Wednesday, September 11, 2013

FDI and Acquisition of Shares on the Stock Exchange

Under the prevailing regime on foreign direct investment (FDI) in India, only certain types of investors are entitled to buy and sell shares on the stock exchange through a registered broker. They are foreign institutional investors (FIIs), qualified foreign investors (QFIs) and non-resident Indians (NRIs). All other types of non-resident investors may either buy shares from the company in a new offering or may acquire existing shares through a private arrangement.

Last week, the Reserve Bank of India (RBI) relaxed these stipulations by allowing a non-resident investor to acquire shares in an Indian listed company through the stock exchange, so long as such investor has already acquired and continues to hold control in accordance with the SEBI Takeover Regulations. Other conditions include those pertaining to pricing, manner of payment of consideration and compliance with other aspects of the FDI policy such as sectoral caps.

Although the genesis for this limited relaxation is unclear, it might have something to do with liberalizing the inflow of foreign exchange into the country. By permitting non-residents to invest in listed companies without the requirement of prior approvals, it is expected to encourage foreign exchange inflows.

The key condition for availing this route is that it is available only to a non-resident investor that is already in control of the company. This gives rise to some issues. First, the definition of “control” itself is a matter of interpretation, as we have discussed earlier. Hence, it is not necessary for a non-resident investor to hold a majority of shares in the listed company in order to be in control. It may be in control with limited shareholding (even less than the 25% limit prescribed for triggering mandatory open offers) so long as the subjective aspects of the definition of control are complied with due to protections sought by the non-resident investor under a shareholders’ agreement or the articles of association of the company.

Second, due to this condition of control, the benefit of acquiring shares in the market is available only to incumbents in the company. Hence, it allows non-resident investors who are already in control to entrench themselves further in the company. This can be achieved through the creeping acquisition route available under the SEBI Takeover Regulations. This is understandable in the context of foreign exchange concerns as well. An investor who is already in control of a company is likely to be a long-term investor. Hence, further acquisitions of shares will ensure foreign exchange inflows without the risk of any outflow through liquidation of investors in the short-term. At the same time, this stipulation operates against non-resident investors without control, for whom stock exchange purchases may be a means of acquiring a “toe hold” that provides a platform from which they can launch an open offer to acquire control over the company. The regulatory concern appears to be that if the gates are opened up to such non-resident investors, there is no certainty that the investment will remain long-term in nature, lest the investor decides to liquidate the investment if it does not succeed in acquiring control over the company.

Update (September 11, 2013: 5.16 pm IST): Our reader and guest contributor, Yogesh Chande, sends us his observations on RBI’s circular, which raise a number of practical considerations. His observations are as follows:

1.      This will also require a corresponding amendment to the FDI policy.  

2.      Wherever the promoter shareholding in an Indian listed company is at around 75%, no further or hardly any head room is available to such promoters to consolidate their shareholding in any manner.

3.      The words " accordance with...." gives an impression that such promoters should have been currently holding control over an Indian listed company, provided they have acquired control after making an open offer in accordance with the SEBI Takeover Regulations, not realising that even an acquisition which is exempted under the SEBI Takeover Regulations could be termed as an acquisition in accordance with the provisions of the SEBI Takeover Regulations by relying on the exemption provisions prescribed therein.

4.      It also therefore not clear as to whether promoters who are in control of an Indian listed company, but have not acquired control pursuant to an open offer in past [in accordance with] or not even pursuant to relying upon any exemption under the SEBI Takeover Regulations, can avail of such a mode to acquire further shares through this newly introduced route. 

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