it easier for Indian public companies to list their equity shares within International Financial Service Centres (‘IFSCs’) such as the Gujarat International Finance Tec-City (‘GIFT City’), under the framework of Direct Listing of Equity Shares Scheme and the Companies (Listing of Equity Shares in Permissible Jurisdictions) Rules, 2024. One of the significant changes under the Amendment is the reduction of minimum public shareholding thresholds from 25% to 10% for listing made in IFSCs, making international listings more accessible, especially for start-ups and technology-driven enterprises. This move mirrors the government’s broader commitment towards placing India among the world’s competitive investment-friendly destinations and financial hives. This article attempts to analyse the legal framework of this Amendment, alongside exploring its practical implications for the Indian financial landscape.

    REGULATORY FOUNDATIONS AND LEGISLATIVE DEVELOPMENTS

    The SCRR was notified by the Central Government to help achieve the objectives of the Securities Contracts (Regulation) Act, 1956 (‘SCRA’) effectively. The preamble clause of the SCRA states that the objective of the statute is to regulate undesirable transactions in securities by overseeing the dealing in securities and monitoring other ancillary business activities. The Amendment aligns the SCRR with this overarching objective. The legal foundation of this Amendment lies in section 30(h)(A) of the SCRA, which gives the Central Government the power to introduce rules stipulating the specific requirements that companies have to follow to get their securities listed on any stock exchange. The word “any” here has to be given a wide interpretation to align with the framers’ intention which was to bestow supervisory and regulatory authority upon the Government to foster the maintenance of a reliable and efficient securities business framework. Therefore, the regulation of listing of securities on IFSCs squarely falls within the competence and authority of the Government.

    Earlier in 2024, the MoF, through a notification amending the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (‘NDI Rules’), explicitly enabled the listing of securities of public Indian companies on international exchanges recognized in Schedule XI of NDI Rules. This, termed as the Direct Listing Scheme, governed several intricacies such as permissible investors, compliance with sectoral caps, regulations regarding prohibited sectors, and pricing guidelines. Simultaneously, the Ministry of Corporate Affairs (‘MCA’) had also introduced the Companies (Listing of Equity Shares in Permissible Jurisdictions) Rules, 2024 by virtue of its power under section 23(3) r/w section 469 of the Companies Act, 2013 to regulate the entities that can list and jurisdictions where the listing can take place.

    However, both these enactments, along with the Companies (Amendment) Act, 2020 which prescribed certain similar requirements pertaining to listing in international exchanges, served as mere regulatory tools rather than efficient operational guidelines. They prescribed an overarching framework that has to be adhered to during such listing and discussed the eligibility criteria but failed to provide or clarify points regarding specific thresholds and other operational mechanisms specified under the SCRR.

    LEGAL ANALYSIS

    The recent Amendment fills the void identified above by introducing a few but impactful changes in the securities listing regime, thus reflecting its commitment to fostering a globally competitive and investor-friendly framework while aligning domestic practices with international standards. These international standards include the minimum public float thresholds in jurisdictions like Singapore, the International Organisation of Securities Commissions’ principles of efficiency, transparency and fairness in cross-border listings, the securities regime in the Dubai International Financial Centre, the Financial Action Task Force’s Anti-Money Laundering /Combating the Financing of Terrorism recommendations, and the pricing mechanisms and sectoral compliance thresholds present in the European Union Capital Markets Union and the United States Securities and Exchange Commission Regulations.

    The widespread benefits accruing to investors and other stakeholders through the effectuation of this Amendment not only covers the inflow of higher foreign capital and a more efficient and dynamic securities framework but also extends to direct tax advantages. section 10(4D) of the Income Tax Act, 1961 provides a significant tax exemption on income arising from transactions conducted on recognized stock exchanges within IFSCs, including GIFT-IFSC. This incentivizes participation, reduces transactional costs for investors, and creates a persuasive financial rationale for businesses contemplating listing on foreign exchanges. It is also in line with the numerous Double Taxation Avoidance Agreements (‘DTAAs’) entered into by India to prevent non-resident Indians from being taxed twice, in both, India and their country of residence, thus significantly alleviating their tax burden. Additionally, the Securities and Exchange Board of India (‘SEBI’) has considerable control over listing and transactions in the IFSC, as is evident from the scheme of the SEBI (International Financial Services Centres) Guidelines, 2015. This reiterates the commitment of SEBI to safeguard the interests of investors and other stakeholders, alongside maintaining an effective securities landscape.

    An important caveat to consider with respect to this Amendment is that the reduction of thresholds from 25% to 10% extends only to listings made in the IFSC. This implies that as per domestic subscription requirements, the extent of public shareholding is still fixed at the previous 25%. This distinction creates a dual regulatory framework, potentially leading to compliance complexities for companies seeking listings in both domestic and IFSC exchanges. This may limit the seamless integration of domestic and international listing strategies, requiring companies to carefully navigate the differing regulatory requirements to maximize benefits and avoid potential conflicts. Although the text of the Amendment alters Rule 19(2)(b) of SCRR, which covers domestic listings, the primary intention of the legislature was to effect changes in the IFSC listing framework. This ambiguity necessitates a clarification, which will most likely uphold uniformity by stating that the reduction also extends to listings made on domestic stock exchanges by companies wishing to obtain listing on permitted international exchanges. The importance of such uniformity and standardization is also evident from the two definitions (IFSC and International Financial Services Centre Authority (‘IFSCA’) that have been introduced which do not impose their own requirements but simply suggest an alignment with the definitions incorporated in existing legislations. The Amendment while defining these terms states that an IFSC means an IFSC as defined under section 3(1)(g) of the IFSCA Act, 2019 and an IFSCA means the Authority established under section 4(1) of the IFSCA Act. This significantly reduces complexity and fosters consistency and clarity in the navigation of relevant legalities pertaining to share listing and other compliance requirements.

    PRACTICAL IMPLICATIONS

    This Amendment marks a shift in India’s financial regulatory regime by redefining the entry of companies into global capital markets. In its amplitude, it is not an ordinary technical change but a strategic recalibration of structures of investment. The reduction of public shareholding thresholds from 25% to 10% for foreign listings creates an easier route for start-ups, emerging businesses, and small, mid and large capitalisation companies to access global capital, a phenomenon that is already experiencing an upward trajectory. For example, the gross foreign portfolio investment (‘FPI’) in India was massively estimated at around US$ 41.6 billion in the year 2023-24, which is bound to increase manifold due to this Amendment. The business insights from  companies like Reliance Industries Limited and HDFC Bank Limited, among others, reflect clear examples of corporations successfully accessing large amounts of global capital due to international financial listing. This consequentially places Indian business enterprises in a robust position as reduction in public shareholding compliance requirements is an attractive proposition for investors.

    Interestingly, the lowering of the barriers to international capital access also provides the same growth opportunities to a wider spectrum of sector-specific enterprises, including deep technology, renewable energy and biotechnology. These are crucial sectors requiring large investments. Furthermore, this change may even decentralise India’s economic hubs by allowing international capital to penetrate smaller companies located in tier-2 and tier-3 cities. As an offshoot, regions other than the economically prospering metro cities would witness increased industrialisation and employment generation since more local companies would gain access to foreign investments.

    A research conducted by the International Monetary Fund on emerging markets provides a broader context in which this Amendment fits into a global trend, towards more accessible and flexible capital markets. It represents the benefits of India’s strategic approach to positioning itself as an attractive destination for global investors. Indian firms may be better positioned to raise capital in foreign currencies with a more straightforward pathway to listing abroad while hedge-protecting firms reliant on imports for raw materials or technology from the capricious market exchange rate.

    Contrary to the apprehensions of capital outflow, this Amendment may benefit India’s domestic markets since an international listing enhances reputation of a company, provides international exposure, and encourages investor confidence. Companies will attract a larger pool of sophisticated retail and institutional investors, leading to increased credibility and brand value through such listings. This will enhance liquidity, valuation, expertise, innovation and overall market efficiency.

    However, the opportunity comes with nuanced challenges, particularly for companies that aim to be listed on both domestic and international exchanges. In a dual-listed company structure, the requirement for multi-jurisdictional shareholder and board approvals introduces complexities to decision-making and company operations. This substantially increases audit and compliance costs, necessitating detailed planning and high investments in financial and legal advisory services.

    CONCLUDING REMARKS

    This Amendment is more than a routine regulatory change because it aims to manifest India as a global financial hub by significantly relaxing listing requirements in the IFSC. It serves as a forward-looking measure with the objective of modernising the Indian securities law landscape and aligning it with international best practices by furthering a more inclusive access to global capital markets. With the introduction of this Amendment, the legislature has taken a significant step in the right direction and it will be interesting to observe the future course this Amendment adopts, particularly concerning its effective implementation.

