Equity capital markets in India: regulatory overview
A Q&A guide to equity capital markets law in India.
The Q&A gives an overview of main equity markets/exchanges, regulators and legislation, listing requirements, offering structures, advisers, prospectus/offer document, marketing, bookbuilding, underwriting, timetables, stabilisation, tax, continuing obligations and de-listing.
To compare answers across multiple jurisdictions visit the Equity Capital Markets Country Q&A tool.
This Q&A is part of the PLC multi-jurisdictional guide to capital markets law. For a full list of jurisdictional Q&As visit www.practicallaw.com/capitalmarkets-mjg.
Main equity markets/exchanges
Main equity markets/exchanges
The two main equity and debt market platforms in India are the National Stock Exchange of India Limited (NSE) (www.nseindia.com) and the Bombay Stock exchange Limited (BSE) (www.bseindia.com) (collectively, Stock Exchanges).
The Stock Exchanges have three trading segments:
Capital market (trading in equity shares).
Derivatives market (trading in futures and options).
Wholesale debt market (institutional trading in debt securities).
The applicable law, rules, regulations, bye-laws and guidelines relating to listing of securities on the Stock Exchanges are substantially identical.
Both these Stock Exchanges are demutualised stock exchanges with trading memberships and majority memberships being segregated.
Standard Chartered PLC is the only foreign company to be listed on the Stock Exchanges.
Market activity and deals
Although India has been affected by the global slowdown, there were over 40 listings of public issues in equity and debt capital markets in 2011. The offer documents are accessible on the official website of the Securities and Exchange Board of India (SEBI) (www.sebi.gov.in).
SEBI and the Stock Exchanges are the main regulators of equity markets. The Reserve Bank of India (RBI) regulates all aspects of exchange controls. The trading of equity shares takes place on the Stock Exchanges (in specified platforms).
The primary legislative framework that applies is the following:
Companies Act 1956.
SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009 (ICDR).
Securities Contracts (Regulation) Act 1956 and Securities Contracts (Regulation) Rules 1957.
Listing agreement between the Stock Exchanges and the listed companies (Equity Listing Agreement).
All primary issues, by Indian or foreign issuers, require approval from the Stock Exchanges. In addition, for issues such as primary issuances and rights issues, SEBI issues observations on the draft offer document, which must be addressed for a successful listing.
The requirements for listing include:
A minimum public float of 25% of post-issue share capital (other than for certain entities such as government companies).
That SEBI has not barred the issuer, any of its promoter or promoter group (both defined terms in the ICDR), directors or persons in control of the issuer from accessing the capital markets.
That the promoters, directors or persons in control of the issuer are not also promoters, directors or persons in control of any other company that is barred from accessing the capital markets by SEBI.
All equity shares are fully paid up.
There are no outstanding convertible securities or any other rights that would entitle any person with any option to receive equity shares.
A grading from a SEBI-registered grading agency.
For foreign issuers, listing in India is possible through an issue of Indian depository receipts (IDRs) under Chapter X of the ICDR, Section 605A of the Companies Act and Companies (Issue of Indian Depository Receipts) Rules 2004. The eligibility requirements of IDRs include that:
The issuer must be listed in its home country.
The issuer must not be prohibited from issuing securities by any regulatory body.
The issuer must have a track record of compliance with securities market regulations in its home country.
Minimum size requirements
There are various eligibility norms under the ICDR and prescribed by the Stock Exchanges.
NSE requires that the paid-up equity capital of the issuer is at least INR100 million and the capitalisation of the issuer's equity share capital is at least INR250 million (as at 1 February 2012, US$1 was about INR50).
The BSE requires, among other things, that for "large cap companies" the issue size, the post-issue paid up capital and market capitalisation must be at least INR100 million, INR30 million and INR250 million respectively. For "small cap companies", the issue size, the post-issue paid up capital and market capitalisation must be at least INR30 million, INR30 million and INR50 million respectively.
