Tushar Chitlangia and Shivanshu Tripathi[i]
In a notable development on 19 June 2020, Reliance Industries Limited (“RIL”) became the first Indian company to be valued at over 11 lakh crores after declaring that it became net-debt free before its actual target date of 31 March 2021. There are two primary reasons why the company was able to achieve its ambitious target in the opportune time—first being the investment from the world’s top financial investors for its digital subsidiary- Jio; second, the mega rights issue of the shares of RIL. The promoter of RIL, Mukesh Ambani, announced on 30 April 2020, that India’s largest rights issue of Rs 53,125 crores would be raised wherein holders of fifteen shares will be entitled to one rights share of RIL.
Apart from RIL, other companies have launched the rights issue in the recent past, and there are reports that some are planning to launch them soon. The simple process of rights issue, affirmative permanent and temporary relaxations introduced by the Securities and Exchange Board of India (“SEBI”), and changes in the Foreign Exchange Management Act 2000 (“FEMA 2000”) has become a significant drive for companies to use the rights issue mechanism. This article shall critically examine the recent changes made in SEBI Regulations and FEMA Rules concerning the launching of the rights issues.
Understanding Rights Issue
A rights issue is a system where companies issue new shares to only the existing shareholders at a discounted price. The rights are issued in ratio to the shares already held by shareholders. Some distinguishable benefits of a rights issue are that the compliance costs are lower compared to Initial Public Offerings and there is no limit on the fund being raised. Before issuing any rights, there are some procedures that a company must follow. These have been enlisted under Section 62 of Companies Act 2013. The listed companies are additionally required to comply with SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (“ICDR Regulations 2018”) and SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015. The rights issue creates three possible scenarios for the existing shareholders, —firstly, shareholders may subscribe to the shares; secondly, they may not subscribe to the shares; and lastly, they may renounce the rights to another person who shall not necessarily be a shareholder of the company.
Rights Issue on the Rise?
RIL has opted for the fast track rights issue, a select type of rights issue wherein the issuer need not file the draft offer letter for comments from SEBI and to stock exchanges. They directly file the offer of letter to the SEBI[ii], which makes the process of issuing shares simpler and faster. This is consequential to some conditions to be fulfilled by the company, which have been relaxed by the SEBI due to the recent Coronavirus outbreak. ‘Draft letter of offer’ is a preliminary form of ‘letter of offer’ or ‘offer letter,’ which is sent to SEBI seeking their satisfaction. There have been some temporary, pandemic-driven relaxations and some permanent relaxations by the SEBI for easing out the process of the rights issue. Some of the FEMA rules have also been amended, which were instrumental in gaining investor confidence.
Relaxation concerning rights issue were introduced vide three circulars by SEBI, two on 21 April 2020, and one on 6 May 2020. The conditions which are to be fulfilled before a rights issue is launched are laid down under ICDR Regulations 2018.[iii] Previously, the companies had to list their equity shares on the stock exchanges for a minimum of three years immediately preceding the date on which letter of offer is to be filed with the stock exchange. This requirement has been relaxed to eighteen months. Another significant improvement is that, previously, the required average market capitalization of public shareholding of the issuer was Rs 250 crores, which has been reduced to Rs. 100 crores. Prior to the 2020 circulars, companies were not allowed to proceed with the issue if they did not receive a subscription of 90% of the total offer. However, that figure is difficult to achieve in these trying times as people have run out of jobs, and the investor mind-set is on the saving side instead of investing. Via the circular, SEBI has reduced the minimum subscription to 75%, creating a win-win situation for both the investors and the companies. These amendments will allow companies with smaller market size to raise funds quickly. The amendments shall prove instrumental for relatively new companies, who have suffered the brunt of Covid-19, as funds can be raised swiftly due to the eighteen-month relaxation. Additionally, these changes will prove instrumental for businesses to survive in these times of sluggish economic growth.