  • Examining the Flaws in SEBI’s Proposed AI & ML Regulations

    Examining the Flaws in SEBI’s Proposed AI & ML Regulations

    BY SACHIN DUBEY AND AJITESH SRIVASTAVA, THIRD-YEAR STUDENTS AT NLU, ODISHA AND LLOYD LAW COLLEGE

    INTRODUCTION

    Artificial Intelligence (‘AI’) has become an integral part of our daily lives, influencing everything from smart home technology to cutting-edge medical diagnostics. However, it’s most profound influence is perhaps in transforming the landscape of securities market. AI has advanced the efficiency of investor services and compliance operations. This integration empowers stakeholders to make well-informed decisions, playing a pivotal role in market analysis, stock selection, investment planning, and portfolio management for their chosen securities.

    However, despite the advantages, AI poses risks such as algorithmic bias from biased data, lack of transparency in models, cybersecurity threats, and ethical concerns like job displacement and misuse, highlighting the need for strong regulatory oversight. Therefore, Securities and Exchange Board of India (‘SEBI’) vide consultation paper dated 13thNovember, 2024 proposed amendments holding regulated entities (‘REs’) accountable for the use of AI and machine learning (‘ML’) tools.  

    These amendments enable SEBI to take action in the event of any shortcomings in the use of AI/ML systems. SEBI emphasises that these entities are required to safeguard data privacy, be accountable for actions derived from AI outputs, and fulfil their fiduciary responsibility towards investor data, while ensuring compliance with applicable laws.

    In this article, the author emphasises the necessity of the proposed amendments while simultaneously highlighting their potential drawbacks. 

    NEED OF THE PROPOSED AMENDMENTS

    The need for proposing amendments holding REs accountable for AI/ML usage has arisen due to various risks associated with its usage. 

    AI relies heavily on customer inputs and datasets fed into them for arriving at its output. The problem is that humans have found it very difficult to understand or explain how AI arrives at its output. This is widely referred to as “black box problem”. In designing machine learning algorithms, programmers set the goals the algorithm needs to achieve but do not prescribe the exact steps it should follow to solve the problem. Instead, the algorithm creates its own model by learning dynamically from the given data, analysing inputs, and integrating new information to address the problem. This opacity surrounding explainibility of AI outputs raises concerns about accountability for AI-generated outcomes within the legal field.

    Further, if just one element in a dataset changes, it can cause the AI to learn and process information differently, potentially leading to outcomes that deviate from the intended use case. Data may contain inherent biases that reinforce flawed decision-making or include inaccuracies that lead the algorithm to underestimate the probability of rare yet significant events. This may lead to jeopardising the interests of customers and promoting discriminatory user biases. 

    Additionally, relying on large datasets for AI functionality poses considerable risks to privacy and confidentiality. AI models may sometimes be trained on datasets containing customers’ private information or insider data. In such situations, it becomes crucial to establish accountability for breaches of privacy and confidentiality. 

    SHORTCOMINGS

    SEBI’s proposal to amend regulations and assign responsibility for the use of AI and machine learning by REs is well-intentioned. However, it could create challenges for both regulated entities and industry players, potentially slowing down the adoption of AI and stifling innovation.

    a. Firstly, SEBI’s proposal to assign responsibility for AI usage adopts a uniform, one-size-fits-all regulatory approach, which may ultimately hinder technological innovation. Effective AI regulation requires greater flexibility, favouring a risk-based framework. This approach classifies AI systems based on their risk levels and applies tailored regulatory measures according to the associated risks. A notable example is the European Union’s AI Act which adopts a proportionate, risk-based approach to AI regulation. This framework introduces a graduated system of requirements and obligations based on the level of risk an AI system poses to health, safety, and fundamental rights. The Act classifies risks into four distinct categories- unacceptable risks, high risks, limited risks and minimal risks. As per the classification, certain AI practices which come under the category of unacceptable risks are completely prohibited while others have been allowed to continue with obligations imposed upon them to ensure transparency.  

    b. Secondly, while SEBI’s regulatory oversight of AI usage by REs is crucial for protecting investor interests, it is equally important to establish an internal management body to oversee the adoption and implementation of AI within these entities. SEBI could draw insights from the International Organization of Securities Commission’s (‘IOSCO’) final report on AI and machine learning in market intermediaries and asset management. The report recommends that regulated entities designate senior management to oversee AI/ML development, deployment, monitoring, and controls. It also advocates for a documented governance framework with clear accountability and assigning a qualified senior individual or team to approve initial deployments and major updates, potentially aligning this role with existing technology or data oversight.

    c. Thirdly, SEBI has entirely placed the responsibility for AI and machine learning usage on REs, neglecting to define the accountability of external stakeholders or third-party providers. REs significantly rely on third parties for AI/ML technologies to ensure smooth operations. Hence, it is vital to clearly outline the responsibilities of these third parties within the AI value chain. 

    d. Fourthly, the Asia Securities Industry & Financial Markets Association (‘ASIFMA’) raised a concern that financial institutions should not be held responsible for client decisions based on AI-generated outputs. It contends that it would be unjustified to hold institutions liable when an AI tool provides precise information, but the client subsequently makes an independent decision. This viewpoint goes against SEBI’s proposed amendments which seemingly endorses broader institutional liability.  

    e. Lastly, SEBI’s proposed amendments and existing regulations remain silent on the standards or requirements for the data sets (input data) utilized by AI/ML systems to carry out their functions. While the amendments imply that REs must ensure AI models are trained using data sets that either do not require consent (e.g., publicly available data) or have obtained appropriate consent, particularly under the Digital Personal Data Protection Act, 2023 (DPDPA), SEBI could have more explicitly define the standards for high-quality data sets suitable for AI/ML functionality particularly crucial when the data protection rules have not seen the light of the day.

    CONCLUSION

    While it is commendable that SEBI, recognizing the growing use of AI/ML tools in the financial sector, proposed amendments to hold REs accountable for their usage, it should have given due consideration to the factors mentioned above. Because it is vital to ensure that any policy introduced is crafted carefully in a way that does not, in any way, discourage innovation and growth in the emerging fields of AI and ML technology. 

  • Centralised Fee Collection Mechanism: Sebi’s Move To Shield Investors

    Centralised Fee Collection Mechanism: Sebi’s Move To Shield Investors

    BY SUKRITI GUPTA, THIRD-YEAR STUDENT AT NLU, ODISHA

    INTRODUCTION

    The Securities and Exchange Board of India (“SEBI”), has recorded around 33,00 registered entities according to its recognised intermediaries data. Amongst these, SEBI has close to 955 registered Investment Advisors (“IA”) and 1381 Research Analysts (“RA”) as of September 2024. 

    In common parlance, an IA is an entity that provides investment advice to the investors and an unregistered IA is simply the one who provides such advisory without having registration from SEBI. Interestingly, around 35% of IA are unregistered in India which entails a violation of the SEBI (Investment Advisers) (Amendment) Regulations, 2020.

    Additionally, RA also plays a pivotal role in preparing research reports by conducting investigations, research, and evaluation of financial assets. They provide advisory to investors to assist them in making decisions regarding investing, buying, or selling off financial securities, and they are administered by the Securities and Exchange Board of India (Research Analysts) Regulations, 2014.

    It was observed by SEBI through several accusations and grievances reported by investors that there is an incremental rise in the misconduct of unregistered analysts who falsely portray themselves as registered IA and RA to facilitate investment services. These entities exploit investors by giving them fake and unrealistic securities advisories to encourage investments. 

    Thus, pursuant to this, SEBI issued a circular dated 13th September 2024 to set in motion a uniform system for fee collection by IA and RA, known as the “Centralised Fee Collection Mechanism”. This initiative, co-drafted by BSE Limited followed rigorous consultations from common people and feedback from several stakeholders.

    The author in this post delves into the significance and objectives of SEBI’s new mechanism by highlighting its broader implications. Furthermore, the author critically inspects the potential concerns and queries related to this initiative. 

    HOW DOES THE CENTRALISED FEE MECHANISM WORK?

    Under this mechanism, SEBI has established a supervisory platform for IA/RA to offer a uniform and centralised fee collection process. It provides a portal through which the investors can pay the fees to registered IA/RA which will be overseen by a recognised Administration and Supervisory Body (“ASB”). Every transaction will be initiated by assigning a virtual account number, with the availability of various modes of payment like UPI, net banking, NEFT etc. For using this facility, there is likely to be a system where IA/RA shall enroll themselves in this platform and provide fee-related details for their clients and the fee collected will then be transferred to these registered entities. It is made optional for both investors and IA and RA. 

