Foreign investment through convertible securities

Foreign investors invest in Indian companies through equity shares or securities that are fully and mandatorily convertible into equity shares within a specified time period. These convertible securities include compulsorily convertible preference shares (CCPS) and compulsorily convertible debentures (CCD).

Convertible securities are considered foreign direct investment (FDI) under the Foreign Exchange Management Act, 1999, (FEMA). Both CCPSs and CCDs have similar features and advantages although there are differences such as limited voting rights for CCPS holders. Also, the distribution of dividends to CCPS holders is subject to the requirements relating to distributable reserves under the Companies Act, 1956, and in the event of a company being wound up, CCD holders are considered creditors of the company and have priority over all shareholders including CCPS holders.

Traditionally, there has been some flexibility in structuring investments by foreign investors through convertible securities especially with respect to the conversion price. For example, the conversion price could be linked to the performance of the investee company. However, recent regulatory developments suggest that this position may have changed and the conversion price may now need to be a fixed price determined at the time of the issue of the convertible securities.

Rajat Sethi is a partner and Tanya Aggarwal is an associate at S&R Associates, a New Delhi-based law firm.