Monday, August 17, 2015

Demystifying FEMA - FDI - Instruments Other Than Equity

Direct Investment implies investment in equity with a long term commitment. A short term commitment in equity is in the form of portfolio investment.

FDI traditionally has been seen as investment in equity with a long term commitment. This long term commitment is in the form of JV or WOS. Long term commitment by individuals is seen in the form of Private Placement or Subscription to the Memorandum and Articles of Association.

Over the years, however, some non-equity instruments, which have a nature of long term commitment, have also been taken as instruments of Direct Investments.

Prominent among these are Convertible Debentures. Initially only Compulsorily Convertible Debentures were treated as Direct Investments. However, recently, Optionally Convertible Debentures have also been permitted as elegible instruments.

As Compulsorily Convertible Debentures ultimately lead to subscription to equity, these were treated as commitment of longer duration.

Optionally Convertible Debentures, on the other hand, may not result in subscription to equity. These have still been permitted to be treated as equity only if the exit clause does not ensure any assured exit price. Hence, these debentures cannot be redeemed at face value or a predetermined premium or discount. Thus, in effect, these debentures exhibit a characteristics of equity.

Other instrument in this category is Compulsorily Convertible Preference Shares. CCPS are also long term commitment which ultimately gets converted into equity. CCPS have additional restriction regarding the assured dividend that can be promised. The rate of dividend promised shall not be more than 300 basis points above the prime lending rate of State Bank of India on the date of the board meeting in which the dividend has been fixed.

The conversion price of CCDs or CCPS into equity has to be determine upfront at the time of issue. This price can be in the form of a fixed price or a price determined by a formula. However, the price thus determined or fixed should not be lower than the fair value of equity as on the date of issue of CCD or CCPS. Further, the entire inflow of FDI has to be used at the time of conversion.

Warrants and Partly paid Equity Shares have also been permitted to be part of FDI. The pricing has to be decided upfront and shall not be less than fair value. Further, 25% has to be brought upfront. The balance, in case of partly paid shares, has to be brought with in 12 months. However, if the issue size is more than Rs. 500 Crores the requirement of 12 months may be relaxed. In that case a monitoring agency will have to be appointed. The time frame for getting the balance 75% amount in case of warrants is 18 months.



  1. Kureel - nice explanation of complex financial tools

    1. Thanks Trideeb. Slowly I will be covering the entire gamut of FEMA.


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Vasant Vihar, New Delhi, India
A Central Banker with 22+ years of experience. Interested in latest developments in Indian Economy and Banking. Certified Trainer with 5+ years of experience in classroom training. VIEWS EXPRESSED ARE PURELY PERSONAL