SEBI Chooses Its Favourite Buyback Route

SEBI has come out with a consultation paper on Nov. 16, 2022, on “Review of SEBI (Buyback of Securities) Regulations, 2018”. The changes proposed are quite extensive in nature and, if approved, would bring about major changes in the regulatory framework for buybacks in India.

Even though the Securities and Exchange Board of India has been tweaking its buyback rules, ever since they were first notified in 1998, including by bringing in a new set of regulations in 2018, there has never been any policy changes to the theme which has continued from 1998.

The proposed changes come from the recommendations of a sub-group formed by SEBI, overseen by SEBI’s Primary Market Advisory Committee. 

Buybacks largely occur under either of the two routes—through open market, which can be through stock exchanges or book building, or through tender offer. Given that changes are being proposed to both routes, the Consultation Paper deals separately with each route.

Some of the more important and impactful proposals are discussed below.

Glide path: Buybacks under the open market through stock exchange route are, as per SEBI, prone to a greater degree of misuse.

Given that management of a company, in a way, has unfettered powers when it comes to undertaking a buyback under this route, especially on size and price, there is a significant lack of certainty and transparency.

For this reason, the Consultation Paper proposes that this route be phased out in the next three years and be replaced with a framework which will involve a separate window on the stock exchange. It also proposes certain guardrails until this route is done away with, by progressively reducing the max buyback size and decreasing the number of days for which the buyback can remain open.

Even though the Consultation Paper is silent on what the ‘new separate window’ for this route would actually involve, it appears that the primary reason behind this is to make it clear whether shares are being sold back to the company or just to another buyer. Knowing this would have an impact on tax computation for the shareholders, since buyback under this route are currently done on the normal trading window of the stock exchanges where details of the buyers or sellers, for that matter, are unknown.

Following is the proposed phase out plan:

SEBI has also proposed to change the minimum amount that is utilised for a buyback from the current 50% of the amount earmarked to 75%, while ensuring that at least 40% of such amount is utilised within the first half of the period for which the buyback is open. The stated reason here is to discourage companies from announcing buybacks with no real intention to use the full amount. 

Eligibility, volume and pricing: Another important change being proposed is to limit this route to only those companies whose shares are ‘frequently traded’, since market price of shares which are not frequently traded would not be reflective of the true value of such shares. This proposal is followed by another which places a limit of the buyback price, linking it to current published price or last reported sale price, whichever is higher. 

Other changes: There are also some procedural changes, including relating to escrow account. As per the proposal, shares, G-securities and units of certain mutual funds would also be allowed to be used to fulfil escrow obligations, in addition to the existing cash and bank guarantee. 

While SEBI has clearly signaled its reservations on the open market through stock exchange route, as is evident from the changes it has proposed, it seems to favour buybacks though tender offers and has proposed changes that will make undertaking a buyback under this route less time-consuming and more cost-effective. 

No SEBI review: One of the most important proposals for this route has been to dispense with the SEBI review process for the letter of offer. Under the current framework, much like the review of prospectuses, SEBI reviews the draft letter of offer and gives comments which are incorporated in the final letter of offer sent to shareholders. It is now proposed to do away with this requirement and only continue with the existing certificate from the merchant bankers certifying compliance with the Buyback Regulations.

Even though the Buyback Regulations require SEBI to give its comments within seven working days, this clock gets reset every time SEBI asks for clarifications. It is typical for SEBI to take anywhere between three to six weeks to complete its review. Cutting SEBI’s review out will help reduce the time taken for a buyback and given these are listed entities making regular disclosures to the public, SEBI’s review process would not be missed. 

Buyback size and cooling off: It has been proposed to increase the buyback limit of 25% of paid up share capital and free reserves, to 40%. Since the requirement also comes from the Companies Act, SEBI would have to make representation before the Ministry of Corporate Affairs to carry out corresponding changes in the Companies Act for this to take effect.

It is also proposed to allow companies, which are ‘net debt free’, to undertake more than one buyback through tender offer route within a financial year, with a minimum six-month gap between the two and subject to some other requirements.

Currently, no company can undertake a buyback unless it has undergone a cooling off period of 12 months between two buybacks. 

Other changes: It has also been proposed to give greater flexibility to companies by allowing the board to revise the buyback price (and consequently reduce the number of shares being bought back, without changing the size) till the opening of the buyback.

Currently, no revision in the buyback price is allowed. There are also changes proposed to be made to the escrow mechanism in line with those proposed for the open market route. 

The Consultation Paper also sets out a revised mechanism for buybacks undertaken though the open market through book-building route. This route has invoked little interest in the past and has been rarely used by companies.

With a view of making it more desirable, SEBI has proposed a host of new changes ranging from timelines to pricing. SEBI is also proposing to do away with the 15% limit on buybacks under this route while also restricting promoter participation under this route.

Some other changes proposed by SEBI include (i) including stock appreciation rights, like ESOPs or employee stock options, under the definition of ‘specified securities’, (ii) doing away with the defunct ‘buyback from odd-lot holders’ method, and (iii) mandating disclosure of lender consent requirement in the public announcement/letter of offer. 

On taxation: With effect from July 2019, buybacks have been taxed to the listed company as opposed to in the hands of the shareholders. This according to SEBI’s analysis, has created a situation where companies are paying disproportionately higher tax for the benefit of promoters.

In their analysis of 19 companies, out of a total tax of Rs 29.9 billion paid by these companies, Rs 27.3 billion was paid for shares tendered by promoters.

To fix this, SEBI has proposed to the government to shift the incidence of tax on buybacks from the company to the hands of the shareholders. Even though many factors play into why a company decides to undertake a buyback, there is no denying that a favourable tax regime has been an important factor. Any reversal of this is likely to result in a reduction of deal size and volumes. 

There is no doubt that these changes will have the effect of rewriting the regulatory framework for buybacks. The Consultation Paper makes it evident that SEBI is trying to walk a tightrope when dealing with buybacks.

On the one hand, it, of course, wants to ensure that buybacks are not used for market manipulations, as is evident from the proposed phasing out of stock exchange route, for example, but on the other hand, it also wants to encourage transparent methods like tender offer and book building, evident from the many concessions proposed for these routes.

There are also some ambitious changes, such as increasing the buyback limit to 40% from the current 25%, which will need amendments to the Companies Act.

From experience, changes to the Companies Act often come with a lag. Even though the changes under the Consultation Paper are sweeping and reflect many major policy shifts, one must keep in mind that these are still proposals, and the final changes could very well be a bit tamed. The point on taxation, however, remains critical, and may end up deciding the future of buybacks in India.

Manan Lahoty and Manshoor Nazki are partners in the capital markets team of IndusLaw.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.