Introduction
The synergy amongst the employees, investors and the management are the foremost concern of any listed corporation. The principles of corporate governance stemming from Berle-Dodd debate, aim to balance the requirements of both shareholders and stakeholders. In terms of investments, the companies in the manufacturing sector, prefer equity trade, bank loans and initial public offerings. While service sector companies rely more on Investment Managers (‘IMs’) to raise capital. For businesses that lack access to traditional finance sources, impetus is given by ‘Investment Trusts’ institutions. Therefore, from the lens of investor protection, stakeholder management in these trusts are of vital importance. India has noted an upsurge in the Real Estate and Infrastructure deals, and investments from them. This article aims to cover the critical analysis of developments in the Real Estate Investment Trusts, in sync with the recent consultation paper released by SEBI on 9 December, 2023.
Page Contents
Understanding the nature of REITs
A ‘Real Estate Investment Trust’ (‘REIT’), is a type of investment vehicle that is formed as a trust under the Indian Trusts Act, 1882 and registered under the Registration Act, 1908. A trust, according to the Indian Trusts Act, 1882 is ‘an obligation tied to property ownership. The owner of the trust creates the obligation, which is accepted by the property owner and owed to the beneficiaries named in the trust document.’[1] In the context of a REIT, the trust is established by the sponsor, the property is owned by the REIT, and the beneficiaries of the trust are the REIT unitholders.[2] The Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014 (collectively, ‘REIT Regulations’), govern the aspects with respect to the REITs. As per regulations, ‘Real estate’ comprises ‘land and any permanently attached improvements to it, whether leasehold or freehold, but excludes mortgages’.
The Regulations draw a clear distinction between, ‘Real Estate’ and ‘Infrastructure’, though exceptions have been made with respect to ‘(i) hotels, hospitals, and convention centres forming part of composite real estate projects, whether rent-generating or income-generating’; and ‘(ii) common infrastructure for composite real estate projects, industrial parks, and SEZs’. Infrastructre investments are regulated under, the Securities and Exchange Board of India (Infrastructure Investment Trusts) Regulations, 2014 (collectively, ‘InvIT Regulations’), and altogether REITs and InvITs are referred to as ‘Investment Trusts’.
Disclosures with respect to REITs, and a gradual shift from SEBI LODR norms
The Securities and Exchange Board of India (‘SEBI’) notified changes (the “February 2023 Amendments”) to the REIT Regulations and the InvIT Regulations on February 14, 2023. These amendments codify the regulatory norms applicable to Investment Trusts. The REIT Regulations and the InvIT Regulations, prior to the February 2023 Amendments, mentioned certain governance requirements, such as ‘appointment of a compliance officer’ and the appointment of independent directors in investment management of an InvIT/ REIT.
In practical sense this governance mechanism, acted in contravention to the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR Regulations’). As LODR Regulations serves a guiding factor for all the listed entities in India, some Investment Trusts voluntarily followed the requirements outlined in the LODR Regulations as a good governance strategy; nonetheless, the practice was not uniform.
Addressing this issue, on January 17, 2023, the LODR Regulations were amended to specify that governance criteria of LODR Regulations will not apply to Investment Trusts.[3] The February 2023 Amendments, clarify that at present, REITs and InvITs which are HVDLEs (i.e.‘REITs and InvITs which has listed debt securities of Rs. 500 crore and above’), are required to comply with corporate governance norms given under Reg. 15-27 of LODR. The regulatory watchdog assured that, in near future each Investment Trust will have separate Corporate Governance norms. Until then, the norms listed out in SEBI LODR, will not be applicable to any Investment Trust from April 1, 2023.
Draft Consultation Paper On REITs- Opinion
The treatment of employees and stakeholder holds the foremost position in the governance of a company. In this direction, on 9 December, 2023, SEBI released a consultation paper on Framework for Issuance of Subordinate Units and Unit Based Employee Benefits (UBEB) to REITs and InvITs.
The Consultation Paper outlines a proposed framework for two distinct for public feedback on: (a) the issuing of subordinate units by InvITs and REITs to sponsors, their associates, and the sponsor group; and
(b) the UBEBs to employees of the Investment Manager of InvIT and Manager of REIT.
