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Rights Issue under the amended ICDR Framework - regulatory arbitrage through backdoor entry for preferential issue of shares?
- NLS Business Law Review
- 11 hours ago
- 10 min read
Pranati*
I. INTRODUCTION
In March 2025, the Securities and Exchange Board of India (“SEBI”) notified amendments to SEBI Issue of Capital and Disclosure Requirements, 2018 (“ICDR”). One of the key elements of the change includes amendments to the rights issue framework. The amendment now permits “specific investors” to acquire renounced or undersubscribed rights entitlements, subject to appropriate disclosures made through advertisements. The previous regulations under ICDR had not laid down a statutory framework to govern allotment of rights entitlements by promoters during a rights issue. Rights entitlements are a pre-emptive right of a shareholder to purchase new shares of a company that are allotted during a rights issue, they are offered to pre-existing equity shareholders on a pro rata basis i.e., in proportion to their existing shareholdings.
The objective behind bringing forth this legislative amendment (discussed in the proposal to the Board regarding ‘Faster rights issue with flexibility of allotment to specific investors under Chapter III of ICDR’) was to promote the adoption of rights issue as a preferred mode of fundraising, among other modes like preferential issue and qualified institutional placements - as it gives existing shareholders a direct say in controlling their shareholding; by choosing to subscribe or renounce a new round of fundraising before shares are offered to third-party investors - this way, pre-existing shareholders can control the shareholding on their own terms. Among other reasons, longer timelines to raise funds through rights issue and rigid obligations for promoters who wished to renounce their shares also played a role in bringing forth this change. Before the amendment, raising funds through rights issue took around 317 days - which the amended indicative timeline has brough down to around 23 days.
While the amendment is a welcome step towards making rights issue accessible and streamlined, the amendment to the framework - where companies can issue rights entitlements to specific investors - now effectively mirrors the pre-existing preferential issue framework, but with an easier way to subscribe to a company’s shares with relaxed obligations on the issuer and the investors (especially promoters renouncing shares in favour of specific investors). Essentially, this gives companies and specific investors an alternate route through which they may circumvent the rigours of preferential issue. It is in this broad context that this article introduces the amended rights issue framework and then sheds light on the possible scope of regulatory arbitrage by companies while comparing the rights issue and preferential issue frameworks. Lastly, the author offers suggestions that may help to mitigate probable regulatory arbitrage.
II. REGULATORY FRAMEWORK
Rights issues draws its statutory framework through Section 23(1)(c) and Section 62(1)(a) of Companies Act, 2013 (“Companies Act”), which allows issuance of securities by way of rights issue. Additionally, the statutory framework in this regard for listed companies can be found under Chapter III of ICDR. These legislations read together provide that the shareholders can treat the offer of rights entitlements in different ways, once issued in their favour - they can either fully subscribe to the offer or, subscribe partially and renounce the remainder or, renounce all the shares in a third-party's favor or, not subscribe to rights entitlements at all. The previous framework gave this right to all shareholders of a company issuing rights issue, but the legislation was more restrictive for promoters and promoter groups.
Previously, under Regulation 86 of ICDR, promoters could only renounce their shares to the extent of the promoter group, unless 90% of the offer had been subscribed. This put an additional burden on promoters. If the issue did not achieve the minimum subscription of 90%, the issue could not move forward and often had to be subscribed by the promoter and promoter group themselves to meet the threshold. The amended framework now allows pre-emptive rights of promoters to be exercised in favour to specific investors - even if the 90% threshold has not been met. Further, ICDR was silent on allotment of undersubscribed portion to any persons other than rights entitlement holders. The 2025 amendment has added Regulation 77B in ICDR which governs allotment to specific investors in a rights issue and allows allotment of undersubscribed portion to specific investors as well. SEBI has not communicated any eligibility requirements to be met in order to qualify as a specific investor.
Regulation 90(d) of ICDR has added specific investors on the last rung of the waterfall mechanism for allotment of undersubscribed entitlements. The amendment fails to provide clarity on whether or not a single specific investor can subscribe to renounced rights entitlements as well as undersubscribed rights entitlements. This clarity is required for procedural and technical necessities laid down under ICDR. If a single specific investor subscribed to both renounced rights entitlements and undersubscribed portion of the rights issue, they will be required to make one application on the first day of the issue prior to 11:00 a.m. and the second application on the last day of the issue but prior to the finalization of rights entitlements. Therefore, a single specific investor would have to fill multiple applications in the rights issue which may be a ground for technical rejection of their application.
