RBI Revises Pricing Guidelines Applicable to Equity Transfers between Indian Residents and Non-Residents

The Reserve Bank of India (RBI), Foreign Exchange Division, has revised its guidelines for pricing equity interests that are transferred between Indians and non-residents of India. The revised guidelines are contained in notifications released in April and May 2010, amending the applicable foreign exchange management regulations. They apply to equity shares, including compulsorily convertible preference shares and compulsorily convertible debentures. The revised guidelines will impact the determination of pricing in certain equity transfers.
The revised pricing guidelines appear to be an effort to simplify, consolidate and conform pricing guidelines. For example, under the new scheme, all transfers of listed company shares (whether or not a “preferential allotment” or a brokered, exchange transactions) are to be made using the SEBI guidelines for preferential allotments, and all transfers of non-listed shares are to be made at not less than price determined under the discounted cash flow (DCF) method.
However, a number of new potential problems are created under the guidelines, and questions unanswered. They may become problematic in valuing shares of unlisted companies in which the DCF method would otherwise not be a preferred method of valuation of equity interests.
An Indian company is permitted to issue equity shares to non-residents of India subject to the Government of India’s Foreign Direct Investment (FDI) policy. “Non-Residents of India” refers to non-Indian nationals, non-resident Indians (NRIs) and foreign institutional investors (FIIs).
The FDI policy includes restrictions on ownership in certain industry sectors, and pricing guidelines that apply to the transfer by way of sale of any shares between Indian residents and non-residents. Under the previous pricing guidelines, the transfer price for listed companies occurring on a stock exchange was the “ruling market price,” and the transfer price for non-listed companies was to be the fair value as determined by an Indian chartered accountant using guidelines issued by the erstwhile Controller of Capital Issues (CCI), the predecessor of the Securities and Exchange Board of India (SEBI).1 The current guidelines for valuing shares are now amended.
The revised pricing guidelines affect the transfer by way of sale of shares in unlisted companies, listed companies and “preferential allotments” made in listed companies.

Transfer by Sale of Shares in Listed Companies and Preferential Allotments
The revised pricing guidelines also impact the valuation method to be used on the transfer by way of sale of listed companies, and preferential allotments made by listed companies. The previous rules contemplated transfers completed on the stock exchange through a registered merchant banker or stock broker, or off exchange transfers. In the former case, the transfer of listed company shares made by way of a sale by a resident to a non-resident could be made only at a price equal to the “ruling market price.”6 In the latter case, the price was to be determined by taking the average quotations (average of daily high and low) for one week preceding the date of application, and permitted a variation of up to five percent.7 However, where the shares were being sold by a foreign collaborator or foreign promoter of the Indian company to the existing promoters in India with the objective of passing management control in favor of the resident promoters, the price could be up to 25 percent over market price calculated in the same manner.8
Under the revised pricing guidelines, transfers of listed company shares by residents to non-residents are required to be made at not less than the price at which a preferential allotment may be made under the applicable SEBI rules.9 The applicable SEBI rules for the pricing of preferential allotments is contained in the Issue of Capital and Disclosure Requirements Regulations, 2009. In general, the SEBI rules provide for a calculation based upon an average weekly high and low closing price over a trailing six month period, or a trailing two week period, from the “relevant date.”10 There is a slight modification if the allotment is being made by a company that has been listed for six months or more.11
One impact of the revised pricing guidelines is to conform the manner of computing the minimum transfer price of preferential allotments and other transfers by sale of listed company shares from residents of India to non-Residents. Any such transfer must now be priced at least at the market price, determined in accordance with the SEBI rules. Therefore, in a transaction in which a non-resident of India is acquiring shares in a listed company, even if the shares are being acquired other than in a brokered transaction through an exchange, the transfer must be at market price.
The rule did not, however, conform the different pricing requirements that apply when the transfer is being made by non-residents to residents. As noted above, the previous rules permitted up to a 5% variation from the market price when non-residents transferred shares of a listed company in an off-exchange transactions back to a resident of India (up to 25% when control is being transferred). This effectively means that residents could pay a premium of up to 25% above the market price in shares that were acquired from non-residents by residents in control transactions. Curiously, the new rule specifies that such transfers cannot be made at more than the minimum price permitted under the SEBI pricing guidelines for preferential allotments.

Source:omm