The monetary policy announced on April 1, 2014, by the Reserve Bank of India (RBI) contains a fundamental policy shift on valuation norms governing acquisition and sale of shares under the foreign direct investment (FDI) route. The policy specifies that as regards FDI, it has been decided to withdraw all the existing guidelines relating to valuation. Such transactions will henceforth be based on acceptable market practices and operating guidelines will be notified separately.
The point on valuation has always been a common subject of interest for both residents and non-residents. Until the discounted cash flow (DCF) method of valuation was introduced, it was the guidelines formulated by the controller of capital issues (CCI) which were to be considered. Although the DCF method was considered better and forward-looking, there were no strict rules for such computation.
In January 2014, RBI formally allowed optionality clauses linked to securities issued to a non-resident investor, albeit with a few conditions. A lock-in period of 1 year was one such condition to be satisfied should a non-resident investor choose to enforce such a right. The key takeaway, though, from this notification was that a non-resident investor cannot be guaranteed any assured return. There was also a fundamental shift in the manner in which RBI approached pricing while such options were being exercised ? a return on equity method/basis was specified for shares and the pricing for compulsorily convertible debentures and compulsorily convertible preference shares was allowed to be worked out as per any internationally accepted pricing methodology. Such price was required to be certified by a chartered accountant or a Sebi-registered merchant banker.
Although the January circular did not address various issues that could arise given the differential pricing for shares and convertible instruments and particularly by reason of the return on equity basis computation for shares, it now appears (with the announcement of the decision under the monetary policy) that the January circular was the first step towards liberalising the valuation/pricing norms.
The shift of RBI?s stance from a regulator of the pricing/valuation policy to one of monitoring is a bold one and is welcome. What, however, remains unclear is the position of the January circular.
Although it seems logical that the January circular will be superseded by the operating guidelines to be issued, it is also likely that the conditions attached to options will continue, with other acquisition/sale transactions based on acceptable market practices.
The difference, therefore, would be where two contracting parties enter into a contract at their free will, and the pricing/valuation norms will not come in the way and it will be assumed that there are mutual considerations including fair pricing for the parties to reach such agreement. However, should there be any enforcement of rights by one party, the regulator may want to ensure that the other party is protected.
It appears that with the announcement under the monetary policy and leaving the valuation guidelines open, RBI has shifted the onus on the non-resident investor to justify the price should they be called to reason, rather than merely complete a ?check the box? valuation.
These operating guidelines are sure to be keenly watched since they will have a significant impact on structuring transactions. To say the least, the non-resident investors may be able to breathe a sigh of relief since exit is one of the key considerations for any investment and it is unfair to hope that any investor would be encouraged to invest without clarity on exit.
The guiding principle of the January circular that there cannot be an assured return to a non-resident investor for equity investments would not be too worrisome given that equity investments are considered high risk and high reward, but such steps are likely to provide the much-needed boost to the investing community.
RBI perhaps wants to watch the game rather than play it.
Raj Ramachandran
The author is a partner at J Sagar Associates. Views are personal
