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Why and how the RBI relaxed pricing norms for foreign investors in its first policy statement: Jay Parikh

Jay Parikh
Jay Parikh
Verus Advocates partner Jay Parikh explains why the Reserve Bank of India recently announced it won’t dictate valuation of shares for foreign investors anymore.

Under the Foreign Exchange Management Act, 1999 (“FEMA”) read with the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 and RBI circular dated 4 May 2010, different pricing norms are prescribed for the acquisition and sale of listed as well as unlisted equity instruments of companies by non-residents.

On one hand, shares of a listed company may be acquired by non-residents for at least the price prescribed under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“SEBI Guidelines”), on the other, shares of an unlisted company may be acquired by non-residents for at least the price arrived at as per the discounted cash flow method (“DCF Method”).

Similarly, for sale of shares by a non-resident to a resident, the same valuation methodologies would apply i.e. SEBI Guidelines for listed shares and DCF Method of unlisted shares, save that the price thus arrived at shall work as the ceiling or maximum transaction price.

The pricing guidelines are further nuanced for equity instruments embedded with optionality clauses issued to non-residents.

Post the expiry of a lock-in period of 1 year or any other applicable lock-in period, whichever is higher, the non-resident investors are eligible to exit, without any assured return, (i) in case of instruments of a listed company, at the market price prevailing at the recognised stock exchanges; (ii) in case of an unlisted company’s equity shares, at a price not exceeding that arrived at on a Return on Equity (“RoE”) basis, and (iii) for investments in convertible instruments, at a price worked out as per any internationally accepted pricing methodology at the time of exit.

While the move from Controller of Capital Issues determined pricing formula to DCF Method in 2010 evoked mixed reactions, the DCF Method, it was discovered, had its own share of criticisms - for example, the heavy reliance on future projections for arriving at a valuation. There was also growing discontent over the ‘step-motherly’ treatment given to foreign investors in having differential pricing norms for entry and exit.

In view of the criticisms, in the first bi-monthly monetary policy statement for 2014-15 (“Policy Statement”), the RBI has announced that “as regards foreign direct investment (FDI), it has been decided to withdraw all the existing guidelines relating to valuation in case of any acquisition/sale of shares and accordingly, such transactions will henceforth be based on acceptable market practices. Operating guidelines will be notified separately.”

What this essentially means is that the methodology for valuation of shares basis which the entry and exit price is determined for non-resident investors, as discussed above, will now no longer be prescribed by RBI. It is likely that the operating guidelines, once notified, would be in tune with the income tax provisions regarding fair value and the global standards for valuation of shares. Further, it is widely felt that such relaxation could provide far greater flexibility to transacting parties to achieve their commercial objectives in an FDI transaction.

While such a relaxation of the pricing restrictions on equity instruments has been greeted warmly by the foreign investors, till such time as the operating guidelines are actually notified, foreign investors continue to debate certain concerns that arise. For instance, one big concern amongst foreign investors is whether RBI would retain base / ceiling price requirements given that the Policy Statement only speaks about withdrawing “existing guidelines relating to valuation”.

Another concern is whether RBI would continue to frown upon “assured returns” mechanisms. 

Download policy statement here.

Jay Parikh is a corporate and transactional partner at Verus Advocates.

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