Demystifying Valuations Under SEBI Regulations

The Securities and Exchange Board of India (SEBI) plays a critical role in safeguarding investor interests and promoting transparency in the Indian stock market. One key mechanism for achieving this is by mandating valuations for various transactions undertaken by listed companies. This blog post dives deep into the world of valuations under SEBI regulations, exploring who can conduct valuations, the methodologies used, and the legal framework governing the process.

Why SEBI Mandates Valuations

SEBI valuations serve several critical purposes in the Indian capital market:

• Investor Protection: Accurate valuations prevent investors from being misled by inflated or deflated share prices during transactions like preferential allotments or debt restructuring.
• Market Transparency: Regular and reliable valuations contribute to a more transparent market by providing investors with a clearer picture of a company’s financial standing and the underlying value of its shares.
• Compliance & Risk Mitigation: Adherence to SEBI regulations safeguards companies from potential legal issues and penalties associated with non-compliance.
• Fair Pricing: Valuations ensure a fair and objective basis for determining the price of shares or assets involved in various transactions, protecting both companies and investors.

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Process for SEBI Valuations

1. Transaction Triggers Valuation Need: The first step involves identifying a transaction that falls under SEBI regulations and necessitates a valuation. Common examples include debt restructuring, preferential issue of shares, infrequently traded shares, and valuation of listed security receipts.
2. Engage a Registered Valuer: Companies must appoint a registered valuer to conduct the valuation. These valuers are qualified professionals meeting the requirements under Section 247 of the Companies Act, 2013, and possess the expertise to perform valuations adhering to SEBI guidelines.
3. Valuation Methodology Selection: Depending on the specific regulation and transaction type, the valuer will select the appropriate valuation methodology. Common methodologies used include the market price approach, income approach, and discounted cash flow (DCF) method.
4. Valuation Report Preparation: The valuer conducts a thorough analysis using the chosen methodology, considering relevant financial data, market conditions, and industry benchmarks. This analysis culminates in a comprehensive valuation report.
5. Submission and Compliance: The completed valuation report, certified by the registered valuer, is submitted to the company and relevant stock exchange(s) as required by the specific SEBI regulation. This ensures adherence to regulatory compliance.

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Eligibility for Conducting SEBI Valuations

Only registered valuers appointed under the Companies Act are eligible to conduct valuations under SEBI regulations. These valuers possess the following qualifications:

• Professional Qualifications: Hold a bachelor’s degree in a relevant field such as finance, accounting, or engineering.
• Experience: Possess experience in valuation methodologies and practices.
• Registration: Successfully complete a registration process with the Institute of Valuers (IVS) or any other designated body.
• SEBI Compliance: Uphold the code of ethics and maintain professional competency as prescribed by SEBI.

Who Can Be a Valuer Under SEBI Regulations?

SEBI regulations primarily rely on registered valuers appointed under Section 247 of the Companies Act, 2013, and the relevant rules framed thereunder. These valuers possess the requisite qualifications and expertise to conduct valuations in accordance with established standards.

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Valuing Mutual Fund Holdings

1. Actively Traded Securities:

These are securities (except debt instruments) that are regularly traded on a stock exchange. Their value for mutual fund purposes is determined by the most recent closing price on the exchange, but no earlier than 30 days before the valuation date.

2. Thinly Traded Securities:

These fall into two groups:

• Equity-Related Securities: Shares or similar ownership interests in companies that are not actively traded.
• Thinly Traded Debt Securities: Bonds or other debt instruments with limited trading activity.

For both types of thinly traded securities, the valuation standards applied to non-traded securities (explained below) will also be used.

3. Non-Traded Securities:

These are securities that haven’t been traded on any stock exchange in the 30 days leading up to the valuation date. The valuation standards for thinly traded securities will also be applied to non-traded holdings within a mutual fund.

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How Mutual Funds Value Their Holdings (SEBI Rules)

There are three main categories of holdings in a mutual fund, each with its own valuation method:

1. Actively Traded Securities:

These are securities (except debt) that trade regularly on a stock exchange. Their value is based on the most recent closing price on the exchange, but no earlier than 30 days before the valuation date.

2. Thinly Traded Securities:

These are securities with limited trading activity, falling into two groups:

• Equity/Equity-Related: Less than 50,000 shares or Rs. 5 lakh traded in a month.
• Debt: No individual trades in marketable lots on the valuation date (except government securities).

Mutual funds can use a stock exchange’s list of “thinly traded” shares if it meets specific criteria and is publicly available. Otherwise, they must independently assess if a security qualifies as thinly traded using the criteria mentioned above.

