Private equity firms expect inflow of mezzanine, hybrid structured investments in the PE space in India
Private equity (PE) firms expect the proposed amendments to Section 6 of Foreign Exchange Management Act, 1999 (FEMA) to help fast-track investments into India and allow them more flexibility in the use of hybrid investment instruments.
In the Union Budget 2015-16, the government proposed to amend Section 6 of FEMA. “The central government may, in consultation with the Reserve Bank prescribe; any class or classes of capital account transactions, involving debt instruments, which are permissible; and the limit up to which foreign exchange shall be admissible for such transactions.”
PE funds have interpreted this to mean that on capital account transactions, the decision making process will be exercised by the “government” in “consultation” with the “Reserve Bank of India”. The same amendment also gives the central government the power, along with the RBI, to decide on what constitutes a debt instrument.
“RBI was rigid with its regulations and investment criteria. The central government is likely to allow more investor friendly instruments by foreign investors in India. We expect more inflow of mezzanine, hybrid structured investments in the PE space in India,” Munesh Khanna, deals advisory partner at PricewaterhouseCoopers India, said.
An executive of a leading PE firm with assets under management of around $500 million, who did not wish to be quoted, said the government has been trying to fast-track investments but the RBI has not kept pace. “The government wants the RBI to continue as an administrator and let the regulation be done by the government,” he said.
Tushar Sachade, co-head of private equity at BBSR & Co, said this will help to progressively redefine investment instruments used in deal structures while Amit Bhagat, CEO and MD at ASK Property Investment Advisors, said the government wants to facilitate speedy changes in regulations required.
Typically, PE funds prefer to invest through debt instruments or quasi-debt instruments — a mix of debt and equity (like an optionally convertible debenture), since they need not convert the debt into equity if the venture does not do well and they can earn an assured return. The RBI has frowned on such instruments since they are not equity but masquerade as such.
In a circular dated June 8, 2007, the RBI had clarified that some Indian companies were raising funds under the foreign direct investment (FDI) route through issue of hybrid instruments such as optionally convertible/ partially convertible debentures which were intrinsically debt-like instruments.
“Routing of debt flows through the FDI route circumvents the framework in place for regulating debt flows into the country. It is clarified that henceforth, only instruments which are fully and mandatorily convertible into equity, within a specified time would be reckoned as part of equity under the FDI Policy and eligible to be issued to persons residing outside India under the Foreign Direct Investment Scheme,” RBI had said.