Options trading in India and the changes made by the Reserve Bank of India

The Reserve Bank of India must review its position on put options or risk driving foreign investors away

Umakanth Varottil explains

Put options provide a customary and useful exit mechanism to foreign financial investors such as private equity funds and venture capital funds which invest in Indian companies. Such investments are made with the expectation of an exit through an initial public offering (IPO) of an Indian portfolio company. However, if an IPO does not materialize – a possibility that is entirely real given current market conditions – investors are likely to rely on put options to exit a company by compelling the Indian promoters to acquire their stake. Legally speaking, a put option is the right or entitlement, but not obligation, of an investor to sell its shares in a company to the grantor of the option.

Although put options are a well-accepted right in any financial investment, their validity as a matter of Indian law is fraught with difficulties. Their enforceability is subject to grave risks posed by a mixture of complex domestic regulations.

First, since an option usually restricts transferability of the underlying shares, the ability of the shareholders of a company to self-impose restrictions is not free from doubt in the context of the Companies Act, 1956. This position has been obscured further by diverse approaches adopted by the Indian courts.

Umakanth Varottil is an assistant professor in the Faculty of Law at the National University of Singapore. Before his foray into academia, he practised law in India and was a partner at Amarchand Mangaldas.