The listening regulator

There have been instances in the last year when Indian regulators warranted opprobrium. The month-long confusion over the use of put and call options on foreign direct investment (FDI) transactions was a classic case of poor communication.

The Department of Industrial Policy and Promotion ruled that any investment instrument with built-in options could not be used as part of FDI, effectively reclassifying investments made by offshore PE funds - which allow an exit through a buyback or a put and call option - in a way that made them subject to caps and limits. After a host of angry phone calls and newspaper editorials, the regulator backtracked.

However, there are grounds for suggesting that overall, the positives now outweigh the negatives. The Securities and Exchange Board of India (SEBI) has increased the ownership threshold that automatically triggers a takeover bid for a company from 15% to 25%, allowing PE investors more leeway in their public market investments. It has also introduced a raft of measures designed to make it easier for private equity-backed firms to go public.

On page 10, we highlight efforts announced last week to open up direct secondary transactions to foreign private equity and venture capital firms. Like a lot of legislation, it is a work in progress but without doubt a step in the right direction.

Even more recent is the final version of rules governing the structure of the domestic private equity industry as a whole, unveiled by SEBI on Monday. Revisions made to the original proposals suggest that industry consultation has to some degree paid off. India's regulators, it seems, are willing to listen.

AVCJ has devoted considerable space in recent weeks to the plight of the Indian LP. All of the major institutions - banks, insurers, pension funds - that might help create a sustainable domestic fundraising base are subject to strict limitation on their private equity exposure. While China is slowly letting its institutions off the leash, few expect India to follow suit, and fund managers must continue to seek capital overseas.

Yet repairs are necessary on the GP side as well. The existing venture capital funds system is outdated and, in the absence of a registration requirement, it is difficult to impose standards and protect investors.

When SEBI unveiled its proposals last summer, critics said that the regulator's desire for clearly delineated fund structures had got the better of it. Nine sub-categories was too many and threatened to leave GPs, used to a degree of flexibility in their investment mandates, tangled in red tape. Concerns were also expressed at plans for managers to personally finance at least 5% of their fund corpuses. Where would a first-time GP get the cash from?

SEBI has compromised on both counts, while holding firm in other areas such as minimum fund size and disclosure requirements.

These reforms will have minimal direct impact on foreign investors. Deal size, access and valuations will no doubt remain the preoccupation of GPs, while LPs - in some but not all cases - complain that funds have underperformed. Also, spare a thought for the general anti-avoidance rule (GAAR), slated for inclusion in this year's budget. It has potentially serious implications for the tax treatment of offshore structures used to channel capital into India, and threatens Mauritius' status as the conduit of choice.

Private equity is a long-term business, and alterations that appear inconsequential today could turn into potential game changers several years down the line. In this context, a more stable domestic industry could contribute to a more stable investment environment for everyone.

There will no doubt be those who claim that Indian authorities are trying to assert an undue amount of control over the asset class, but a regulator willing to listen and engage with the industry warrants a modicum of praise.

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• Topics
• South Asia
• Regulation
• India
• regulation
• SEBI