(The following post is contributed by Raghav Sharma, who is an associate with a law firm in Delhi)
This post relates to Mr. Somasekhar Sundaresan’s article titled “RBI cuts sorry figure over norms for share transfers” wherein the author has highlighted certain ambiguities arising from the Reserve Bank of India’s (“RBI”) A.P. (DIR Series) Circular No. 49 dated May 4, 2010 (the “May Circular”). This article, which has been published in Business Standard’s edition on June 7, 2010, makes a very interesting reading for those who regularly come across difficult pricing issues in cross border transactions. Below are a few observations regarding the arguments canvassed by Mr. Sundaresan (I hope this would offer some food for thought for all of us):
In relation to NRIs and FIIs the new pricing norms stipulated under the May Circular are in conflict with already existing exchange control rules which allow NRIs and FIIs to trade on the stock exchange without adhering to any special pricing norms.
The May Circular amends the pricing guidelines stipulated under A.P. (DIR Series) Circular No. 16 dated October 4, 2004 (the “October Circular”). The May Circular includes NRIs and FIIs in the list of eligible non-resident transferees while prior to this, NRIs and FIIs were not eligible as transferees under the October Circular. However, as per paragraph 4 of the May Circular, it only amends paragraphs 2.2 and 2.3 of the Annex to the October Circular (dealing with pricing) and all other instructions of the October Circular remain unchanged.
Paragraph 2.1 of the October Circular (which has not been amended by the May Circular) states that the pricing guidelines stipulated therein are applicable to transfers from residents to non-residents or vice versa, by way of sale under “private arrangement”. The crucial term is “private arrangement” which according to common understanding is a transaction where the buyer and seller know each other’s identities. Such a transaction may also occur on the stock exchange e.g. a block deal.
The exchange control rules which allow NRIs and FIIs to sell on the stock exchange without any price restriction are those stipulated under Schedule 3 and Schedule 2 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (“FEMA 20”) respectively, i.e. the portfolio investment route. In such transactions, the buyer and seller do not know the identity of each other and the sale and purchase occurs on the normal segment of the stock exchange. Therefore, there does not appear to be any conflict as argued by Mr. Sundaresan.
The only effect of the May Circular is that transfer by a resident to an NRI or an FII under Regulation 10A (b) of FEMA 20 can take place under the automatic route if the pricing guidelines are adhered to. Under the October Circular, NRIs and FIIs were not eligible transferees and thus, transfer by a resident to NRIs or FIIs by way of private arrangement would have required approval under Regulation 10A (b) of FEMA 20.
One of the consequences of applying the SEBI guidelines applicable in case of preferential allotment to transfer of shares of listed companies from residents to non-residents or vice versa would be that in case of companies whose equity shares have been listed for less than six months, the parties could potentially violate the foreign exchange law by either receiving less than the floor price or paying more than the ceiling price.
It seems that the reference in this argument is to Regulation 76(3) of the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR Regulations”) which requires recomputation of issue price of shares allotted on preferential basis in similar circumstances and payment of differential by the allottee to the issuer company.
However, such a consequence does not flow from the text of the May Circular. The May Circular does not incorporate all the provisions of Regulation 76 by reference. It only adopts the SEBI pricing formula as a standard for determining the sale price while taking the relevant date to be the date of purchase or sale of shares. Mr. Sundaresan’s view appears to be a remote possibility as the text of the May Circular does not warrant the conclusion that the specific principle of recomputation specified in Regulation 76(3) was intended to be adopted in the May Circular.
SEBI has not envisaged a preferential allotment being made within two weeks of listing of a company. Thus, the price formula would not work in such cases and as a consequence of this no cross-border transfer of such shares may legitimately take place during such period.
Chapter VII of the ICDR Regulations (which deals with preferential allotment) does not prohibit a preferential allotment within two weeks of listing of a company. Assuming that the period of listing of the company is less than two weeks from the relevant date, Regulation 76(2) provides that where equity shares have been listed for a period less than six months as on the relevant date, then the floor price for allotment has to be higher of the following:
(a) price at which equity shares were issued by the issuer in its initial public offer or value per shares arrived in a scheme of arrangement pursuant to which shares were listed, as the case may be, or
(b) average of weekly high and low of the closing prices of the related equity shares quoted on the recognised stock exchange during the period the shares have been listed preceding the relevant date.
There is no provision in the ICDR Regulations which prohibits a preferential allotment being made within two weeks of listing of a company and appropriate pricing formula has been prescribed.
- Raghav Sharma