The Securities and Exchange Board of India (SEBI) has introduced important amendments to the regulatory framework governing Infrastructure Investment Trusts (InvITs). These changes, detailed in SEBI/LAD-NRO/GN/2024/182, aim to strengthen investor protection, increase transparency, and provide a more flexible structure for infrastructure investments. The amendments focus particularly on the introduction of subordinate units, revisions to unitholder eligibility criteria, and clear procedures for issuing, transferring, and reclassifying subordinate units.
The regulatory landscape for InvITs has evolved over time to meet the growing needs of infrastructure financing and investor safeguards. InvITs serve as a vehicle for pooling capital from investors to finance infrastructure projects, and SEBI’s latest changes are designed to ensure that these instruments operate efficiently and transparently in the market.
Understanding Infrastructure Investment Trusts (InvITs)
Infrastructure Investment Trusts are investment vehicles that allow investors to participate in infrastructure assets, such as roads, power transmission lines, and renewable energy projects. They operate similarly to mutual funds but are specifically focused on infrastructure projects, offering investors a stable income through distributions backed by cash flows generated by infrastructure assets.
InvITs issue units to investors, which represent a share in the underlying infrastructure assets. These units typically provide investors with the right to receive income distributions and voting rights on certain matters. The legal and regulatory framework ensures that InvITs are managed transparently, with appropriate governance and risk management mechanisms in place.
Introduction of Subordinate Units in InvITs
One of the most significant changes brought by SEBI is the introduction of subordinate units within InvITs. Subordinate units are a new class of instruments issued by InvITs alongside ordinary units. Unlike ordinary units, subordinate units are initially non-voting and do not carry rights to distributions until they are reclassified.
These subordinate units are typically issued as part of the acquisition consideration for infrastructure projects, mainly to sponsors, their associates, and sponsor group entities. This addition allows for more flexible structuring of capital and aligns the interests of sponsors and investors.
The subordinate units are issued in dematerialized form and carry unique International Securities Identification Numbers (ISINs) separate from ordinary units. This clear distinction facilitates better tracking and regulation of these instruments.
Key Differences Between Subordinate Units and Ordinary Units
Subordinate units differ from ordinary units in several key ways. Ordinary units are generally offered to the public during initial public offerings or fundraising activities and carry voting and distribution rights from the outset. These units are freely transferable and tradable on recognized stock exchanges without reclassification.
In contrast, subordinate units lack voting and distribution rights initially. They are primarily issued to sponsors and associated parties as part of acquisition transactions and cannot be transferred freely. Transfers and encumbrances of subordinate units are heavily restricted and can only be made within the sponsor group or associates.
Revised Eligibility Criteria for Unitholders in InvITs
The SEBI amendments also introduce changes to the eligibility criteria for unitholders holding substantial stakes in InvITs. Specifically, unitholders possessing at least ten percent of the total outstanding units, whether individually or collectively, are now subject to additional governance responsibilities. These unitholders are required to nominate a director to the board of the Investment Manager. This nominee must comply with specific recusal provisions designed to prevent conflicts of interest and ensure impartial decision-making.
Furthermore, such unitholders must adhere to the stewardship code outlined in the regulations. The stewardship code emphasizes responsible ownership and accountability, requiring these large unitholders to actively participate in governance and support the long-term success of the InvIT.
These changes strengthen governance by ensuring that significant stakeholders have formal roles in oversight and strategic decisions, enhancing transparency and investor confidence.
The Process of Issuance of Subordinate Units
The issuance of subordinate units by InvITs follows a carefully structured and regulated process under SEBI’s framework. These units are issued in dematerialized form exclusively to sponsors, their associates, and entities within the sponsor group, generally as part of consideration for acquiring infrastructure projects.
The issuance is subject to pricing guidelines consistent with those applicable to ordinary units. The terms and conditions, including the potential for reclassification and the rights associated with subordinate units, must be clearly disclosed in official documents such as term sheets and placement memorandums. This ensures that all parties are fully informed of the characteristics and implications of the subordinate units.
Issuances beyond the initial offer require approval from unitholders to protect investor interests and prevent conflicts. The total subordinate units issued cannot exceed ten percent of the acquisition price of the infrastructure project and must also remain below ten percent of the total outstanding ordinary units, although certain exceptions apply for InvITs with pre-existing subordinate units.
Restrictions on Transfer and Encumbrance of Subordinate Units
Subordinate units are subject to strict restrictions regarding transferability and encumbrance. According to SEBI regulations, these units must remain locked in until they are reclassified as ordinary units. Transfers are only permitted within the sponsor group, including associates, ensuring that ownership remains closely held during the lock-in period.
