Foreign investment laws and policies in India have been and continue to be a subject matter of much deliberation. Most debates are fuelled by unclear regulations, multiple notifications, press notes and circulars issued by multiple regulators regulating foreign investments in the country.
In an effort to abridge the number of press notes, notifications and circulars issued by the authorities, the Department of Industrial Policy and Promotion (“DIPP”) of the Ministry of Commerce and Industry, Government of India issued a consolidated foreign direct investment (“FDI”) policy on April 1, 2010 which, in the words of the policy itself, was published merely to consolidate existing policy. However, in consolidating the foreign investment policy, the DIPP also changed the policy and left open various avenues of interpretation. Most have not been addressed even in the revised policy published on October 1, 2010. This article aims to discuss some of these aspects.
Wholesale Cash and Carry and Single Brand Retail
Wholesale cash and carry and single brand retail are sectors which have been greatly impacted by the consolidated policy of the DIPP.
While 100% foreign direct investment (“FDI”) under the automatic route is permissible in wholesale cash and carry activity, FDI of only 51% is permitted under the government approval route in single brand retail. FDI in multi brand retail is prohibited.
Typically, investors would invest in companies carrying on the business of wholesale cash and carry with 100% FDI which in turn would sell all of its wholesale and cash and carry goods to an Indian held group company on cash and carry basis, at favorable margins. This company would then sell the goods as a retailer, directly to consumers. Under this structure, technically, no FDI norms were breached and foreign investors could make profit by using the retail front of the wholesale activity. Hence, foreign investors were able to benefit indirectly from retail trade.
When DIPP issued the consolidated policy, it stated that wholesale trading of goods would be permitted among companies of the same group but that such wholesale trading to group companies taken together should not exceed 25% of the total turnover of the wholesale venture. It added that the wholesale made to the group companies should be for their internal use only. This was clearly a change in policy on the part of the government, one which resulted in most wholesale-retail structures failing. Several questions arose. Which companies were companies of the same group? What does internal use mean? While the revised policy of October 1, 2010 removed the condition of “internal use”, the meaning of the term “companies of the same group” has not been provided and remains open to interpretation. Until the DIPP defines the term “companies of the same group”, foreign investors will be wary of following the wholesale-retail structure for fear of being caught on the wrong side of the law.
Pricing of Convertible Instruments
FDI in Indian companies through subscription to compulsorily convertible instruments is quite common. In a typical investment through convertibles, the conversion price is calculated based on a performance linked formula. Hence the conversion price is fluid and dependent on the performance of the company. However, the introduction of language in the consolidated policy which states that the pricing of the convertibles should be determined upfront at the time of issue of the instruments nullifies the advantages of subscribing to convertibles in a company. While a view was being taken that this means that the mechanics for the conversion should be decided upfront, the RBI has been seeking clarifications from investors and is insisting on a specific price of conversion at the time of issue of the convertibles. The reasoning provided by the RBI is that the investor should have the appetite to bear the risk involved in deciding the conversion price upfront and the investor should be subject to the same risk that an equity investment would result in.
This argument has not been well accepted. Risk bearing is a commercial understanding of the parties. It can be argued that so long as the investor converts its convertible instruments at a price above the fair market value (as per the new pricing guidelines), the RBI should not interfere.
There is yet another problem. Analysts have for the longest time debated whether the price of conversion of convertibles should be determined on the date of issue of the instrument or on the date of conversion. While there has still been no solution to this problem, there is now another facet which needs to be looked at. Since now the price of conversion has to be determined at the time of issue of the instrument, what happens if at the date of conversion, the price of conversion is in variance with the pricing guidelines, i.e. if at the time of conversion, the fair market value of the shares is higher than the conversion price specified. This question remains unanswered.
Foreign Venture Capital Investors (FVCI) and Domestic Venture Capital Funds (VCF)
With the new master circular on FDI being issued by the RBI in July 2010, a new entry was introduced at No 34 of Annexure I to the master circular. It states that Sebi registered FVCI are allowed to invest in domestic venture capital undertakings and domestic venture capital funds through the automatic route subject to the Sebi regulations and sector specific caps. At the same time however, the consolidated policy suggests that where the entity undertaking venture capital fund activity is a trust registered under the Indian Trust Act, 1882, FDI would be permitted with approval. The reading of these provisions together raises a question whether the consolidated policy creates an exception to the rule of automatic investment permitted by the RBI circular.
Secondly, when the master circular states that FVCI are permitted to invest subject to sector specific caps; in the event a Sebi-registered VCF (in which FVCI is a majority investor), undertakes downstream investment in companies in various sectors with different caps on FDI, would such investments also be subject to sector specific caps? Would the pricing guidelines be applicable? Further, would the principles laid down by DIPP in the erstwhile press notes 2, 3 and 4 of 2009 apply to such downstream investments? None of these issues are addressed by the new consolidated policy.
While the effort of the DIPP to issue a consolidated policy every 6 months is a benevolent one, there are issues faced by investors’ everyday due to the unclear way in which the policy has been drafted. One would imagine that perhaps the regulators did not anticipate these practical issues. However, hopefully, the government will address these issues in the forthcoming policies to reduce regulatory uncertainty and create a more comprehensive, all encompassing policy.
The authors are with DSK Legal, a law firm. The views expressed are personal and not those of DSK Legal
