Tuesday, July 21, 2009

Venture Capital - Foreign and Domestic: Some Comparisons

Consistent with the expansion of the venture capital industry in India, the regulatory regime has been formulated with a view to foster such growth. While the domestic venture capital industry is governed by the SEBI (Venture Capital Funds) Regulations, 1996, the foreign venture capital industry (investing into Indian companies) is governed by the SEBI (Foreign Venture Capital Investors) Regulations, 2000. On the face of it, the regimes appear similar to both types of venture capital investors. Both have been bestowed several exemptions and concessions from other applicable regulations, be it from the lock-in period in an IPO of an investee company or from the obligation to make a mandatory takeover offer when they sell shares to promoters of the investee company. Moreover, foreign venture capital investors (FVCIs) are not subject to pricing guidelines applicable to other foreign investors.

However, while there are similarities between domestic and foreign venture capital investors that emerge from the text of the regulations, there is striking disparity when it comes to the implementation of these regulations. That is also owing to the regulators that govern the two types of venture capital. While SEBI is the sole regulatory authority over domestic venture capital investors, both SEBI and RBI have roles to play when it comes to FVCI. Due to the foreign exchange concerns involved with FVCIs, a more cautious approach has been adopted with reference to FVCIs as compared to domestic venture capitalists. This has invited a significant amount of criticism in the manner in which FVCI applications have been handled by the regulators in the recent past, particularly by the RBI.

As Pranay Bhatia and Rachana Kapadia argue in FVCI Licensing and Pitfalls, RBI’s concern appears to stem from the fact that the FVCI route should not be used to circumvent restrictions under the general foreign direct investment (FDI) route, more so in sensitive sectors such as real estate. Further, they also note that RBI seems to have adopted the view that FVCI investments should be allowed only in nine sectors listed in Section 10(23B) of the Income Tax Act, 1961. Also, as we saw earlier this month, there was uncertainty as to the financial commitment or capitalization of FVCIs before they could submit their applications for registration, which has since been clarified. Such ambiguity in the stance of the regulator has resulted in significant delay in approval of dozens of FVCI application, as a report in The Mint indicates:

At least 43 foreign venture capital investors have been unable to begin investing in Indian start-ups because the requisite permissions from the Reserve Bank of India (RBI) have been delayed. Ten applications have been pending since 2005 and 11 more since 2006.

Capital markets regulator Securities and Exchange Board of India (Sebi) is the regulator for venture capital investors but it typically routes applications from foreign funds through RBI and clears them only after the central bank gives its nod. RBI gets involved because capital flows across national borders are involved.

As the Mint report notes, there is a need for greater transparency on the part of RBI in handling such applications. When there is already a detailed set of regulations, there ought to be very little scope for interpretation or for discretion to authorities to decide on individual applications. Moreover, there is no room for ambivalence in policy stances. The policy ought to be clearly stated in no uncertain terms so that market players are reasonably certain as to the outcome of their applications.

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