    It aims to increase the participation of investors in the securities market by creating a transparent and riskless payment environment to curb the activities of unregistered IA/RA from taking dominance of investors under the guise of regulatory compliance.

    SAFEGUARDING INVESTORS INTERESTS: NEED FOR A CENTRALISED FEE COLLECTION MECHANISM

    By introducing a Centralised Fee Collection Mechanism, SEBI aims to mitigate all possible misleading and fraudulent activities of the unregistered IA/RA. To ensure that the investor’s money is in safe hands, it is imperative to save them from becoming a victim of illegitimate entities. Since many investors may not know how to inspect whether an entity is a registered one or not, therefore, it is the onus of SEBI, being a market regulator, to guard the interests of investors by introducing such an appropriate mechanism. 

    In the author’s view, by providing a centralised platform for payments, SEBI might ensure that the investor’s personal information and data remain fully confidential and safe since there will be a very minute chance of data leakage due to all the services being provided in one designated sphere. Secondly, through various digital payment modes being facilitated, there remains a minimal chance of disruption in the payment mechanism, ensuring a seamless and steady payment. It will also keep a check on the fees charged by these registered entities concerning  SEBI’s guidelines regarding the fees charged by IA, thereby helping to reduce exorbitant charges. Additionally, investors will not be charged any platform fee thus reducing unnecessary expenditure.

    Also, by operationalisation of this centralised payment system, investors will easily identify which entity is a registered entity. This will in turn be beneficial to IA and RA because they will get due recognition as they will be distinguished from unregistered ones. This will help them to attract genuine clients seeking their assistance. Furthermore, it will also help IA/RA who do not have any automated platforms of their own, thereby saving time and reducing burden

    CRITICAL EXAMINATION OF THE MECHANISM

    To delve deeper into the implications and analysis of the Centralised Fee Collection Mechanism, it is essential to ponder on three major points. Firstly, for what purpose the mechanism is kept optional, Secondly, whether such an initiative enhance investor’s vigilance when hailing services from unregistered entities? Lastly, how will this mechanism ensure the security and privacy of investor’s data?

    Discussing the first point, in the author’s view, it is essential to note that keeping the mechanism optional for users to pay and IA/RA to collect fees, is providing a flexible choice by giving them time to adapt and integrate into the new framework of the mechanism. By not mandating its use, SEBI is trying to ensure that they don’t feel that it is being involuntarily imposed upon them. Rather, they have the discretion to avail it. Additionally, potential shortcomings, challenges and doubts can also be identified for allowing further incorporation of necessary amendments and improvements based on the experience and feedback of the users and entities. 

    Therefore, the main idea behind keeping it optional is to grab the attention and trust of the investors and entities in this platform and make them familiar with the procedures for gradual adoption. This flexibility will enable a smoother transition and necessary adjustments. According to the author, SEBI might eventually make it compulsory in the near future. 

    Gauging on the second point, while this mechanism has significant potential to reduce the number of unregistered entities and heighten investor’s attentiveness, it is crucial to recognise that not all users may be aware of the reforms and regulations brought by the regulator. Thus, according to the author, to attain the full purpose of the mechanism, SEBI needs to prioritise its promotion through advertisements, webinars, awareness activities etc., via authorised channels. If the targeted audience becomes aware of such a facility, the likelihood of success of such an initiative would increase, eventually serving a larger segment of the investing public.

    One concern of IA/RA regarding this mechanism could be the reluctance of investors to provide their personal information while paying fees. Many of them may not be comfortable sharing their details on an online platform like such. To cater to this, SEBI must ensure transparency by rolling out certain procedures for safeguarding investor’s privacy and trust. One approach could be to give a unique identification number to each investor for aid in digital enlisting. E-receipts, payment tracking and reconciliation could also be enabled. SEBI can also launch a portal alongside, which will enable the investors to report any issue encountered by them during transactions. It may operate like a customer care center to deal with and sort out the grievances faced by them. 

    While it appears that this mechanism is viable to ensure adequate safety and privacy of the investors, yet, there is a need for vigorous regulation to fully reassure the investors of their privacy and trust in IA/RA. 

    CONCLUSION

    SEBI’s introduction of Centralised Fee Collection Mechanism is a double-edged sword, safeguarding both investors and entities. By offering a compliant and centralised system for fee collection, it is not only protecting investors from deceitful and unauthorised entities but also fortifying the credibility of registered IA and RA. It also marks a noteworthy step towards establishing a transparent, viable and secured space in security’s advisory sphere. However, for initiatives like this to become successful, it is crucial to focus on its continued promotion, awareness, investor education and robust privacy safeguard standards to entrust confidence in the platform. Eventually, this mechanism aims to build a safer, systematic and coherent environment that benefits both the investors and advisory entities alike. Let us see whether it will be welcomed or feared.  

  • Revamping Venture Capital: SEBI’s Progressive Amendments for Dynamic Fund Migration

    Revamping Venture Capital: SEBI’s Progressive Amendments for Dynamic Fund Migration

    BY SHRIYANSH SINGHAL, SECOND-YEAR STUDENT AT NLU, ODISA.

    Introduction

    On July 20, 2024 the Securities Exchange Board of India (‘SEBI’) amended SEBI (Alternative Investment Funds) Regulations, 2012 significantly. Subsequently, guidelines were released by SEBI to these amendments which are particularly concerning the VCFs which were earlier governed under SEBI (Venture Capital Funds) Regulations, 1996. The change to the Alternative Investment Funds (‘AIF’) Regulations is advantageous to Venture Capital Funds (‘VCF’) as it provides more freedom to the VCFs especially in regard to unliquidated investments at the end of the tenures. The changes are in consonance with SEBI’s intention to amend the legal provisions governing the venture capital funds to suit the current market conditions.

    SEBI has been advancing AIF as an ideal investment vehicle in India which has facilitated all forms of funds including venture capital funds, private equity funds and infrastructure funds. As more investors are investing their money in AIFs, SEBI has also upped its ante to make sure that such funds operate in the most transparent manner and for the benefit of the investors. These amendments are a doctrinal transformation of the existing legal framework, to enable VCFs transition to this new flexibility, which improves operational effectiveness and investors’ safeguards. This way, SEBI modernises the previous regulations, adapting them to the present conditions of the market and presents AIFs as a primary stimulator of innovation and investments in the Indian economy.

    Rationale Behind the New Guidelines

    The rationale for the development of these new guidelines is anchored on shifts that have taken place in the investment climate in India. The VCF Regulations were introduced in 1996 and at that time they were rather innovative. However, the changes in the venture capital industry continue and the regulations have become outdated. The introduction of the AIF Regulations in 2012 was a significant improvement as it offered a more complex and flexible framework for various structures of AIFs including VCFs. However, there were still many VCFs that have been registered under the old regulations but still operated under a structure that was not completely appropriate to the industry’s needs.

    The changes in the amendments are directed to the increase in the demand for the harmonization of the regulations and the flexibility. SEBI has provided these VCFs an opportunity to migrate to the AIF Regulations and therefore, avail the benefits of a relatively modern framework. This has included the improvement of the management of unliquidated investments which is crucial to funds that are in the final stages of their life cycle. Also, the amendments seek to bring all funds as one so as to enhance the protection of investors as it is easily regulated.

    Deciphering the Amendments
    • Migration of VCFs to AIF Regulations

    The essence of the amendments is in the possibility of the VCFs’ transition to the AIF Regulations. This migration is not compulsory but is very advantageous for anyone who decides to migrate. These changes are beneficial as they allow VCFs to operate through a modern, flexible framework, offering longer liquidation periods, better regulatory reporting and increased investor protection which will lead to improved handling of unliquidated investments and transparency overall. This flexibility is accompanied by the migration deadline of July 19, 2025, which provides VCFs with enough time to take decision about the transition.

    The amendments to the AIF Regulation in contiguity with VCF Regulations are expected to have significant effects on India’s venture capital industry. An increase in the regulatory cohesion by SEBI can be enforced by encouraging VCFs to migrate to the AIF framework which will lead to simplification in compliance maintenance by fund managers and clinch all funds under a unified set of regulations.

    • Additional Liquidation Period

    Another significant amendment is the provision for a one-time additional liquidation period. VCFs with schemes whose liquidation period has expired but have not yet wound up their operations can now apply for an additional year to complete the liquidation process. This extension, valid until July 19, 2025, provides much-needed breathing room for fund managers, allowing them to manage their exits more effectively and avoid fire sales that could harm investor returns.

    As for the VCFs with the schemes which have not yet achieved the end of the liquidation period, the migration enables such funds to remain active within the framework of the AIF Regulations. Also, it is important to note that if a fund’s scheme had a defined tenure under the old regulations, such tenure remains frozen on migration. But if no tenure was previously fixed, the fund has to fix a residual tenure with the concurrence of at least three-fourth of the investors. This provision helps to protect the investors and also helps the fund to operate in a very transparent manner.

