SEBI Compliance Rules for InvITs & REITs

The Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) – SEBI LODR – were amended by the Securities and Exchange Board of India (SEBI) to clarify that the provisions mentioned therein shall not be applicable to Infrastructure Investment Trusts (InvITs) and Real-Estate Investment Trusts (REITs).

The REITs along with InvITs are together known as ‘Investment Trusts’.

It should also be noted that the SEBI (Infrastructure Investment Trusts) Regulations, 2014 (‘InvIT Regulations’), and the SEBI (Real Estate Investment Trusts) Regulations, 2014 (‘REIT Regulations’) shall need Investment Trusts to comply with certain governance norms.

Post this, in February 2023, SEBI notified the Securities and Exchange Board of India (Infrastructure Investment Trusts) (Amendment) Regulations, 2023 and the Securities and Exchange Board of India (Real Estate Investment Trusts) (Amendment) Regulations, 2023 to dictate certain governance norms that shall, thereafter, apply to Investment Trusts.

Changes Introduced by Amendments (14 February 2023)

What is the Term of Auditors?

After the 2023 amendments, the audit structure of Investment Trusts has been brought in line with that of listed companies. The key amendments include the following:

• The appointed statutory auditor can be an individual or a firm and shall hold the position for a five-year period.
• While the individual auditor’s term shall be five years, the firm appointed in the same role shall hold the position for two terms of five years.
• A five-day period shall be available after the culmination of each term to help cool down.

SPV/ Holdco Financial Statements to undergo Limited Reviews

A limited review of the audit of all the entities/companies that are going to be consolidated with the Investment Trusts must be conducted by the Auditors (i.e., special purpose vehicles - ‘SPV’ and Holdcos of the Investment Trust), as per the applicable Standards for Indian Accounting. As such, additional safeguards have been put in place in the regulations, while keeping the investors’ interests in mind. This has been done to account for circumstances auditors of Investment Trusts as different from the legal auditors of one or more SPVs/Holdcos.

How is Debt Leverage of Investment Trusts Computed?

The combined borrowings and deferred payments of listed REITs and InvITs, net of cash and cash equivalents, are barred from being more than 49% and 70% of the value of the Investment Trust’s assets, respectively.

It is prohibited for the consolidated borrowings and deferred payments of listed REITs and InvITs, net of cash and cash equivalents, to exceed 49% and 70% of the value of the Investment Trust's assets, respectively. In accordance with the Amendments, the following has been clarified:

• The investments of Investment Trusts in overnight mutual funds shall fall under cash and cash equivalent.
• The total amount of cash and cash equivalent must be excluded when calculating the assets’ value of the Investment Trust.

What is the scope of ‘Change in Control’?

Considering the scope of the term ‘change in control’ has certain limitations under the InvIT Regulations and the REIT Regulations, SEBI aimed to create a more harmonized meaning of the term ‘change in control’ to individually cover:

• Listed companies & listed body corporates and linked them to the definition of ‘control’ under Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
• Unlisted companies/unlisted body corporates and linked them to the definition of ‘control’ under the Companies Act, 2013.
• The ambit of this term has been widened for entities apart from body corporates to include change in their legal structure/ownership or change in the controlling interest of not less than 50% voting rights or interest. The aim of the Amendment was to broaden the scope of the term ‘change in control’ and bring entities like trustees of Trusts, sponsors of Trusts, etc. within its coverage.

Directions in relation to Unclaimed or Unpaid Distributions

Any amount that stands unclaimed or unpaid out of the investments declared by an Investment Trust must compulsorily be transferred to the ‘Investor Protection and Education Fund’ that has been created by SEBI.

What are the changes applicable from 1 April 2023?

Requirements related to Independent Directors

Independent directors must make up 50% of the Boards of Investment Trusts. However, the Regulations for REITs and InvITs did not define what makes a director an ‘independent director’ before the 2023 Regulations.

While listed Investment Trusts willingly follow the tests for independence prescribed under the ‘LODR Regulations’ as a guiding criterion, the 2023 Amendments have added the definition of ‘independent director’ and aligned the tests of independence for Investment Trusts with the LODR Regulations.

Following are some key considerations:

• Independent Directors must pass independence tests, including proving they do not have any financial relationship or conflict of interests. They must also have the required skills to hold the position of an independent director.
• Entities that must go through the test include the Investment Trust, the Holdco/SPV, and the parties to the Investment Trusts (and its holding company, subsidiary, or associate, along with their directors/promoters). Compared to the tests of listed companies, the independence tests for Investment Trusts are significantly more expansive as the parties to the Investment Trust consist of the sponsor(s), sponsor group (applicable only to a REIT), trustee, manager/investment manager, trustee, and project manager (applicable only to an InvIT).
• The parties to Investment Trusts also includes ‘Trustees’ of the Investment Trusts.
• Considering that some of the independence criteria shall be required to be tested at the level of the holding company and associates of the Trustee, it will be crucial to view the independence criteria from a Trustee’s perspective as the REIT and InvIT Regulations demand Trustees to be independent entities who have no relation with the sponsor(s) or the investment manager/manager.

