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Equity Instruments with Put Options not to be considered as FDI

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Shruti Priya, Anuj Sahay

Following up on an often declared policy intention, the new policy on Foreign Direct Investment (“FDI”) issued by Department of Industrial Policy and Promotion (“DIPP”) effective from 1st October 2011 has eliminated all all instruments with an in-built options, such as right to sell back shares, out of FDI ambit.

Section 3.3.2.1 of the FDI Policy[1] states as follows:

“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 non residents 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.”

The Reserve Bank of India has often expressed the desire to “re-characterize” equity or preference based structures where promoters or other third parties provide put options at specified prices since they have “debt-like characteristics”. This policy decision finally brings much needed, if unwelcome clarity to the situation.

Private equity/ venture capital will now have to consider alternate structures to protect returns or accept pure-play equity risk.

The government supported their stand in respect of the aforesaid amendments by reasoning that the changes have been made in order to attract long-term equity funds which otherwise is defeated as the options are usually designed to provide exit which results in incurring inflow of more debt than equity.[2]

[1] FDI Policy – Circular 2 of 2011

[2] http://m.economictimes.com/PDAET/articleshow/10190843.cms

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1 Comment

  1. Kapish says:

    If we treat these equity as “ECB” can we not use para 3.4.6 which allows Conversion of ECB/Lumpsum Fee/Royalty into Equity ??

    If the FDI is under Automatic Route.

    Can we interpret as an accounting measure rather than aa complete ban ??

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