FDI and Acquisition of Shares on the Stock Exchange

Under the prevailing regime on foreign direct investment
(FDI) in India, only certain types of investors are entitled to buy and sell
shares on the stock exchange through a registered broker. They are foreign
institutional investors (FIIs), qualified foreign investors (QFIs) and
non-resident Indians (NRIs). All other types of non-resident investors may
either buy shares from the company in a new offering or may acquire existing
shares through a private arrangement.
Last week, the Reserve Bank of India (RBI) relaxed
these stipulations by allowing a non-resident investor to acquire shares in an
Indian listed company through the stock exchange, so long as such investor has
already acquired and continues to hold control in accordance with the SEBI
Takeover Regulations. Other conditions include those pertaining to pricing,
manner of payment of consideration and compliance with other aspects of the FDI
policy such as sectoral caps.
Although the genesis for this limited relaxation is unclear,
it might have something to do with liberalizing the inflow of foreign exchange
into the country. By permitting non-residents to invest in listed companies
without the requirement of prior approvals, it is expected to encourage foreign
exchange inflows.
The key condition for availing this route is that it is
available only to a non-resident investor that is already in control of the
company. This gives rise to some issues. First,
the definition of “control” itself is a matter of interpretation, as we have discussed
earlier
. Hence, it is not necessary for a non-resident investor to hold a
majority of shares in the listed company in order to be in control. It may be
in control with limited shareholding (even less than the 25% limit prescribed
for triggering mandatory open offers) so long as the subjective aspects of the
definition of control are complied with due to protections sought by the
non-resident investor under a shareholders’ agreement or the articles of
association of the company.
Second, due to
this condition of control, the benefit of acquiring shares in the market is
available only to incumbents in the company. Hence, it allows non-resident
investors who are already in control to entrench themselves further in the
company. This can be achieved through the creeping acquisition route available
under the SEBI Takeover Regulations. This is understandable in the context of
foreign exchange concerns as well. An investor who is already in control of a
company is likely to be a long-term investor. Hence, further acquisitions of
shares will ensure foreign exchange inflows without the risk of any outflow
through liquidation of investors in the short-term. At the same time, this
stipulation operates against non-resident investors without control, for whom
stock exchange purchases may be a means of acquiring a “toe hold” that provides
a platform from which they can launch an open offer to acquire control over the
company. The regulatory concern appears to be that if the gates are opened up
to such non-resident investors, there is no certainty that the investment will
remain long-term in nature, lest the investor decides to liquidate the
investment if it does not succeed in acquiring control over the company.
Update (September
11, 2013: 5.16 pm IST): Our reader and guest contributor, Yogesh Chande, sends us his observations on RBI’s circular, which
raise a number of practical considerations. His observations are as follows:
1.      This
will also require a corresponding amendment to the FDI policy.  
2.      Wherever
the promoter shareholding in an Indian listed company is at around 75%, no
further or hardly any head room is available to such promoters to consolidate
their shareholding in any manner.
3.      The
words “……in accordance with….” gives an impression that such
promoters should have been currently holding control over an Indian listed
company, provided they have acquired control after making an open offer in
accordance with the SEBI Takeover Regulations, not realising that even an
acquisition which is exempted under the SEBI Takeover Regulations could be
termed as an acquisition in accordance with the provisions of the SEBI Takeover
Regulations by relying on the exemption provisions prescribed therein.

4.      It also
therefore not clear as to whether promoters who are in control of an Indian
listed company, but have not acquired control pursuant to an open offer in past
[in accordance with] or not even pursuant to relying upon any exemption under
the SEBI Takeover Regulations, can avail of such a mode to acquire further
shares through this newly introduced route. 

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.

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