The `call and put option’ rules have undergone frequent changes, creating policy confusion and delays that undermine business sentiment, according to experts.
It was this year’s finance Act that shifted control on equity capital flows to the finance ministry from the Reserve Bank of India, giving the government power to review these rules.However, the government has to administer these in consultation with the central bank.
CASE In January, the RBI had suggested allowing the transfer of shares by a nonresident investor at a price higher than their fair value in view of the Indian partner’s contractual commitments in the Tata-DoCoMo case.
The policy allowed for a fair valuation different from the exit valuation agreed between the two investors in the telecom venture.
The RBI’s view was that the contractual agreement should be honoured and pitched for a change in policy.
The finance ministry, wary of changing the existing policy in one instance, asked RBI to take a view on the case in line with the central bank’s own guidelines. It subsequently took over jurisdiction of the policy in the February budget.
CASE FOR MORE FELXIBILITY
The Narendra Modi-led government, which has launched the Make in India initiative among others to boost economic activity , is keen to attract foreign capital to spur the country’s manufacturing sector. Last week, the union cabinet cleared a policy to allow fungibility of all forms of foreign capital within sectoral caps as part of its drive to make the country a more attractive destination for overseas investors. The review of the `call and put option’ pricing rules are part of the government’s push to iron out difficulties they posed for investment of risk capital in emerging areas.
The central bank had also written to the finance ministry on the issue of pricing norms governing exits and the need to re-examine the existing policy.Industry has sought changes as well.
“The pricing norms should facilitate the execution of the real commercial understanding between the parties, especially concerning the putcall option pricing for the deal, irrespective of the fair market valuation of the shares,“ said Punit Shah, partner, Dhruva Advisors.
A `call’ option allows the holder to buy shares in an entity at an agreed price, while a `put’ option allows an investor to sell. Though popular, these instruments were not looked upon with too much favour by the RBI as it was worried that they would lead to foreign debt coming in disguised as equity.
Put options, which give special rights to foreign investors to sell back equity if certain conditions such as timely listing are not fulfilled by Indian company, were seen largely as facilitating debt flows that would go out after a certain period.
In 2011, the Department of Industrial Policy and Promotion (DIPP), taking its cue from the RBI, had even banned these instruments but soon retracted the policy measure over fears it could slow down foreign investment.
In 2013 the RBI, finance ministry, market regulator Securities and Exchange Board of India (Sebi) and DIPP reached an understanding on these instruments and agreed to allow them with a one-year lock-in period after adhering to pricing norms.
In its rules, the RBI said exits could not be at a price higher than that arrived at on the basis of return on equity, a change from the earlier norm based on the discounted cash flow method it had specified. After representations against this condition, in July 2014, the RBI said any internationally recognised pricing methodology would be accepted.
The RBI’s views in the case of Tata NTT DoCoMo were thus seen as a complete reversal of its earlier stance against such instruments.
Let Them Plan Their Exit
The rules for pricing of `call and put option’ have rarely been objective, informed more often than not by the fear of debt entering in the guise of equity. Such fears do not sit well with India’s attempts to bring private equity and venture capital to fund avalanche of ideas by the internet generation.And India’s external account is no longer vulnerable to a few billion dollars flowing out. Investors putting up risk money to funds innovation need to be commensurately rewarded. Simpler rules are called for to govern how companies provide exit to foreign investors. Within a broad framework this needs to be left to the companies.