The ‘Reit’ Measures To ‘Invit’ Better Regulatory Practices: Key Take-Aways For India

 [By Shaivi Nihal Shah & Palash Moolchandani]

The authors are students at the National Law University Odisha.

Introduction

Infrastructure Investment Funds (“InvITs”) and Real Estate Investment Trusts (“REITs”), collectively referred to as ‘business trusts’, have recently witnessed increased popularity in the country. Over the past few months, Indigrid, an Indian InvIT (“I-InvIT”), put out a Rs. 1284 crore – rights issue and Brookfield India, an Indian REIT (“I-REIT”), listed a Rs. 3800 crore – public issue, showcasing the growing traction of business trusts. Some of the reasons investors find such trusts attractive are the tax benefits offered and the mandatory requirement to pay out 90% of distributable cash flows on a semi-annual basis.

Recently, the government has made significant efforts to promote these trusts and make them more accessible to retail investors. For instance, in 2019, the Security and Exchange Board of India (“SEBI”) notified certain amendments to the SEBI (Infrastructure Investment Trusts) Regulations, 2014 and the SEBI (Real Estate Investment Trusts) Regulations, 2014 whereby a number of positive changes to the existing regime were introduced. In February 2021, the Finance Minister of India, Ms Nirmala Sitharaman, while releasing the Budget 2021-22, announced that business trusts would be exempted from Tax Deducted at Source, and advance tax payments would only be needed to be made when the amount of dividend income was announced. Notably, business trusts were also permitted to raise debt funds from foreign portfolio investors to reduce the liquidity crunch.

However, despite the impetus given to business trusts by the government, India is still in a fairly nascent position as only 15 InvITs and 4 REITs are registered with the SEBI. This article attempts to analyse the regulatory framework of more mature business trust regimes and determine the key takeaways that India can replicate.

Structure of Business Trusts

In essence, business trusts can be considered to be collective investment schemes formulated as trusts. They are multi-tiered and comprise sponsors, trustees, investment managers and project managers. Certain requirements have been laid down by the SEBI to determine the eligibility of individuals and entities to qualify for these positions. The factors for eligibility are based on assets owned, net-worth and the relevant work experience.

In terms of tiers, the sponsor acts as the anchor and creator of the trust. The sponsor then appoints the trustee, who is expected to oversee the work of the project manager and the investment manager.

The investment manager typically supervises, manages and makes decisions regarding the investments and divestments of these trusts, and guarantees their activities. The duties of the project manager are to manage the assets of the trust and ensure that the projects undertaken by it are concluded in a timely manner.

Deconstructing the Best Practices from Other Jurisdictions: Key Takeaways for India

           I.         Investment in foreign assets

All mature business trust regulatory jurisdictions do not restrict investments in foreign assets. Jurisdictions like Singapore have benefitted greatly from this and have experienced exponential growth in the last decade. In fact, its last 10 REIT IPOs have 100% of their assets outside Singapore while 80% of all the REITs in the country have investments in foreign assets. This is a clear indication of its transformation into an international hub for REIT listings.

I-REITs/I-InvITs should also be allowed to invest in offshore assets as this would help them diversify their portfolio and explore different avenues of generating income. Further, the recent addition of institutional investors like mutual funds and insurance intermediaries as ‘strategic investors’ will ensure less shortage of funds for investments in foreign assets. This would also lead to higher investments from foreign and non-resident holders, as was observed in the case of Singapore.

However, introducing such a provision should come with a caveat. Permitting investments in foreign assets can take attention away from Indian projects, contravening the very objective of introducing business trusts in India- to revive the cash strapped real estate and infrastructure sectors. Therefore, it is suggested that there should be a maximum limit on investment in foreign assets.

