India Inc to get freedom on use of options

Law minister clears Sebi's regulation on put & call options

India Inc will soon have greater flexibility in structuring deals through use of options, with Law Minister Kapil Sibal clearing a put & call option regulation framed by the Securities & Exchange Board of India. This means, for mergers & acquisitions, listed firms could use such options that create a right to buy/sell more shares in the future. The issue was stuck with the ministry for nine months.

Sebi was earlier opposed to put & call options on the ground these encouraged speculation. It had rejected the use of these in two deals, including one between Cairn and Vedanta in August 2010. Sebi also felt the arrangement did not conform with the requirements of spot-delivery contract or a derivative contract under Section 18A of the Securities & Contract Regulation Act. A similar arrangement between two investors in case of a firm, Vulcan Engineering, was also rejected by Sebi as the contracts were to be exercised at a future date, and so did not qualify as spot-delivery contracts.

A call option allows the holder to buy a security at a predetermined price, usually above the current, within a limited time. A put option gives the holder the right to sell securities at a specified price within a limited period. When an option is exercised by the holder, the shareholder is obligated to buy or sell the shares at the predetermined price. While a put option provides an investor an exit route from a firm, a call option gives the option to increase the shareholding in the firm.

Law ministry sources said the Reserve Bank also had reservations about the legality of the put/call option system. To address its concern, the Department of Industrial Policy & Promotion had earlier inserted a provision in the foreign direct investment policy that said any instrument with an inbuilt option would be considered debt and treated as external commercial borrowing.

Law ministry sources added Sebi had since softened its stand and sent a revised regulation as put/call option was an integral part of modern finance. Besides, there was a realisation India had been left behind, as there was no legal clarity on such contracts. Sebi drew up regulations and sent to the finance and law ministries for vetting. The new regulation will be notified shortly.

Dara Kalyaniwala, head of investment banking at Prabhudas Lilladher, said the move would bring in transparency in M&A deals and other large strategic investments. “All shareholder agreements have some kind of put-call option, but they are kept out of the main shareholders’ agreement, which is open to inspection by regulators. Instead, the clause is included in a supplementary shareholder agreement that is kept confidential and away from regulatory and public scrutiny,” he says.

This was because while the Companies Act didn’t recognise put-call option, it didn’t explicitly prohibit it, either. Promoters and investors then resorted to the Indian Contracts Act to enter into separate agreement outside the ambit of the Act. This created the problem of enforceability if either of the parties refused to abide by the agreement at a later date.

“It’s a boon to PE investors. It will allow them to enter into open and transparent agreements with promoters and will go a long way in curbing disputes when things go sour,” said Ashustosh Maheshwari, CEO (investment banking), Motilal Oswal Financial Services.