On March 14, 2018, SEBI issued an informal guidance to UBS AG (“Applicant”), a SEBI registered FPI, clarifying the position on whether non-disposal undertakings (“NDU’s”) constitute an ‘encumbrance’ under the SEBI (Foreign Portfolio Investors) Regulations, 2014 (“FPI Regulations”).

Regulation 32(2)(d) of the FPI Regulations imposes an obligation on the designated depository participant engaged by an FPI to ensure that equity shares held by an FPI are free from all encumbrances.  Therefore, as FPIs are not permitted to pledge shares, they execute NDUs to avail finance. An NDU is an agreement between a shareholder and a third party, usually executed in relation to any credit facility availed by the shareholder, wherein the shareholder undertakes to not dispose the shares during the existence of the agreement. An NDU provides assurance to the creditor that the debtor will not transfer the shares held by it by way of outside arrangements and leave the creditor without access to the assets of the debtor. Pursuant to executing an NDU, the shares are transferred to an escrow demat account but the beneficial interest in over the shares will remain with the debtor. The creditor will not be able to dispose off the shares to clear dues, like in the case of a pledge.

In the present matter, the Applicant issued NDUs to avail finance or to enter into certain commercial contracts. However, it was unclear if issuing NDUs will amount to the creation of encumbrances as the FPI Regulations do not define the term encumbrance.

The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SAST Regulations”) lay down an inclusive definition of encumbrance. It is defined as to include a pledge, a lien or any such transaction, by whatever name called. With respect to NDUs, it is clarified in the FAQs to the SAST Regulations that NDUs executed by promoters will be covered within the scope of encumbrance for the purpose of disclosure obligations. However, the Applicant is not a promoter of any listed company.

In light of the above, the Applicant requested guidance as to whether the term encumbrance in the FPI Regulations would include NDUs executed by FPIs who are merely investors/acquirers and not promoters. The Applicant also sought to know if FPIs are restricted from providing a limited undertaking to not transfer, dispose of, or create any encumbrances over the equity shares held by them without creating any rights in favour of the third party. SEBI took a view that the term encumbrance used in Regulation 32(2)(d) of the FPI Regulations would include NDUs. Therefore, FPIs are restricted from executing NDUs and create an encumbrance over equity shares held by them in listed companies in India.

Currently, the FPIs are circumventing the FPI Regulations by executing NDUs to avail credit facilities as there is uncertainty on whether NDUs create encumbrances. By clarifying the position on NDUs, this informal guidance has provided much-needed clarity to the FPIs and the designated depository participants on the correct position of law.

[This article has also been published on CNBC-TV18]