[Uddhav and Prakhar are students at NALSAR University of Law.]
In today’s corporate world, operating through subsidiaries and associates is common, driven by corporate strategy or regulatory requirements. While listed subsidiaries are under the scrutiny of the Securities and Exchange Board of India (SEBI), the parent company’s board must oversee unlisted subsidiaries to protect public shareholders’ interests. The board should consider all entities under the corporate umbrella. Since subsidiaries use the parent company’s resources, their activities directly impact the parent company.
The SEBI is undertaking a significant initiative to review and standardize disclosures within conglomerates comprising both listed and unlisted entities, subsidiaries, and other related parties. As detailed in SEBI’s 2022-23 annual report, new regulations will require more detailed group-level disclosures, particularly focusing on financial transactions, cross-holdings, and material financial dealings within the conglomerate. This includes mandatory annual reporting to provide a clearer and more comprehensive picture of the financial health and interdependencies within conglomerates.
The urgency of these reforms is underscored by the Adani-Hindenburg controversy, which has brought to light significant issues in conglomerate disclosures. Allegations against the Adani Group involved non-transparent offshore investments and related-party transactions. SEBI’s investigation found critical shortcomings in the group's disclosure practices, including failure to properly disclose affiliations with various foreign entities, potentially used to manipulate share prices. This raised serious concerns about the group's transparency and financial integrity. Despite clear necessities, India currently lacks a comprehensive framework to address these issues.
This article examines the regulatory frameworks in the United Kingdom (UK), and South Korea, and the principles outlined in International Organization of Securities Commissions (IOSCO) reports, highlighting how these international standards provide more rigorous oversight and transparency. By analyzing India's existing regulations, the article reveals significant inadequacies and proposes a new mechanism to enhance regulation, ensuring better protection for investors and market stability.
Global Regulations and International Guidelines for Conglomerate Disclosures
Foreign regulatory frameworks
The United Kingdom
The regulatory environment for financial conglomerates in the UK is structured to ensure comprehensive oversight and transparency in their financial reporting and risk management practices. There are various regulations governing disclosure requirements to maintain market integrity and investor confidence.
A 'financial conglomerate' is a consolidated group of companies identified under the General Prudential Sourcebook (GENPRU) 3. This includes a variety of financial entities consolidated for regulatory purposes to ensure that risks are managed at a group level.
The Guidance on Risk Management, Internal Control, and Related Financial and Business Reporting provides that all reporting for groups of companies in the UK should be from the perspective of the group as a whole. The board must explain how it assesses and manages the risks associated with investments in significant joint ventures and associates. If the board lacks access to detailed information and oversight of these entities' business planning, risk management, and internal controls, this fact must also be disclosed.
The UK's Disclosure Guidance and Transparency Rules (DTR), issued by the Financial Conduct Authority and applicable to financial conglomerates among other entities, mandate that issuers must provide adequate information to investors, enabling them to make informed decisions and maintain market integrity.
DTR 2 focuses on the disclosure and control of inside information, mandating issuers to disclose information promptly unless delayed disclosure is justified to protect legitimate interests and does not mislead the public, transparency must be maintained regarding significant developments affecting any part of the group.
DTR 4 (4.1.3-4.1.5) deals with periodic financial reporting, stipulating that annual financial reports must be published within 4 months of the financial year-end and remain publicly available for at least 10 years. These reports must include audited financial statements, a management report, and responsibility statements.
Additionally, DTR 4.1.6 mandates that issuers must prepare consolidated accounts following the UK-adopted International Financial Reporting Standards (IFRS), reflecting the financial position of the entire group. DTR 4.2.8 and DTR 7.3 provide that issuers must disclose any related party transactions from the first 6 months of the current financial year that materially affect the enterprise's financial position or performance, as well as any changes from the last annual report that could have a similar impact in the current financial year.
South Korea
The South Korean government mandates large business groups to disclose their ownership structure under the Monopoly Regulation and Fair-Trade Act. Articles 11(2), (3) and (4) of the Act mandate specific disclosure requirements for business groups including the status of member companies’ shareholdings, cross or circular shareholdings, and debt guarantees. Additionally, a special committee has proposed that the controlling shareholder should disclose any shareholdings or circular shareholdings that overseas affiliates have in domestic affiliates, whether directly or indirectly. Moreover, significant matters concerning unlisted companies must be promptly disclosed, and regular updates on the business group's status must be provided.
International guidelines
IOSCO
The IOSCO Resolution on the Supervision of Financial Conglomerates, passed by the Presidents’ Committee in October 1992, represents a pivotal set of principles for the supervision of financial conglomerates (with the latest set of principles issued in September 2012 in Basel, Switzerland). Although these principles are not binding, they serve as guidelines to enhance regulatory practices globally. They are crucial guidelines endorsed by a coalition of regular member organizations from diverse jurisdictions, including India and many other countries.
