On November 9, 2021, the markets regulator SEBI issued a notification that made significant changes in the provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR Regulations) to strengthen the monitoring and enforcement of related-party transaction norms. The Notification shall become effective from April 1, 2022.
Subsequent to aforesaid Notification, SEBI has further come out with Circular dated November 22, 2021 in which format for disclosure of related parties transactions to the stock exchange has been provided. Additionally, the circular has also prescribed the information to be placed before audit committee and shareholder for approval of related party transaction.
The key provisions of the Notification, as well as the circular, are summarized herein below:
Definition of Related Party
The new norms brought into the regulation have changed the definition of related party provided under Regulation 2(1) (zb). Earlier regulation provided any person or entity will be deemed ‘related party’ if they belong to the promoter or promoter group of the listed company ‘and’ holding more than 20% of the shareholding in the listed company.
The new definition widens the scope of ‘related party’ as provided under the earlier regime. It states that any person or entity who forms a part of promoter and promoter group of listed company (irrespective of holding) and further provides that any person or entity holding more than 20% of the equity shares or more than 10% of the shareholdings (with effect from April 23, 2023); either directly or on a beneficial basis (provided under Section 89 of Companies Act 2013) shall also constitute as related party. With this introduction in the regulation, the ‘and’ condition has been replaced with the ‘or’ condition provided between belonging to the promoter or promoter group and shareholding threshold.
Definition of Related Party Transaction
The amendment also changed the definition of related party transaction. Previously, a related party transaction was defined as a transfer of resources, services, or obligations between a listed entity and a related party of the listed entity. scope of RPT has been widened through the new definition which now includes transactions between a listed entity/any of its subsidiaries and a related party of such listed entity / any of its subsidiaries. It shall also include transactions between a listed entity/any of its subsidiaries and any other person or entity with the purpose and effect of benefiting related party of listed entity/any of its subsidiaries w.e.f. April 1, 2023.
The definition has also specifically exempted corporate transactions by the listed entity which is uniformly applicable or offered to all the shareholders like payment of dividend, right issue, buy-back, split or consolidation etc.
Approvals and Disclosure Requirements under Regulation 23
As per the provisions of LODR, listed entity is required to formulate a policy on materiality and the explanation to Regulation 23(1) explaining what shall be construed as “material” is amended and now any transaction will be deemed material if it exceeds the threshold of rupees one thousand crore or ten per cent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity, whichever is lower. Earlier the threshold was merely ten per cent of the annual consolidated turnover.
Further as per the amendment in Regulation 23(2), now all related party transactions including any subsequent material modifications thereof shall require approval of audit committee of the listed company. It is further provided to include following provisos to sub-regulation (2):
- The audit committee of listed entity to define ‘material modification’ and incorporate the same in materiality policy;
- Related party transactions to which subsidiary of listed entity is a party and listed entity is not a party, shall also require approval of audit committee of the listed entity if the value of such transaction whether entered individually or taken together with previous transactions during a financial year exceeds ten per cent of the annual consolidated turnover, as per the last audited financial statements of the listed entity. Further w.e.f. from 1st April 2023, approval of audit committee of listed entity would be needed if transaction value exceeds ten per cent of the annual standalone turnover, as per the last audited financial statements of the subsidiary;
- However, prior approval of audit committee of listed company will not be needed when listed subsidiary is party to the transaction but not the listed entity and if regulation 23 and sub-regulation (2) of regulation 15 of LODR Regulations are applicable to such listed subsidiary.
Corresponding to the amendment in sub-regulation (2), similar amendment is made in Sub-regulation (4) mandating prior approval of shareholders of listed entity, for all material related party transaction as well as for any subsequent material modification to such approved transaction. Likewise, prior approval of shareholder of listed company will not needed when listed subsidiary is party to the transaction but not the listed entity and if regulation 23 and sub-regulation (2) of regulation 15 of LODR Regulations are applicable to such listed subsidiary.
Under sub-regulation (5); additional exemption from the applicability of provisions of Regulation 23 (2), (3) and (4), is provided for transactions entered into between two wholly owned subsidiaries of a listed entity whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.
Lastly, changes have been brought to sub-regulation (9) according to which the disclosure of related party transactions will be needed to be provided in the format as specified by SEBI from time to time instead of format provided under relevant accounting standards. Also these disclosures are to be made every six months within fifteen days from date of publication of its standalone and consolidated financial results instead of existing thirty days. Further w.e.f. April 1, 2023 these disclosures shall be made on the date of publication of its standalone and consolidated financial results.
Information to be reviewed by Audit Committee to approve related party transaction as per circular dated November 22, 2021:
As per SEBI circular, following key information are required to be provided by the listed company for approval of a related party transaction:
- Type, material terms, tenure, value of the proposed transaction and its percentage to the listed entity annual consolidated turnover for the immediately preceding financial year (and in case transaction of subsidiary percentage to the standalone turnover of subsidiary);
- Name of the related party and its relationship with listed entity or its subsidiary;
- Justification why the proposed transaction in interest of listed entity;
- Copy of valuation or external party report if any relied upon;
- Percentage of the counter-party’s annual consolidated turnover that is represented by the value of the proposed related party transaction;
- Additional information as prescribed in case proposed transaction relates to loan/ inter corporate deposits, advances or investment made or given by the listed entity or its subsidiary;
- Such other information as deemed relevant.
Information to be provided to shareholders for consideration of related party transaction as per circular dated November 22, 2021:
SEBI circular also requires that the information to be also provided as part of the explanatory statement to the notice sent to the shareholders for their approval on the proposed related party transaction. The information required to be shared with the shareholders are similar to those to be provided to the Audit Committee and as broadly enlisted herein above.
Format for reporting the related party transaction to the stock exchanges.
The circular also encloses the format as annexure in which reporting of the related party transaction is to be carried out to the stock exchanges.
Conclusion
The amendments in the provisions of related party transactions have not only broadened the definition and scope of related party but have made the provisions more stringent including seeking prior approval of shareholders and also prior approval of audit committee and shareholders for even any material modification in the approved transaction. The disclosure format provided vide the latest circular further brings more transparency in the disclosure of related party transactions on stock exchanges. The circular also enlists the information to be shared with Audit committee and shareholder for their approval making the process more uniform and transparent and removes ambiguities.