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Partners Aashit Shah and Sidharrth Shankar along with Senior Associate Chinmayee Prasad of J. Sagar Associates discuss investments by venture capital funds and foreign venture capital investors in India.
Investment by venture capital funds (VCF) and foreign venture capital investors (FVCI) in India are primarily governed by the SEBI (Venture Capital Funds) Regulations, 1996 (VCF Regulations), and the SEBI (Foreign Venture Capital Investors) Regulations, 2000 (FVCI Regulations), which provide, amongst other things, certain investment restrictions that VCFs and FVCIs must comply with.
One of the restrictions common to both VCFs and FVCIs is that they are permitted to invest up to 33.33 percent of their investible funds in listed companies, but only by way of preferential allotment of equity shares (unless the issuing company is a financially weak or sick industrial company, in which case a VCF may also invest in such company by way of equity linked instruments).
On the other hand, as per Indian exchange control norms, more particularly, Schedule 6 to the FEMA (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (FEMA Regulations) – applicable to investments made by SEBI registered FVCIs – an FVCI may invest either in an Indian venture capital undertaking (which is a domestic unlisted company) or in a VCF. Therefore, and rather interestingly, the FEMA Regulations do not expressly permit (or prohibit) investments by FVCIs in listed companies, even to the limited extent otherwise permitted by the SEBI FVCI Regulations! In the absence of an express prohibition, it is unclear whether the intention of the regulators was to limit the avenues of investments available with an FVCI to unlisted companies alone, or whether Schedule 6 to the FEMA Regulations should be interpreted liberally with a view to allow all such investments which have not been specifically disallowed.
The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations), which too in part apply to VCF and FVCI investments, also do not help solve this conundrum. Under chapter VIII of the ICDR Regulations, a qualified institutional buyer (QIB) is permitted to invest in “eligible securities” of a listed company on satisfaction of certain prescribed conditions. The ICDR Regulations define the term “eligible securities” to include “convertible securities”, which have further been defined to mean “securities convertible into or exchangeable with equity shares of the issuer”. Since FVCIs and VCFs fall within the definition of QIB for the purposes of the ICDR Regulations, logically (as well as legally), they too should be permitted to invest in “eligible securities” of domestic listed companies, including compulsorily/optionally convertible preference shares and debentures, and resultantly, should not get limited in their investment portfolio, as has been effected by the SEBI VCF and FVCI Regulations; and similarly, FVCIs should not be subjected to a blanket prohibition to invest in listed companies, as impliedly understood on a reading of the FEMA Regulations.
Although the FEMA Regulations provide that FVCIs must at all times abide by the relevant regulations issued by SEBI (both, the FVCI and the ICDR Regulations have been issued by SEBI), it fails to clarify which regulation will trump the other in the event of an inconsistency (as brought out above). It may be argued by purists that since the VCF and FCVI Regulations are the “mother regulations” governing VCFs and FVCIs, their provisions will override all other applicable legislations. However, considering the limiting effect of such an interpretation on investments by FVCIs, it is pertinent that the authorities issue a clarification to put this issue to rest.
The need for consistency in the various legislations governing foreign investments in general, and foreign venture capital investments in particular, has been raised by jurists and practitioners alike. With the existing ambiguities in the law affecting the flow of foreign investment in India, it is perhaps time the relevant ministries returned to the drawing board with an aim of bringing in some uniformity; thereby ensuring that, the numerous legislations which wholly or in part govern domestic and foreign venture capital investments, work in tandem, and not antagonistically.
Aashit Shah and Sidharrth Shankar are partners at J. Sagar Associates and handle the firm’s corporate and commercial work along with Banking & Finance, including Mergers & Acquisitions and Private Equity investments. They were assisted by Senior Associate Chinmayee Prasad.