The move will generate goodwill with foreign investors but unfairly creates a special category of exemption
Siddharth Shah
Head — Funds Practice, Nishith Desai Associates
It demonstrates the sovereign’s willingness to fulfil its contractual obligations under a treaty
The proposal by the Securities and Exchange Board of India (Sebi) to create a specific exemption for sovereign wealth funds (SWFs) from the open offer provisions in terms of their aggregate stake going up to 20 per cent stems from the government’s obligation under the Comprehensive Economic Cooperation Agreement (CECA) signed with Singapore in 2005. Under the CECA, India had undertaken to treat the investment arms of the Singapore government (GIC and Temasek) as independent and separate for all regulatory purposes. Since then, Sebi has been confronted with the question of whether these two very active investment vehicles owned by the Singapore government should be treated as separate entities under Foreign Institutional Investor (FII) and takeover regulations. Though the immediate beneficiary of this proposal would be these two sovereign investors from Singapore by giving them more headroom to play in the Indian market, Sebi’s move is welcome even otherwise.
First, it demonstrates the sovereign’s willingness to fulfil its contractual obligations under a treaty, even if it calls for regulatory changes. This would definitely lend more credibility and negotiating strength to current and future negotiations for other CECAs. Second, it recognises the fact that many of these SWFs have different investment strategies and completely independent managements, even though the source of capital is common. So, in a sense, aggregation of their holdings for the purpose of FII regulations as well as the takeover code goes against their independent status. The takeover code’s definition of “persons acting in concert” (PAC) states that there has to be a “commonality of objective” between PACs, and even for “deemed PACs”, the presumption is a rebuttable presumption if the contrary can be established. Thus, this move to offer a specific exemption from an open offer in the absence of a “change in control” is not really giving away anything more than what exists except that it creates more certainty for these funds.
Third, considering that this exemption will be limited to those countries with which India negotiates a CECA, concerns over security issues and the stigma of “undesirable foreign influence” associated with SWFs would have been addressed while negotiating these agreements. Also, now that India is considering setting up its own SWF, it should also be in a position to negotiate such reciprocity in the CECA.
Fourth, SWFs, by virtue of their more permanent source of capital, can take a much longer term strategic view of a market unlike limited life funds or institutions. This could offer more stability and depth to the Indian market that has always shown a higher degree of volatility in FII flows. And finally, as the Sebi minutes have noted, this move may turn out to be non-consequential if and when the trigger for the open offer is raised to 25 per cent as recommended by TRAC. Thus, without giving away anything more, this move will establish more goodwill for India globally.
The proposal also recommends corresponding changes in the FII regulations to allow non-aggregation of limits based on source for SWFs. This again goes back to the same principle that so long as each of these sovereign entities are independently managed, giving them an individual limit would offer them more flexibility in investment. This is akin to the “managed accounts” where a similar principle should apply with emphasis on independence of management rather than source of capital. Globally, from an investor perspective, managed accounts are a preferred option for large endowments, pension funds and also SWFs rather than funds that come in as part of multiple pooled accounts.
To conclude, it is a good tactical and strategic move by the government that should yield more quantitative and qualitative results in the long run. In the short run, it will help augment foreign capital inflows, which have been declining for the past 12 months or so. When the world is fighting for limited capital, this move will send out strong signals to world markets that India is willing to go the extra mile to remove blocks to the flow of such capital into the country.
Sandeep Parekh
Founder, Finsec Law Advisors
If an exemption is given to SWFs that are considered passive, it must also be given to all passive investors
There should be consistency in drafting laws and a law must have a philosophy behind it. Where a legal idea is fleshed out in the form of a formal law, it is drafted in cold legal language but retains a living core and philosophy. The Indian takeover regulations provide for the making of a public tender offer once a person acquires a substantial number of shares or control of an Indian listed company. It also provides for a series of exemptions for certain types of acquisitions, for instance, on acquiring a sick company or transfer between existing promoters. Broadening the exemption for a new class of persons should have a nexus to the object sought to be achieved from that classification.
The Securities and Exchange Board of India (Sebi) and the government are seeking to give special status to sovereign wealth funds (SWFs) when they seek to acquire shares of a listed company. Specifically, the proposal is to exempt SWFs from the ambit of takeover regulations for up to 20 per cent as opposed to 15 per cent for other acquirers. There is also a proposal to allow twice the limit available to other acquirers from a limit of 10 per cent holding per Foreign Institutional Investor (FII), that is to say, an SWF can acquire 20 per cent instead of 10 per cent.
The background to the issue is that the government signed a trade treaty with another government in which it has agreed to these higher numbers. However, the treaty was executive in nature — it was signed by the government as opposed to agreed upon or ratified by Parliament. Given that Sebi regulations (both FII and takeover) are tabled in Parliament, in case of a conflict between a government treaty, which really is a contract signed by the government versus a delegated legislation, it would clearly be the Sebi regulation that would trump a contract, even if it is by the state itself. Sebi has recently put on its website a proposal to be taken up by its board, whether to amend the regulations in line with the treaty and cites the opinion of the attorney general that Sebi is entitled to exempt SWFs, but must do so on a case-by-case basis.
The question of why create a special category of exemption for SWFs begs the question, what are SWFs? There are two answers depending on whom you ask. The first answer is that these funds are arms of the government and deploy surplus sovereign money as investment in various gilts, debt and equity securities of countries across the globe to deliver both returns and strategic benefits. The second answer is that these are surplus funds with no strategic value, and are pooled so that they can be invested in asset classes that deliver higher returns compared to investing in US treasury securities with its low returns. Being sovereign in nature there is little data available about these funds and their objectives. It is, therefore, impossible to answer the question accurately for most countries whether a fund is strategic in nature or is merely a passive investment.
If the answer is the first, then there are dangers attached to foreign governments taking larger stakes in Indian companies and delivering sovereign outcomes. Conspiracy theorists would point to foreign governments trying to reduce outputs of industries that compete with their own industries. Thus, tweaking the rules just for SWFs does not seem appropriate.
If the answer is closer to the second, that they are passive investors, assuming that they provide a high level of transparency and accountability to the world at large about their objectives and source of funds, the issue is less problematic. There are lots of passive international investors who don’t have the benefit of this special class. For instance, a pension fund based out of, say, a state in the US, by its charter will clearly not have any control motives. To treat these obvious passive investments on a lower pedestal compared to SWFs is unfair. If an exemption is given to SWFs that are considered passive, it must also be given to all passive investors including pension funds, social security funds, university fund, mutual funds, charitable trusts and insurance/reinsurance companies. While the law creates un-equals out of equals, there may be strategic merit in signing executive treaties that give special fair treatment to certain countries.