While India has endorsed these principles, it is important to note that this endorsement does not equate to incorporating them into a specific disclosure framework, as India does not currently have such a framework in place. These principles emphasize a robust regulatory framework that supports comprehensive group-based risk assessment, particularly concerning intra-group exposures and the structure of financial conglomerates. They guide supervisors on assessing risks posed by the entire conglomerate, ensuring effective risk management and regulatory compliance across the group. The principles cover key areas such as investments in other group companies, management standards, supervisory cooperation, and the role of external auditors in group-based risk assessment.
Key to these principles is the role of a designated group-level supervisor, facilitating coordinated supervision among regulators and enhancing transparency through shared information. Financial conglomerates are urged to implement rigorous risk management frameworks that encompass detailed reporting on intra-group transactions, including those involving unlisted subsidiaries. Disclosure should be accessible and comprehensive, encompassing the conglomerate's consolidated financial condition, risk exposures, and governance policies, including those specific to unlisted subsidiaries. These principles emphasize that listed entities must provide comprehensive, timely and accessible disclosure about their corporate structure, affiliations and related party transactions including those involving unlisted subsidiaries in order to enable investors to make informed decisions.
Assessing and Redesigning Framework for Conglomerate Disclosures in India
The current Indian framework governing the disclosure practices of group-level transactions is primarily dictated by Regulation 24(4) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 and existing Accounting Standards (AS). However, both are inadequate for effectively regulating these transactions. This section analyzes the limitations of the existing framework and suggests incorporating the best practices outlined above to enhance transparency and accountability.
Regulation 24(4) requires the management of unlisted subsidiaries to periodically inform the board of directors of the listed entity about all significant transactions and arrangements they enter into. However, there is uncertainty about whether these transactions should be evaluated based on standalone figures or on a consolidated basis, encompassing the subsidiary's total revenues, expenses, assets, or liabilities. In global practice, it is customary to aggregate these figures on a consolidated basis for the preceding financial year.
Moreover, the Regulation 24 primarily focuses on the relationship between listed entities and their unlisted subsidiaries, inadequately addressing the complexities inherent in conglomerates, such as cross-holdings, joint ventures, and related party transactions across multiple entities. SEBI can bridge this gap by drawing inspiration from the Fair-Trade Act in South Korea, requiring listed entities to disclose comprehensive ownership structures, including indirect shareholdings and inter-corporate investments. Additionally, SEBI should mandate disclosures on the governance structures of conglomerates, detailing board compositions, key management personnel and the roles, and responsibilities across all entities. Furthermore, SEBI should also consider adopting principles from IOSCO, including group-based risk assessment, regulatory control over intra-group exposures, and increased cooperation among regulators to manage systemic risks.
Unlike the DTR 4 guidelines, which mandate the publication of financial reports within 4 months of the financial year-end, the SEBI regulations do not specify a specific timeline for this reporting, leaving it at the board's discretion. To enhance clarity and consistency, SEBI should consider introducing a specific timeframe for such disclosures. This would align with international standards and ensure timely and uniform reporting of significant transactions and arrangements by unlisted subsidiaries.
Additionally, SEBI should stipulate that listed entities disclose detailed information on related party transactions similar to DTR 4 and 7. Beyond mere financial figures, disclosures should include comprehensive explanations of the nature, purpose, and commercial rationale behind each related party transaction. Furthermore, these disclosures should outline the potential risks and benefits involved, ensuring stakeholders have a clear understanding of the transaction's impact on the company's financial health and operations. Importantly, material-related party transactions should undergo rigorous scrutiny and approval by an independent board committee, distinct from the involved parties, to mitigate conflicts of interest effectively.
Finally, adherence to relevant accounting standards is crucial in supplementing these regulations, as it enables businesses to provide clear and accurate financial information to stakeholders. In India, while AS 21 addresses reporting of consolidated financial statements, it lacks the comprehensiveness required for conglomerate-level disclosures. For instance, it does not encompass accounting for investments in joint ventures and associates, which are covered separately under AS 28 and AS 27. To comprehensively address these gaps, the adoption of a more comprehensive and unified framework like the IFRS 10, as adopted by the UK, would be beneficial.
Conclusion
Insights from diverse authorities underscore the urgent need for SEBI to implement a unified regulatory framework with comparable standards. India’s current fragmented and insufficient provisions necessitate SEBI to decisively adopt and enforce these corresponding regulations. This would establish robust oversight for conglomerates, addressing opacity in their transactions. Prioritizing transparency is crucial for investor protection. Without stringent disclosure norms and regulatory oversight, mistrust will persist, deterring critical investments and compromising India’s economic landscape. Embracing rigorous disclosure standards will enhance market integrity, protect investors, and ensure the stability and growth of India’s financial markets.
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