Decoding the amended preferential allotment norms

On 14 January 2022, the Securities and Exchange Board of India (SEBI) introduced the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) (Amendment) Regulations, 2022 (amended preferential allotment norms). These amended the provisions on preferential issuances by listed companies, as dealt with under chapter V of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (SEBI ICDR regulations).

Because of covid-19 and its adverse impact on the securities market, SEBI had introduced a temporary additional method for pricing preferential issues, that is the higher of the average of the weekly high and low of the volume-weighted average price (VWAP) for 12 weeks or two weeks preceding the relevant date, subject to enhanced lock-in provisions. This was introduced to counter the sudden and extreme fall in the prices of shares due to the pandemic. Because of the drop in price, the valuation of the floor price under regulation 164(1)(a) of the SEBI ICDR regulations, that is the average of the weekly high and low of VWAP for 26 weeks, was significantly higher than the floor price determined in accordance with regulation 164(1)(b) of the SEBI ICDR regulations, that is the average of the weekly high and low of VWAP for two weeks, and it was felt that pricing calculations should be eased for listed issuers.

Having introduced the temporary relief, and following representations by stakeholders and the recommendations of the Primary Market Advisory Committee (PMAC), SEBI has, by virtue of the amended preferential allotment norms, addressed most of the concerns relating to pricing of preferential issuances in order to facilitate fund raising. A primary concern was the disparity in the determination of the floor price under regulation 164(1) of the SEBI ICDR regulations. In brief, volatile and dynamic market conditions had resulted in the price determined based on 26 weeks’ average to be significantly different from the price determined based on a two-week average. This was becoming a deterrent to promoters or investors coming to the aid of the listed company in times of need. To counter this anomaly, the determination of the floor price has now been made the higher of VWAP for 90 trading days or 10 trading days preceding the relevant date, thereby significantly reducing the upper cap. While the recommendation of PMAC was to use the higher of VWAP for 60 trading days or 10 trading days, this change, nevertheless, is a move in the right direction.

At the same time, to address concerns surrounding the valuation of scrips where change in control is triggered by preferential allotments, the amended preferential allotment norms now require a valuation report to be prepared by an independent registered valuer to determine the floor price. The valuation report must also give guidance on the control premium that is to be computed in addition to the floor price. Any preferential issue that may result in a change in control of the listed issuer may now only be made following a reasoned recommendation from a committee of independent directors of such listed issuer. The committee must consider all aspects relating to the preferential issue, including pricing. The results of the voting at the meeting of this committee must also be disclosed in the notice calling the general meeting of the shareholders.

One of the most discussed changes brought about by the amended preferential allotment norms is where the articles of association (AoA) of a listed issuer provide for a method of determining the floor price, that is the AoA floor price. In such cases, the amended preferential allotment norms provide that if the AoA floor price is higher than that determined under the SEBI ICDR regulations, the AoA floor price will be the floor price for equity shares to be allotted in the preferential issue. At the same time, given that the SEBI ICDR regulations gave no guidance on what forms of consideration other than cash are permitted in cases of preferential issuances, the amended preferential allotment norms have provided welcome clarity by providing that a swap of shares is the only permissible form of consideration other than cash.

Overall, the changes introduced by the amended preferential allotment norms are expected to result in better value for the listed companies considering preferential allotment as well as their investors.