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New pricing guidelines for FDI instruments with optionality clauses

In terms of the extant foreign direct investment policy (“FDI Policy”) of the Government of India, only equity shares and compulsorily and mandatorily convertible preference shares/debentures are allowed to be issued by Indian companies to non-residents.

However, the Reserve Bank of India (“RBI”) has vide A.P. (DIR Series) Circular No. 86 dated January 09, 2014, now also recognized and allowed certain optionality clauses with respect to issuance of the above instruments to non-residents, that oblige the buy-back of securities from the non-resident investor at the price prevailing/value determined at the time of exercise of the option, so as to enable the non-resident investor to exit without any assured return. 

The above optionality clauses have been permitted subject to fulfillment of the following conditions:

(a) There should be a minimum lock-in period of 1 (one) year or a minimum lock-in period prescribed under the FDI Policy for the relevant sector (if any), whichever is higher (e.g. in regulated sectors such as defence and construction development). The lock-in period will begin from the date of allotment of the securities, unless otherwise prescribed for any specific regulated sector under the FDI Policy;

(b) After completion of the lock-in period, a non-resident investor exercising its exit option as aforesaid, will be eligible to exit without any assured return, as under:

(i) In case of a listed company, the non-resident investor will be eligible to exit at the market price prevailing on the recognized stock exchanges;

(ii) In case of an unlisted company, the non-resident investor will be eligible to exit from the investment in:

(A) equity shares at a price not exceeding that is arrived at on the basis of ‘Return on Equity’ (i.e. profit after tax/net worth, where net worth would include all free reserves and paid up capital) as per the latest audited balance sheet of the Indian company. Henceforth, any agreement permitting return linked to equity as above will not be treated as violation of FDI Policy.

(B) Compulsorily convertible debentures and compulsorily convertible preference shares at a price worked out as per any internationally accepted pricing methodology at the time of exit, after being duly certified by a Chartered Accountant or a SEBI registered Merchant Banker.

The guiding principle would be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment/agreement and will be eligible to exit at the price prevailing at the time of exit, subject to lock-in period requirements and other sectoral conditions, as applicable. The RBI has further emphasised that all existing investment contracts will now need to comply with the above conditions to qualify as FDI compliant.