Taking someone by surprise is a virtue, but mostly when one is at war. In other circumstances, particularly in matters of investment policy, surprises are mostly unpleasant. Yet, our policy-makers have demonstrated their penchant for taking the investment community by surprise. In the evening of Friday, September 30, when the world thought India was looking forward to a weekend of Navaratri night revelry, the Department of Industrial Policy and Promotion (“DIPP”) took the world by surprise, causing sleepless nights all around.
The DIPP announced the “Consolidated FDI Policy” to take effect that midnight. It contained this bombshell: “Only equity shares, fully, compulsorily and mandatorily convertible debentures and fully, compulsorily and mandatorily convertible preference shares, with no in-built options of any type, would qualify as eligible instruments for FDI. Equity instruments issued/transferred to non-residents having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the extant ECB guidelines.” (Emphasis, mine.)
In plain English, on a weekend with no prior engagement with “civil society”, the Indian government unleashed a policy that changed the way equity investments would be treated. Overnight, investors were told that what they hitherto thought of as an equity investment was in the eyes of the Indian government, a debt instrument. If an investor had invested in an instrument that was mandatorily convertible in equity shares, merely if someone else had agreed to acquire the instrument from the investor as a condition of contract, the equity investment would be regarded as a debt investment. The usage of the words “would lose their equity character” could only signal that there would be a change of characterisation of something already done – in short, a retrospective amendment, normally abhorred in law-making except in major emergencies. To rub salt into the injury, the press release summarising the material changes in the policy did not even mention this change – almost as if this were always the law, and the policy merely consolidated it in one place.
The new policy contained a footnote about the policy on issuance of warrants (instruments that would entitle the holder to acquire a share by exercise of an option) being under active consideration of the government. Yet, in the same breath, the policy has ruled that any options supported by third parties would render an instrument to be a debt instrument. Therefore, if you were to invest in an equity share of a company, and a third party agreed to buy it from you on certain terms, the new policy would regard you as a lender and not an equity investor.
The consequence is that your investment ought to have been compliant with the policy governing external commercial borrowings (“ECB”) although your investment is an Indian Rupee-denominated equity share and not in a foreign currency instrument.
Rules governing ECB would mean that overnight you would have to fit a square peg in a round hole. The restrictions in ECB policy, just to cite a few, would entail requirements that the proceeds of investment may be expended only towards capital expenditure, no borrowing may be made from outside the debt capital markets or banks and financial institutions, and the cost of borrowing would have to be capped.
The Reserve Bank of India (“RBI”) did pilot such an amendment earlier last decade to treat optionally convertible preference shares as debt instruments. Therefore, the market was asked to introduce an element of compulsory conversion into equity. Even with mandatory conversion into equity, this is a new doosra bowled by our policymakers. Joint ventures between Indian and foreign promoters normally entail put and call options on each other so that if they do not see yet to eye on the future path of the company they have created together, one of them could buy the other out and take the company on a specific path. Arguably, the new policy would now mean the foreign promoter is an investor in a debt instrument – a completely mindless exercise.
It seems the mood in the system is either one of one-upmanship across regulators, or a smug feeling that foreign capital needs India more than India needs foreign capital. There is an even more sinister whisper doing the rounds – some influential Indian promoters are said to be in trouble over commitments to buy out their foreign investment partners, and the insinuation is that they have gotten the rules of the game changed to win the game. Whatever it is, we have all the trappings of a banana republic.
(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)
