ISSUE III : Regulations enabling global moves

INTRODUCTION

Corporate growth is no longer limited to the home turf. Companies have started to look beyond the domestic landscape for expanding their business prospects. This is true for both Indian companies which are spreading wings abroad and foreign companies who want to establish base in the Indian soil. In this context, laws play a crucial role. It is, therefore, important to implement regulations that will facilitate growth and expansion in the economy.

The Reserve Bank of India (RBI), India’s main bank is responsible for creating a favorable economic climate in the country. For this purpose, it issues circulars pertaining to diverse areas periodically. Our current issue focuses on the highlights of the relevant portions of the credit policy¹ that was released by RBI on October 31, 2006 and the guidelines that have been laid down by RBI for overseas investment, in particular with respect to acquisition by Indian corporations of companies abroad.

1.0  Highlights of credit policy

The latest credit policy has allowed corporates to borrow more from overseas market as well as take larger loans from the Indian banks to fund international acquisitions and expansions. The relevant features of the policy are as follows:

• RBI has allowed corporates to access additional External Commercial Borrowings (ECB) of US$ 250 million under the approval route² during a financial year. This is in addition to the existing limit of US$ 500 million which is allowed under the automatic route.³ The average maturity of loan should be more than 10 years.

• Further, corporates have been allowed to pre-pay their foreign borrowings of up to US$ 300 million as against the earlier prescribed limit of US$ 200 million without prior approval of RBI. This is subject to the maturity period which is applicable to the loan.

• RBI has increased the ceiling for overseas investment by Mutual Funds (MFs) from the current US$ 2 billion to US$ 3 billion. The rationale for the increase is to encourage Indian investors to diversify their investment in international assets. Prior to this policy, MFs were only allowed to invest in ADRs/GDRs of Indian companies, rated debt instruments and in the equity of overseas companies that are listed on a recognized stock exchange abroad and have a shareholding of at least 10% in a listed Indian company.

• In order to discourage excessive inflow of foreign exchange into the economy, RBI has allowed all categories of foreign exchange earners to retain up to 100% of their foreign exchange earnings in their Exchange Earner’s Foreign Currency accounts (EEFC)⁴ as against the earlier limit of 75%.

Exporters have been allowed to deploy their surplus cash in short-term bank deposits or AAA-rated paper abroad.

• The limit for individual remittances abroad has been doubled from US$ 25,000 to US$ 50,000. Also, Non-resident Ordinary Rupee Account (NRO)⁵ holders can now remit up to US$ 1 million a year.

• RBI has allowed banks to grant up to 20% of their unimpaired capital funds⁶ as loans and guarantees to companies. This would imply greater availability of resources for Indian firms who are interested in overseas acquisition and expansion.

• RBI plans to increase the investment limit of Foreign Institutional Investors in government securities in phases. The current limit of US$ 2 billion will be raised to US$ 2.6 billion by December 31, 2006 and further to US$ 3.2 billion by March 31, 2007.

2.0 RBI guidelines for overseas acquisitions

In the recent past, Indian companies have scripted several acquisitions abroad. Until now, 130 overseas acquisitions have been announced which are estimated to be worth nearly US$ 9 billion. The biggest so far is Tata Steel’s US$ 8 billion takeover bid for UK-based Corus Group which will catapult Tata’s ranking to No. 5 in the steel industry. The world is witness to the wide range of Indian companies investing across varied sectors and destinations abroad. Be it steel, pharmaceuticals, banking, software, automobiles, consumer durables, India is conquering every sector. The following segment focuses on the guidelines laid down by RBI for direct investment abroad, specifically catering to overseas acquisitions.

To regulate acquisition and transfer of a foreign security by a person resident in India i.e. investment by Indian entities in overseas Joint Ventures (JV) and Wholly-Owned Subsidiaries (WOS) as well as investment by a person resident in India in shares and securities issued abroad, the Reserve Bank has issued Foreign Exchange Management (Transfer or issue of any foreign security) Regulations, 2004 (Notification) under Foreign Exchange Management Act.

2.1 Eligibility

Regulation 6 of the Notification deals with direct investment by Indian parties in JV/WOS abroad. For this purpose, form ODA⁷ has to be submitted to a designated branch of an authorized dealer bank. The investment should not exceed 200% of the net worth of the Indian party as on the date of the last audited balance sheet. However, this ceiling is not applicable if the Indian entity makes the investment from the balances held in the EEFC account or out of funds raised through ADRs/GDRs. These transactions are allowed under the automatic route.

The following categories of investors are permitted to invest in equity of companies registered abroad. They do not require any prior permission from RBI.

Corporates – Listed Indian companies are allowed to invest abroad in (a) other listed companies and (b) which hold at least 10% in a listed Indian company.⁸ Indian entities are also allowed to invest in rated bonds/fixed  income  securities  of  such  companies.  The  investment  should  not  be  more  than  25%  of  the Indian company’s net worth as on the date of the latest audited balance sheet.

Individual – Resident individuals are allowed to invest in equity and rated bonds/fixed income securities of overseas companies without any monetary limit.

