The central bank’s aversion to put and call options at a pre-determined price is well known—if investors, RBI has consistently argued, were to be allowed to exit at a fixed price, this would encourage lenders to disguise debt as equity, and circumvent the caps that RBI puts on returns on foreign debt. Indeed, several ‘equity’ investments in the real estate space have pretty much looked like debt given the returns assured in the buyback price. Which is why, when RBI finally agreed to allow options last year, it laid out strict guidelines—if the firm was listed, the option was to be exercised based on the market price; in case of an unlisted firm, the valuation could not be greater than that based on a return on equity.
This is where Japanese telecom major Docomo’s investment in Tata Teleservices got stuck. When Docomo bought a 26% stake in Tata Teleservices, it had a put option, obligating the Tatas to buy back its investment at half the value it was made at were the JV not able to achieve certain milestones. The problem was, when an independent valuation was done, this put the price at R23.34 a share as compared to the R58.05 that the agreement between the two firms envisaged as the exit price. Given Japan is emerging as a strategic investor in India, RBI has done well to recommend that a one-time exception be given to the deal—it would send out a bad signal if Docomo was not able to exit at even half its entry price, and that’s without building in the exchange rate fluctuations. RBI’s decision is a good one not just because Japanese firms are serious investors in India, but also because, since there was no clarity on such options in the past, the agreement was made in good faith. Indeed, when the NDA sold shares of Balco and Hindustan Zinc to Sterlite Industries in 2001, it gave Sterlite a call option that allowed it to buy the residual stake at a pre-determined price—it is a different matter that this was not honoured by the UPA and that Sterlite did not legally challenge this. While it is not clear if RBI will extend this exception to other old cases, it may be a good idea if certain principles are laid out. Since the idea is to prevent equity from masquerading as debt, one such principle could be to cap the returns on options at the maximum levels RBI allows for pure debt issuances—investors will still take big hits in case valuations fall, which is par for the course for equity, but there will be some cap on the downside risk.