The amended framework does introduce certain procedural safeguards - specific investors who receive renounced entitlements from promoters must apply on the first day of the issue before 11:00 a.m., and no later than 11:30 a.m.; such applications cannot be withdrawn once made. However, these safeguards seemingly remain largely procedural and not substantive in nature. The timing of applications or the bar on withdrawal of application fails to address the deeper structural concerns around pricing discretion that remains with the company, the lack of shareholder approval, or the absence of a lock-in period for specific investors.
Additionally, in cases where the offer or any part thereof is not accepted by the existing shareholders, the board of directors of a company has the discretion to dispose the unsubscribed portion of the offer in such manner which is not disadvantageous to the shareholders and the company according to Section 62(1)(a) of Companies Act. In light of recent amendments, it can now be argued that the board of directors may justify allocating these unsubscribed shares to a specific investor however they deem fit, bypassing the procedural and substantive safeguards that govern preferential issue under Section 62(1)(c) of Companies Act. This statutory flexibility, combined with the regulatory green light under Regulation 77B of ICDR, opens the door for potential regulatory arbitrage, especially in promoter-heavy boards where the threshold for “what’s not disadvantageous” is left largely undefined.
III. SCOPE FOR REGULATORY ARBITRAGE
Victor Fleisher defines regulatory arbitrage or regulatory gamesmanship as “a planning technique which occurs when parties take advantage of a gap between economics of a deal and its regulatory treatment, restructuring the deal to reduce or avoid regulatory costs without unduly altering the underlying economics of the deal”. Preferential issue, defined under Regulation 2(1)(nn) of ICDR, is a fundraising method through which companies raise money by issuing shares to specific groups and finds a pre-existing framework under Chapter V of ICDR. The addition of specific investors in the amended rights issue framework mirrors the concept of preferential issue at present. This raises the concern of companies and investors using the amended framework as a technique to restructure a (preferential) issue as a rights issue to avoid the rigors of preferential issue hence potentially performing regulatory arbitrage. Through this section, the author analyses how the amended framework mirrors the preferential issue framework and where loopholes in the framework exist.
Firstly, to raise funds through a preferential issue, a shareholder resolution is mandatory under Section 62(1)(c) of Companies Act read with Rule 13 of the Companies (Share Capital and Debentures) Rules 2014; and Section 42 of Companies Act read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules 2014. A rights issue under Section 62(1)(a) of Companies Act only requires a board resolution and no involvement of shareholders takes place within this process - hence circumventing shareholder approval. Under Regulation 84 of ICDR, the promoters are required to issue advertisements disclosing the details of specific investors, such as their names, the number of rights entitlements renounced, etc. But the regulation does not require disclosure of explanation for renouncing shares in a favour of a specific group. Therefore, this structure permits promoters to redirect entitlements without shareholder oversight and without providing any explanations whatsoever.
Secondly, after issuance of shares through a preferential issue, a lock-in period is mandated under Regulation 167 of ICDR - however no lock-in is mandatory post issuance of rights entitlements. The specific investors are not under any legal obligation to hold on to the allotted shares in a rights issue and can exit from the company at will - even right after listing of the rights issue. This can act to the detriment of existing shareholders due to the fluctuations in price of shares that an exit of a specific investor might cause in the secondary market.
Thirdly, under the preferential issue framework, a company needs to follow pricing guidelines and volume - weighted average price method as specified under Regulation 164 of ICDR when deciding how to price their fundraising. Conversely, under Regulation 73 of ICDR, the pricing of rights entitlements is decided by the issuer and their board of directors, in consultation with stock exchanges and no specific pricing guidelines are provided under the statutes. The only caveat given under ICDR in this regard is that the price shall not be less than the face value of the shares. Therefore, shareholders have no say in the price at which securities get transferred to a specific investor under the amended framework. This silence on pricing gives a broad leeway to promoters to allot rights entitlements at a discount without shareholder supervision.