        II.         Minimum Subscription Size

SEBI has recently amended the minimum allotment and trading lot requirements for publicly issued business trusts. The minimum subscription for I-InvITs has now been reduced to 1 lakh from 10 lakhs and for I-REITs to 50,000 from 1 Lakh. However, in order to attract a larger base of retail investors, there is a need to further dilute the amount under this threshold or completely do away with it. The SEBI should take a cue from advanced jurisdictions like the United States (“US”), Australia, the United Kingdom, Germany, etc., who do not follow the principle of minimum subscription threshold.

      III.         Internally Managed v. Externally Managed

The question of whether business trusts should be managed internally or externally has always been proffered to regulators around the world. The US-REIT market, which is the largest in the world, predominantly follows an internal management system, whereas in the Asia Pacific region, apart from Australia, REITs are mostly externally managed. The latter has historically faced challenges regarding fee structures and conflicts of interest between the external management and the unitholders of the REIT. Thus, while an external manager offers better expertise, resources, personnel and influence than an internal manager, it is extremely difficult to align the interests of the manager with that of unitholders.

To counter these challenges, countries have adopted strong corporate governance requirements to ensure better market discipline and accountability of business trust managers to the unitholders. For instance, the Monetary Authority of Singapore’s (“MAS”) Licensing Guidelines require licensed management companies registered on the Singapore Exchange to mandatorily conform to the country’s Code of Corporate Governance.

In India, in order to prevent any unscrupulous activities by trust managers, a minimum of 50% of the managing company’s governing board must be independent directors who are not directors on the board of another business trust. However, the regulations do not envisage the responsibilities and explicit liabilities of independent directors of such companies. In this regard, a cue can be taken from the MAS which mandates business trust managers to disclose remuneration policies and procedures in the trust’s annual reports. Further, they are required to justify the remuneration by explaining the methodology for computing performance fees. They must also clearly demarcate how the methodology takes into consideration the interest of the unitholders. It is submitted that India should replicate this as, first, this would maintain consistency of standards between I-REITs/I-InvITs and international best practices; and second, following good governance practices would ensure increased investments from existing and new investors who are sceptical about the functioning and handling of business trusts.

       IV.         Gearing restrictions/limits

A gearing limit or a leverage limit is the ratio of the trust’s total debt to its total assets. These limits/restrictions act as a tool to protect unitholders from excessive debt levels taken on by managers. The threshold of gearing limits varies across the world. For example, countries like the  US and Australia do not impose any gearing restrictions whereas countries in the Asian region have observed a gearing limit of around 50%. Recently, Singapore and Malaysia have loosened their gearing restrictions from 45% to 50% and 50% to 60% respectively, to provide relief in terms of accessible liquidity during the COVID-19 pandemic.

India, currently, has a leverage limit of 49% which can be extended to 75% for I-InvITs, provided they meet certain criterion. There should be no leverage limits/restrictions on business trusts because; first they are perpetually short on cash/funds, as they have to pay out most of their earnings to unitholders. For example, I-InvITs/I-REITs have to distribute a minimum of 90% of the income generated to unitholders. Imposing leverage restrictions impede organic growth as the trusts are prevented from exploring different avenues. Thus, such restrictions should not exist so long as proper guidelines of corporate governance are implemented, and the rights and interests of unitholders are not compromised.  Second, if business trusts are held to the same standards as companies in aspects of governance, they should be allowed to raise money like them. Therefore, the usage of debt-funding should remain a business decision of the trusts.

Conclusion

Business trusts in India have the potential to serve as a remarkable solution to the issues faced by the real estate and infrastructure sectors in the country. The liquidity crunch in these sectors is a result of the harsh stance taken by banks on funding such projects and the lack of exit options for big players from these investments. In this context, I-InvITs/I-REITs can act as a plug to the existing funding gaps.

It is evident that the Indian government and the SEBI have made numerous efforts to give a boost to business trusts. However, there still remain a number of measures that can be implemented to ensure that the Indian regulatory system is at par with its more-developed, overseas counterparts. These have been enumerated through the scope of this article. Only if the international best practices are implemented in India, can it be considered a global powerhouse and attract worldwide investments for its home-grown real estate and infrastructure projects.

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