    • Enhanced Regulatory Reporting in case of non-migration

    In case VCFs do not migrate, SEBI has come up with improved regulatory reporting standards. These funds will be more regulated and if they continue to exist beyond the liquidation period they will face regulatory actions. This aspect of the amendments acts as a form of threat that will compel VCFs which are no longer actively investing to either join the AIF framework or wind up their operations.

    The amendments also specify circumstances under which migration is not possible. VCFs which have no more active investments or have wound up all their schemes are expected to surrender their registration by 31st March 2025. Otherwise, SEBI will proceed to cancel their registration as the latter failed to meet the requirements provided by the former. This provision helps in avoiding the creation of a bureaucratic burden on the regulatory framework by funds that are inactive or dormant, thereby enabling SEBI target active participants in the market.

    The potential of increased fund activity with the option to migrate to a relatively modern regulatory framework, may incentivize VCFs to launch newer schemes or extend the life on present ones. Hence, benefiting both investors and the broader economy by increased activity in the venture capital space. The stipulation for inactive VCFs to surrender their registration will streamline the regulatory landscape. Consequently, ensuring that only active and compliant funds are registered and as a result, reducing administrative burdens and allowing SEBI to focus on more significant regulatory issues.

    • Strict Compliance and Accountability

    Lastly, the amendments impose a great deal of obligation to the managers, trustees, and other personnel of both VCFs and Migrated VCFs. These people are responsible for compliance to the new regulations and they will have to fill and submit the Compliance Test Report to SEBI. This report which is a compliance to the SEBI Master Circular for AIFs is an important mechanism of ensuring that the industry is accountable to the public.

    There can be an enhancement in the investor protection steps taken by SEBI to assure investors that their interests are being safeguarded within a robust regulatory framework. This can be done by necessitating investor approval in ascertaining the tenure of migrated schemes and the insistence on compliance reporting.

    Forging new Horizons

    The modifications carried out to the SEBI (Alternative Investment Funds) Regulations, 2012 are a welcome change for the enhancement of the venture capital funds in India. In the future, SEBI should focus at giving the required assistance to those VCFs that wish to opt for the AIF structure by issuing appropriate instructions and keeping the concerned parties informed. This will assist VCFs to address the operational and compliance challenges of the migration process appropriately. SEBI could also contemplate on the need to carry out regular audits of the framework with a view of making changes that could help to address some of the problems that may arise after migration as well as to ensure that the regulations are up to par with the best practices in the international markets. Moreover, enhancing the investor awareness and increasing the transparency of the mechanisms will help to increase the confidence in AIFs and therefore the capital will flow into the venture capital more freely. Therefore, SEBI can contribute to the formation of the startup market and the non- traditional type of financial instruments in India due to the formation of a more integrated and adaptable system of regulation.

    Conclusion

    The proposed amendments to the SEBI (Alternative Investment Funds) Regulations, 2012 are huge in the growth of venture capital industry in India. Thus, SEBI is ensuring that the regulations are relevant and comprehensive by providing VCFs a chance to move from the VCF Regulations to the AIF Regulations. The emphasis on flexibility, investor protection and compliance are very much seen in the SEBI’s attempt to make the investment environment healthy and active. To the fund managers, investors and the market in general, these amendments introduce a new dimension of understanding and certainty which would help foster the future growth and development of the industry. In the long run, the value of the integrated and updated regulation of the industry will be seen as it adapts to the changes that have been identified.

  • Rationalizing ‘Connected Persons’: Analyzing SEBI’s Proposed Insider Trading Amendments

    Rationalizing ‘Connected Persons’: Analyzing SEBI’s Proposed Insider Trading Amendments

    BY PRIYA SHARMA AND ARCHISMAN CHATERJEE, Fourth AND third YEAR STUDENTS AT NATIONAL LAW UNIVERSITY, ODISHA

    I. Introduction 

    Securities and Exchange Board of India (‘SEBI’), in the consultation paper dated 29 July 2024 (‘consultation paper’), proposed amendments to the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) to rationalize the scope of ‘connected person’. The consultation paper proposes to add additional categories to the current definition of connected persons in the PIT Regulations, and thereby cover more persons who may have access to unpublished price sensitive information (‘UPSI’) by virtue of their relation with an insider.

    While the proposed amendments will help SEBI target additional persons and raise a presumption of possession of UPSI against them, the existing ambiguities in the insider trading legal framework will increase the likelihood of false positives and overregulation in this arena.

    II. Proposed Amendments

    Under the PIT Regulations, an insider is defined as any person who is either a connected person or is in possession of or having access to UPSI. Presently, a ‘connected person’ is defined as a person who is or has, during the six months before the act, been associated with the company, directly or indirectly, in any capacity [Regulation 2(1)(d)]. The relationship with the ‘connected person’ may be contractual, fiduciary or employment-related, and may be temporary or permanent, that allows them access to UPSI or is reasonably expected to allow such access. The PIT Regulations also specify certain categories ‘deemed to be connected persons’, including immediate relatives of the connected person, a holding or associate company or subsidiary company, etc. within its ambit. 

    UPSI is defined as “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 materially affect the price of the securities”. A person who falls under the scope of a ‘connected person’ will be presumed to have access to UPSI, and the person will carry the onus to disprove this presumption. If a person does not fall under the scope of a connected person, the onus to prove access to such information will lie on SEBI.

    The consultation paper notes that certain categories of persons, who have a close and proximate relationship with connected persons, may not be covered under the present definition of ‘connected person’. Therefore, it proposes to replace the term ‘immediate relative’ in section 2(1)(d)(a) with the term ‘relative’. It also proposes the inclusion of additional categories of people who will be deemed to be connected persons, including any person on whose advice, directions or instructions a connected person is accustomed to act, a body corporate whose board of directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a connected person, persons sharing household or residence with a connected person, and persons having material financial relationship with a connected person including for reasons of employment or financial dependency or frequent financial transactions. 

    In order to ensure ease of doing business, the definition of ‘immediate relative’ is proposed to be retained for the purpose of disclosures, and the definition of ‘relative’ is rationalized only for establishing insider trading.

    III. The Good: Targeting a Regulatory Gap

    The changes are proposed with the aim to include persons who may seemingly not occupy any position in the company but are in regular contact with the company and its officers. By virtue of this relationship, such persons may be aware of the company’s operations and get access to UPSI. 

    Under the current regime, the scope of connected persons does not include non-immediate relatives of the person. ‘Immediate relative’ includes the spouse of a person, parent, sibling, and child of such person or of the spouse, any of whom is either financially dependent on this person or consults such a person in making decisions relating to trading in securities. Under the proposed amendments, the term ‘relative’ would include spouse, siblings, siblings of spouse, siblings of parents, any lineal ascendant or descendant of the individual or spouse, or spouse of any of the mentioned persons. Evidently, the new definition will include many more persons.

    Many relevant relations remain uncovered in the present terminology, which requires that either (a) the mentioned person be financially dependent on such a person, or (b) consults such a person in making decisions relating to trading. Such facts are difficult to prove, as they involve the family’s internal affairs, and make it difficult to establish the presumption of insider trading. 

    For illustration, under the current regime, if A is a connected person, B, the father-in-law of A’s sister who lives in another city with her husband’s family, would not be deemed to be an insider unless he fulfills the criteria mentioned in the definition. The proposed amendments would bring B under the ambit of ‘deemed to be connected person’ since he is a lineal ascendant of the sister’s spouse. No other criteria are required to be fulfilled.

    The proposed amendments formulate a comprehensive definition of ‘relative’, much like the Income Tax Act, 1961, and do not limit it to immediate family members. This proposed change promises a stricter, and stronger, regulatory regime.

    IV. The Bad and the Ambiguous: Pre-existing issues

    Section 15G of the SEBI Act specifies that any individual who enters into a trade on the basis of UPSI would be penalized for insider trading. The emphasis here is on the term basis since it showcases the requirement of mens rea for the liability to be attracted. On the other hand, Regulation 4 of the PIT Regulations states that if any individual executes any trade while in possession of UPSI, the liability for insider trading shall be attracted. 

    In this regard, the Supreme Court, in Balram v SEBI, observed that ascertaining the intent of individuals is necessary to affix the liability for insider trading. On similar lines, in Abhijit Rajan v SEBI, the apex court highlighted the need to determine the profit motive of the individuals who are in possession of the UPSI. This showcases a clear conflict between the specific wording of the PIT regulations and the interpretation of the court in terms of the presence of mens rea and increases differences in interpretations. 

