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Incremental Reforms to FDI rules pricing guidelines for rights issue


The Ministry of Finance on 17 October 2019 notified the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules)  in supersession of the Foreign Exchange Management (Transfer of Issue of Security by a Person Resident outside India) Regulations, 2017 and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018. On 27 April 2020, the Foreign Exchange Management (Non-Debt Instruments) (Second Amendment) Rules, 2020 (Amendment) were notified by the Ministry of Finance which amended the NDI Rules to give effect to the following changes:


Acquisition through rights issue: Prior to the Amendment, the explanation to Rule 7 stated that the conditions specified in Rule 7 are also applicable in case a non-resident made an investment in the equity instruments (other than share warrants) issued by an Indian company as a rights issue that are renounced by the person to whom it was offered.

In other words, a non-resident could have subscribed to renounced shares (i.e., renounced either by a non-resident or a resident) subject to compliance with Rule 7 inter alia at a price determined by the company (in case of a listed company) or at a price not less than the price offered to residents (in case of an unlisted company).

This explanation has been deleted and a new rule, namely 7A, has been inserted. As per Rule 7A, a non-resident can now subscribe to renounced shares in a rights issue, which have been renounced by a resident in its favour, subject to the pricing guidelines prescribed under the NDI Rules. While Rule 7 did provide clarity on how one could determine the price for a rights issue, reference to Rule 21 has led to a position where compliance with pricing guidelines would apply for acquiring equity instruments pursuant to Rule 7A. This would lead to a separate price in a single rights issue for renounced shares intended to be subscribed by a non-resident so far as unlisted companies are concerned.

For listed companies, given the reference to the Securities and Exchange Board of India (SEBI) guidelines in the NDI Rules, a position could be taken that the pricing would continue to be as decided by the issuer company in consultation with the lead managers.


Sourcing norms in single brand retail trading (SBRT): Prior to the Amendment, the sourcing norms applied 3 years from the commencement of business i.e., opening of the first store for entities undertaking SBRT of products having 'state-of-art' and 'cutting-edge' technology and where local sourcing is not possible. Pursuant to the Amendment, it has been clarified that the period from which sourcing norms will become applicable will be 3 years from commencement of the first store or start of online retail, whichever is earlier. The Amendment has notified the change suggested in the Press Note No. 4 of 2019 issued by the Department of Promoter of Industry and Internal Trade (DPIIT) on 18 September 2019.


Divestment by foreign portfolios (FPIs) upon breach of investment limit: In case of breach of the prescribed limit, FPIs have an option of divesting their excess holdings within 5 trading days from the date of the settlement of trades causing the breach. If the FPI chooses not to divest, then its entire investment in the Indian company is considered as a foreign direct investment (FDI) and such FPI and its investor group is not permitted to make any further portfolio investments in the Indian company. Such breach is not considered as a contravention of the NDI Rules during the time taken to follow the said procedure. The Amendment has introduced an additional condition i.e., the divestment of holdings by the FPI and the reclassification of FPI investment as FDI will be subject to further conditions, if any, specified by SEBI and the Reserve Bank of India in this regard.


Investment in insurance sector: The Amendment also notified the government’s budget proposal to permit upto 100% FDI in insurance intermediaries under the automatic route, which was earlier capped at 49%.

Please click here for a more detailed analysis for the insurance liberalisation.


While this Amendment aims to tighten the pricing mechanism for renunciation of shares, it does pose the following challenges for its implementation:


Differential pricing in the same rights issue

In a rights issue made by an unlisted company, the existing non-resident shareholder can subscribe to equity shares (up to its entitlement) at a price not less than the price offered to residents. However, pursuant to the Amendment, they would need to pay a different price for acquiring shares which are renounced by a resident in their favour. Such price would need to be determined as per the pricing guidelines.


Computation of price

Rule 21 of the NDI Rules  links the price to relevant SEBI guidelines in case of a listed company; or (b) valuation arrived at by a chartered accountant or a SEBI registered merchant banker or a practising cost accountant in case of an unlisted company. Since these rules do have a reference to SEBI guidelines for listed companies, one could rely on the pricing prescribed by SEBI for rights issue.

However, if one was to treat this as a separate issuance and not refer to the SEBI prescribed guidelines for rights issues, this would lead to challenges on what would the relevant date be for determining the price of the renounced shares i.e., whether it would be the date of the board meeting approving the rights issue or would it be the date of allotment of the renounced shares to the non-resident. This approach would also create challenges for participation by FPIs.


Additional Shares

Lastly, the issue relating to subscription to additional shares by a non-resident in a rights issue, remains to be addressed.

-       Moin Ladha (Partner) and Gaurav Malhotra (Senior Associate)

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Moin Ladha (partners)

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