No retrospective application of policy for hybrid instruments: FM rejects RBI proposal

NEW DELHI: The finance ministry has rejected the Reserve Bank of India’s suggestion for retrospective application of a proposed foreign investment policy for hybrid instruments, a move that’s significant in the backdrop of the ongoing Tata-Docomo dispute that threatens to sour business ties with a strategic ally.

The ministry has moved a cabinet note on a Budget proposal that could allow domestic companies to issue hybrid instruments such as optionally and partially convertible debentures to overseas entities under the foreign direct investment (FDI) policy. Accepting the RBI suggestion may have helped resolve the Tata-Docomo row although it could impact other such transactions differently.

"An FDI policy change cannot be carried out with retrospective effect," said a government source aware of the deliberations. The RBI letter was written just about a month back. The development comes in the backdrop of the ongoing tussle between the Tata Group and its Japanese partner NTT Docomo over their joint telecom venture Tata Teleservices. The Japanese company had invested $2.2 billion in 2008.





Both companies had agreed the Indian partner would buy 26.5% stake in 2014 or find a buyer for it if milestones weren’t reached. NTT Docomo alleged last week that its Indian partner was shirking its commitments by taking refuge in the RBI policy that bans exits by overseas investors at an assured price to avoid paying $1.17 billion in arbitration damages won recently in London. The Japanese company has said the money should come from the overseas assets of the Tata Group not governed by local laws.

Tata Sons, the group holding company, said on Friday that it had deposited $1.17 billion with the Delhi High Court and that its overseas assets can’t be seized as these are not party to the dispute. The RBI had written to the finance ministry a while back on the issue during consultations on a new framework for hybrid instruments that the latter was working on.

The central bank suggested retrospective application of the draft policy based on the Budget proposal could help address such disputes arising out of stringent pricing norms for quasi-equity instruments. This new policy would, however, be governed by conditions on schedules for conversion and fair market value.

Finance Minister Arun Jaitley had said in the February Budget that the basket of eligible instruments would be widened to include hybrid ones to expand the scope of tools that foreigners can use to invest in India. Instruments that are fully and mandatorily convertible into equity within a specified period are regarded as equity under the FDI policy and eligible to be issued to persons residing outside India. Any instrument that is not mandatorily converted is considered debt and governed by external commercial borrowing (ECB) rules.

RBI has made case earlier
The central bank had on December 22, 2014, written to the finance ministry seeking to do away with pricing norms altogether and leaving it to investors to decide, citing Tata-Docomo case. "We observe the proposed structure is not in line with extant provisions, as fair value of the shares is Rs 23.34 per share. However, the larger issue here is of fair commitment in contracts in relation to an investment and a downside protection of an investment, rather than assured return," RBI had said in its letter. Besides India’s strategic relationship with Japan, the impact on FDI flows should also be kept in view, RBI had said. "In view of this, we are inclined to accept the proposal and in future, in all such cases, similar principle shall be applied," it had said. But the central bank subsequently rejected Tata Sons' proposal to pay Docomo a price that was higher than the fair value after the finance ministry told RBI to take a decision as per its own guidelines.

Quasi-equity
RBI has traditionally frowned upon quasi-equity instruments, which it judged to be equity in the guise of debt. Its reservations on "call and put options" stemmed from the view that equity capital is risk capital and therefore could not have any capital protection or an assured return, the tenet anchoring the instruments that became popular in cross-border transactions. A call option allows the holder to buy shares in an entity at pre-agreed price while a put option allows an investor to sell as per agreed terms. The RBI’s opposition to these instruments prompted the department of industrial policy and promotion (DIPP) to impose a ban in 2011. It soon retracted the controversial press note that generated much opposition. But the RBI continued to drag its feet on the issue by delaying approvals to foreign investment transactions with such inbuilt assurances.

It was only in 2013 that RBI, the finance ministry, market regulator Securities and Exchange Board of India ( Sebi) and DIPP reached an understanding on these instruments and agreed to allow them with a one-year lockin after adhering to pricing norms.

Sebi announced a change in regime for listed companies in October 2013. For unlisted companies, RBI pricing guidelines had to be followed. In January 2014, RBI specified that exits could not be at a price in excess of what was arrived at on the basis of return of equity. The earlier method was on the principle of discounted cash flow.

This was changed following representations from industry in July 2014 to any internationally accepted pricing methodology on arms-length basis, the guiding principle being that a nonresident investor is not guaranteed any assured exit price at the time of making the investment and exit price is a fair price.