The minimum income/turnover of the issuer must be at least INR30 million in each of the preceding three 12-month periods. For this purpose, a "large cap" company is categorised as a company with a minimum issue size of INR100 million and a market capitalisation of at least INR250.
For the Stock Exchanges, the minimum application size requirement is INR5,000 to INR7,000. There is no minimum size requirement for a primary listing. However, in terms of listing platform, an issuer with a post-issue face value of INR10 million must be listed on the non-main board terminal of the Stock Exchanges.
For IDRs, the issue size and minimum application amount must be at least INR500 million and INR20,000 respectively.
Trading record and accounts
There are no minimum trading record and account requirements. However, the BSE requires, as a condition for the issue, that the issuer, its promoters and group entities (all defined terms in the ICDR) must be in compliance with the Equity Listing Agreement.
Other than disclosure, there is no working capital requirement (such as a "clean working capital" statement, as may exist in other jurisdictions).
Shares in public hands
There is a statutory minimum public float of 25% of post-issue share capital (other than for certain entities such as government companies).
An initial public offering (IPO) may comprise:
Convertible securities including warrants, convertible debt instruments and convertible preference shares.
An IPO is understood to include a primary offer for the sale of securities to the public by any existing holders of such securities. The eligibility and disclosure requirements in such an offering are governed primarily by ICDR.
An IPO can also comprise of non-convertible debt instruments. Such an offering is governed primarily by the SEBI Debt Regulations 2008.
A subsequent offering of equity shares can be made through:
Public issue (that is, an IPO or a further public offering).
Rights issue (that is, an offering to existing shareholders).
A qualified institutions placement (QIP) (that is, a private placement to qualified institutional buyers).
An IPO can also be a full offer for sale, that is, an offer of equity shares to the public by the issuer's existing shareholders.
Composite issues are also possible (issues where a public issue and a rights issue is made simultaneously).
Further, preferential allotments to pre-identified allottees are permitted.
All such structures are regulated by the ICDR and in certain cases the pricing is also regulated through a pricing floor.
For a primary listing of shares, the key processes are as follows:
A resolution authorising the issue by the issuer's board of directors.
A special resolution by the company shareholders authorising the issue.
Appointment of SEBI-registered merchant bankers and other intermediaries, and external advisors such as legal counsel and a peer-reviewed auditor.
Commencement of due diligence.
Filing of draft offer document with SEBI.
Obtaining in-principle approvals from the Stock Exchanges.
Receiving and responding to observations of SEBI (and of the Stock Exchanges, if any).
Filing of red herring prospectus with SEBI and the Stock Exchanges.
Bookbuilding and closure of issue (for a book-built issue).
Filing of prospectus with the Registrar of Companies (RoC).
Listing and trading approvals from the Stock Exchanges.
The process for listing of IDRs is similar and is governed by:
Chapter X of the ICDR.
Section 605A of the Companies Act.
Companies (Issue of Indian Depository Receipts) Rules 2004.
Advisers: equity offering
The primary advisors are SEBI-registered merchant bankers who assist with the various processes. Merchant banks are governed by the SEBI (Merchant Bankers) Regulations 1992, which impose various regulatory duties and codes on merchant bankers including the duty of independent verification regarding the adequacy of disclosures in the offer documents.
Legal counsel assists in drafting the offer document and the disclosures contained therein. The company's statutory auditor assists in the financial due diligence aspect of the offer document including providing comfort letters for the issuer and its subsidiaries' key financial data.
The main document required in equity offerings differs according to the type of offering. The level of disclosures and documentation is most onerous for an IPO and least for preferential allotments. In an IPO, the main documents include the:
Underwriting agreement entered into between the merchant banks and the issuer.
Escrow agreement between the escrow agent, the issuer and the merchant banks.
Equity prospectus/main offering document
A prospectus must be published for a public offer, that is, when the offer of securities is to more than 49 persons. A prospectus must be filed with SEBI, the Stock Exchanges and the RoC.