    If the proposed changes are implemented, many more individuals would be deemed to be connected persons, and the presumption of access to UPSI will be raised against them, even if the access is factual or not, or any mala fide intent to act upon it is present or not. For instance, B, being the father-in-law of A’s sister, who may be deemed to be a connected person by virtue of being a relative if the proposed amendments are made, is able to overhear certain UPSI at a family function, and despite the same, he sells his shareholding as he intended to do so even before possessing the UPSI. In such a scenario, B could still be liable for insider trading under PIT Regulations even though there was a lack of intent and profit motive. 

    Therefore, the present regulatory framework showcases the lack of uniformity and clarity about the threshold for attracting liability for insider trading, and the issue will be exacerbated if the definition of ‘deemed to be connected persons’ is widened. Additionally, such a low threshold (no mens rea required, according to the PIT Regulations) to hold a person liable might lead to false positives, which in turn may overburden SEBI as well as the accused persons. In fact, it was advised by the N. K. Sodhi Committee, which was formed to review PIT Regulations of 1992, that a defense should be incorporated into the provisions which would allow the insider to prove that the alleged illegal trade has an effect which is opposite to what the UPSI requires for one to draw an unfair advantage.

    To address this, we suggest implementing a higher threshold for those connected persons who are very remotely connected to the primary insider and a lower threshold for those who are directly connected. The current framework treats all immediate persons on the same footing. For instance, an individual who came into accidental possession of UPSI might get prosecuted for the offence of insider trading. 

     The incorporation of a threshold on the basis of a higher burden of proof or requirement of mens rea (possession or usage) could increase the efficiency of the framework. To elucidate, for proving insider trading in the case of relatives by birth, the mere possession of UPSI should be enough to hold them guilty, and the opposite can apply in case of relatives by marriage. Similarly, the burden of proof required to prove their innocence should be lesser for relatives by marriage and the contrary for those related by blood. Such a framework is more effective than the proposed changes, as it does not automatically deem ‘immediate relatives’ as connected persons (as is the case in the present scenario), and instead, creates comprehensive criteria for the regulator to implicate relatives in actions against insider trading. Moreover, SEBI should not overlook profit motive as mens rea and refine the insider trading provisions in the PIT Regulations, bringing it more in line with the Act. Lastly, the addition of more defenses in Regulation 4, such as those recommended by the Sodhi Committee, may help dilute the adverse impacts of the proposed amendments. 

    V. Conclusion

    While the proposed amendments aim to broaden the scope of ‘connected persons’ to encompass those in close proximity to insiders, thereby strengthening regulatory oversight, they also introduce challenges. The potential for increased false positives and ambiguities surrounding the intent requirement highlight ongoing concerns within the insider trading legal framework. To mitigate these issues, SEBI must strike a balance by refining definitions, clarifying thresholds for liability, and incorporating defenses against inadvertent breaches. Such measures are essential to uphold both the integrity of the securities market and the rights of individuals ensnared in the regulatory net.

  • From Hearsay to Hard Facts – SEBI’s Crackdown on Rumour Verification

    From Hearsay to Hard Facts – SEBI’s Crackdown on Rumour Verification

    BY RITUNJAY SINGH AND SEJAL SINGH, FIFTH-YEAR STUDENTS AT RMLNLU, LUCKNOW

    Introduction

    On May 17, 2024, the Securities Exchange Board of India (‘SEBI’) announced a pivotal change by notifying the SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2024 (‘2024 Amendment’). The amendment brings notable updates to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR Regulations’) by mandating Market Rumour Verification (‘MRV’) by listed companies, particularly those that lead to material price movement (‘MPM’).

    Understanding the Regulation and its Evolution

    The 2023 Amendment focused on triggering rumour verification upon a ‘material event’ occurrence but failed to define ‘material event’, leading to unclear compliance requirements. Consequently, SEBI proposed the formation of an Industry Standards Forum (‘ISF’) by industry associations in July 2023. By August 2023, the ISF, a collaboration between the Associated Chambers of Commerce, the Confederation of Indian Industry, and the Federation of Indian Chambers of Commerce and Industry, was established to formulate standards for implementing specific circulars and regulations. This collaboration resulted in a Consultation Paper released in December 2023, which laid the groundwork for the 2024 Amendment.

    The 2024 Amendment builds on this foundation, which initially mandated MRV but delayed its enforcement. The new regulations mandate rumour verification for the top 100 listed entities from June 1, 2024, and aim to extend it to the top 250 listed entities from December 1, 2024. The entity must verify specific market rumours reported in mainstream media that lead to MPM, usually within 24 hours from the trigger of MPM. General or vague rumours do not necessitate a response. It shall be specific to the industry consisting of unpublished information. 

    Mainstream media includes Indian newspapers with substantial circulation and readership, their digital versions, designated online news sources, and select international newspapers and news channels. It excludes news sources behind paywalls, news aggregators, and social media platforms, except for verified accounts of recognised news sources. Such focused delineation may presumably provide entities with a manageable scope to monitor. However, excluding social media platforms may leave gaps in differentiating facts from fiction, as seen in the Sadhna Broadcast pump-and-dump controversy, where rumours on social media and YouTube videos artificially inflated stock prices, causing investors losses once the stock inevitably crashed. A similar scenario occurred in the infamous Reddit-fuelled GameStop frenzy, where a coordinated effort by retail investors caused an unexpected stock surge, defying traditional market expectations and forcing hedge funds into massive losses. Furthermore, SEBI’s recent efforts to caution the public against dealing with unregulated entities and clamping down on the association between regulated entities and ‘finfluencers’, SEBI acknowledges this pervasive influence. Excluding such platforms from rumour verification leaves a blind spot in the regulatory framework.

    Having mentioned price volatility, it is crucial to understand MPM. The Bombay Stock Exchange (‘BSE’) and the National Stock Exchange (‘NSE’) introduced the MPM Framework to standardise its assessment, providing clear criteria for its calculation. It considers the cut-off percentage to price variation in share price between the closing price of the previous trading day and the next trading day’s opening price, excluding the benchmark index’s impact (e.g., NSE’s NIFTY 50 and BSE’s SENSEX). Additionally, intraday price movements are analysed, focusing on volatility throughout the trading day rather than just the opening versus closing prices. This responsibility of identifying the MPM rests with the listed entity, which may delegate this role to a designated officer. Owing to the constant fluctuation in stock prices, notifying the listed entity regarding the MPM necessitates a sophisticated technology-based solution. Going forward, service providers will likely offer these alert systems to companies. The lookback period i.e. the timeframe within which companies must retrospectively examine previous market rumours that might have induced an MPM is not specified, allowing companies to tailor their verification procedures flexibly to ensure a thorough and context-appropriate assessment.

    On May 21 2024, SEBI released another circular regarding the “framework for considering the unaffected price for transactions upon confirmation of market rumour.” This framework calculates the unaffected price by excluding the effect of MPM and rumour confirmation on equity share prices. In mergers and acquisitions, if parties’ names are non-disclosable due to confidentiality, the unaffected price is valid for 180 days from rumour confirmation; if names are disclosable, it’s valid for 60 days post-confirmation (Paragraph 5.2.2). If the price variation due to rumour confirmation hits the price band on the next trading day, subsequent trading days’ price variation is included for adjustment until it no longer hits the price band. For example, if ‘A’ trades at Rs. 100 per share and a rumour about acquiring ‘B’ causes the stock price to rise to Rs. 400 per share, later proving untrue and falling to Rs. 50 per share, the rumour period causing the fluctuation is determined. The average stock price of ‘B’ prior to the rumour, over a fixed period (e.g., six months), is analysed. If this average is Rs. 100 per share and market trends align, the unaffected price is Rs. 100 per share. This benefit only applies if the rumour is confirmed within 24 hours of MPM.

    Bridging the Gaps: A Vision for the Future

    The 24-hour timeframe provided under Regulation 30(11) not only seems insufficient to locate the exact source of the rumour in order to effectively address it, given the vast trenches of media requiring navigation; but also, proves to be a very small window to provide the public with the necessary documents that support its confirmation or denial. Something similar took place in the short-selling saga of the Adani-Hindenburg case, wherein even after their quick response within 24 hours, Adani’s stocks continued to tread downwards. Moreover, such a stringent timeline could attract regulatory scrutiny under the PFUTP Regulations in the accidental case of a hasty and, incorrect disclosure. Conversely, the NYSE Manual allows the confirmation of a rumour without the ticking 24-hour time clock, alleviating any pressure and allowing the company to make an accurate statement that verifies the accuracy of a rumour without the risk of any regulatory repercussions for incorrect disclosures.

