SEBI (ICDR) Regulations 2023: A Critical Analysis

A Critical Analysis of the SEBI (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations 2023

Introduction:

Recently the Securities and Exchange Board of India (SEBI) brought the SEBI (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations 2023 (SEBI (ICDR) Regulations 2023), which amend the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (SEBI (ICDR) Regulations 2018). Major changes were made to Regulations 40 and 136 of the SEBI (ICDR) Regulations 2018, which concern underwriting in the event of an initial public offer (IPO) and further public offer (FPO), respectively. These changes appear to be crucial for both the issuers and the intermediaries and have significant regulatory-compliance-related implications. Accordingly, this article presents a critical analysis of the SEBI (ICDR) Regulations 2023 and highlights what compliance-related requirements need to be fulfilled post the publication of SEBI (ICDR) Regulations 2023. The paper focuses mainly on Regulation 40 of the SEBI (ICDR) Regulations 2018, as the provisions of Regulation 136 are the same as that of Regulation 40.

Major Changes Made by SEBI (ICDR) (Second Amendment) Regulations 2023:

IPO Other Than Through a Book-Built Issue

The amended Regulation 40(1) of the SEBI (ICDR) 2018 provides, in relation to an IPO other than through a book-built issue, that the underwriting agreement shall be entered into with the merchant banker or stock brokers registered with the SEBI to cover the risk of under-subscription. The said agreement shall indicate the maximum number of securities that shall be subscribed to either directly by the merchant banker or stock brokers or by procuring a subscription at a predetermined price, which shall not be less than the issue price. The issuer is also obliged to make disclosures related to the underwriting agreement in the prospectus.

Further, Regulation 40(2) makes provisions for the rejected applications and says that an issuer shall enter into an underwriting agreement with merchant bankers or stock brokers. Such underwriting agreement shall provide the number of securities that shall be subscribed to by the underwriters either directly by themselves or by procuring subscription, at a predetermined price which shall not be less than the issue price. Again, a disclosure in relation to the said agreement shall be made in the prospectus.

IPO through the Book-building Process

The amended Regulation 40(3) of the SEBI (ICDR) 2018 provides that the issue, excluding the portion reserved for the Qualified Institutional Buyers (QIBs) under Regulation 6(2), shall be underwritten by lead managers and syndicate members. Regulation 40(3) also requires that the underwriting agreement shall be entered into with the lead managers and syndicate members prior to the filing of the prospectus and it shall provide the number of securities to be subscribed to on account of rejection of bids, either by the lead managers and syndicate members or by procuring subscription, at a price which shall not be less than the issue price, and shall disclose the fact of such underwriting agreement in the prospectus.

Further, it has also been provided that if the issuer desires to have the issue underwritten to cover under-subscription, it shall enter into an agreement with the lead managers and syndicate members on such terms that shall dictate the maximum number of securities to be subscribed to either by the lead managers and syndicate members, at a price which shall not be less than the issue price, and shall disclose the fact of such underwriting agreement in the red herring prospectus. Also, similar to the older provisions, the obligation of the lead manager has been kept more stringent by providing that they shall fulfil the obligations of the syndicate members should they fail to take the agreed number of securities. Besides, none of the two can subscribe to the issue in excess of what is necessary to fulfil the underwriting obligations.

Analysis of the New Amendments in Brief:

Crucial changes have been made by the SEBI in relation to the underwriting mechanism applicable to both the IPOs other than through a book-built issue and the IPOs through a book-built issue. First of all, in relation to the IPOs other than through a book-built issue, the new changes define who is going to underwrite the public issue, which was not the case earlier. The old Regulation 40 of the SEBI (ICDR) 2018 merely stated that the issuer desirous of having the issue underwritten shall appoint underwriters per the SEBI (Merchant Bankers) Regulations 1992. Regulation 2(g) of the SEBI (Merchant Bankers) Regulations 1992 defines the term “underwriter” as any “person who engages in the business of underwriting of an issue of securities of a body corporate.” The new amendments limit the generality of this term in relation to Regulation 40(1) of the SEBI (ICDR) 2018 and provide that the issue shall be underwritten only by merchant bankers or stock brokers. Nevertheless, akin to the old provisions, the book-built issues shall be covered by the lead managers and syndicate members.