For non-public issues of listed issuers, there are varying requirements of publication, filing and delivery (these are all less exhaustive and less onerous than prospectus requirements). For example, for a QIP, the offer documents need only be filed with the Stock Exchanges.
For preferential allotments to pre-identified allottees, there is no offering document. The explanatory statement to be sent to shareholders for seeking their authorisation for such an allotment must set out certain basis disclosures such as the:
Objects of the preferential issue.
Shareholding pattern of the issuer before and after the preferential issue.
Time within which the preferential issue is expected to be completed.
Identity of the proposed allottees, and the percentage of post-issue capital that will be held by the allottees.
Possible change in control, if any, in the issuer consequent to the issue.
For a prospectus, the disclosures are set out in both:
Schedule VIII Part A of the ICDR.
Schedule II of the Companies Act 1956.
A prospectus must contain the issuer and subsidiaries' financial statements for the previous five years. The standards of financial reporting of Indian entities are generally accepted accounting principles set out by the Institute of Chartered Accountants of India. The International Financial Reporting Standards (IFRS) will be implemented in a phased manner over the next few years.
The financial statements must be adjusted (that is, restated) in the following situations, among others:
For adjustments/rectification for all incorrect accounting practices or failures to make provisions or other adjustments that resulted in audit qualifications.
For highlighting audit qualifications, which have not been given effect to, along with the management comments.
Where there has been a change in accounting policy. In which case, the profits or losses of the earlier years (required to be shown in the offer document) and of the year in which the change in the accounting policy took place must be recomputed to reflect what the profits or losses of those years would have been had a uniform accounting policy been followed in each of those years.
Financial statements must be valid for six months from the date of the offer document. A statement of related party transactions must also be disclosed.
In addition to financial statements, the main heads of disclosure in a prospectus are:
History and certain corporate matters.
Basis of issue price.
Objects of the issue.
Managements' discussion and analysis of financial condition and results of operations.
Both for public and private issues, there is a liability on the issuer to ensure true and fair disclosures. Additionally, there is a requirement to appoint SEBI-registered merchant banks for public issues. Therefore, merchant banks are responsible to SEBI for the offer document to be compliant with applicable laws and are required to exercise independent due diligence. Legal counsel is engaged to draft and assist in the process. The offer document preparation process involves due diligence of the issuer as well as drafting sessions where key officials of the issuer participate in discussions with merchant banks and the legal counsel.
Additionally, the Companies Act provides that misstatements in the prospectus attach civil liability to the:
Authority that authorised the issue of the prospectus.
Any person who is named or has authorised himself to be named as a director, or as having agreed to become a director of the company.
Misstatements in the prospectus, depending on whether they are untrue, fraudulent, reckless or negligent, can also result in either or both:
Imprisonment for a term of two years.
A fine of INR50,000.
In addition, SEBI has powers to prohibit the issuer and/or others from accessing the securities markets or from dealing in securities.
Marketing equity offerings
Publicly offered equity securities are marketed by road show presentations for institutional investors, and general advertising including in newspapers for retail investors.
Publicity restrictions set out in Chapter VI, particularly Regulation 60 of the ICDR, must be strictly adhered to at all times.
Research reports are typically prepared by analysts. Research reports are primarily regulated by publicity restrictions in the ICDR as well as SEBI (Prohibition of Insider Trading) Regulations 1992.
The insider trading regulations, among others, require that an organisation maintains a "Chinese Wall" policy that separates those areas of the organisation that routinely have access to confidential information from areas which are connected with sale, marketing or investment advice.
Analysts must disclose their shareholdings in companies for which they are preparing research reports to their employer's compliance officers. In addition, analysts who prepare research reports of listed companies are prohibited from trading in securities of that company for 30 days from preparation of the research report. Listed companies are prohibited from providing non-public information to analysts or any section of the public. Violation of these norms include penalties such as a penalty of up to INR250 million or three times the profits made from insider trading, whichever is higher.
Bookbuilding is the most widely used form of price discovery in IPO and further public offers.
