The Government of India’s (GOI) new consolidated foreign direct investment (FDI) policy circular effective from 1 October 2011 has de-classified instruments with options from being FDI investments and introduced other significant changes, such as increasing FDI caps in FM Radio and changes in single-brand retail trading norms.

“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 nonresidents 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,” stated clause 3.3.2.1 reflecting the revised FDI policy stance of the government.

According to a client advisory note issued by Wakhariya & Wakhariya partner Neeta Sanghavi, who was the former legal head at UBS India, shares with call and put options would now be treated as loan instead of an FDI. “The key is to note that shares with in-built options issued/transferred to non-residents or shares supported by options issued/transferred to non-residents will not be recognized as FDI and such instruments would have to comply with the ECB guidelines.”

“In other words, equity shares, fully and compulsory convertible preference shares, fully and compulsory convertible with no in-built options issued to non-residents will be eligible as foreign direct investment.”

The revised guidelines, which have now been formally included in the regulatory framework, had earlier been adopted by the Reserve Bank of India which treated instruments with ‘put options’ as ECB according to India Corporate Law blog.

“It is bound to curtail investments in certain sectors and by specific types of investors (e.g. financial investors such as private equity funds) who tend to rely upon put options in securities as an essential component of the transaction structure.”

Further, the new FDI policy does not clarify on the retrospective implication for put and call options existing prior to 1 October 2011.

The Wakhariya & Wakhariya release also set out the other sector specific conditions:

FDI in Terrestrial Broadcasting FM (FM Radio) is now permissible up to 26% (from the earlier 20%) under Government Route.

FDI in Apiculture (bee-keeping) has been allowed under the category of permitted agricultural activities under controlled conditions.

In the Defence sector, prior approval of FIPB is not required for transfer of equity from one non-resident investor to another non-resident investor, after the non-resident seller has held the shares for a minimum of 3 years.

FDI into construction development activities in the education sector and in respect of old-age homes has been exempted from the conditionalities imposed on FDI that apply to construction-development activities in the real estate sector. These conditions include minimum built-up area, minimum capitalization and lock-in.

In single brand product trading, foreign investor should now be the owner of the brand.

Basic and applied R&D on bio-technology, pharmaceutical sciences/ life sciences has been allowed as ‘industrial activity’ for purpose of establishing industrial parks, where FDI is allowed up to 100% under the automatic route.

The FDI policy also introduces provisions on ‘pledging of shares’ and opening of non-interest bearing escrow accounts.

• Download the circular here.