Sebi Bolsters Regulations Surrounding Related-Party Transactions

In a bid to strengthen corporate governance and bolster investor protection, market watchdog Securities and Exchange Board of India (Sebi) has introduced a slew of regulations and industry standards governing related-party transactions (RPTs).

Sebi’s latest reform will take into effect from April 1, 2025. These measures have been framed with a view to protect the interests of minority shareholders while promoting transparency.

Why do we need such regulations?

Related-party transactions normally involve transactions within entities who have shared ownership, which can sometimes lead to conflicts of interest. Under this arrangement, conflicts can also result in diversion of resources from the listed company to the promoter group, thereby undermining investor confidence and the integrity of financial reporting. For many years, the market regulator has worked on refining its regulatory framework to address these risks and bolster investor protection.

As per the Sebi (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations), audit committee must thoroughly review RPTs and seek approval from shareholders if deemed material. Previously, disclosures on RPTs lacked uniformity, which often led to incomplete or inadequate information being made available for scrutiny.

Measures taken to improve transparency

The new standards are developed by Industry Standards Forum (ISF), which includes ASSOCHAM, CII, and FICCI. These standards are meant to establish a dynamic framework for disclosure, setting a benchmark for transparency across the market.

Under the new rules, listed companies are mandated to provide a detailed 88-item disclosure before seeking approval for any RPTs. The disclosure includes information related to the nature of the transaction, its terms, and its potential impact on the financials of the company. This step has been introduced to eliminate ambiguity, while also promoting fairness and transparency in RPT decision-making processes.

Notably, a related-party transaction will be considered material if it exceeds 10% of a company’s annual turnover or INR1,000 crore, whichever is lower.

“The new standards will help clarify and provide consistency in disclosure norms to be adopted across the board for listed companies. Whilst the detailed disclosure requirements were already in place vide Sebi’s Master Circular dated November 11, 2024, the Minimum Standards Circular, being industry led (formulated by ISF), will provide a level playing field and ensure greater transparency for stakeholders,” said Suhana Islam Murshedd, Partner, AQUILAW.

She added, “RPTs have always been a sensitive issue for audit committees especially in cases of promoter driven companies. There is an inherent risk of conflict of interest that the audit committee must be apprised of so that it can independently evaluate the transaction brought to its notice and fulfil its fiduciary responsibility.”

Audit lapses

An audit report by the National Financial Reporting Authority (NFRA) involving two audit firms, Price Waterhouse Chartered Accountants LLP (PWCA) and Price Waterhouse & Co Chartered Accountants LLP (PW & Co CA), found significant lapses in auditing practices and highlighted several deficiencies that cast doubt on the integrity of the audit procedures employed by these firms. The most concerning issues revolved around verifying RPTs, thereby calling for stricter and standardised disclosures in such transactions.

Shiju PV, senior partner at Indialaw LLP said, “Since most of the listed companies in India are promoter driven, the potential for conflict between the interests of listed entities and its related parties is very high. Over the years, Sebi has been strengthening the regulatory framework governing RPT; the new set of rules prescribing Industry Standard is a significant step towards striking a balance between benefits arising out of synergies associated with RPT while minimising the potential conflict inherent in RPT.”

Compliance: A Step in the right direction?

Though new regulations are expected to improve transparency, they have a fair set of challenges.

Listed companies will now face an increased compliance burden, requiring significant investments in financial reporting, internal controls, and governance frameworks.

Compliance teams will have to be trained to ensure adherence to the new guidelines, and many companies may need to adopt advanced digital solutions to streamline the documentation and approval processes.

Murshedd adds, “Whilst most listed companies have already tweaked their internal policies relating to RPTs to include the December 2024 LODR amendments post their Q3 results, the additional time of up to April 1, 2025, provided in the Minimum Standards Circular, will help ease the compliance burden for listed companies to some extent.”