In a rights issue, the issue price is determined in consultation with designated stock exchanges. In bookbuilt issues, bids are collected, on the basis of the red herring prospectus, within the price band. The price band is decided between the issuer and the merchant banks and is advertised before the bid opening date. Bidders can bid at any price within the price band.
Bookbuilding is price discovery where potential investors bid (within the price band) and the highest price at which the company is able to offer the required number of shares is the price at which the book "cuts off" (Cut-Off Price). The company, in consultation with the merchant bankers, arrives at the final price. The final price is set at or below the Cut-Off Price.
In addition, ICDR enables pricing discounts as well as minimum and maximum percentages for allocation of shares across categories of investors.
QIPs are private placements and therefore, invitations to subscribe cannot be made to more than 49 potential subscribers. Inviting more than 49 bids would trigger prospectus registration requirements. Therefore, the issuer and merchant bankers circulate numbered copies of the preliminary placement document and the bid application form (BAF) to potential investors, all of whom are qualified institutions buyers. The BAF contains bidding options. On the basis of the bids in the BAFs received, the issuer and merchant bankers determine the QIP price. Accordingly, the contract allocation notes (CAN) are circulated to bidders who have been allocated securities. The dispatch of the CANs is deemed a valid, binding and irrevocable contract.
Underwriting: equity offering
Hard underwriting (that is, when the merchant banks take an issue on their respective books) is very uncommon in India. Almost all issues that are underwritten are in the soft underwriting structure. Underwriting is mandatory for book-built issues. The ICDR lists certain clauses that must be part of the underwriting agreement, such as the role and obligations of each underwriter, and a clause stating that margin collected must be uniform across all categories, indicating the percentage to be paid as margin by the investor at the time of bidding.
Underwriting fees are not a separate disclosure item and are not in the public domain. However, they tend to be in the form of percentages of issue size accruing on listing.
Timetable: equity offerings
The timetable for a typical equity offering varies depending on the nature of the offering. Broadly, an IPO is most time consuming and it is not uncommon for such a listing to require a year for completion, from the board meeting authorising the offering. The longest period in the process can arise during the regulatory scrutiny of the draft red herring prospectus. Further, public complaints must be responded to by merchant banks and this process can be time consuming.
The key steps involved in an IPO include:
Board resolution authorising the issue.
Resolution for appointment of intermediaries.
Shareholders' resolution authorising the issue.
Constitution of sub-committees of directors (such as the audit committee).
Compliance with clause 49 of the Equity Listing Agreement.
Modification of the memorandum of association and articles of association.
Compliance with the Stock Exchanges.
Identification of the promoter, group entities and promoter group.
Legal and financial due diligence.
Execute issue agreement.
Bring down diligence call, issue of opinions by legal counsel and issue of auditor's comfort letter.
Filing of the draft red herring prospectus with SEBI.
Responding to SEBI's interim and final observations.
Obtain grading by a SEBI-registered rating agency.
Updating the draft red herring prospectus with incremental due diligence and SEBI's observations.
Bring down diligence call, issue of opinions by legal counsel and issue of auditor's comfort letter.
Execute escrow agreement.
Filing red herring prospectus with the registrar of companies.
Finalisation of price band.
Issue opening and closing.
Execute the syndicate and underwriting agreement.
File prospectus with registrar of companies.
Board approval of allotment.
QIPs and preferential allotments are faster paced and can complete within six to three months of the board meeting.
An issuer making a public issue of equity shares can provide a greenshoe option for stabilising the post-listing price of its equity shares under Regulation 45 of the ICDR. The price stabilisation mechanism must be authorised by a resolution passed in the issuer's general meeting of shareholders. A greenshoe option means an option of allotting equity shares in excess of the equity shares offered in the public issue as a post-listing price stabilising mechanism. The stabilisation agreement is entered into between the:
Stabilising agent (that is a SEBI-registered merchant banker).
Greenshoe lender (that is, a pre-issue shareholder of the issuer, including the promoter).
Regulation 3 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations 2003 (SEBI (PFUTP) Regulations) deals with market manipulation.