For both types of thinly traded securities:

• If trading is halted for less than 30 days, the most recent trade price is used.
• If trading is suspended for more than 30 days, the asset management company or trustee determines the valuation standards, which are documented.

3. Non-Traded Securities:

These are securities that haven’t been traded in the 30 days leading up to the valuation date. The valuation methods used for thinly traded debt securities apply to non-traded securities as well.

Valuing Debt and Money Market Instruments in Mutual Funds

1. Short-Term Investments (Up to 91 Days):

• Actively Traded: If the security is traded on the valuation date, its value is based on the average price of all its trades that day.
• Non-Traded: If not actively traded, the investment is valued using its amortization cost, which spreads the total cost over its lifetime.

2. Long-Term Investments (Over 91 Days):

• Actively Traded: Similar to short-term, the value is based on the average price on the valuation date if traded.
• Non-Traded: When not actively traded, the value is determined using one of two methods:
  • Benchmark Approach: This compares the security to similar investments to estimate its value.
  • Spread Matrix: This method considers the difference between the security’s yield and a risk-free benchmark yield, provided by an authorized agency similar to AMFI (Association of Mutual Funds in India).

3. Uncommon Securities:

If a mutual fund invests in something outside these guidelines, they must:

• Immediately report the situation to AMFI.
• Ensure these holdings stay below 5% of the total fund value (Assets Under Management).
• AMFI will collaborate with valuation agencies to incorporate valuing these securities within six weeks.

Valuing Non-Publicly Traded Securities in Mutual Funds

Method:

1. Net Worth per Share:
   
   • We use the latest available balance sheet to calculate this value.
   • It considers the company’s share capital, reserves (excluding revaluation reserves), total expenses, and the number of outstanding shares.
2. Capitalized Earnings Value:
   
   • This method considers the company’s earnings per share (EPS) from the latest audited annual accounts.
   • An industry average capitalization rate (a measure of investment value) is used, but discounted by 75%.
   • Only 25% of the industry average price-to-earnings (P/E) ratio is used as the capitalization rate.
3. Fair Value:
   
   • The average of the net worth per share and capitalized earnings value is taken.
   • This average is further discounted by 10% to account for the difficulty of selling the security (illiquidity).

Additional Considerations:

• If a company has negative earnings per share in a particular year, zero is used for valuation purposes that year.
• If a company’s latest financial statements are unavailable within nine months (excluding accounting year changes), the security may be valued at zero, especially if it represents more than 5% of the fund’s total assets.
• In such cases, an independent valuation expert or advisor might be appointed to assess the security’s value.

Valuation Methodologies Under Different SEBI Regulations

SEBI prescribes specific valuation methodologies for various scenarios under different regulations. Here’s a breakdown of some key regulations and their valuation requirements:

• SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations):
  
  • Debt Restructuring (Clause 158(6)(b)): When debt is converted into equity as part of a restructuring scheme, two independent valuers must certify the conversion price.
  • Preferential Issue of Shares (Clause 163(3)): If a company issues shares in exchange for assets other than cash, an independent valuer must determine the fair value of those assets.
  • Infrequently Traded Shares (Clause 165): For companies with shares that don’t trade frequently, an independent valuer’s certificate is required to verify that the issuance price considers customary valuation parameters for such companies.
• SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations):
  
  • Listed Security Receipts (Clause 87C(1)): Listed security receipts require quarterly valuation by an independent valuer.
• SEBI (Issue and Listing of Securitised Debt Instruments and Security Receipts) Regulations, 2008 (Security Receipts Regulations):
  
  • Listed Security Receipts (Clause 38G(1)): Similar to LODR regulations, listed security receipts under these regulations also require quarterly valuation by an independent valuer.
• SEBI (Appointment of Administrator and Procedure for Refunding to the Investors) Regulations, 2018 (Administrator Regulations):
  
  • Valuation of Attached Properties (Clause 7(2)(b), 8(1)): When properties of a defaulter are attached, the Administrator must engage a registered valuer to conduct an independent valuation and submit a certified report following SEBI guidelines. Additionally, independent valuation by a registered valuer is mandatory before proceeding with the sale of such properties.

