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Call/Put Options: RBI Takes A U-Turn?

Published on Fri, Jan 23,2015 | 23:23, Updated at Fri, Jan 23 at 23:23Source : CNBC-TV18 |   Watch Video :

Just when you think that the call and put options issue has been put to rest, you’re proved wrong! This time the RBI seems to be sympathetic to the cause of enforceability of call and put options. It has written to the Finance Ministry proposing that Tatas should be allowed to buy DoCoMo’s stake in Tata Teleservices at the pre-determined price – something that RBI’s 2014 circular disallows. What has caused this change of heart and what does it mean for the future of optionality clauses- Payaswini Upadhyay reports.

The Reserve Bank of India’s dislike for call and put options in shareholder agreements has been a much discussed and debated issue. For the uninitiated, the regulator disallowed call and put options that guaranteed a fixed price exit as that amounted to debt disguised as equity. In 2013, RBI budged a little. It legalised call and put options but prescribed a RoE based exit price. A year later, the RBI budged further when it made way for free pricing saying non-resident can issue and transfer shares of unlisted companies at a fair value.

Pratibha Jain
Partner, Nishith Desai Associates
“In the first place, such put and call options were held to be null and void by the regulator- specifically the RBI- which led to not only those particular clauses being held as null and void but the RBI started taking a view that any agreement that had such clauses, the whole agreement could be held null and void. This led to quite a bit of fear in the market. Overtime, the agreements were amended by the investors to state that it will be as per the current regulations of the country.”

Vivek Gupta
Partner, BMR Advisors
“Through all this that was happening over the last couple of years, contracts that private equity and other foreign investors entered into with Indian companies continued to contain the commercial understanding where downside protection was built in or generally for achieving other commercial purposes, put and call options existed. What that did was when those put and call options matured and the foreign investors sought to enforce them, because the law was unclear or had certain bans in it, promoters of Indian companies took the argument that these put and call options cannot be enforced.”  

Now, it seems like the regulator is waking up to commercial realities!

Last month, the RBI sent a letter to the Finance Ministry that may spell good news for foreign investors. The letter was in the context of Tata and Japan’s DoCoMo’s joint venture where RBI has suggested that DoCoMo be allowed to exit at a pre-determined price.

The 2009 agreement between Tata and DoCoMo provides for an exit for DoCoMo if certain key performance indicators are not met by 31st March 2014. This exit price was decided to be at least half the sale price that turns out to be Rs 58.04 per share.

But as per RBI’s 2014 circular, DoCoMo can exit only at fair value which– as determined by PwC- turns out to be Rs 23.34.

So now, RBI has proposed that fair commitment in the contract should be given credence and a downside protection of an investment rather than an assured return should be permitted.

Pratibha Jain
Partner, Nishith Desai Associates
“RBI does seem to be making a distinction between downside protection and assured return and in my view, it’s a welcome step. It is recognizing that if two contracting parties believe that contractually they want to enter into an agreement which gives a downside protection to the investor. Just because it’s an equity investment does not mean it cannot have a downside protection. And I think any mature market will recognize the capability of two parties to negotiate terms which are in the long term interest of both the parties.”

Anand Desai
Managing Partner, DSK Legal
“I think they are trying to find ways now because it is probably inhibiting investors because they have put money in believing they have a contract which was enforceable and then one fine day they find it cannot be enforced. So to that extent it’s helpful to give the facility to an investor to get his money out; it should encourage investment. The bigger issue is how often will this issue keep changing in terms of the stand being taken, who will it apply to, how will it be applied. So I still think there will be uncertainty given this particular scenario and given the RBI’s recommendation to the government.”

Vivek Gupta
Partner, BMR Advisors
“In so far as Indian companies are concerned, if the RBI were to come out with a norm that says only capital will be protected, I think for a lot of arbitrations that are currently pending between private equity and promoters- that will still offer perhaps in some situations a mechanism whereby a reasonable settlement could be found. There are many investments from 2007-2008 timeframes where, I think, capital has been significantly eroded. So at least some degree of protection will flow to the foreign investor. Has RBI also permitted IRRs, that would have caste even higher obligation on the Indian companies. So I would say overall Indian promoters will not find it completely unpalatable or difficult to swallow.”

Worried promoters issue aside, the bigger question is how will RBI’s new position reflect in its guidelines; if at all? If the regulator goes on to allow downside protection, what will happen in cases where funds are invested at different price levels?   

Pratibha Jain
Partner, Nishith Desai Associates
“If they want to provide for downside protection, then they would allow for minimum guaranteed price as per the sale price or lower. That’s the only way to assure because I can’t think of them coming up with arbitrary figure. In the case of Tata-DoCoMo, the agreement itself said 50% of the sale price. But I can’t see the government coming up with a percentage to the sale price. I would say they should allow for downside protection and that’s the only way to ensure there is no confusion in the market with respect to such clauses.”

The other confusion that the government needs to be mindful of is that this treatment should not be given to investors of only a particular country. What leads me to say that? Well..the RBI, in its letter to the government, has made a case for Tata’s proposal saying that it should also be accepted on grounds of India’s recent strategic relationship with Japan in relation to FDI flows. Experts say that exemptions should not be given based on where the investor is coming from because that will only lead to bilateral investment treaty claims against the government since most treaties have a most favored nation or MFN clause embedded in them. That said, we clearly haven’t heard the last word on call and put options and we’ll revisit the issue soon- hopefully to discuss a clearer policy framework.

In Mumbai, Payaswini Upadhyay


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