Companies have already faced legal battles nationwide for using rights issue as a tool to practice alleged oppression and mismanagement in the past. To further illustrate the potential for regulatory arbitrage, and oppression and mismanagement under the amended framework, consider a hypothetical case involving company ABC, which is a listed entity seeking to raise capital. The board of ABC approves a rights issue, and promoters allow a substantial portion of entitlements to be renounced in favour of a select group of specific investors. No shareholder approval is required under Section 62(1)(a) of the Companies Act, and the rationale for the renunciation is not disclosed. The board of ABC prices the rights issue at a steep discount (as low as 90%) to the market price, citing internal assessments and the need for operational capital. Unlike a preferential issue which has pricing guidelines under Regulation 164, no regulatory safeguards prevent such arbitrary pricing. Moreover, the subscribing investors are not subject to any lock-in period owing to which they exit their position shortly after their allotment, making gains on the discounted shares. This strategic structure mimics the economic features of a preferential issue without triggering its associated legal obligations. Such a transaction is seemingly compliant with the rights issue framework, but it undermines the rights of minority investors.
IV. SUGGESTIONS
Reforms to the capital markets in India since 1990s have aimed to remove barrier restrictions, upgrade technological infrastructure and moreover evolve to become a safe, efficient and more transparent market. To this effect, SEBI has tried to evolve while maintaining a balance between growth and investor protection. Hence, to mitigate regulatory arbitrage, SEBI must recalibrate the amended ICDR framework.
Firstly, drawing from Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014 which provides for the detailed disclosures to the shareholders in case of preferential issues, within the amended rights issue framework, a requirement to issue disclosures in case the investment by specific investors exceeds a certain threshold should be added particularly where transfers are made to non-retail and related-party entities. This would increase transparency throughout the process and may give investors an opportunity to raise grievances before rights entitlements are listed for trading.
Secondly, SEBI should also impose a soft lock-in period for non-retail specific investors receiving renounced shares. This can help to ensure that specific investors do not profit of the allotment at the detriment of pre-existing shareholders and can act as a deterrent against opportunistic short-term profiteering especially in cases where rights entitlements are issued at significant discounts.
Thirdly, SEBI should also issue guidelines on the process to be followed by the issuer regarding allotment to specific investors especially when issuing rights entitlements to non-retail investors and pricing guidelines while allocating shares to specific investors. In 2020 Reliance Industries allotted a rights issue at a discount of 14% on its prevailing share price and in 2024 Byju’s issued a rights issue at a discount of 99% on it last valuation. Had these companies opted for raising capital through preferential allotment, they would have had to oblige with pricing calculations as per volume weighted average price method which would have mandated higher issue price which might have hindered the viability of a successful capital raising round. However, the absence of any guidance regarding pricing in rights issue creates room for potential misuse of discounts to benefit a specific group of investors. Hence, guidance with respect to pricing can help streamline the process of allotment of shares to specific investors.
Lastly, SEBI should consider introducing clear classifications of investor categories to establish defined boundaries within the regulatory framework for rights issue specifically with respect to allotment of renounced shares by promotors. These classifications can be made between non-retail, related party, institutional investors, strategic partners, etc., thereby enabling streamlined and effective oversight. Owing to the fact shareholder approval is not necessary for a company to proceed with a rights issue, the approach towards the issue should be disclosure-heavy and focused on transparency in order to protect minority shareholders and prevent misuse of the framework.
V. CONCLUSION
While the amendment is a timely and progressive step to revitalise rights issue as a fundraising method, the amendment if left unchecked may dilute the legislative purpose of bringing forth the amendment and dilute minority shareholders’ rights. To this effect, this paper has sought to evaluate the regulatory implications of the 2025 ICDR amendment to the rights issue framework particularly focusing on its potential to cause regulatory arbitrage by mirroring the pre-existing preferential allotment framework under ICDR. The absence of robust disclosure, pricing, and investor classification safeguards renders the framework vulnerable to misuse, especially in promoter-heavy businesses.
Hence, going forward, a nuanced recalibration of the framework can help preserve the legislative intent of the amendment especially in instances involving related parties or non-retail specific investors. Further empirical study on actual post-amendment issuances, response of investors and change in promoter shareholding could provide a more nuanced understanding of the implications of the amendment and how they might impact minority shareholders’ interests.
This analysis is limited by its reliance primarily on SEBI’s Consultation Paper on ‘Faster Rights Issue with flexibility of allotment to Selective Investor(s)’ and a doctrinal reading of the law in the absence of significant post-amendment case studies, given the recency of the amendment. Future analysis incorporating data-driven assessments, and inter-jurisdictional regulatory comparisons could add depth to this research and lend empirical weight to the recommendations proposed herein.
*Pranati is a 4th year student at Maharashtra National Law University, Mumbai. She is interested in corporate and securities law.