    Furthermore, in the event of a merger and acquisition, a Non-Disclosure Agreement, which more often than not governs these negotiations, may act as a significant impediment to the Regulation, restricting the information that can be publicly shared. A premature confirmation or outright denial may attract a weaker negotiating position for the entity. While an argument can be made that a rumour may be surfacing owing to an already existing breach, that is not an argument strong enough for intentionally breaching confidentiality agreements. Henceforth, if a company were to deny a rumoured merger and later go through with it, investor trust could still very well be damaged. Some countries, like the United Kingdom (‘UK’), have a standstill period of 6 months under section 2(6) of the UK Takeover Code, in case a company does not verify a rumoured merger within 28 days. However, while this prioritises investor clarity and market stability, it is done at the expense of corporate flexibility and strategic planning. Companies might be forced into premature decisions that misalign with their timelines or negotiation strategies. A premature confirmation could also lead to a failed negotiation and wasted resources in case the deal does not go through.  Nevertheless, missing the 28-day verification window would result in being barred from making any such offers within the next six months, potentially missing out on opportunities.

    A balance can be restored by allowing the company to delay disclosures if an immediate clarification poses potential harm. This postponement ensures that an entity can manage sensitive information without being forced into a premature disclosure that could disrupt ongoing negotiations. The same is ensured by Chapter 3 of the European Union Market Abuse Regulation. However, this ability to delay does not come without oversight. Entities choosing to delay shall have to provide regulators with an explanation for the same, demonstrating how exactly it aligns with their legitimate interests, thereby preventing the misuse of the provision for any unfair competitive advantage. Similarly, vis-a-vis leaving room for corporate flexibility, SEBI can also take note of Part III of Appendix 7A of the Corporate Disclosure Policy of Singapore that carves out exceptions to disclosure due to market rumours: (a) The information to be disclosed doesn’t breach any law (Rule 703(2)); (b) The issuer can temporarily refrain from publicly disclosing particular information if a reasonable person would not expect it to be disclosed, and the information is kept confidential (Rule 703(3)). This comes with the caveat of maintaining the strictest confidentiality to prevent leaks.

    Conclusion

    SEBI’s attempts to balance transparency and accountability are evident, even addressing possible concerns via its Guidance Note, including handling speculations regarding a Managing Director/Chief Executive Officer’s health. Yet, as noted earlier, the indeterminate lookback period tips the scales slightly against corporations. By adopting a more structured approach akin to international practices, Indian entities could be better equipped to safeguard their legitimate interests while maintaining investor confidence. Such regulatory evolution could demystify market speculations, enhance stability, and bring India’s disclosure standards into closer alignment with international standards, safeguarding the truth in trading.

  • SEBI’s Norms For Sharing Real-Time Price Data: Laudable Yet Restrictive

    SEBI’s Norms For Sharing Real-Time Price Data: Laudable Yet Restrictive

    BY SACHIN DUBEY AND SUKRITI GUPTA, THIRD-YEAR STUDENTS AT NLU, ODISHA

    Introduction

    Securities and Exchange Board of India (‘SEBI’), vide circular dated 24th May 2024, introduced ‘Norms for sharing of real-time price data to third parties.’ The circular has been brought to tackle the concerns arising from the unauthorized sharing of real-time price data (‘Price data’) with online gaming platforms and other third parties and to protect the securities market. Price data refers to the current data of information which is made accessible as soon as it is generated. It is used in time-centric applications like stock trading and navigation to have real-time price analytics.

    This restriction was made in the purview of an upsurge in online gaming platforms, virtual trading apps, fantasy stock trading apps, and various other websites. Since the past couple of years, there has been an incremental increase in trading through these virtual platforms which therein invited attention to regulate the functioning of these platforms. It works in a way that provides its users with an illusionary image ofhow stock trading is done by featuring the exact parallel stocks listed on Stock Exchanges and also by citing similar price values and fluctuations. Since they do not fall under the domain of SEBI, they,therefore, become an unregulated fragment. Sharing real-time price data poses a high risk of leakage of sensitive information related to securities in the market. These virtual trading platforms appropriately use the data for their apps and websites to build a real trading atmosphere for their users which in turn fabricates their mind to construe this trading to be an actual stock market trading. This may also create parallel, unregulated platforms which would continue to hamper the trust of its users thus, promoting unfair trading. The sharing of real-time price data also acts as a disruptor in the securities market, because of which the regulator is consistently trying to prioritize the interests of investors above all else.

    The circular also mentions that market infrastructure institutions (‘MIIs’) and market intermediaries such as brokerages are forbidden to share price datawith third parties. However, it comes with an exception that price data can be shared if such information is essential for the systematic functioning of the securities market and regulatory compliances. Further, a written agreement needs to be entered and due diligence is required before transferring price data with third parties so that it will not be put to any illegal use.

    This post delves into the impact of SEBI’s recent circular on investors and virtual stock trading apps, highlighting its broader implications. Additionally, it sheds light on the potential drawbacks of the circular and suggests measures to cure the same.

    REGULATORY GREY ZONES AROUND VIRTUAL STOCK TRADING PLATFORMS

    Hitherto, Virtual stock trading apps operate in an ambiguous regulatory environment. Regulatory officials describe it as a form of Dabba Trading, an unlawful practice which involves placing bets on the movement of the price of underlying assets such as stocks or commodities. In India, Dabba trading activities flout various provisions of the Securities Contracts (Regulation) Act, 1956 (‘SCRA’) and are subject to punishment under section 23 of the SCRA. 

    SEBI already made its intention clear in 2016 when it issued a warning to investors against various entities offering leagues/schemes/competitions etc. based on the securities data. SEBI stated that these schemes are neither authorized nor endorsed by SEBI or any SEBI-recognized exchanges. It further sought public input on proposed amendments to SEBI Investments Advisers (Regulations), 2013 which included a provision to prohibit anyone from organizing schemes, games, leagues, or competitions related to the securities market. However, it did not forward the proposal and instead prohibited Stock Brokers from participating in games, leagues, schemes, competitions, etc., that involve the distribution of prizes, medals, gifts, etc. SEBI’s recent circular will further force virtual trading stocks to shut down their operations.

    Apart from SEBI, the National Stock Exchange (‘NSE’) vide circular dated 20th April 2023 observed that some market participants are misusing its data for gaming and virtual trading, which undermines fair and transparent trading principles. It reminded trading members that NSE Data should only be used for legitimate trading activities by their clients and not for gaming or virtual trading purposes.

    Therefore, there has never been regularity clarity regarding virtual stock trading apps which made them operate in a regulatory grey area.

    SEBI’s OBJECTIONS AGAINST VIRTUAL STOCK TRADING APPS USING REAL TIME PRICE DATA

    Although SEBI was not concerned with these platforms working as stock market simulators for education or entertainment purposes utilizing price data, the problem arose with the involvement of money. Platforms like India Trading League or Stock Race charge a small entry fee and award monetary rewards tied to the performance of stocks or commodities. This has sparked an addictive interest among users leading to the successful development of their business model.Further, they do not come within the regulatory foothold of SEBI and therefore are not required to provide disclaimers to users regarding the difference between actual trading and virtual trading as well as the risks attached to virtual trading.

    Further SEBI’s concern about restricting price data with these platforms comes from its objective to protect the interest of investors in the securities market. Out of the regulatory foothold of SEBI, these platforms tend to create a virtual, parallel and uncontrolled securities market where there will be no trust among the users.

    Stock Exchanges primarily generate revenue through transaction fees on trades and subscription fees for providing price data. SEBI has explicitly forbidden the creation and operation of games or competitions related to securities and security markets.If a third-party platform acquires price data and uses it to operate subscription-based games, it would undermine the exchanges’ revenue sources and breach SEBI regulations.

     KEY CONCERNS

    The move to regulate the sharing of price data with third parties, including fantasy stock trading games, is commendable for its aim to prevent investors from becoming addicted to these games and getting duped into the fraudulent practices of these platforms.Still, it has certain shortcomings which need to be acknowledged and taken care of.

    To start with, SEBI should not view every such development with suspicion which is beneficial for innovation and the growth of private businesses in the economy. SEBI should promote these business platforms while simultaneously bringing them under its regulatory foothold.

    SEBI should take a proactive approach by establishing a clear framework for these platforms, detailing the rules and regulations related to securities they must adhere to, and specifying the required disclosures for registration. Such measures will not only ensure compliance but also promote transparency and encourage innovation, creating a more dynamic and trustworthy financial ecosystem. It could have also outlined the eligibility criteria for participants, including age limits, net worth, and other intriguing requirements. The Board can take a cue from the Australian Securities and Investments Commission (‘ASIC’) which requires platforms like fantasy stock trading games to obtain a license before starting operation. Licensed platforms which are called binary options providers in Australia ensure protection to investors as they need to make certain disclosures as well as need to fulfil certain obligations imposed by ASIC.

