Cross-border share transfers have been hit by a new wave of inexplicable regulatory ambiguity. This time, the source is policy framed by the Reserve Bank of India (RBI), which administers exchange controls in India.
As a general rule, exchange controls seek to conserve foreign exchange. They seek to ensure that at a minimum price is paid when ownership of an asset moves from Indian hands to foreign hands. Likewise, they seek to ensure that the price paid is not above a specific maximum price when ownership of an asset moves into Indian hands from foreign hands.
Last month, the RBI introduced significant policy ambiguity when it brought in new regulations to govern the price at which cross-border share transfers may take place. Earlier, shares listed on a stock exchange could be transacted at the ruling market price, which was considered to be a fair price. The RBI has now simply adopted the formula prescribed by the Securities and Exchange Board of India (SEBI) for computing the minimum price at which a preferential allotment may be made by listed companies as a barometer of fairness for cross-border share transfers.
Preferential allotments are out-of-turn allotments that are made to specifically pre-identified persons without offering the shares to everybody on the same terms. Therefore, SEBI’s floor price formula is aimed at ensuring that a minimum amount flows into the listed company towards the allotment. The floor price is essentially the higher of two market price averages – the average of the weekly high and low closing prices for an immediate prior period of six months, and for an immediate prior period of two weeks. While at first blush, nothing may seem amiss with such an approach, a closer read would expose the range of unintended or incongruous consequences.
First, the policy-makers have forgotten that under exchange controls, NRIs and foreign institutional investors (FIIs) are permitted to trade on the stock exchange without adhering to any special pricing norms. However, the new norms introduced by the RBI explicitly require NRIs and FIIs too to adhere to the pricing norm. Therefore, one set of exchange controls explicitly entitle NRIs and FIIs to freely trade on the stock exchange at the ruling market price, and another set of exchange controls require them to adhere to a formula-driven historical average price. Arguably, every FII and NRI could be in breach of the new pricing norms for every purchase or sale made a price variant from the historical average price.
Second, a plain reading of the floor price formula for preferential allotment would immediately show that it could never have been simplistically force-fitted into exchange controls. Under this formula, if shares of the company making the preferential allotment have not been listed for at least six months, the formula would have to be re-applied as and when the six-month listing history is attained. If the formula were to then throw up a higher price, the differential amount ought to be brought into the company.
A direct application of such a formula to cross-border share transfers would result in the legitimacy of transactions being indeterminate in these circumstances. By blindly applying the same formula, as and when the six-month listing history is achieved, a resident Indian seller could find himself to have committed a violation because he actually received less than a compliant price. Similarly, a resident Indian acquirer could discover that he had paid out more than the legitimate price.
Third, other exchange controls also prohibit deferred payment for shares acquired by a person resident outside India from Indian residents. Therefore, the parties would not be able to agree to adjust the price as and when the six-month listed history is completed. Alternately, no cross-border share transfer ought to take place at all, if the company were not listed for at least six months.
Fourth, SEBI has not envisaged a preferential allotment being made within two weeks of listing – it would be really odd for an out-of-turn fund raising immediately upon the first listing. However, cross-border transfers may take place in the shares right from the first day of listing. The price formula would just not work, and therefore, no cross-border trade may legitimately take place during such period.
Finally, there are circumstances and share transactions for which SEBI has formulae to compute a fair price – for example, the minimum price payable in a takeover or delisting transaction. Applying the preferential allotment floor price simplistically in such situations would be unreasonable and unfair. If the RBI believes a SEBI-prescribed formula would throw up a fair price, it ought to respect other SEBI-prescribed formulae as reflective of fairness in the circumstances to which they are applicable.
In short, Indian regulations cut a sorry figure. Being smug about international capital chasing Indian assets despite her regulations being vague would be mis-placed. Smugness would be acceptable only if capital were to flow in with full clarity over whether it is legitimate. (The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)