Scenario	Regulation	Description
Issuing Shares for Non-Cash Consideration	Section 163	When a company issues shares for assets other than cash (preferential allotment), a valuer determines the fair value of those assets. This report goes to the stock exchange if the shares are listed.
Debt-to-Equity Conversion During Restructuring	Section 158	For convertible loans/debentures, if the lender converts debt to equity as part of a restructuring, two independent valuers from the Sebi Facility for Accreditation (SFA) must certify the conversion price determined by restructuring guidelines.
Issuing Shares of Infrequently Traded Companies	Section 165	For companies whose shares are not actively traded, a valuer for SFA must determine the issuance price after a valuation. This doesn’t apply to frequently traded shares on a stock exchange, where the average price over the past two weeks sets the issuance price.
Valuing Listed Security Receipts	Section 87C	Security receipts listed on a stock exchange require valuation by an independent valuer.
Valuing Alternate Investment Funds (AIFs)	SEBI (AIF) Regulations, 2021	Private equity, venture capital, and hedge funds (all AIFs) require periodic valuations from an SFA valuer.
Valuing Infrastructure Investment Trusts (InvITs)	SEBI (InvIT) Regulations, 2014	These trusts need half-yearly valuations of their assets by a valuer and annual valuations for compliance purposes.
Valuing Real Estate Investment Trusts (REITs)	SEBI (REIT) Regulations, 2021	REITs must appoint real estate valuers. These valuers calculate the trust’s asset value biannually (twice a year), which is used to determine the Net Asset Value (NAV) per unit.

Importance of SEBI Valuation Regulations

SEBI’s valuation regulations serve several crucial purposes:

• Investor Protection: Accurate valuations ensure that investors are not misled by inflated or deflated share prices.
• Market Transparency: Regular valuations promote transparency in the market by providing reliable information about a company’s financial health.
• Compliance: Adherence to valuation regulations safeguards companies from legal issues and penalties.
• Fair Pricing: Valuations ensure fair pricing in transactions involving asset exchange or debt restructuring.

Conclusion

Understanding SEBI’s valuation framework is essential for listed companies, investors, and other stakeholders in the Indian capital market. By ensuring adherence to these regulations, all participants can contribute to a fairer, more transparent, and investor-friendly market environment.

Frequently Asked Questions about Valuations Under SEBI Regulations

Q1. When are valuations required under SEBI regulations?

Ans1. SEBI mandates valuations for various transactions undertaken by listed companies. These include debt restructuring, preferential issue of shares, infrequently traded shares, and valuation of listed security receipts.

Q2. Who can conduct valuations under SEBI regulations?

Ans2. Only registered valuers appointed under Section 247 of the Companies Act, 2013, are eligible. They possess the necessary qualifications and expertise to perform valuations adhering to SEBI guidelines.

Q3. What is the process for conducting a valuation under SEBI?

Ans3. The process typically involves:

1. Identifying the transaction requiring valuation.
2. Engaging a registered valuer.
3. Selecting the appropriate valuation methodology.
4. The valuer conducting a detailed analysis using the chosen methodology.
5. Submitting the completed valuation report to the company and relevant stock exchange(s).

Q4. What valuation methodologies are used under SEBI regulations?

Ans4. The specific methodology depends on the transaction type. Common methods include:

• Market Price Approach: Uses prevailing market price of similar shares.
• Income Approach: Considers the future income generation potential of the shares.
• Discounted Cash Flow (DCF) Method: Estimates the present value of expected future cash flows from the shares.

Q5. What are the benefits of SEBI valuations for investors?

Ans5. SEBI valuations help protect investors by:

• Ensuring accurate pricing of shares during transactions.
• Promoting market transparency by providing reliable information.

Q6. What are the benefits of SEBI valuations for companies?

Ans6. SEBI valuations benefit companies by:

• Mitigating the risk of legal issues and penalties from non-compliance.
• Facilitating fair pricing in transactions involving asset exchange or debt restructuring.

Q7. Where can I find a registered valuer for SEBI-compliant valuations?

Ans7. You can search the website of the Institute of Valuers (IVS) or other designated bodies for a list of registered valuers in your region.

Q8. What are the consequences of not complying with SEBI valuation regulations?

Ans8. Non-compliance can lead to:

• Penalties and fines imposed by SEBI.
• Delays or disruptions in transactions.
• Potential legal disputes for companies.

Q9. How often are valuations required for listed security receipts?

Ans9. Listed security receipts typically require quarterly valuations by an independent valuer as mandated by SEBI regulations.

Q10. Are there any additional resources available to learn more about SEBI valuations?

Ans10. Yes. You can refer to the following resources:

• SEBI website: https://www.sebi.gov.in/
• Institute of Valuers (IVS) website: https://www.institutionofvaluers.net/
• Relevant SEBI regulations like ICDR, LODR, and Security Receipts Regulations.