    Further, the circular states that that price data will be provided to investor educational platforms with a delay of one day.If price data is allowed to be shared with educational platforms with lag of one day, then these platforms will be compelled to use delayed data which will not serve the purpose of such learning platforms. Their business model would go in negatives as its whole object of live simulation-based tasks would be affected, offering no monetary incentives. Their contribution in enhancing investment skills and simplifying the investment process for individuals through realistic stock market simulations will be significantly impacted. Therefore, SEBI should consider repealing it from the circular.

    Hence, while SEBI’s plan to issue a circular regulating the sharing of price data with third parties, including virtual trading platforms, is praiseworthy, yet restrictive. This regulation may hinder innovation that aids in the development of investment skills and simplifies the investment process for individuals.

    Conclusion

    Globally, many countries are adapting to digital era due to the rise of various online platforms offering monetary services. With the increase in these platforms, there is a growing concern regarding sharing price data with the third parties. Regulators around the globe are becoming aware of the risks and challenges connected with manipulation of markets, and leakage of sensitive data. So, it has become essential to have rules and regulations to regulate data sharing. Therefore, amidst this, SEBI has brought such norms which restricts sharing price data with third parties to bring credibility and stability in the worldwide stock market. Although it is commendable, SEBI could have implemented regulations to bring these platforms under its regulatory framework while still allowing them to operate. After all, a country’s legislation aim should be to let the private business develop in the country with having certain regulatory control over them.

  • SEBI’s Instantaneous Trade Settlement: Evaluating the Implications on Foreign Investors

    SEBI’s Instantaneous Trade Settlement: Evaluating the Implications on Foreign Investors

    BY PARV JAIN, A THIRD-YEAR STUDENT AT INSTITUTE OF LAW, NIRMA UNIVERSITY, GUJARAT

    Introduction

    According to SEBI’s annual report, the year 2022–23 faced a foreign portfolio investors (“FPIs”) outflow of Rs 40,936 crore. This was the third highest sell-off by FPIs during a financial year. This FPI pull-out could be driven by the opening of China post-lockdown, the Russia-Ukraine crisis, and a series of rate hikes due to inflationary pressures. But now, it is the need of the hour to ensure not to give offshore investors any reason to pull out of India, given the huge contemporary capital requirements.

    In September 2023, Securities and Exchange Board of India (“SEBI”) announced the plan for the implementation of instantaneous trade settlements, which has caused a plethora of debate regarding the future implications of such a move. SEBI Chairperson Madhabi Buch had expressed her enthusiasm for instant trade settlement, which will become a game-changer for the Indian stock market and will benefit investors greatly by making trading faster, safer, and cheaper. According to her, it will also enhance India’s position as a leading financial market in the world. This implies that the instant trade settlement plan might roll out very soon, but it is still unclear whether the regulator would resolve the potential challenges for foreign investors from such a change beforehand or not. SEBI now aims to achieve a same-day i.e. T+0 settlement system by March 2024, and then aspires to move towards a method of instantaneous settlement of trades.

    As the discussions increase, people are anticipating a withdrawal of offshore investors from the market, who fear that the settlement of equity market trade on the same day will eventually fragment the liquidity of the market. In this regard, I discuss how the instant trade settlement affects foreign investors. I argue that the demerits of such a change could outweigh its merits. Lastly, I propose certain additions and changes in the framework to ensure the inflow of foreign investment. 

    Addressing the Lacunae

    From a practical standpoint, achieving instant trade settlement might be impossible within the current financial framework.  In 2020, the Asia Securities Industry and Financial Markets Association (ASIFMA) also highlighted the difficulties for foreign investors if the settlement cycle is reduced, as this may result in inefficiencies for trade matching and end of day reconciliations. This is because the settlement of securities transactions requires a multi-faceted procedure, demanding seamless coordination and communication among a diverse array of stakeholders. Adequate time must be allocated post agreement on a trade for the underlying securities to undergo the necessary transfers and for the corresponding funds to be transferred. At the core of the settlement process, time must be allowed to guarantee legitimacy, accuracy, and adherence to regulatory standards. 

    These conceptual issues might be solved through technological alterations and mutual agreements, but the core issue would lie in the fact that such a move would require an alteration of the whole financial system. This includes the configuration of the Indian payment system as well as the framework governing pivotal banking functions, such as the facilitation of deposit accounts and the extension of credit. To achieve instant trade settlement, a substantial restructuring of the current clearing, payment, and settlement infrastructure within the Indian market would be required.

    Demystifying the Implications on Foreign Investors

    Currently, there is a set procedure followed by foreign investors to deal in the Indian stock market. For instance, if a Germany-based foreign investor wants to buy shares in India, he has to first send euros to the custodians, who will then book the forex, convert the euros into Indian rupees, and deposit the funds into the FPI’s cash account in India. By the time settlement occurs, the funds are deposited with the custodians. Currently, there is a set window of time for transferring the funds and converting them to Indian rupees, subject to market fluctuations which almost occur within a day. But the instantaneous trade settlement will reduce this time, which means foreign exchange transactions will have to be expedited as well to fast track the conversion of currency into Indian rupees. The foreign investors will have to face a lot of challenges, and this might cause a lot of unexplored issues.

    The core issue with instantaneous trade settlement arises from the time difference between Indian and foreign jurisdictions. As a result, foreign investors would need to predict the entry price of a stock in advance, and the price may also fluctuate before they make a purchase. To mitigate this, offshore investors would be compelled to prefund the transaction. Consequently, in the case of SEBI’s instant settlement plan, the law of diminishing returns applies, as the shortened time frame introduces more risk without generating additional benefits for widespread adoption across the market. This could potentially lead to a situation where capital is underinvested, making the delivery of securities more complex, fraught with increased risk and escalation of costs. Thus, the implementation of this measure could make the Indian financial markets less appealing to global investors. 

    The Way Ahead

    Ms. Madhabi Buch has said that FPI would not face any problems as they would be given the choice to opt out of instantaneous settlement if they prefer not to use it. She ensured that SEBI had ascertained the data that shows which trades are matched with each other. Based on this data, they believe that choosing not to opt for instantaneous settlement will not create any issues or problems for anyone involved. In essence, they are reassuring that the traditional settlement process will still be accommodated and will not cause any difficulties for those who prefer it. However, this optimistic model would fail when the foreign investors would be left with no option but to opt for instant trade settlement if a large share of retail volume does so. This is because, with two distinct trade settlement cycles, the liquidity could be divided in the two-way transaction. Most of the domestic investors are likely to prefer instant trade settlement creating a risk of fragmentation of liquidity and an increased likelihood of failed trades. To prevent this, SEBI should take certain measure like trade limit for a specific settlement cycle to ensure that the liquidity is sufficient, if not equal in both the trade settlement cycles.

    To bypass this hurdle, SEBI will have to formulate a mechanism similar to the one implemented in China. China, at the time of introduction of the T+0 settlement cycle for Stock Connect, was facing several challenges as it increased the operational burden for foreign investors and market participants to complete the settlement obligations. Also, when China A-shares got listed on global indexes such as Morgan Stanley Capital International and Financial Times Stock Exchange, foreign interest in the Chinese onshore equity market skyrocketed. It became very crucial to make an A-share investment channel to entice foreign investment. Thus, in partnership with Depository Trust and Clearing Corporation, Hong Kong Exchanges and Clearing Limited (“HKEX”) launched HKEX Synapse, a revolutionary settlement platform specialized to Northbound Stock Connect. 

    Synapse works as a standardized and centralized platform that efficiently transmits settlement instructions to all relevant parties concurrently. This simultaneous processing ensures full transparency in the trade processing status. After obtaining consensus and approvals, Synapse transmits settlement instructions to the Central Clearing and Settlement System (“CCASS”) for final settlement. Real-time integration with CCASS allows Synapse to provide prompt status updates to all involved parties after a matching or settlement batch run. This results in comprehensive transparency, improved control, and increased efficiency for investors and their counterparts throughout the settlement process.

    In India, if instant trade settlement has to be introduced despite having several loopholes, a platform similar to HKEX Synapse is necessary to ensure that international investors gain immediate access to the real-time status of their trade settlements. This would provide a measure of relief from the constraints imposed by the narrow settlement window. Also, this will standardize and simplify post-trade procedures and empower investors to optimize connectivity and operational efficiencies within a framework that is both transparent and secure. Custodians will be equipped with comprehensive insights regarding the parties that have endorsed and sanctioned specific trades, thereby furnishing them with the essential data needed to promptly address and rectify any trade anomalies prior to the designated cut-off time. 