Encumbrances or pledges against subordinate units are also limited to entities within the sponsor group. The depository system is responsible for ensuring that transfers or encumbrances are only registered if the recipient is authorized under these provisions.
The Investment Manager has a duty to disclose any transfer or encumbrance of subordinate units to the recognized stock exchange within one working day. This promotes transparency and timely reporting of ownership changes.
In the event of a change in sponsor, the outgoing sponsor must transfer any subordinate units it holds to another sponsor, an associate, or an entity within the sponsor group, maintaining continuity and compliance with regulatory limits.
Conditions and Timing for Reclassification of Subordinate Units
SEBI’s regulations set clear guidelines for when and how subordinate units may be reclassified as ordinary units. Reclassification depends on meeting a defined performance benchmark that is objective, measurable, and based on audited financial statements. The performance benchmark and related terms are detailed in the term sheet provided to investors.
There is a minimum period of three years from the date of issuance before subordinate units become eligible for reclassification. Extensions to this entitlement period are allowed only under strict conditions with approval from unitholders, ensuring that the process remains transparent and well-regulated.
Reclassification confers voting and distribution rights to the holders of the subordinate units and allows them to trade freely on stock exchanges, effectively converting these instruments into ordinary units.
Reporting and Disclosure Requirements for Performance Benchmark in InvITs
SEBI’s amended regulations impose comprehensive reporting and disclosure obligations on the investment manager regarding the progress towards achieving the performance benchmark necessary for the reclassification of subordinate units. The investment manager must monitor this progress continuously and report it at least annually or as otherwise prescribed.
This reporting must be certified by the statutory auditor of the InvIT and approved by both the trustee and the audit committee of the investment manager. Such oversight ensures accuracy and reliability of the reported information.
The investment manager is also required to disclose progress on the performance benchmark in the InvIT’s Annual Report, providing transparency to all stakeholders. Alongside this, diluted net asset value (NAV) and diluted distribution per unit figures, reflecting the impact of subordinate units, must be reported to the recognized stock exchange until all subordinate units are reclassified.
These disclosures enhance accountability and allow investors to track how subordinate units may transition to ordinary units over time.
Certification, Review, and Approval Process for Reclassification
The process to reclassify subordinate units into ordinary units is rigorous and involves multiple layers of certification, review, and approval to protect investor interests.
Initially, the statutory auditor certifies whether the performance benchmark has been met. This certification is then reviewed by the trustee of the InvIT and the audit committee of the investment manager. These entities assess the auditor’s findings and confirm compliance with regulatory requirements.
If the benchmark is achieved within the entitlement period or any approved extension, the subordinate units are eligible for reclassification on a pari-passu basis, meaning they convert into an equal number of ordinary units. This can occur either in full or in parts, depending on the extent to which performance benchmarks have been met as detailed in the term sheet.
Handling Non-Achievement of Performance Benchmarks
In cases where the performance benchmark is not met by the entitlement date or any extension thereof, the subordinate units are extinguished without any compensation to their holders. This mechanism ensures that sponsors and associated parties are incentivized to achieve the agreed performance targets, aligning their interests with those of other investors.
The investment manager’s board of directors plays a key role in evaluating whether the reclassification or extinguishment of subordinate units should proceed. They pass a resolution based on the certification and review outcomes, which is then submitted to the trustee for final approval.
The trustee must confirm regulatory compliance before approving any reclassification or extinguishment. The decision is communicated back to the investment manager, which initiates further steps to notify relevant authorities and exchanges.
Notification and Listing Procedures Following Reclassification
Once the trustee approves the reclassification or extinguishment, the investment manager must notify the recognized stock exchange, depositories, and the registrar and transfer agent. Notification must include the record date, which signifies when subordinate units will convert into ordinary units.
This record date must be disclosed to the stock exchange at least two working days in advance, excluding the day of intimation and the record date itself. Transparency in timing allows market participants to prepare for changes in the trading status of these units.
Following reclassification, the newly converted ordinary units are listed on the recognized stock exchange(s) after receiving final listing and trading approval. This enables holders to freely trade their units with full voting and distribution rights.
Impact of Subordinate Units on Investor Protection and Market Transparency
The introduction of subordinate units within the InvIT framework represents a significant regulatory enhancement aimed at balancing sponsor incentives with investor protection. By creating a distinct class of units with restricted rights and transferability, SEBI ensures that sponsors remain committed to the long-term performance of infrastructure projects before gaining full rights as ordinary unit holders.