Terms to be used vis-à-vis LODR Regulations (Investment Trusts)

While the 2023 Amendments changed the applicability of certain terms of the LODR Regulations and made them applicable to Investment Trusts, the amendments also brought clarity to the following substituted terms for the purpose of interpreting the norms under LODR Regulations in the context of Investment Trusts:

Promoters:

• Under InvIT Regulations: Parties to InvITs
• Under REIT Regulations: Parties to REITs

Listed Entities

• Under InvIT Regulations: InvIT or the InvIT’s investment manager
• Under REIT Regulations: Manager of the REIT

Company Secretary:

• Under InvIT Regulations: Compliance Officer
• Under REIT Regulations: Compliance Officer

Executive Directors:

• Under InvIT Regulations: A Non-independent Director
• Under REIT Regulations: A Non-independent Director

Non-Executive Directors:

• Under InvIT Regulations: Independent Directors
• Under REIT Regulations: Independent Directors

Listed Entity’s Board of Directors:

• Under InvIT Regulations: Investment manager’s Board of Directors
• Under REIT Regulations: Manager’s Board of Directors

Listed Entity’s Subsidiary:

• Under InvIT Regulations: Holdco and/or SPV of the InvIT (whichever may be applicable)
• Under REIT Regulations: Holdco and/or SPV of the REIT (whichever may be applicable)

Implications of Applicability of Provisions under LODR Regulations (Investment Trusts)

Committees

The Board of Directors of the investment manager/managers of Investment Trusts must include:

• An auditing committee,
• A nomination and remuneration committee,
• A stakeholders relationship committee,
• A risk management committee (as per the 2023 Amendments).

The 2023 Amendments provide that Investments Trusts shall be subject to other provisions of the LODR Regulations related to the constitution, quorum, frequency of meeting, and the role of such committees.

Independent Directors

Tenure, Appointment and Removal As per the Companies Act, 2013, the term for an independent director is five years, which can be extended for another term of five years. In addition, a specific resolution must be used to appoint, reappoint and to remove any independent director. The language clarifies that a special resolution that has the approval of the shareholders of the investment manager/manager shall be required to appoint, reappoint or remove an independent director. Besides, the proviso to regulation 25(2A) of the LODR Regulations notes that special resolution shall be considered approved, even if they do not have the required majority of votes, if: more votes have been cast in favor of a resolution as compared to those cast against it, and more votes are cast in favor of the resolution by public shareholders as compared to those against it.

Independent Directors' Meeting Independent directors must hold at least one meeting every financial year without the presence of any independent directors and managing members to review the performance of non-independent directors and the board of directors of the investment manager/manager as a whole.

Independent Directors’ Liability Independent directors shall only be held liable for any action or inaction that occurs with their consent or knowledge and also if they fail to act diligently.

Director, KMP, Senior Management & Employee

Committee Membership Restrictions

As per the Listing Regulations, a director is not permitted to be a member of more than 10 committees or a chairperson of more than 5 committees across all listed companies where they hold a director’s position, provided that the limit does not consider:

• Private, international, publicly traded firms with large debt values, companies covered by Section 8 of the 2013 firms Act, or

The chairmanship/membership of any committee other than the audit or stakeholders' relationship committees.

Under the recent amendments, this obligation is now applicable to Investment Trusts too. However, considering the explanations stated by the Amendments about the replacement of defined terms, specifically ‘listed entities,’ there is a need for more clarity with respect to how the same should be implemented for Investment Trusts.

Compensation or Profit-Sharing Arrangements

Under this Amendment, another crucial provision that shall be applicable to Investment Trusts w.e.f. 1 April 2023 is the restriction on employees from entering into any agreement related to compensation or profit sharing.

Although upside sharing agreements have been duly tested in listed companies, the unique holding and governance structures of Investment Trusts along with the guidance already provided under the Amendments pertaining to the interpretation of the term ‘listed entity’ shall demand for significantly more attention and thorough analysis before applying the provision for the same to current and future contracts.

Board Composition, Quorum & Meetings  

Previously, under the REIT Regulations and the InvIT Regulations, half of the investment manager/manager's board of directors were required to be independent.

Post-amendment, the following requirements must be met by the investment manager/manager: The Board Meeting Quorum shall comprise of one-third of the Board’s total strength or three directors, whichever may be higher. It is also imperative for this quorum to include at least one independent director. At least six directors, one of whom must be a woman, shall form a Board. Bare minimum details must be shared with the Board, including annual operational strategies, capital budgets, etc.

Compliance Requirements

The additional compliance necessities imposed under the 2023 Amendments include:

• Compliance report to review whether there has been compliance with laws applicable to Investment Trusts and if any steps were taken to ensure the same.
• Within 60 days of the end of any financial year, a Secretarial Compliance Report must be submitted to the stock exchange every year. This report must be duly prepared by a practicing company secretary and should adhere to a specific format.
• On a quarterly basis, a Corporate Governance Compliance Report must be submitted to the stock exchanges in the predefined format.
• The Chief Executive Officer, the Chief Financial Officer and the Compliance Officer must share a compliance certificate pertaining to the financial statements of Investment Trusts and internal controls with the Board of the investment manager/manager.

Vigil Mechanism & Whistleblower Policy

In order to allow Directors and employees to reach out in case of genuine concerns, Investment Managers must create certain monitoring systems, for example, a whistleblower program. The 2023 Amendments state that the Audit Committee shall be obligated to review the working of vigil mechanisms. It further notes that such mechanisms may be provided or managed by independent service providers, who will report to the Audit Committee.