Foreigners secure entry to India’s secondaries market

Motilal Oswal Private Equity's partial exit of non-banking finance company Au Financiers to Warburg Pincus earlier this month was one of just 16 private equity-backed secondary sales in India since January 2011. Twelve months hence, the total could be considerably larger as a result of full participation by foreign private equity firms.

According to new rules announced by the Reserve Bank of India (RBI) last week, registered foreign venture capital investors (FVCIs) are now free to buy stakes in domestic companies from other PE and VC firms. It marks the clarification of an opaque policy position.

"It was not just completely prohibited for FVCIs to invest in the secondary market. There was no clarity," explains Ashish Ahuja, partner at Wadia Ghandy & Co, which provided legal counsel to Au Financiers on its recent stake sale. This confusion was precipitated in 2006, when an FVCI asked for permission to carry out such a transaction. The RBI said no, and so most FVCIs refused to do secondary investments.

Improved clarity

Now that the RBI has indicated that secondaries are in favor, deal volume is expected to rise, although perhaps not to the levels that some might predict. Many foreign firms are not registered as FVCIs after all - in fact, around 80% of the PE firms Wadia Ghandy works with are not - so they already had the ability to invest in secondaries transactions.

As an example, Warburg Pincus did not invest in Au Financiers via an FVCI vehicle, and nor did Actis for its acquisition of 15% of Endurance Technologies from Standard Chartered Private Equity last December. Sales of secondary stakes between two offshore entities have also never been subject to restrictions. The relaxation of the rules is a net positive for FVCIs, but they're still very much in the minority.

Skepticism exists in any case as to whether these vehicles will actually feel the full benefit of the move, as their investments are currently still restricted to nine sectors. According to Ahuja, however, these restrictions will soon be phased out. "There's going to be an amendment to the domestic VC provisions, allowing funds to get tax exemptions even in sectors that aren't among the nine," he says. "It's going to open up the industry to a different level altogether."

Whether or not the RBI's announcement will have a substantial impact, the Indian secondary market is expected to take off over the next three years. Between 2006 and 2008, private equity firms invested nearly $30 billion in the country, and many of these deals are now ripe for an exit. Depending on what return multiple one applies, around $45-60 million will need to be exited between now and 2015. With the IPO window appearing to be shut for this year at least, secondary sales are one of few options.

The other driver for this trend is the increasing appetite from foreign private equity firms - which represented the buyer in 13 of the deals recorded over the past 15 months - for Indian businesses already backed by PE or VC firms.

"Any foreign fund that invests in India typically targets large-size deals ranging from $30-130 million, which usually involves companies held by another PE fund," says a senior executive at a Indian private equity firm which recently completed a secondary sale to a foreign private equity player. "Offshore funds want to invest in larger companies and those that aren't already backed by PE would prefer to list on the public markets."

Indian PE funds often play an important role in enhancing the corporate governance and financial management of a firm, typically leaving larger-scale foreign players with businesses better prepared for the next stage of PE involvement.

While a more active secondary market stands to benefit both domestic and foreign investors alike, the RBI hasn't explained why it has made this concession - albeit modest - in support of the asset class. One assumption is that it recognizes the contribution long-term investors such as FVCIs and other offshore PE funds can make to the domestic economy. Foreign institutional investors that only target public markets, such as hedge funds, usually only invest for 1-3 years.

For private equity specifically, a greater number of potential secondary buyers could help bring more depth into the market, thus reducing the impact of future volatility.

More new rules

In fact, the RBI's new standpoint went hand-in-hand with a number of other reforms. FVCIs are now exempt from entry and exit pricing restrictions and lock-ins on the shares of their portfolio companies going public. They can also now buy stakes of more than 10% in listed firms.

As none of these concessions applies to foreign PE firms using the generic foreign direct investment route, it is anticipated that FVCI will become the favored path for offshore investors. "We are not listed as an FVCI because the earlier guidelines were restrictive, and we did not want to be bound by those restrictions," says J.M. Trivedi, Mumbai-based partner and South Asia head at Actis. "But we would be happy to register if the restrictions go away because there seem to be some benefits, especially if you are buying secondary shares from Indian residents."

It would be naïve, therefore, to expect the regulation affecting secondary transactions to transform the market. If seen in the context of multiple measures designed to make life easier for investors in this category, though, the move could be more meaningful.

"If we restrict ourselves to the regulation relating to secondary sales, it'll have a limited positive impact," Trivedi maintains. "But if you go beyond that - if all these restrictions have been removed - that would encourage a lot more foreign PE funds to register as FVCIs, and that could be a great positive for the deal activity in PE in India."

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• Topics
• Secondaries
• Secondaries
• South Asia
• India
• Secondaries
• Actis Capital
• Warburg Pincus Asia
• regulation