SEBI’s Public Float For Private Unlisted InvITs – Regulatory Overreach

Just as unlisted InvITs became the flavour, SEBI has significantly eroded the very idea & lucrativeness with its recent amendments

<div class="paragraphs"><p>Workers labour on reinforcing steel at a flyover construction site in Patna. (Photographer: Anindito Mukherjee/Bloomberg)</p></div>
Workers labour on reinforcing steel at a flyover construction site in Patna. (Photographer: Anindito Mukherjee/Bloomberg)

Infrastructure development has been one of the focal points for the Narendra Modi government. The infrastructure sector in India has historically failed to attract large offshore capital because of various systemic reasons – one of which being the lack of a well-governed tax optimal investment structure.

To address this, after years of deliberation, the Securities and Exchange Board of India introduced infrastructure investment trusts allowing for a SEBI governed tax-optimised investment regime. InvITs could be public or privately listed. One of the challenges that even private listed InvITs faced was that key private communication between the manager and the sponsor or the investors had to be publicly disclosed. Despite being private in nature, private listed InvITs had to comply with regulations around leverage, investments, number of unitholders, etc., akin to publicly listed InvITs.

To provide a more flexible regime for sophisticated investors, SEBI introduced the concept of ‘unlisted’ InvITs.

At the heart of it, unlisted InvITs achieved two important objectives:

(a) a tax-optimal investment regime for global investors; and

(b) SEBI oversight (to inspire investor confidence) with light-touch regulations.

Once the tax benefits were aligned between listed and unlisted InvITs, the latter became the most preferred asset-monetisation vehicle for all developers and investors.

Within a short span of time, the industry has already witnessed two large unlisted InvITs.

Just as unlisted InvITs became the flavour, SEBI has significantly eroded the very idea and lucrativeness of unlisted InvITs with its recent amendments.

Effective August 2021, SEBI prescribed that every unlisted InvIT must have

  • A minimum of five distinct unitholders other than the sponsor, its related parties, and its associates; and

  • Such five unitholders must hold at least 25% of the total InvIT units.

These amendments strike at the core of the unlisted InvIT regime for the following reasons.

Counterintuitive Amendments

Legislative ‘certainty’ is the cornerstone of any new mergers and acquisitions vehicle.

Unlisted InvITs were introduced just a couple of years ago after several deliberations and therefore, investors were naturally expecting the broader legal landscape to remain unaltered. To impose a minimum ‘public’ (persons unrelated to promoter/sponsor are generally referred to as public) float in an unlisted vehicle not only appears counterintuitive but destroys the vestiges of regulatory predictability that foreign investors expect.

Such drastic regulatory flip-flops can be devastating – especially when the government is unveiling multiple programmes simultaneously to attract investments into the infrastructure sector.

Intent And Amendment Misaligned

SEBI’s amendments were premised to achieve the following purposes – to discourage sponsors from setting up unlisted InvITs which are driven by tax incentives, but do not result in either of (a) fresh capital infusion, (b) monetisation of assets, (c) development of infrastructure, or (d) repayment of existing domestic debt.

It seems that the Ministry of Finance was keen to proscribe structures aimed at exploiting the tax benefits without ‘true asset monetisation’ being achieved.

The simplest solution in such a scenario would have been to mandate that every unlisted InvIT, which fails to fulfill the purposes sought to be achieved by the amendment, will be disallowed from claiming the tax benefits. However, prescribing public (non-sponsor-related) float requirements without adequate industry consultation disturbs the paradigm of regulatory predictability that forms the foundation of foreign investor sentiment. SEBI’s amendment, in fact, encourages ‘innovative’ structuring by which the mere letter of the law is complied with but achieves very little practical benefit.

‘Unrelated’ Ambiguity

The SEBI amendment defines “related parties” and “associates” of the sponsor relationship in the widest possible manner. The terms draw their meaning from the definition of the Companies Act 2013 and applicable accounting standards, which define the term in the context of ‘significant influence’. A mere appointment of an investor director on the sponsor could result in the investor being qualified as an associate of the sponsor. The broad ambit of the terms has created interpretational uncertainty, leaving the door wide open for regulatory misinterpretation. SEBI should, in line with its general practice, initiate industry-wide consultations before enacting such all-pervasive legislation that disturbs deal-making equilibrium and has far-reaching implications.

Presumption Of Abuse

To begin with, given the capital-intensive nature of the infrastructure sector, only a select pool of large global fund-houses have the ability to commit patient capital. In most cases, such capital was coming through sovereign wealth funds and pension funds that invest patiently under the so-called ‘social license’. At least such investors, known for their stature and ethics globally, should be treated differently.

However, in one stroke, SEBI has coloured all investors with the same brush and mandated every investor to find other like-minded co-investors in order to set up unlisted InvITs, which can sometimes be difficult.

Grandfathering Omitted; Sub-Optimal Compliance Timelines

Existing InvITs are required to find new unitholders within a six-month grace period.

First, SEBI’s reluctance to grandfather existing legitimate structures (which have already fulfilled the purposes of the amendments) is an egregious exception to the well-accepted principle of ‘legitimate expectation’ and should be re-assessed.

Second, considering the high valuations of the existing InvITs and the current global outlook, SEBI should consider a longer grace period since the introduction of new independent investors will need to be effected carefully and could be time-consuming.

Overall, while SEBI’s objective with the amendment appears to address a tax abuse concern (i.e. developers rolling over assets to self-owned InvITs), it unsettles the foundational principles of unlisted InvITs on several counts.

The unlisted InvIT regime was introduced in the first place as a regime for sophisticated investors and private ownership of assets. To muddle the regime now with a public float requirement is unlikely to send the right signals to the global investor community. SEBI and the Ministry of Finance should consider realigning the amendments such that the objective of preventing tax abuse is achieved without disturbing the nuts and bolts of the existing unlisted InvIT framework.

Ruchir Sinha is Partner and Head-Mumbai; Shreyas Bhushan is Senior Associate; at Touchstone Partners. Both have advised several investors in the InvIT space.

The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.