Revised FDI Policy: Options Outlawed

In the comments section to my previous post on the new FDI policy, reader Menaka highlights another important clarificatory change regarding the policy stance of the Government that now clearly outlaws options in securities held by foreign investors in Indian companies. The relevant clause in Circular No 2 of 2011 is as follows: Only equity shares, fully, compulsorily and mandatorily convertible debentures and fully, compulsorily and mandatorily convertible preference shares, with no in-built options of any type, would qualify as eligible instruments for FDI. Equity instruments issued/transferred to non- residents having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the extant ECB guidelines. [emphasis supplied]
Although the Reserve Bank of India has been adopting this stance lately (as discussed here), it is now well-etched in the policy of the Government of India as a formal matter, and not just in the form of interpretation of the regulations. This suggests that the Government has taken strong exception to the use of put options in equity investments as a method of guaranteeing returns to foreign investors and providing financial protection against their investments. It is bound to curtail investments in certain sectors and by specific types of investors (e.g. financial investors such as private equity funds) who tend to rely upon put options in securities as an essential component of the transaction structure.

Another aspect to consider is that even though the concern of the foreign investment regulators arises in the context of a “put” option as that may provide the investment with the character of an external commercial borrowing (ECB), a plain reading of the clause in the new FDI policy quoted above is wide enough to extend it to “call” options as well. This would lead to the result that foreign investors holding call options will also fall within the proscription contained in the new policy, although it does not carry the same reasoning for a ban as that of put options.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.


  • "supported by options 'sold' by third parties"..can this statement not be construed to apply to Exchange Traded Derivatives ("ETF") such as stock options instead of put-option arrangements which are in essence contingent contracts (where there is no sale of the option only sale of the security on exercise of the option) and since an option can only be "sold" on a stock exchange (under SCRA) leading to the inference that the aforesaid statement applies to ETF. If this is so, then, in effect, there is no change in the present law….

  • I saw a discussion on CNBC program 'The Firm'. People are furious on the retrospective effect of the FDI policy which may have adverse effect on the overseas investors particularly real estate industry. Such move will definitely affect the fund flow to the industry and likely to create friction with JV partners.

  • A very interesting post. Hhowever I would argue that the new clarification would not cover call options, either where the call option is on further securities of the target or where the counterparty has a call option. The first should not be covered as it is not an option which relates to the instruments in question, and the second should not be covered as it does not "support" the instrument in question or assure a financial return for the investor. However, as always, the language of the statute remains sufficiently wide for the regulator to take a contrary view.

  • Dear Umakanth,
    The Policy talks of equity shares with no 'in-built options'. Thus, if the call/put options are given to an investor under a separate agreement, and such options are not an attribute of the equity instrument itself, would it still be covered under clause of the policy?

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