This mechanism also limits the potential dilution of voting power and distributions for public investors by controlling the timing and conditions under which subordinate units convert to ordinary units. The stringent reporting, disclosure, and approval requirements further reinforce transparency, providing investors with clear visibility into the progress and performance of underlying infrastructure assets.
Together, these measures promote confidence among investors and contribute to the sustainable development of the infrastructure investment market.
Advantages of the Subordinate Units Framework for Infrastructure Projects
The subordinate units framework introduced by SEBI marks a significant advancement in enabling more efficient and flexible capital structuring for infrastructure acquisitions through Infrastructure Investment Trusts (InvITs). Traditionally, sponsors faced challenges in managing immediate cash outflows when acquiring infrastructure assets or investing in projects, often requiring substantial upfront capital. The ability to issue consideration in the form of subordinate units offers sponsors a strategic alternative that helps alleviate liquidity constraints while simultaneously aligning their financial interests with the long-term success of the project.
By receiving subordinate units instead of cash, sponsors effectively share the risk and rewards associated with the project’s performance. This alignment is particularly important in infrastructure investments, which are typically characterized by long gestation periods, capital-intensive development phases, and exposure to various operational risks such as construction delays, cost overruns, or revenue shortfalls. The subordinate units serve as an incentive mechanism, motivating sponsors to focus on the successful completion and sustainable operation of infrastructure assets, rather than merely acquiring them. This results-driven focus is further reinforced by the framework’s imposition of lock-in periods on subordinate units, which prevents sponsors from exiting prematurely and ensures their continued commitment to the asset’s performance.
Moreover, the introduction of rigorous performance benchmarks within the subordinate units framework acts as a safeguard for investors. Sponsors are required to meet specific financial and operational criteria before subordinate units can be reclassified into ordinary units, which generally carry greater voting rights and priority in income distribution. These benchmarks typically include targets related to project completion, operational efficiency, cash flow generation, and debt servicing. By linking the upgrade of subordinate units to the achievement of these milestones, the framework creates a robust mechanism that holds sponsors accountable for delivering tangible results and maintaining asset quality.
The flexibility to reclassify subordinate units into ordinary units upon meeting performance criteria provides an effective exit or reward pathway for sponsors. This reclassification acts as a form of value realization, allowing sponsors to convert their subordinate holdings into equity-like interests once the asset demonstrates stability and profitability. Such a mechanism not only incentivizes sponsors to improve project outcomes but also enhances the liquidity and marketability of InvIT units, making them more attractive to a wider investor base. Potential investors gain confidence knowing that the sponsor’s interests are closely tied to the asset’s success, which can lead to increased capital inflows and a more vibrant InvIT market.
Furthermore, this capital structuring flexibility benefits the overall InvIT ecosystem by fostering sustainable investment practices. By encouraging sponsors to invest through subordinate units with lock-in and performance conditions, the framework discourages short-term speculative behavior and promotes long-term value creation. This alignment of interests between sponsors and investors strengthens the governance framework, mitigates common risks inherent in infrastructure projects, and contributes to the steady growth of India’s infrastructure sector.
Role of the Investment Manager and Trustee in the New Regulatory Environment
The investment manager and trustee hold pivotal and clearly defined responsibilities under the revised SEBI regulations governing Infrastructure Investment Trusts (InvITs), ensuring robust governance and protecting the interests of all stakeholders. The investment manager plays a hands-on role in the day-to-day operations and strategic management of the InvIT’s assets. One of the key functions of the investment manager is to diligently monitor the performance benchmarks established under the amended regulations. These benchmarks encompass various financial and operational metrics, such as project completion timelines, asset quality, cash flow generation, and return on investment. Regular monitoring helps identify any deviations or risks early on, allowing for timely corrective actions to safeguard investor interests.
In addition to performance oversight, the investment manager coordinates audits of the InvIT’s assets and financials. These audits are crucial for validating the accuracy of disclosures and maintaining transparency. By working closely with external auditors and ensuring that audits are thorough and timely, the investment manager enhances the reliability of financial statements and operational reports shared with investors and regulatory authorities. The manager is also responsible for preparing periodic disclosures mandated by SEBI, which provide investors with up-to-date information on the InvIT’s financial health, asset performance, risk factors, and any material developments. These disclosures form the basis for informed decision-making by investors and help maintain market confidence.