    Apart from this, SEBI can also give brokers the responsibility of guaranteeing payments on behalf of foreign investors, effectively extending them credit for the interim two-day period until the transactions are duly finalized. For instance, Indian stockbrokers can vouch for foreign investors and settle their trades in instant trade settlement, and later, these investors can repay money to the brokers within two days. While the brokers would take some risks, in the long term they would benefit from the new inflows. 

    Concluding Remarks

    India has at various instances, taken the lead in terms of technological innovation by changing the digital infrastructure with platforms like CoWIN and Unified Payments Interface. Instant trade settlement might put India at the forefront of the globe in terms of trade settlement if it is proven to be the fastest and most efficient in the world. 

    However, it is crucial to recognize the complexities and potential disruptions it may introduce to the existing financial framework. Foreign investors, in particular, will face significant hurdles with the proposed instantaneous settlement. This may necessitate prefunding transactions, introducing added complexity and risk to the process. Additionally, the implementation of this measure may lead to increased operational costs for foreign investors, potentially making the Indian financial markets less attractive on a global scale. SEBI’s assurance that traditional settlement processes will still be accommodated is a positive step, but it may not entirely alleviate concerns, especially if a significant portion of retail volume opts for instantaneous trade settlement.

    Therefore, careful consideration and strategic measures are essential to mitigate potential risks and ensure a seamless transition. By adopting proven mechanisms and addressing the concerns of foreign investors, India can pave the way for a more dynamic and resilient financial ecosystem in the years ahead.

  • SEBI in the Shoes of CCI: the Jurisdictional Tussle Continues

    SEBI in the Shoes of CCI: the Jurisdictional Tussle Continues

    By Deepanshu Agarwal, a fourth-year student at UPES, Dehradun

    Introduction

    The Securities & Exchange Board of India (‘SEBI’) and the Competition Commission of India (‘CCI’) are separate independent regulatory bodies which often jurisdictionally overlap with each other. This happens due to the commonality in their objectives of ensuring the protection of consumers and promoting a healthy market.

    In the case of Advocate Jitesh Maheshwari v. National Stock Exchange of India Ltd. (2019) (‘NSE Case’), CCI refused to deal with the matterregarding abuse of dominance by National Stock Exchange (‘NSE’) and allowed SEBI to continue with their practice. This was a drastic turn taken by CCI to allow a sectoral regulator to deal with the abuse of dominance, which is an issue majorly dealt with by CCI under section 4 of the Competition Act, 2002.

    In the instant case, the informant alleged that for almost four years (i.e. 2010-2014), NSE had been giving preferential treatment and unfair access to some of the traders by communicating to them price feed and other data. According to the informant, this was a discriminatory practice followed by NSE towards other traders on the same footing & thus resulted in ‘denial of market access’. Moreover, the informant proposed the relevant market as the ‘market for providing services of trading in securities’ and contended that NSE is a dominant player in the market as it holds a huge market share, consumer dependency and entry barriers for the new stock exchanges.

    Though CCI noted that such discriminatory practices exist in its jurisdiction, the case was dismissed without going into its merits. The reasoning of CCI was that: (i) the allegations against NSE were not final and are yet to be established in appropriate proceedings; and that (ii) there was a lack of evidence to form a prima facie opinion about the role of NSE. However, CCI mentioned that it could examine the discriminatory and abusive conduct independently, based on cogent facts and evidence after the completion of investigation by SEBI. But the question that remains unanswered here is that if SEBI does not reach an adverse finding on the question of NSE’s role, can CCI then still examine NSE’s conduct? To answer this question, it becomes imperative to analyse this order in the light of the Supreme Court’s judgment in the case of CCI v. Bharti Airtel Ltd. & Ors. (2019) (‘Bharti Airtel’).

    The jurisdictional tussle in Bharti Airtel

    Though this case revolves around the jurisdictional fight between Telecom Regulatory Authority of India (‘TRAI’) and CCI, yet it is a landmark judgment when it comes to the jurisdictional overlap between CCI and other sectoral regulators, apart from TRAI.

    Reliance Jio Infocomm Ltd., a new entrant in the telecom market, approached CCI against the Incumbent Dominant Operators (or ‘IDOs’ namely Bharti Airtel, Idea Cellular and Vodafone) for forming a cartel to deny market entry and thereby causing an adverse effect on competition in the telecom market. While the case was already under investigation by TRAI, CCI found out a prima facie violation against the IDOs. The Bombay High Court, in the appeal made by the IDOs, set aside the order of CCI on the grounds of lack of jurisdiction as the matter was already under investigation by TRAI.

    The Supreme Court while confirming the findings of the Bombay High Court did not deny the jurisdiction of CCI altogether but made its investigation subject to the findings of TRAI. It did so by giving CCI a secondary jurisdiction over the matter. In this regard, the court held that “Once that investigation is done and there are findings returned by the TRAI which lead to the prima facie conclusion that IDOs have indulged in anti-competitive practices, the CCI can be activated to investigate the matter going by the criteria laid down in the relevant provisions of the Competition Act and take it to its logical conclusion”.

    Applying the reading of Bharti Airtel to the NSE case, it can be concluded that the jurisdiction of the CCI begins only when there are adverse findings returned by SEBI. Similar to TRAI, SEBI is also a sectoral regulator and will have primary jurisdiction in dealing with the abuse of dominance/adverse competition in the capital markets. Therefore, it can be concluded in the instant order that the CCI was justified in not going into the merits, by accepting itself as a regulator having a secondary jurisdiction in such cases.

    Since the instant order passed by CCI is in line with Bharti Airtel, it also suffers from similar criticisms.

    Criticism of the NSE Case

    Since both SEBI and CCI have a common objective to ensure consumer protection and fair market competition, it is clear that there may be jurisdictional overlaps. Both the Securities and Exchange Board of India Act, 1992 and the Competition Act, 2002 provide for jurisdiction in addition to and not in derogation to other laws. However, neither of the two acts provide the remedy in case of a jurisdictional overlap. This ambiguity paves the way for concurrent jurisdiction of both the regulators which further leads to conflicting decisions and legal uncertainty.

    In such a scenario, putting CCI at a lower pedestal by giving it secondary jurisdiction (as evidenced in Bharti Airtel and the NSE case) may not be the optimal solution for jurisdictional issues. Rather, the CCI being an independent competition watchdog should be allowed to deal with the competition matters freely and irrespective of the findings of the sectoral regulators. It has to be noted that CCI is a specialized body created solely with the purpose to prevent abuse of dominance and adverse effect of competition. Therefore, subjecting CCI’s jurisdiction to the findings of any other sectoral regulator would only hamper the object for which it was created, thereby weakening its authority.

    The Way Forward

    The best way through which the jurisdictional tussle can be resolved is following the mandatory consultation approach. This means that if a situation of jurisdictional intersect arises, then both the regulators should consult with each other as to who can deal with the matter more effectively and efficiently. This can be a credible solution to remove all defects from such jurisdictional matters and ensure some technical input is also given by the sectoral regulator.

    Under the current regulatory framework, India follows a non-mandatory consultation approach. Section 21 & 21A of the Competition Act incorporates a mechanism for consultation between the statutory authorities and the commission. However, consultation under these sections is neither mandatory nor binding.

    Lessons should be drawn from other countries which are successfully following the mandatory consultation approach. For example, in Turkey, under the Electronic Communications Law No. 5809, the Competition Board has the statutory duty to receive and take account of the opinion of the relevant regulatory authority (the Information Technologies and Communications Authority) when enforcing the competition law in the telecommunications sector. Moreover, Turkey’s competition authority also sends its opinion to the Information Technologies and Communications Authority regarding draft regulations in the consultation process.

    The mandatory consultation process is also followed in other countries like Argentina and France. This process was also suggested in India by the National Committee on National Competition Policy and Allied Matters in 2011. Therefore, it is the need of the hour that this change be implemented.

    Considering the existing legislative framework, substituting the word ‘may’ with ‘shall’ in Sections 21 and 21A of the Competition Act and making the opinion of CCI or the sectoral regulators binding upon the other will leverage the expertise of both the entities and will enable the initiation of a cooperative regime.

    Conclusion

    Abuse of dominance/adverse effect on market is specifically the area that CCI deals with, it is erroneous for SEBI to encroach upon the same. Both the technical aspects and the competition matters in a case have to be viewed separately. SEBI being a sectoral regulator and a lex specialis in the capital markets can deal with the technical matters more effectively than CCI. Whereas, on the other hand, CCI being a lex specialis in competition matters can deal with the same with more proficiency. Therefore, in cases involving jurisdictional conflict, it is fallacious to place CCI at a secondary stage. Rather, the mandatory consultation approach should be followed by the regulators in such cases to solve the conflict in a more harmonious and effectual manner.