To make the process of rights issue easier and to facilitate faster completion of the process of rights issue, SEBI made certain permanent amendments under its regulations in November 2019. SEBI introduced dematerialized trading of Rights Entitlements (RE) in stock exchanges, which earlier happened through physical form. RIL witnessed the first RE exchange in dematerialized form in its recent rights issue. Further, the timeline of the rights issue process was reduced from T+55 to T+31 days. (T is an abbreviation for transaction date, which means the date on which trading of a security takes place.) A circular dated 22 January 2020, was another bid to streamline the rights issue process. Earlier the issuer had to give notice of ‘at least seven working days’ before announcing the record date and its purpose. The record date is the date on which shareholders must hold securities to be eligible for the rights issue. Due to the requirement of a seven working days’ notice, the notice effectively amounted to 9 to 10 days. For example, if the company had to announce the record date on Wednesday of week two, they had to give out a notice on Monday of week one. Now, this has been changed to at ‘least three working days.’ This was done to reduce the effective timeline of rights issue.
Changes Under FEMA Rules
In the case of non-resident Indian shareholders (a citizen of India who is residing outside India), provisions of FEMA 2000 have to be complied with. The latest Foreign Exchange Management (Non-Debt Instruments) (Second Amendment) Rules, 2020 (“FEMA (NDI) Second Amendment Rules 2020”) amended the Foreign Exchange Management (Non-Debt Instrument) Rules 2019, (“FEMA (NDI) Rules 2019”). The recent amendment deleted the explanation under Rule 7 of FEMA (NDI) Rules 2019. Rule 7 read with the explanation stated that general pricing guidelines, with respect to the renunciation of the rights issue by the resident share holder specified under Rule 21 of the FEMA (NDI) Rules 2019 rule shall not apply when a resident shareholder renounces its right in favor of a non-resident shareholder. Pricing guidelines are directions that are to be kept in mind before setting a price of any equity instrument of any Indian company. Subsequently, it added a new rule which stated that pricing guidelines would apply at the time of renunciation. FEMA (NDI) Second Amendment Rules 2020 provided a much-desired boost to the investing morale of the resident shareholders especially for the rights issue because before the amendment non-resident investors were able to make a significant amount of investment at a price lower than the fair market value. This was detrimental to the resident shareholders. Interestingly, even due to these pricing restrictions, Foreign Portfolio Investors (FPIs) holding RIL shares increased from 1,318 on 31 March 2020 to 1,395 on 11 June 2020.
In these tough times of COVID-19, when not only economies are shrinking, but the market capitalization of many companies is also shrinking, the amendments made under SEBI Regulations, and the FEMA Rules have undoubtedly created the much-needed opportunity for the companies to bail themselves out. The example of which has already been set by RIL’s achievement of becoming debt-free before its target date. Moreover, the relaxations which were granted permanently are majorly intended to reduce the total time frame of the rights issue, which will attract more companies to opt for a rights issue. Altogether, the relaxations will be financially captivating for the companies, and we can expect to see more of rights issue this year. Although most of the amendments made have been succinct, FEMA (NDI) Second Amendment Rules 2020 remain silent on the situation when a non-resident shareholder renunciates its rights in favor of another non-resident. If the authorities do not roll out any provision addressing the mentioned scenario, then it would not be wrong to assume that the non-resident shareholder might be able to purchase the shares at the original rights issue price, and the price will not have to be set according to the pricing guidelines.
[i] Tushar Chitlangia is a second-year law student at NLUO. For any discussions related to the article, he can be contacted via mail email@example.com. Shivanshu Tripathi is a second-year law student at NLUO. For any discussions related to the article, he can be contacted via mail firstname.lastname@example.org. [ii] Securities and Exchange Boards of India (Issue of Capital and Disclosure Requirement 2018), Regulation 71 (1). [iii] Securities and Exchange Boards of India (Issue of Capital and Disclosure Requirement 2018), Regulation 99. Preferred Citation: Tushar Chitlangia and Shivanshu Tripathi, Analysing Rights Issue process through the lens of Reliance Industries, Arbitration & Corporate Law Review, Published on 28th July, 2020.