Editorial: Fresh options

Removing ambiguity is always a good thing so, to that extent, the clarity provided by the law ministry on call and put options in M&A transactions is welcome. The law ministry opined on Wednesday that the rules would be amended to allow such instruments to be incorporated in bilateral transactions. The fact that the Securities Contracts and Regulation Act (SCRA) doesn?t permit a transaction in the ?future? had compelled the Securities and Exchange Board of India (Sebi) to disallow call and put options in foreign direct investment (FDI) deals such as the Cairn-Vedanta transaction; Sebi was right in recommending that these be permitted. There is also the debate on whether the call and put options should be exercised at a pre-determined price or whether these should be executed at market-related price, in the case of a listed company. Ideally, any two parties should have the freedom to build in any riders into their agreement, though one could also argue that assets should be bought and sold at market value.

Indeed, the Reserve Bank of India (RBI) is understood to have expressed concern that assets should not be bought or sold at undervalued prices and that there should be a ?fair value? at which deals are done, more so in the context of foreign buyers purchasing assets in India. The view has probably arisen from the apprehension that, if transactions are executed at prices lower than the market value, money could change hands elsewhere. Of course, it?s also true that Indian promoters?mainly in the real estate space?have used the lack of legal clarity on call and put options to wriggle out of commitments to foreign investors. In fact, RBI?s worry is that much of the FDI that has come into the real estate space is actually debt masquerading as equity, since most investors negotiated an internal rate of return (IRR) with the promoters. The clarity that call and put options are legally valid will also come as a relief to private equity (PE) players where the investor almost always builds in a put option, linked to milestones to be achieved by the investee over a specified period of time. Indeed, foreign investors will be reassured that such structures, used widely across the globe, are now permitted in India too. While in the real world a promoter or an investor can choose to misbehave, stronger regulation will now act as a deterrent. What regulators must desist from is too much control; they must allow risk-reward to play out.