Another important duty of the investment manager involves managing the complex process of issuance and reclassification of subordinate units. This process includes ensuring compliance with eligibility criteria, adherence to procedural requirements, and proper documentation of transactions. The investment manager must ensure that issuance or reclassification does not adversely affect the rights of existing unit holders and complies with SEBI’s regulatory framework. Through meticulous management of these processes, the investment manager facilitates smooth capital mobilization and flexible investment structures, thereby enhancing the InvIT’s attractiveness to a broader range of investors.
Complementing the investment manager’s role, the trustee acts as a custodian and independent watchdog, serving as a critical check-and-balance within the InvIT’s governance framework. The trustee’s primary responsibility is to safeguard the interests of unit holders by ensuring that the InvIT complies fully with SEBI’s regulations and internal governance policies. One of the trustee’s key functions is reviewing certifications provided by the investment manager and other parties, validating that all required conditions for transactions such as issuance, transfer, or reclassification of units have been met.
The trustee also plays a decisive role in approving or rejecting significant actions, including the reclassification or extinguishment of subordinate units. By exercising independent judgment and oversight, the trustee helps prevent any misuse of power by sponsors or managers and ensures that all actions are conducted fairly, transparently, and in the best interest of investors. Furthermore, the trustee regularly monitors the InvIT’s overall compliance status, identifying and escalating any instances of regulatory or operational non-compliance to the appropriate authorities.
This dual oversight model—where the investment manager manages day-to-day operations and the trustee provides independent supervision—creates a balanced governance environment. It enhances accountability by distributing responsibilities and instituting checks on decision-making. The collaboration between these two entities ensures that the InvIT operates with high standards of governance, transparency, and accountability. Ultimately, this governance framework fosters trust among investors, supports regulatory adherence, and contributes to the sustainable growth and resilience of infrastructure investment through InvITs.
Conclusion
SEBI’s introduction of subordinate units and the related amendments to the regulatory framework represent a significant and progressive step towards refining the governance and operational structure of Infrastructure Investment Trusts (InvITs) in India. These reforms aim to bridge existing gaps in the InvIT ecosystem by establishing a more nuanced and transparent classification of units, which clarifies the rights, privileges, and responsibilities of different classes of investors. Prior to these amendments, the regulatory framework primarily recognized only a single class of units, which limited flexibility and sometimes led to ambiguities in investor protections and distribution priorities. By introducing subordinate units alongside existing units, SEBI has created a dual-class unit structure that better aligns investor interests with the risks and returns associated with their investments.
One of the critical aspects of these amendments is the clear demarcation of rights attached to subordinate units as compared to existing units. Subordinate units typically carry different voting rights, priority in income distribution, and risk exposure. This classification allows sponsors and asset managers to design investment structures that cater to diverse investor profiles, balancing capital requirements with investor appetite for risk and return. Importantly, subordinate units can provide a buffer by absorbing initial project risks, thus offering existing unit holders greater protection. This structural refinement enhances governance by ensuring that unit holders with different stakes and risk exposures have clearly defined rights and obligations, reducing potential conflicts and fostering a more transparent governance environment.
The amendments also introduce enhanced eligibility criteria for entities seeking to establish and manage InvITs. These stricter standards ensure that only experienced and financially sound sponsors and managers can operate within the InvIT framework, thereby elevating the overall quality and reliability of infrastructure investments. Detailed procedures for issuance, transfer, and redemption of units have been outlined to streamline transactions, reduce operational risks, and promote liquidity in the market. These procedural clarifications assist in building investor confidence by ensuring smoother execution and regulatory compliance.
Further, SEBI has mandated rigorous performance benchmarks and comprehensive reporting requirements for InvITs. These benchmarks focus on financial performance, asset quality, and project execution timelines, among other metrics. Such requirements foster discipline among sponsors and managers, incentivizing them to achieve sustainable project outcomes and deliver consistent returns to investors. The enhanced reporting framework promotes transparency by requiring regular disclosures on asset performance, financial health, and risk factors, thereby equipping investors with clearer and more timely information.
Collectively, these regulatory reforms create a robust and investor-friendly environment for infrastructure investment in India. Investors benefit from improved protection mechanisms, greater clarity regarding their rights, and enhanced access to relevant information. Meanwhile, sponsors and managers are motivated to uphold high standards of governance and operational efficiency, which can lead to more successful project completions and long-term value creation. In essence, SEBI’s amendments strengthen the InvIT ecosystem, making it more resilient, attractive, and aligned with international best practices, thereby supporting the growth of India’s infrastructure sector through sustainable and transparent investment avenues.