Eased hybrid securities' pricing hits RBI barrier

The Reserve Bank of India (RBI) has thrown a spanner in the works of a government proposal to liberalise the pricing guidelines of hybrid securities such as foreign direct investment (FDI)-compliant instruments.

RBI feels that only shares, as well as fully and compulsorily convertible debentures (CCDs) and preference shares (CCPs), should continue to be considered FDI compliant. If any of these instruments have an option, under which the price is determined at a future date based on performance, it ought not to be considered FDI compliant.

In a communication to the Ministry of Commerce & Industry at the end of September, RBI has argued that any shift in policy stance on pricing guidelines under existing FDI policy would first require detailed discussions between the Department of Economic Affairs and the Ministry of Finance.

Many companies have been clamouring for an easing of rules. This is because the fair value of company shares can only be determined on future performance or at a time when debentures are converted into equity. It is difficult to fix an upfront value on a share’s premium.

However, RBI believes that only instruments that primarily have equity characteristics be deemed FDI compliant. In other words, for an instrument to be FDI compliant, an overseas investor should bear the same risks as does an ordinary shareholder of an Indian company.

RBI also believes that an Indian company or foreign investor that still wishes to maintain formula-based or open-ended pricing for the conversion of CCDs or CCPs into shares have the option of taking the external commercial borrowing route, where both options are available on redemption. Furthermore, Indian companies can issue foreign institutional investors rupee-denominated bonds within an overall $20-billion limit.

The central bank also argues that Securities & Exchange Board of India (Sebi) rules state: “Where the value of the convertible portion of any convertible debt instrument exceeds Rs 50 lakh, and the issuer has not determined the conversion price at the time of making the issue, the holders of such convertible debt instruments shall be given the option of not converting the convertible portion into equity shares.”

RBI says this provision being mandatory for listed Indian companies would create a possibility where an FDI-compliant instrument issued to non-resident Indians would cease to be FDI compliant, as it need not compulsorily convert into equity shares. While Sebi rules are mandatory for listed companies, a special dispensation for unlisted Indian companies – performance-linked pricing -- creates an asymmetric situation, which may not be advisable in the interests of regulatory parity, the central bank feels.