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Concept of approval and automatic route
 
Sectors where foreign investment is permitted up to 100% without approval of the Foreign Investment Promotion Board (FIPB) qualify under the automatic route. This is the default route for FDI in absence of any specific rules - all sectors which are not prohibited or fall under the approval route (listed out in the FDI policy) belong to the automatic route. Practically, barring a handful of sectors which are regulated, FDI in most cases happens through the automatic route. Many high growth sectors such as software, biotechnology, manufacturing, exploration of petroleum and natural gas etc. are in automatic route, signifying that no FIPB approval is required for FDI.
Securities that can be purchased or issued to foreigners under the FDI route
 
Investment in equity shares or any other instruments which compulsorily convert after lapse of a pre-determined period of time is covered under the FDI policy. Hence, foreigners can invest in compulsorily convertible preference shares (CCPS) and compulsorily convertible debentures (CCDs) through the FDI route. Any other instrument, e.g. non-convertible debentures (NCDs), redeemable preference shares (RPS), optionally convertible instruments such as optionally convertible preference shares (OCPS) or optionally convertible debentures or OCDs will be considered as loans, and will not be covered under the FDI route.
 



Pricing regulations for acquiring Indian securities
 
There are three ways in which a foreigner may acquire shares/ convertible securities of an Indian company, which are described below.
  1. he may purchase shares from a resident
The minimum price for such shares should be computed by looking at the valume weighted average of historical market prices for 26 months if the company is listed - detailed methodology is explained in Regulation 76 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (SEBI Guidelines). If it is not listed, the minimum price must be as per fair valuation of shares undertaken by a SEBI registered Category - I Merchant Banker or a Chartered Accountant any internationally accepted pricing methodology arm's lenght basis.
  1. he may purchase from a non-resident
The maximum price for such shares should be as specified under the SEBI guidelines (i.e., the Issue of Capital and Disclosure Requirements Regulations, 2009), if the company is listed. If it is not listed, the maximum price must be as per fair valuation of shares undertaken by a SEBI registered Category - I Merchant Banker or a Chartered Accountant any internationally accepted  pricing methodology arm's  lenght basis.
  1. he may subscribe to fresh shares issued by the company
The minimum price for such shares should be the same as in case 1 above. 

Pricing issues also emerge with respect to foreign investors holding put options – a put option enables the foreigner to compel the Indian promoters to purchase its shares on exercise of the option. In January 2014, the RBI issued fresh pricing for price of securities sold by exercising options. In case of put options, the price is determined on the basis of the type of security sold, as follows:
  • The price of equity shares must be capped on the basis of a specific method known as the return on equity method (which calculates the ratio of profits after tax to the total net-worth).
  • The price of any convertible instruments (such as compulsorily convertible preference shares or compulsorily convertible debentures) must be arrived at in accordance with any internationally accepted pricing methodology (for example - return on equity, discounted cash flow, book value are some of the internationally accepted pricing methods). A SEBI registered Category I Merchant Banker or a Chartered Accountant is responsible for providing a certificate for arriving at the price. 

In a real-life situation, more than one of the above methods may be used – that is, a foreigner may purchase shares from residents (or non-residents) as well as subscribe to fresh shares issued by the company. That enables the company to raise investment as well as provides an opportunity to existing shareholders to dilute their stake for a profit.


Pricing in case of transfers is explained by a diagrammatic representation below:

 


 

Recap of pricing requirements

  • In case of sale by resident to a non-resident - The floor (minimum permissible price) at which shares can be sold to a non-resident must be determined by a must Chartered Accountant/ SEBI Registered Category I Merchant Banker (in case of an unlisted company) based on the discounted free cash flow method. In case of a listed company, the price must be the minimum price as permissible under the SEBI Guidelines. The price for sale to a non-resident cannot be lower than this amount.
  • In case of sale by non-resident to resident - the price determined by the Chartered Accountant/ SEBI Registered Category I Merchant Banker (in case of an unlisted company) or the SEBI Guidelines is the cap (maximum permissible price) at which the shares may be transferred. Shares cannot be sold to a resident at a higher price than this. In case of sale of securities by exercise of put options, the price shall be as follows:
    • The price of equity shares must be capped on the basis of a specific method known as the return on equity method (which calculates the ratio of profits after tax to the total net-worth).
    • The price of any convertible instruments (such as compulsorily convertible preference shares or compulsorily convertible debentures) must be arrived at in accordance with any internationally accepted pricing methodology (for example - return on equity, discounted cash flow, book value are some of the internationally accepted pricing methods). A SEBI registered Category I Merchant Banker or a Chartered Accountant is responsible for providing a certificate for arriving at the price.

 





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