REIT, InvIT Subordinate Units: Insights into Proposed Framework

The Securities and Exchange Board of India (“SEBI”) recently issued a consultation paper dated December 9, 2023 (“Consultation Paper”)[1], that deals with the lacunae in the SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”)[2] and SEBI (Infrastructure Investment Trusts) Regulations, 2014 (“InvIT Regulations”)[3] regarding the issuance of subordinate units and employee benefits. The objective of the Consultation Paper is to propose a regulatory framework for issuing subordinate units of REITs and InvITs to sponsor(s), their associates and sponsor group. Vide this Consultation Paper, SEBI also seeks opinion on the framework for unit-based benefits for the employees of the Manager of REIT and the Investment Manager of InvIT.

Framework for Issuing Subordinate Units

Regulation 4(2)(g) of the REIT Regulations and Regulation 4(2)(h) of the InvIT Regulations provide for equality among unit holders, ensuring no superior voting or additional rights for any individual. However, the proviso to these regulations allows for the issuance of subordinate units exclusively to sponsors and their associates. These subordinate units, while maintaining an overall sense of equality, have inferior voting or other rights compared to regular units, establishing a distinct category for sponsors and associates within the regulatory framework. Nevertheless, SEBI, to date, has not prescribed a mechanism for the mode and conditions of issuing subordinate units to sponsors and their associates.

SEBI’s Hybrid Securities Advisory Committee (“HySAC”)[4] has proposed several significant norms central to the fact that subordinate units are issued only to the sponsor(s), its associates and sponsor group and these units are designed to bear inferior voting or other rights compared to regular units. Three significant aspects highlighted in the consultation paper are noteworthy. Firstly, these subordinate units can be issued during the initial or subsequent offerings, but any post-initial issuance necessitates prior approval from 75% of unitholders by value, excluding votes from sponsors, associates, and related parties. Secondly, subordinate units come with a mandatory lock-in period until conversion to ordinary units or extinguishment, with a minimum one-year gap between issuance and conversion. The regulation prescribes that converted units shall be listed and tradeable on the stock exchanges only upon approval from the stock exchanges. Finally, following the issuance of subordinate units, any proposed modifications to their terms and conditions highlighted in the REIT or InvIT Trust Deed require approval from 75% of ordinary unitholders by value and unanimous approval from subordinate unitholders. The framework also covers the recommendation and conversion process, performance benchmarks the requirement of audit, and the need for unitholder approvals in case of changes to the terms and conditions of subordinate units.

Employee Incentives for REIT or InvIT Management

Any company or LLP or body corporate incorporated in India which manages assets and investments of the REIT or InvIT and undertakes operational activities of the trust constitutes a manager of the REIT[5] or Investment manager of InvIT[6] (collectively referred to as “Management”), respectively. In its Consultation Paper[7], SEBI proposes Unit Based Employee Benefits (“UBEB”) catered toward Employees of the Manager of REIT or Investment Manager of InvIT (“REIT or InvIT Employees”), in the hope that structure would foster better alignment of REIT or InvIT Employee interests with the respective trust.

Key elements of this framework include the creation of a distinct Employee Benefit Trust (“EBT“) at the discretion of the Management of the respective trusts. EBTs are designed to acquire units of REIT or InvIT from the shareholders of the Management or via subscription in lieu of management fees. If units are allotted to the EBT in exchange for management fees, specific conditions come into play, including the requirement for approval by 75% of unitholders and considerations for pricing based on factors like net asset value and market price. Importantly, units of such nature cannot be sold or transferred for purposes other than that of employee benefit. The framework additionally ensures regulatory compliance by imposing SEBI restrictions[8] on the Manager, Investment Manager, and associated businesses. The Nomination and Remuneration Committee is responsible for creating guidelines that guarantee conformity to securities regulations, with a focus on legal compliance and transparency.

Analysis

The proposed framework under the consultation paper appears to be comprehensive and addresses several important aspects such as eligibility, voting rights, approval processes, and disclosure requirements, providing a robust structure for market participants.  Also, the proposal regarding the creation of a separate EBT and mechanisms for it to receive REIT or InvIT units is aimed at balancing overall trust interest with employee incentives, emphasising transparency and accountability of management. While the framework aligns interests and emphasises transparency, it allows for the issuance of units to be done only once a year, within sixty days after the completion of the annual valuation exercise, which seems excessive in light of the rapid real estate market fluctuations, potentially leading to the EBT acquiring the unit at a price higher than market value. 

References:

[1] Consultation paper on Framework for issuance of subordinate units and Unit Based Employee Benefits – REITs and InvITs, available at https://www.sebi.gov.in/reports-and-statistics/reports/dec-2023/consultation-paper-on-framework-for-issuance-of-subordinate-units-and-unit-based-employee-benefits-reits-and-invits_79760.html

[2] Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations 2014 [Last amended on February 14, 2023], available at https://www.sebi.gov.in/legal/regulations/feb-2023/securities-and-exchange-board-of-india-real-estate-investment-trusts-regulations-2014-last-amended-on-february-14-2023-_68061.html

[3] Securities and Exchange Board of India (Infrastructure Investment Trusts) Regulations, 2014 [Last amended on February 14, 2023], available at https://www.sebi.gov.in/legal/regulations/feb-2023/securities-and-exchange-board-of-india-infrastructure-investment-trusts-regulations-2014-last-amended-on-february-14-2023-_68062.html

[4] SEBI’s Hybrid Securities Advisory Committee (“HySAC”) deliberated on November 15, 2022

[5] Reg. 2(1)(w) of the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations 2014 [Last amended on February 14, 2023], available at https://www.sebi.gov.in/legal/regulations/feb-2023/securities-and-exchange-board-of-india-real-estate-investment-trusts-regulations-2014-last-amended-on-february-14-2023-_68061.html

[6] Reg. 2(1)(zf) of the Securities and Exchange Board of India (Infrastructure Investment Trusts) Regulations, 2014 [Last amended on February 14, 2023], available at https://www.sebi.gov.in/legal/regulations/feb-2023/securities-and-exchange-board-of-india-infrastructure-investment-trusts-regulations-2014-last-amended-on-february-14-2023-_68062.html

[7] Decided on the basis of deliberations of SEBI’s Hybrid Securities Advisory Committee (“HySAC”) on February 28, 2023 and June 1, 2023

[8] Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 [Last amended on November 24, 2022], available at https://www.sebi.gov.in/legal/regulations/nov-2022/securities-and-exchange-board-of-india-prohibition-of-insider-trading-regulations-2015-last-amended-on-november-24-2022_65864.html and the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 [Last amended on January 25, 2022], available at https://sebi.gov.in/legal/regulations/jan-2022/securities-and-exchange-board-of-india-prohibition-of-fraudulent-and-unfair-trade-practices-relating-to-securities-market-regulations-2003-last-amended-on-january-25-2022-_55604.html

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Photo by Christian Wiediger on Unsplash

The proposed framework under the consultation paper appears to be comprehensive and addresses several important aspects such as eligibility, voting rights, approval processes, and disclosure requirements, providing a robust structure for market participants.  Also, the proposal regarding the creation of a separate EBT and mechanisms for it to receive REIT or InvIT units is aimed at balancing overall trust interest with employee incentives, emphasising transparency and accountability of management. While the framework aligns interests and emphasises transparency, it allows for the issuance of units to be done only once a year, within sixty days after the completion of the annual valuation exercise, which seems excessive in light of the rapid real estate market fluctuations, potentially leading to the EBT acquiring the unit at a price higher than market value. 

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