SEBI Board Meeting Outcome: Tough rules on SME IPOs, insider trades

Strict rules to list small and medium enterprises (SMEs), tight checks on insider transactions, tougher criteria for merchant bankers and easier rules for investment trusts are on the way, with the market regulator approving a series of measures on Wednesday to protect investors and improve ease of doing business.

The biggest measures pertain to SMEs, with new rules aiming to shield vulnerable investors, while ensuring that these companies themselves are on solid financial ground. Investors applying for SMEs' shares in initial public offerings (IPOs) will have to put in a minimum of   ₹2-4 lakh, the Securities and Exchange Board of India (Sebi) said. The regulator hopes this will limit SME IPOs to well-informed investors who can stomach higher risks. Currently, the minimum IPO application amount for SME IPOs is ₹1 lakh. Meanwhile, the SME must have recorded an operating profit of at least ₹1 crore in two out of the last three financial years when filing its draft IPO papers.

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Another crucial change pertains to offer for sale (OFS) by shareholders. SME promoters can collectively sell only 20% of their shareholding in IPO, and no single shareholder can sell more than 50%. Promoters’ holdings above the minimum promoter contribution (MPC) will be subject to phased lock-in periods. Half of the excess promoter holding will be unlocked after one year, while the rest will be unlocked after two years. These measures aim to ensure promoters retain significant shareholdings in their companies even after the IPO.

Aligned with mainboard approach

In terms of allocation, the methodology for non-institutional investors will now be aligned with the approach used in mainboard IPOs, ensuring uniformity in the treatment of such investors.

In a step to limit the potential end-use of IPO proceeds, Sebi introduced a cap on the amount that can be raised for general corporate purposes (GCP). The GCP amount will be restricted to 15% of the total raised amount or ₹10 crore, whichever is lower. The regulator also prohibited SME IPOs that aim to use the proceeds to repay loans from promoters, promoter groups, or related parties.

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To enhance transparency, Sebi mandated that the draft red herring prospectus (DRHP) for SME IPOs must be open for public review for 21 days, during which the public can provide comments. Additionally, SMEs will be allowed to remain listed without migrating to the mainboard, provided they comply with the listing rules governing mainboard companies.

Insider trading rules

In a bid to tighten insider trading regulations, Sebi proposed expanding the definition of unpublished price-sensitive information (UPSI) under the Prohibition of Insider Trading (PIT) Regulations. This comes after a Sebi study showed that companies often fail to classify certain corporate developments as UPSI. The Sebi board approved including 17 more items as UPSI.

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Sebi also included the option for companies to defer the identification of events as UPSI, with a two-day window for updates, along with flexibility in trading window closure requirements.

Merchant banking norms

Sebi also approved a comprehensive revamp of merchant banking regulations, including higher qualification requirements and a stricter net worth threshold. According to the new rules, merchant bankers (MBs), excluding banks, public financial institutions, and their subsidiaries, will only be allowed to engage in permitted activities. Any non-permitted activities must be hived off into a separate legal entity within two years. These entities will operate under a different brand name but may share resources with the parent MB on an arm’s length basis.

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MBs will be grouped into two categories based on their net worth and activities; Category 1 MBs with a net worth of at least ₹50 crore eligible to undertake all permitted activities; and Category 2 MBs with a net worth of at least ₹10 crore, eligible for all permitted activities except managing equity issues on the main board.

Both categories must maintain a liquid net worth of at least 25% of the minimum net worth requirement. Additionally, MBs must generate a minimum cumulative revenue from permitted activities over the last three financial years: ₹25 crore for Category 1 and ₹5 crore for Category 2. Failure to meet revenue criteria may lead to cancellation of its registration.

The underwriting limit for MBs has also been increased to 20 times their liquid net worth, providing more flexibility for these institutions to take on underwriting roles.

REITs and InvITs

Sebi also approved measures aimed at facilitating the ease of doing business for Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs). One key proposal permits the inter-se transfer of locked-in units within the sponsor group, making the process more flexible. Additionally, the definition of “common infrastructure” will be incorporated into REIT Regulations to clarify what constitutes shared assets.

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REITs and InvITs will also be allowed to invest in unlisted equity shares of companies providing property management, maintenance, housekeeping, project management, and other services to the trust’s assets, subject to specific conditions. The Sebi board also streamlined rules for Small and Medium REITs (SM REITs) by standardizing disclosures in scheme offer documents and facilitating easier processing for public issues of units.

PaRRVA

To enable persons regulated by Sebi, or their agents, to market their services to investors using risk-return metrics, the regulator approved a Past Risk and Return Verification Agency (PaRRVA). The agency will verify the risk-return metrics associated with the services of such persons or their agents. A Credit Rating Agency (CRA) will act as PaRRVA, with a recognized stock exchange serving as the PaRRVA Data Centre (PDC).

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PaRRVA will be responsible for verifying the risk-return metrics for Investment Advisors (IAs), Research Analysts (RAs), Algorithmic Traders, and other entities permitted by Sebi to offer these services. Initially, PaRRVA will operate on a pilot basis for a period of two months.