The department of industrial policy and promotion in the ministry of commerce (DIPP) has come out with a “Consolidated FDI Policy” – a document that supersedes all prior press notes, circulars and clarifications issued in connection with foreign direct investment (FDI) as of March 31, 2010.
It is salutary to have a consolidated document that provides an overview of India’s FDI policy. However, rather expectedly, the policy document has initiated an ambig-uity in India’s policy position on pricing of FDI.
Typically, the DIPP’s position on matters of pricing is that the price payable by a foreign investor for ownership of Indian securities would have to be compliant with exchange controls administered by the Reserve Bank of India (RBI). The Consolidated FDI Policy reiterates this stance in several places.
However, two simplistic statements cause trouble. The first: “The pricing of the capital instruments should be decided / determined upfront at the time of issue of the instruments.” The second: “Any other type of instruments (read, other than instruments referred to in the policy) like warrants, partly paid shares etc. are not considered as capital and cannot be issued to person resident outside India.
Both these statements are uncalled for and ill-considered. The first statement has caused an avoidable debate about whether the requirement to determine the price upfront would mean providing a clearly determinable formula upfront, or if it would mean fixing a numerical price upfront. The correct position ought to be the former.
The second statement is not supported by any past stated policy that could be regarded as being consolidated in the new policy document. Therefore, even if sought to be enforced, it could only be done prospectively for future issuance of such instruments. Even the regulations notified by the RBI as part of exchange controls do not explicitly prohibit warrants, and do not mandate that partly paid shares ought not to be issued.
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It would be necessary to review why convertible instruments at all have currency. The need for a convertible instrument arises when the issuer believes it ought to command a greater price for its equity shares while the investor does not fully buy the strength of the issuer’s perception. Therefore, the parties commercially agree that if the issuer delivers on the projections or promised performance, the investor would be willing to pay a superior price i.e. get lesser shares for the money being invested.
In fact, from a policy perspective, having a conversion formula spelt out upfront, rather than have a specific conversion price fixed upfront, would place the Indian economy on a superior footing. A specific numerical price fixed today in compliance with exchange control parameters applicable today (these are based on today’s balance sheet strength of the issuer company) could result in the value actually paid by a foreign person for equity in an Indian company being undervalued (linking the formula to future parameters would link the value payable by the foreign investor to the actual balance sheet of the issuer as on the date of actual conversion).
When the issuer company performs better in the future, it would be able to command a higher price at the point of conversion. If the company indeed underperforms in future, the foreign investor and the Indian issuer would both get fair treatment and foreign investor would have to pay only what ought to realistically be paid by him for his equity interest.
In contrast, the stance adopted in the Consolidated FDI Policy could result in a larger ownership being handed over to persons resident outside India at a cheaper historical price. It is rather strange that government policy would discourage Indian companies from being able to negotiate a fair pricing formulation and force them to issue their stock cheap, by forcing them to take a plunge in the dark with a fixed price determined upfront.
If this clear concept is at all recognised, the baseless aversion to warrants and partly paid shares too ought to have no place in the policy. Warrants are merely convertible instruments that entitle the holder to get shares at a future date – no different from the convertibility component in convertible debentures. The policy would do better to prescribe an upfront forfeitable payment for a warrant as consideration for having a right to convert the warrant into shares in future – far better than prohibiting warrants. The ban on partly-paid shares too militates against the policy position that so long as pricing can be determined upfront, the government has no issue with the pricing of the instrument.
Besides, for listed companies, securities regulations provide for a minimum price for conversion and for upfront payment to get such convertible instruments. It is important for policymakers in one arm of government to note precedents set by other arms of government – a good recipe to avoid seeing ghosts and having baseless misapprehensions.
(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)