Centre to tighten screws on exotic debt

A new set of restrictions could be in store for the realty sector, which has been under intense regulatory scrutiny following heavy capital inflows. The government may impose restrictions on compulsory convertible debentures (CCD) with a put option.
The department of industrial policy & promotion (DIPP) and Reserve Bank of India (RBI) are set to discuss the exact nature of capital raised through this route in the realty sector.
Government sources said some CCDs, usually considered similar to equity, are structured in a manner that makes them akin to debt. This is because in many cases there is a contractual agreement allowing Indian realty players to buy back shares from foreign investors at a fixed price after conversion. In other words, the foreign investor has a put option. Thus, for the foreign investor, CCD is similar to a debt instrument with a fixed rate of return rather than an equity investment.
Real estate companies are barred from tapping debt through external commercial borrowings (ECBs). On the other hand, there is no restriction on pure equity investment, subject to certain conditions such as minimum capital requirement and a three-year lock-in. Sources said the government is concerned that many realty companies have been issuing CCDs with a buyback option to foreign funds at a price that is fixed when the deal is struck.
There is a view in sections of the government and RBI that this is overseas debt masquerading as FDI. CCDs are treated as FDI, so essentially there is nothing that contravenes the regulations. But what has rung alarm bells is the underlying structure (put option) as this makes it similar to debt.
“There have been cases in the Indian real estate sector where companies have issued such instruments which, if scrutinised, come out as pure debt. The government may not take stern steps immediately, but this practice needs to be looked into,” an official told ET.
Companies began opting for this route after the government clamped down earlier this year on raising ECBs, partly and optionally convertible debentures and preference shares.
However, some experts say these instruments are linked to achievement of milestones in a project. Foreign investors impose such conditions on companies when they invest.
“Conversion of debentures on the basis of pre-committed options with no linkage to project performance is a potential case for scrutiny. Companies indulge in such practices, but there are companies who only invest after putting in a clear conversion formula based on project performance. In the latter case, it is not seen as debt.
Of late, investors have been stressing on project performance. Any action to examine the instrument would only help crack down on unscrupulous practices of some players in the real estate sector,” real estate consultancy DTZ India MD Ankur Srivastava said.
Realty companies feel such a move would help genuine players. “Compulsory convertible debentures are good instruments for raising funds. If the government is thinking of removing the put option, it would benefit genuine investors. Investors who invest for short periods would be disincentivised,” Ansal API CEO Anil Kumar said.
The government and RBI’s concern on real estate stems from the fact that the sector witnessed a huge quantum of inflows in the first four months of the current fiscal, surpassing total inflows for the past two years. FDI inflows in April-July 2007 stood at $627 million, compared to $38 million in FY06 and $467 million in FY07.

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