Despite the RBI?s concerns, the government is unlikely to bar inflows of foreign funds through equity instruments with alleged characteristics of debt. However, the department of industrial policy and promotion (DIPP) will impose certain conditions, like a minimum lock-in period for buyback of shares by the Indian promoter, so that the foreign investors will have to take certain risks by remaining invested for a reasonable period of time.
Compulsorily convertible debentures (CCDs) and compulsorily convertible preference shares (CCPS) are the instruments through which foreigners invest in Indian firms. Although these debt instruments are required to be converted into equity within a specified period of time, at the time of conversion the Indian promoters often use put options, letting the foreign investors exit. This undermines the debt nature of the investments as the foreign investors practically don\’t take any significant risk.
According to sources, besides the lock-in period, the DIPP will also make it mandatory that in such cases, the pricing is decided at the time of issuance (of the debentures/preference shares) to the foreign investor. This will be as per Sebi?s pricing guidelines and in concurrence with the RBI.
In September last year, on the RBI\’s behest, the government had shut the door to foreign direct investment deals which it felt were debt masquerading as equity. But, after a month of intense pressure from investors, the government had to withdraw the controversial clause in the FDI policy. This policy (of not allowing these instruments) came under attack from offshore investors, particularly private equity players, as eight out of 10 FDI deals have underlying options.
Indian promoters sell ?put? options to attract foreign strategic investors, thus giving them the \’right\’ to sell back shares if the company fails to fulfil conditions like stock exchange listing or an agreed internal rate of return. Calling them \’debt\’ would mean the deals would have to fulfil stringent rules that applies to foreign debt. The practice has never gone down well with the RBI, which felt such fund flows would increase the country\’s short-term debt. Although the government allows such deals in the policy, the RBI blocks the buyback of shares at the time of invoking ?put? options by Indian promoters.
Saroj Jha, senior partner with SRGR Law Firms, said there have been instances where the RBI raised objections even after the clarification by the DIPP. Since options can significantly influence the pricing and size of a deal, it may also send a wrong signal to investors. ?It is not a good signal in these difficult times if the government and the RBI continue to do a flip-flop on the policy,? Jha said.
According to the RBI, a put option (sell-back right) is similar to over-the-counter equity derivative deals that are not backed by local law.