It is to be noted that both Regulation 4(2)(h) of REIT Regulations and Regulation 4(2)(g) of InvIT Regulations, covers the common factor that all unitholders should have equal rights. However, there is no existing framework describing the process for issuing subordinate units. Furthermore, currently, the regulations prohibit the Manager of REIT/Investment Manager of InvIT from purchasing the Infrastructure Trusts units, in order to provide incentives to its staff that are contingent upon the acquisition of such units.
Key points proposed under framework pertaining to subordinate units:
(a) To be issued only to the sponsor(s), its associates and sponsor group which would have only inferior rights compared to the ordinary units which can be issued either in the initial offer or subsequent offer (this would require approval from 75% of the unit holders;)
(b) The subordinate units will be unlisted and carrying a separate ISIN and will be issued only in dematerialized form;
(c) Mandatory lock in till the time these units get converted to ordinary units and / or are extinguished;
(d) However, for the purposes of mandatory minimum unitholding requirement applicable to sponsor(s) and sponsor group, these will not be considered
(e) There should be a minimum time gap of one year, between issuance of subordinate units and entitlement date/event for conversion of subordinate units to ordinary units.
(f) converted units shall be listed and tradeable on the stock exchanges on the receipt of approval from the stock exchanges.
Key points proposed under the framework pertaining to Unit Based Employee Benefits (UBEB)
(a) Implementation of the UBEB scheme to be done through a separate Employee Benefit Trust
(b) Manager may subscribe to units in lieu of management fees for the purpose of UBEB and this issuance of units in lieu of management fees shall be approved by seventy five percent of unitholders
(c) units held by EB (‘Employee Benefit’) Trust shall be used only for the limited purpose of providing unit-based employee benefits and the trust ought not to transfer or sale of units of REIT/InvIT held by it except for providing unit-based benefits to the employees of the Manager/Investment Manager.
(d) SEBI has also clarified that the provisions of PFUTP Regulations and Insider Trading Regulations will be applicable to the Manager / Investment manager, its directors, its key managerial personnel, recipients of UBEB, EBTrust, etc.
Opinion with respect to the Corporate Governance Aspects in light of recent amendments
In its efforts to formulate a proper governance structure, on 17 August 2023 the regulator introduced the SEBI (REITs) (Second Amendment) Regulations 2023 and the SEBI (InvITs) (Second Amendment) Regulations 2023 (collectively, ‘August 2023 Amendments’). Through the amendments, Regulations 4(2)(g) and 4(2)(h) of the REITs and InvITs regulations respectively, grant qualified unitholder(s) the ability to designate one unitholder nominee director to the board of directors of investment managers (IMs). The methodology was elaborated on similarly worded circulars dated September 11, 2023.
The nominee directors are equipped with a dual role as a representative and as director. This often leads to situations where he expresses dilemma about his position, which was discussed by Supreme Court in TCS v. Cyrus Investments, “while a nominee director is entitled to take care of the interests of the nominator, he is duty bound to act in the best interests of the company and not fetter his discretion.”. Additionally, the Kotak Committee report, also highlights that employees and stakeholders should be at the top of the priority of every management.
When considered all factors in a cumulative manner, the proposed framework under the consultation paper looks thorough and covers a number of significant issues of employee protection. The path traversed by SEBI to govern REITs, emphasises on management accountability and transparency and aims to balance staff incentives with general trust interest. This engine needs to be fuelled by the establishment of a distinct EBTs and employee centric procedures to receive REIT or InvIT units. SEBI also needs to shed light upon the regulatory discrepancies as it only allows for unit issuance once a year, within sixty days of the completion of the annual valuation exercise. This appears to be excessive, especially in rapid real estate market fluctuations, which will potentially resulting in the EBT acquiring the unit at a higher price than market value.
Conclusion:
In conclusion, even while amendments and recent consultation papers by SEBI are a step in the right direction toward enhancing corporate governance, they also provide a fresh set of difficulties and regulatory conundrums for REITs and InvITs. Unitholder nomination (‘Nominee’) directors and eligible unitholders must assume their duties with the utmost responsibility, transparency, and dedication to safeguarding the interests of all stakeholders. In order to appropriately address the governance concerns, it may be necessary to further modify these laws in the future, in keeping with objective to strike a balance between representation and governance.
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