REIT IT RIGHT
An eight-part series covering the commercial and legal considerations of REIT listings in India. The previous parts can be accessed here – Part 1, Part 2, Part 3, Part 4 .
Investor protection forms the bedrock of securities laws frameworks around the world with securities regulators putting in place meticulous and stringent governance, reporting as well as compliance frameworks for listed entities. The Indian securities regulator has also prescribed a labyrinthine set of laws for post-listing reporting and corporate governance compliances by listed companies.
In stark contrast, however, the present regulatory framework for Real Estate Investment Trusts (REITs) in India offers limited guidance on post-listing compliances by listed REITs, mandating few compliances (mainly in relation to financial reporting, annual and half-yearly disclosures and investor grievances) and remaining silent on the applicability of a vast number of other obligations (including in relation to prevention of insider trading, takeovers and acquisitions, open offers etc.) which are typically applicable to listed companies.
Given SEBI’s mandate for investor protection, Indian experiences with corporate fraud, as well as studies conducted in mature REIT jurisdictions drawing a direct link between good governance and corporate performance[1], it is difficult to reconcile the disparity in governance frameworks applicable to listcos and REITs.
Unitholders – Children of a Lesser God?
While one may justify the applicability of differential corporate governance standards on the grounds that jurisprudentially, unitholders have been placed on a different footing from shareholders in terms of their rights and obligations, this line of thought may be discordant in several respects. For instance, REIT sponsors and listco promoters are treated alike when it comes to demonstrating skin in the game – with both being locked-in for specified periods of time; both being required to maintain a minimum percentage of stake in the listed entity; and both being liable to provide an exit to dissenting/ minority unitholders in certain situations. Given the similar obligations, it is hard to rationalise why correspondent compliances pertaining to disclosure of encumbrances over sponsor securities or changes in sponsor unitholding as applicable to listco promoters should not be applicable to REIT sponsors. For instance, while promoters are permitted to create pledges over locked-in shares in limited circumstances and subject to compliance with specific conditions and reporting requirements, similar safeguards have not been extended to pledges created over locked-in Sponsor Units.
Similarly, given the impetus placed on effective management of REIT assets by the Manager under the REIT Regulations (through an independent board, oversight by Trustee, periodic valuations etc.), it is difficult to reconcile the fact that (in contrast to other REIT jurisdictions) related governance norms such as constitution of audit committees, nomination and remuneration committees, risk management frameworks and vigil mechanisms as prescribed for listcos are not prescribed for Indian REITs.
The intricacies and peculiarities of REIT structures make it all the more imperative for checks and balances to be built-in in the form of good corporate governance practices. For instance, REIT structures inherently comprise of a multitude of stakeholders having access to varying degrees of unpublished price sensitive information across different REIT assets and entities. Yet, the present regulatory framework does not provide for regulations monitoring use of unpublished price sensitive information in the context of REITs.
Given that the ideal of investor protection remains paramount in the eyes of the regulator, the conspicuous crevices in the existing regulatory framework may prompt one to look to the regulatory framework applicable to listed companies for guidance in this regard.
Applicability of existing post-listing framework to REITs – Fitting a Square Peg in a Round Hole
With REITs quickly emerging as an attractive and viable option for monetising real estate assets, it is only a matter of time before we witness increased transactional activity in this space – be it in the form of multiple REITs being set up by the same sponsor groups, assets being co-managed by different REITs, different REITs being managed by the same manager, investors acquiring substantial stake in existing REITs, existing REITs acquiring new assets (from related parties and third parties), sponsors leveraging their unitholding, managers holding REIT units etc. giving rise to nuanced and pointed governance related questions on managing conflicts of interest, which the existing regulatory frameworks for REITs as well as the applicable regulatory framework for listcos are ill-equipped to address.
For instance, where an entity is a sponsor group of two or more REITs, such sponsor group will need to address questions of how one REIT should be ring fenced from the other; how one REIT could impact the growth strategy of the other; the nature of safeguards that one should put in place to streamline flow of unpublished price sensitive information from each of the REITs; how one should prioritise between different REITs in respect of pipeline assets that a sponsor wishes to transfer etc. Similarly, where the REIT is acquiring new assets from its sponsor groups, the sponsor groups will find themselves on two different sides of the same transaction as unitholders of the acquiring REIT as well as sellers of the target asset. With common directors on the boards of the sponsor groups, manager as well as the target asset, it is likely that directors of these companies will have to maintain a fine balance while discharging their fiduciary obligations towards divergent set of stakeholders. Investors looking to acquire substantial stake in existing REITs will have to be mindful of potential open offer triggers as the present regulatory regime does not shed much light on this aspect. In addition to acquisition thresholds, it is unclear whether the open offer assessment would be restricted to the unitholding percentages or if it would also extend to rights that the investor acquires in the manager. One would also need to evaluate whether any arrangements amongst shareholders of the manager would also warrant disclosures to unitholders. While the regulatory framework does not preclude the manager from holding units in the REIT, the regulatory framework is silent on how a manager holding units should conduct itself in its capacity as unitholder. Further, the ‘insider’ and ‘connected person’ assessment for compliance with insider trading norms will also need to be tailored to suit REIT structures.
Given the fundamental differences in the structure and management of REITs vis-à-vis listcos, the regulatory framework applicable to listcos cannot be squarely transposed for REITs, leaving REITs and parties to the REIT grappling with testing and complex questions from time to time.
Protecting interests of the REIT and parties to the REIT
While a comprehensive compliance framework built on the learnings from the initially listed REITs and InvITs may be on the anvil, until such time, REITs, their sponsors and managers will need to tread cautiously to ensure that they do not fall foul of the spirit of the governance norms expected of listed entities. It will be up to the management of each REIT to put in place governance frameworks that meet the spirit and intent of regulatory frameworks applicable to listcos; while at the same time taking into account the idiosyncrasies stemming from the REIT ownership structures. REITs would be well placed to have these policies and guidelines in place prior to listing to be able to go about their activities in an equitable and transparent manner.
Marquee REITs are likely to attract a number of sophisticated foreign investors who are accustomed to a high degree of compliance when it comes to corporate governance. Therefore, from the perspective of managing investor expectations as well, it will not bode well for Indian REITs to discount the merits of good corporate governance practices.
Having well defined and well thought out governance practices will help protect the REITs’ management from allegations of wrong doing or preferential treatment. In addition to assuring investors that actions taken by the management are above board, a cogent and robust governance framework can also serve as a guide to aid the REITs’ management to deftly navigate potentially nebulous situations in a transparent manner.
[1] Bauer, Rob and Eichholtz, Piet M. A. and Kok, Nils, “Corporate Governance and Performance: The REIT Effect. Real Estate Economics”, Vol. 38, Issue 1, pp. 1-29, Spring 2010; and
Patrick Lecomte, Joseph T.I. Ooi, “Corporate Governance of Asian REITs: Introducing a New Framework for Analysis”, paper presented at the European Real Estate Society, 17th Annual Conference, 2010