Further, while the optional nature of the underwriting, in general, has survived the changes under Regulations 40(1) and 40(3)(c), the wordings of amended Regulations 40(2) and 40(3)(b) make underwriting of rejected applications or bids obligatory on the issuer. The older Regulation 40 did not provide for the underwriting on account of rejected applications or bids. Rather, they focussed only on the issue of under-subscription and equipped the issuer with a mechanism to cover the risk. Therefore, mandating the coverage of rejected applications or bids is a major change in the underwriting framework and is likely to increase the success of the IPOs by ensuring that minimum subscription is achieved even when the applications or bids, as the case may be, are rejected. Further, the new changes also increase transparency in the capital markets by making underwriting-related disclosures mandatory. The older provisions did not require the issuers to make such disclosures in the prospectus or the red-herring prospectus.

Most importantly, the new changes provide that the underwriters shall have the option to fulfil their underwriting obligations either by subscribing to the securities undertaken to be subscribed, including on account of rejections, in their own names or by procuring the subscription of such securities. Accordingly, the merchant bankers or stock brokers may endeavour to ensure that the obligations undertaken by them are fulfilled even if they do not subscribe to the issue directly in their names except what is mandatorily required to be taken by the lead merchant bankers under Regulation 22 of the SEBI (Merchant Bankers) Regulations 1992. Simply put, the merchant bankers, stock brokers, lead managers, and syndicate members are now free to take the initiative on their own and invite third parties to subscribe to the issue, and that subscription by the parties so invited shall be counted towards the fulfilment of their underwriting obligations.

Regulatory Compliance Aspect of the Amendment:

From the regulatory compliance perspective, for the IPOs other than through the book-building process, it is now necessary for the issuer to enter into agreements with merchant bankers or stock-brokers to have the issuer underwritten, provided the issuer desires to cover the risk of under-subscription. On the other hand, for the issues through the book-building process, the issuer shall enter into an underwriting agreement with lead managers and syndicate members to have the issuer underwritten, provided the issuer desires to cover the risk of under subscription. In the case of both the foregoing methods, the issuers must enter into an underwriting agreement with the respective intermediaries (merchant bankers or stock-brokers and lead managers and syndicate members) to have the issue underwritten on account of rejection of applications or bids, as the case may be.

Further, the aforementioned underwriting agreement shall always be entered prior to the filing of the prospectus or red herring prospectus, as the case may be, and the terms of these agreements shall provide the maximum number of securities that shall be subscribed to either in general or on account of rejection of applications or bids, at a predetermined price, which shall not be less than the issue price. The other terms and conditions shall be per the provisions of SEBI (ICDR) 2018 and the SEBI (Merchant Bankers) Regulations 1992. Besides, the prospectus or the red herring prospectus shall disclose the fact of such an underwriting agreement. Also, in the event of a book-built route, at least seventy-five per cent of the net offer reserved for the QIB shall not be underwritten.

Furthermore, the merchant banker, stock brokers, lead managers, and syndicate members have all been permitted to subscribe to the issue either in their own name or procure the subscription of the securities towards the fulfilment of their obligations. Compliance with Regulation 22 of the SEBI (Merchant Bankers) Regulations 1992 states that “the lead merchant banker holding a  certificate under Category I shall accept a minimum underwriting obligation of five per cent of the total underwriting commitment or rupees twenty-five lacs, whichever is less” shall also be ensured. In no event shall the lead managers and syndicate members be permitted to subscribe to the issue in any manner except for fulfilling their underwriting obligations. However, it appears that this restriction shall not apply to the underwriting obligation dealt with under Regulations 40(1) or 40(2) of the SEBI (ICDR) 2018.

Conclusion:

In conclusion, the SEBI (ICDR) Regulations 2023 is a major step taken by the SEBI in making the underwriting framework robust. The major changes include identifying merchant bankers and stock brokers as underwriters for the purpose of Regulations 40(1) and 40(2) and dictating what is expected from them, providing for the disclosure of the terms of the underwriting agreement in the prospectus, giving the intermediaries an option to procure subscription to the issue towards the fulfilment of the underwriting obligation, and mandating the underwriting on the account of rejected applications or bids, as the case may be. These changes are likely to increase the success of the IPOs by ensuring that minimum subscription is achieved even when the applications or bids, as the case may be, are rejected. The amendments also appear to increase the liquidity and transparency in the Indian capital markets and simplify the compliance process by doing away with the uncertainties that paralysed Regulation 40.

Disclaimer:

This is not professional advice. You may not rely on the opinion expressed in this article to make a business or regulatory compliance-related decision. If you are looking for professional advice, please consult a company secretary. Any comments and/or suggestions concerning this article may be sent to shukla_ashutosh@outlook.com.