MF Investment – MFs can invest in ADRs/GDRs of Indian companies and in equity of overseas companies.⁹

Financial service sector – An Indian entity can invest in financial sector activities overseas. However, the investee must have earned net profit during the preceding three financial years The Indian entity must be registered with the regulatory authority in India for engaging in financial services and must have obtained approval from the concerned authorities abroad for venturing into financial sector activities in their jurisdiction. Finally, the Indian party should have fulfilled the prudential norms relating to capital adequacy as stipulated by the relevant authorities in India.

2.2 Approval of RBI

An Indian entity which does not fall in any of the above mentioned categories has to obtain prior approval from RBI. Application for overseas direct investment in JV/WOS has to be made to RBI in Form ODI whereas if the investment is by way of acquiring shares of a foreign company which is engaged in the same core activity¹⁰ in exchange of ADR/GDRs which has been issued to the foreign company, the application has to be made in Form ODB.

2.3 Method of funding

Investment in JV/WOS abroad can be funded in any of the following ways:

1. By drawing foreign exchange from an authorized dealer bank in India.
2. By capitalization of exports.
3. By swap of shares.¹¹
4. By utilization of ECB proceeds/Foreign Currency Convertible Bonds.
5. By utilization of proceeds of foreign currency funds raised through ADR/GDR issues.

2.4 Guidelines for acquisition of foreign companies

In case of partial or full acquisition of an existing foreign company, where the investment is above US$ 5 million, the company shares have to be evaluated by a category I merchant banker who is registered

with Securities and Exchange Board of India (SEBI) or an investment banker outside India which is registered with the appropriate regulatory authority in the host country.¹² RBI takes into account the following factors while considering the applications which are made for the purpose of investment:

1. Prima facie feasibility of the venture abroad.
2. Contribution to external trade and other benefits which will accrue to India through such investment.
3. Financial position and business track record of the Indian entity and the foreign entity.
4. Expertise and experience of the Indian entity in the same or related line of activity of the venture outside India.

RBI allots a Unique Identification Number for each JV/WOS abroad which has to be quoted by the Indian party in all its communications and reports.

In terms of regulation 8 of the notification, an Indian entity can acquire shares of a foreign company in exchange of ADRs/GDRs that have been issued to the foreign company i.e. there is a stock swap. In this kind of acquisition, the Indian entity uses its own stock to pay for acquiring the shares of the foreign company. It allows the foreign company to retain the ADR/GDR that have been issued by the Indian entity and in turn gets a stake in the foreign company. However the Regulation prescribes the following conditions, which has to be fulfilled:

1. The Indian entity should have made an ADR/GDR issue and the same should be listed on a stock exchange outside India.

• The ADR/GDR issue for the purpose of acquisition should be backed by underlying fresh equity shares issued by the Indian party.

• The total holding in the Indian party by persons resident outside India in the expanded capital base should not exceed the prescribed sectoral caps.

• The valuation of the shares of the foreign company should be made in accordance with the recommendations of an investment banker if the shares are unlisted or on the basis of the market capitalization of the foreign company.

• The Indian party has to submit a report in Form ODG to RBI within 30 days from the date of ADR/GDR issue in exchange for acquisition of shares of the foreign company.

According to regulation 14 of the notification, an Indian entity eligible to make investment outside India can remit earnest money deposit or issue bid bond guarantee for acquisition of a foreign company by way of bidding and tender procedure through an authorized dealer. The bidding and tender procedure is conducted by the foreign company. If the Indian party wins the bid, the authorized dealer bank can allow further remittances towards acquisition of foreign company. The Indian entity has to submit a report to the RBI in Form ODA within 30 days of effecting the final remittance. If the terms and conditions of vacquisition of a foreign company are not in consonance with the prescribed regulations, the Indian entity has to submit an application in Form ODI to RBI for obtaining approval.

1It is a mid-term review of annual policy that is released by RBI. It presents a review of the monetary, development and the regulatory policies for the financial year.
2 Under this route, prior approval of RBI is mandatory.
3 No prior approval of the RBI is required under this route.
4 An EEFC account is expressed in foreign currency and maintained with an authorized dealer bank which deals with foreign exchange in India.
5 NRO account is an account opened in Indian Rupees. It is the ideal way to route investments made out of Indian funds and earnings on investments in India.
6 It includes common and preferred stock, capital notes, surplus fund, undivided profits and any other reserves of the bank.
7 This form is meant for direct investment in JV/WOS abroad under the automatic route.
8 As on January 1 of the year of investment.
9 As per the ceiling prescribed by the Securities and Exchange Board of India (SEBI).
10 Clause 2 (d) of the Notification. It means an activity carried on by an Indian entity where the turnover is at least 50% of its turnover in the previous accounting year.
11It refers to the acquisition of shares of an overseas entity by exchanging the shares of the Indian entity. For instance, if the Indian company agrees to give a certain number of shares to the foreign company, the latter in turn issues shares to the Indian company
12 Clause 2 (j) of the Notification. It means the country in which the foreign entity receiving the direct investment from an Indian party is registered or incorporated.