Foreign investors to see more change on options

By By Sourav Kanti De Biswas and Maneka Khanna, Shardul Amarchand Mangaldas & Co

The regulatory regime governing optionality clauses in India has seen a history of restrictions and uncertainties, leading to ambiguities on their enforceability. A notification issued by the Securities and Exchange Board of India (SEBI) in October 2013, recognizing the validity of such options, albeit with conditions attached, signalled a regulatory overhaul.

Sourav Kanti De Biswas

The Reserve Bank of India (RBI) followed through and in November 2013 amended the regulations under the Foreign Exchange Management Act (FEMA) to give legitimacy to optionality clauses in foreign direct investment (FDI) instruments. However, the RBI imposed conditions for exercise of a put option, which included pricing restrictions on transfer.

So far as a put or call being exercised by a resident or a call being exercised by a non-resident, the standard RBI pricing guidelines for transfer of shares were applicable. However, for a put option to be exercised by a foreign investor, the exercise price could not exceed the price of securities on the floor of the stock exchange (for listed entities) and for unlisted companies, it could not exceed the price arrived at on the basis of return on equity.

In July 2014, the FEMA regulations were further amended to remove the concept of return on equity, and the exit price on exercise of a put option was capped at the price arrived at based on any internationally accepted pricing methodology. It was clear that the RBI was unwilling to allow a foreign investor any assured return on its investment since the RBI viewed options as a form of debt in disguise.

Change of thought?

News reports early this year indicated that the RBI had proposed to permit Tata Sons to buy out the stake held by NTT DoCoMo in their joint venture company Tata Teleservices at a pre-agreed price which was higher than the price computed as per the RBI’s pricing guidelines. This was a radical change from the RBI’s earlier position. The RBI was reported to have said that it changed its stance because: (1) contractual commitments should be given credence; (2) business relations with Japan had improved; and (3) non-resident investors needed some protection against downside risks.

Maneka Khanna
Maneka Khanna

Reports also suggested that the RBI wrote to the Finance Ministry seeking permission to allow Tata Sons to buy back the investment of NTT DoCoMo at the pre-agreed price but the ministry rejected this on the ground that it would contravene the pricing restriction under the FEMA regulations.

In a monetary policy statement issued in February 2015, the RBI hinted it might allow an assured return at an appropriate discount over the sovereign yield curve through an optionality clause or in any other manner, while the RBI governor has indicated that he favours downside risk protection. We have to wait and watch what the final policy guidelines adopt.

Why now?

Put and call options with a fixed return on investment are an integral part of any investment made by private equity/venture capital investors and in joint venture agreements everywhere. Options are strategic rights that investors seek, especially to protect themselves in situations where the promoters or the targets do not meet certain conditions of their investment.

Foreign investors who put their money into new ventures expect to be appropriately rewarded for the risks. Due to ambiguity under Indian laws and the fear that Indian promoters or companies would not honour their obligations, foreign investors had legitimate concerns in making investments. Given the present government’s keenness to attract FDI and the “Make in India” initiative, it is necessary to assure foreign investors that law will uphold contractual agreements on providing assured returns, and leave the rest to negotiations.


Although the Finance Ministry rejected the RBI’s one-time proposal, it seems to have spurred the thought of taking a relook at the exit pricing policy. The RBI and the government now plan to review the pricing mechanism for exits as part of the government’s push to encourage foreign investment of risk capital in emerging areas.

The confusion over assured returns versus downside protection needs to be settled soon. Recognition of contractual commitments and assured returns would be a welcome move for those seeking investment as well as investors. Such measures would go a long way in creating a robust policy framework and confidence in the legal system, which would in turn attract greater levels of foreign investment.

Sourav Kanti De Biswas is a partner and Maneka Khanna is an associate at Shardul Amarchand Mangaldas & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.

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