Under the SEBI (PFUTP) Regulations no person can, directly or indirectly, use or employ any manipulative or deceptive device or contrivance in contravention of the provisions of the SEBI Act (or the rules or regulations under the SEBI Act) in connection with the issue, purchase or sale of any security listed or proposed to be listed on a recognised stock exchange.
Manipulative, fraudulent and unfair trade practices while dealing in securities is also prohibited under Regulation 4 of the SEBI (PFUTP) Regulations.
Tax: equity issues
Issuing and listing securities is not subject to tax except for service tax on fees payable on listing.
Dividends are tax-free at the hands of the shareholders. A company is, however, required to pay a dividend distribution tax. The characterisation of the gains/losses, arising from sale of shares, as capital gains or other income in the hands of the company, depends on the nature of holding and various other factors.
The Equity Listing Agreement sets out requirements for continuing obligations, which include:
Ongoing disclosures to the Stock Exchanges including prompt notifications of unpublished price-sensitive information.
Quarterly disclosure of financials of the company and its subsidiaries (including related party transactions).
A minimum public float of 25% of the total paid-up capital of the issuer (10% for government companies).
Continuing obligations of listed companies are primarily regulated by the Equity Listing Agreement and the Securities Contracts (Regulation) Act 1956. In addition, Clause 49 of the Equity Listing Agreement requires the establishment of sub-committees of the board of directors such as an audit committee and an investor grievance committee with a specified mandate including a minimum composition of independent directors.
The penalties for breaching the continuing obligations include either or both:
Imprisonment of responsible officers of up to ten years.
A fine of up to INR250 million.
SEBI can also issue directives to secure "the interests of the securities markets and investors", which could include directions not to access the capital market or to deal in securities for specified periods of time.
Market abuse and insider dealing
De-listing is governed by the SEBI (Delisting of Equity Shares) Regulations 2009 (SEBI Delisting Regulations). There is no requirement to grant public shareholders an exit opportunity if the equity shares remain listed on any stock exchange having national trading terminals. The process of de-listing in such a case is relatively simple, involving, among other things:
An approval of the company's board of directors of the proposed de-listing.
A public notice in specified public platforms.
An application to the relevant stock exchanges.
In other forms of voluntary de-listing, an exit opportunity must be given to all public shareholders and there is a specified regulatory pricing floor. In terms of process, the key steps include:
Approval of the proposed de-listing by the board of directors as well as shareholders' approval by postal ballot.
In-principle approvals from the relevant stock exchanges.
A deposit by the promoter of estimated funds into an escrow account.
Appointment of SEBI-registered merchant bankers.
A public announcement followed by a letter of offer with specified disclosures.
A "reverse" bookbuilding process, whereby shareholders quote the price to which they would like to be bought out. The price at which the maximum number of shares are tendered is the discovered "exit price". This price must be paid to all shareholders whose shares are acquired in order to take the acquirer's shareholding to the threshold required for a successful de-listing.
For a successful voluntary de-listing, the shareholding of the promoter (along with the persons acting in concert), together with shares acquired under the de-listing offer, is the higher of:
90% of the total issued shares of that class (excluding the shares that are held by a custodian and against which depository receipts have been issued overseas).
The aggregate percentage of pre-offer promoter shareholding (along with persons acting in concert with him) and 50% of the residual shareholding.
A company may also be compulsorily de-listed as a regulatory penalty for breaches of applicable laws, such as non-payment of listing fees. The reasons are not elaborated here but where a company has been compulsorily de-listed, the following are prohibited from access to the securities market or seeking listing for any equity shares, directly or indirectly, for ten years from the date of the de-listing:
The company's full-time directors and its promoters.
The companies that are promoted by the company's full-time directors or promoters.
SEBI and the Stock Exchanges continually reform securities laws, typically by issuing circulars amending the relevant regulations and the Equity and Debt Listing Agreement.
SEBI is expected to work on reforms to link disclosures to materiality thresholds and to reduce the time-frame for completing capital market transactions.