2015 was a big year for private equity, though activity levels for strategic M&A did not match the same tempo of deal making. At the risk of generalising, this reflects a differing approach within the two types of investors. Private equity investors tend to be early movers with a greater inclination to deploy capital towards suitable opportunities sooner rather than later. Strategic/corporate investors, on the other hand, tend to be more deliberate in their approach and are, by their nature, more focused on getting the ‘right fit’.
The soaring activity levels in the private equity industry in 2015 reflect the renewed enthusiasm for the economy as a whole, including the regulatory environment. It is natural that these factors would show up first in the tempo of deals involving private equity investors. It would also be fair to say that such renewed enthusiasm during 2015 was with good reason. All the same, it is difficult to point to specific regulatory interventions that may have been drivers for specific transactions, with some exceptions such as in the insurance, solar power and telecom industries.
Thus, instead of examining specific deals, this article focuses on hits and misses from a regulatory perspective that contributed to the regulatory environment for deal making (or missed to do so).
Public Company Acquisitions
SEBI was at the forefront of regulatory change in 2015. Recent changes in the Takeover Code and the Delisting Regulations have made it easier for an acquirer to acquire and delist a listed public company in one go, which promotes efficient capital markets. That said, the cumbersome book reverse book building process to achieve delisting, and the uncertainty under the Companies Act, 2013 on the acquirer’s ability to squeeze out the minority after delisting, sometimes impose prohibitory costs on the acquirer and continue to constrain deal making. That said, on the whole, SEBI has accounted for more hits than misses in 2015.
Liberalisation of Foreign Investment Norms
- Foreign Direct Investment Limits
The liberalisation of foreign direct investment (FDI) limits in specific sectors has eased some constraints on deal making. For instance, the liberalisation of norms for investments and exits in real estate projects is likely to trigger increased deal making in an industry that has already seen some increase in institutional investment. The new regime for REITS also ties into this, although unresolved tax and stamp duty considerations reflect a missed opportunity.
Another industry in which regulatory changes spurred deal making is the insurance industry, which saw the cap on foreign investment being raised from 26 per cent to 49 per cent. The increase in permissible foreign investment in the insurance industry and associated changes brought much needed clarity in the industry, which occasioned the unwinding (in part) of arrangements that were originally intended as a temporary stop-gap on account of the 26 per cent limitation. However, the new condition that such joint ventures must be controlled by the Indian party remains a material constraint for new money in the industry. To be fair, this is a condition which was specified in the Insurance Laws (Amendment) Act, 2015 and the Insurance Regulatory and Development Authority (IRDA) cannot be faulted for imposing regulations to implement it.
Partial liberalisation of the regime (such as permission to sell through e-commerce) for single brand retail was a catalyst for deal making on this front, both with respect to new investments as well as pre-existing joint ventures. However, it remains to be seen how far the government will go in granting exemptions from local sourcing rules for ‘cutting-edge technology’ (such rules apply to entities having more than 51 per cent foreign investment.) The continuation of local sourcing requirements, and a degree of uncertainty introduced on the question of who is an ‘Indian manufacturer’ (Indian manufacturers are free to retail) are likely to be seen as misses.
No discussion about deal making in 2015 would be complete without touching upon e-commerce. The majority of deal making in the industry would need to be attributed to increased confidence in the underlying economy, governmental attitude as well as Indian entrepreneurs, rather than specific regulatory intervention. At the same time, the reluctance to recognise the marketplace approach for multi-brand e-commerce is likely to be seen by some as a miss.
The Reserve Bank of India’s (RBI) statement in its monetary policy for 2015-16 raised hopes that foreign investment regulations would finally be set free of artificial constraints in transactions entered into at arms’ length, specifically ceilings and floors on pricing tied to fair market valuation. There is considerable force to the argument that progressive expansion and sophistication of the Indian economy and Indian corporates has obviated the need for such restrictions, although it may be appropriate to retain such restrictions specifically to check questionable related party transactions.
In 2014, the RBI went only part of the way by setting out the basis on which put options (against Indian residents) would be allowed and simplifying regulations regarding the valuation methodology to be used. However, the fact that the valuation issue as a whole has not been addressed in 2015 would have to be seen as a hit rather than a miss. Changes in the 2015 Union Budget which placed the regulation of FDI under the primary authority of the central government (rather than the RBI) is an encouraging sign although it puts the ball squarely in the government’s court.
Whereas the 2014 M&A guidelines for telecom operators in India failed to gain much traction during the year, the long awaited spectrum sharing and trading guidelines have proved to be a catalyst for much needed consolidation in the industry. The liberalised regime for spectrum trading which no longer necessitates prior government approval and limits the spectrum trading fee to 1 per cent of the deal value are likely to establish spectrum acquisition as the primary vehicle for M&A in the telecom space (this also reflects the commercial reality of the situation).
It was expected that changes in the regulatory environment affecting infrastructure projects would provide the underpinnings for a significant uptake in deal activity in the sector. The government’s declaration of intent through announcements expanding and modifying the Jawaharlal Nehru National Solar Mission did prove to be a catalyst for deal making in the industry, and investors continue to anticipate a more friendly regime for solar power projects in India.
The low level of activity involving thermal projects, however, has to be seen as a miss, after the expectations generated by the coal block auction. Clearly, the uncertainty on the ability to pass through fuel costs, leaves unanswered questions. Perhaps, the government’s proposal under the ‘UDAY Policy’ to repair the balance sheet of state distribution companies may provide impetus to the entire industry in the coming years.
To sum up, 2015 was a mixed year, although it would be fair to say that there were more hits than misses. Needless to say, some of the misses also represent an opportunity to take the agenda forward in the coming year.
The author is a partner at Trilegal, a law firm which has advised companies on several big M&A and PE deals in India.
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