The finance ministry and the Reserve Bank of India are planning to expand the reach of the Foreign Exchange Management Act (FEMA), to encompass more instruments?such as partly-paid shares issued to foreign investors?under the provisions of this legislation.
This means companies issuing these instruments ?partly-paid shares and convertible warrants?would require the RBI approval under the automatic route for selling them to foreign investors. The changes are being contemplated to prevent a possible breach of existing foreign direct investment (FDI) regulations by overseas investors.
The government feels since holders of partly-paid shares get voting rights in Indian companies and can potentially gain control; they need to be governed by FEMA. Currently, these instruments are neither part of FDI-as the current policy does not have a concept of partly or totally paid shares?nor FEMA, an official explained.
Simultaneously, the government plans to make an exception for the banking sector, by keeping them out of the purview of FDI regulations announced in February last year. As a result, downstream investments of ICICI Bank and HDFC in their respective insurance companies will not be counted as FDI.
After a series of discussions over the past one year, the finance ministry and the department of industrial policy and promotion (DIPP)?the nodal department for framing the FDI policy?have agreed on amending the FDI regime.
The ministry has prepared a note detailing these changes, which the Cabinet Committee on Economic Affairs is expected to discuss on Thursday, sources said. Once the CCEA approves these changes, the DIPP will issue a comprehensive circular on the matter.
??The proposal is there from the DEA (department of economic affairs). We have reached a consensus but a policy decision will be taken only at the Cabinet level,?? a DIPP official said. The review comes a year after the Centre issued detailed norms for calculating total foreign investment in Indian companies based on an ownership and control criterion. For India Inc, the fresh changes could mean some erosion in the flexibility companies enjoyed while raising foreign funds, besides bringing them under the ambit of enhanced scrutiny and sectoral FDI limits.
According to a finance ministry official, the ministry started discussion on these issues in April last year, after receiving inputs from the Financial Intelligence Unit (FIU)-a an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the finance minister. FIU is the central national agency responsible for receiving, processing, analyzing and disseminating information relating to suspect financial transactions.
??Currently, these instruments are not part of FDI. FIPB (Foreign Investment Promotion Board) approval is required for issuing these instruments,?? the DIPP official said. FIPB approves proposals for partly-paid shares and convertible warrants on the condition that these will be turned into to fully paid shares within 18 months.
The inclusion of these two instruments in the FEMA would empower RBI to scrutinize these companies and their FDI levels. Since these will also be reckoned to as FDI, their issuers will have to ensure they do not breach sectoral caps.
Companies issue these partly-paid shares to overseas investors at a pre-determined price receiving only partial payment?typically 5% of the total amount. These are now proposed to be treated as FDI at the issuance stage. Investors will be required to make full payment to the issuers within six months, as compared to present 18 months deadline.
Market regulator Sebi allows companies to issue warrants to investors at a pre-determined share price, after receiving 25% of the total sale amount as upfront payment. The issuer forfeits the money if these warrants are not converted into shares.