by Subhro Sengupta
Pricing Guidelines play a very important part in creating the balance that exists between attracting Foreign Investments, while protecting the interest of the Indian economy. We look at Pricing Guidelines, its history, the need for Pricing Guidelines and the road ahead that the RBI has planned for India.Pricing Guidelines essentially determine the price at which a share/instrument can be transferred to a non-resident entity. The need for this arises, to ensure that shares are not transferred for a lower than expected value, which would in turn effect the price of the share in the domestic stock markets.
The history of the Pricing Guidelines starts with the Capital Issues (Control) Act, 1947 (“CICA”), which provided that no Company shall make an issue of capital within or outside the territory of India, without permission from the Central Government.
Through this Act the Government introduced the office of the Controller of Capital Issues (“CCI”) which would determine the valuation of shares to be issued by any Company. The CCI was established as the first market regulator pre-dating SEBI. 
By the 1980’s the CCI had begun to become a defunct behemoth and by 1991 the Narasimhan Committee setup by the Finance Ministry, in its Report recommended the abolishment of the CCI, and further recommended that the SEBI which had been setup in 1988, be entrusted with the “task of a market regulator to see that the market is operated on the basis of well laid principles and conventions” and for the removal of bureaucratic hurdles in the way of capital issues since involvement of the CCI in determining issue prices meant involvement of the bureaucracy via the Ministry of Finance.
The Government took this suggestion and repealed the CICA in 1992. However, at this point permission was still required from the Foreign Investment Promotion Board (“FIPB”) and the Reserve Bank of India (“RBI”) to transfer any shares from a resident to a non-resident.
In 2004, with an aim to further liberalize the economy, the RBI vide its circular notified that prior permission of the Central Government and the RBI was not required for transferring shares to non-residents (with certain exceptions). However, Chartered Accountants had to follow the guidelines issued by the erstwhile CCI (“CCI Method”) to determine the minimum transfer price of unlisted securities when transferred from a resident to a non-resident.
Subsequently in 2010, the RBI vide its circular did away with the CCI Guidelines on valuation and changed the valuation methodology, for unlisted shares, to the Discounted Cash Flow Method (“DCF Method”) which is one of the many internationally accepted pricing methodologies for securities.
While the previous CCI guidelines provided for calculation of “Fair Value” of Equity Shares based on (1) Net asset value (NAV) (2) Profit-earning capacity value (PECV) & (3) Market value (MV) in the case of listed shares; the DCF method provided for calculating the valuation of shares based on future free cash flow projections discounted to arrive at a present value estimate.
Since the CCI Method only took into consideration the past performance of a Company, it was felt that the future performance of the Company should also be taken into consideration. However the Investors still remain unsatisfied since the Regulators had again limited the means of determining of fair value to DCF, which had its own shortcomings. DCF limited the choices that the Industry had; the Industry might use one of the various internationally accepted pricing methodologies to determine a fair price based on the situation at hand.
The RBI in 2014 came up with new provisions concerning Foreign Direct Investment (“FDI”) under which it firstly decided that Optionality clauses would henceforth be allowed on Equity Shares and Compulsorily and Mandatorily Convertible Preference Shares/Debentures when issued to any person resident outside India, under existing FDI norms. This was subject to a minimum lock-in period of one year or higher in certain cases.
In a move to further liberalize the Investment scenario, six months later in July the RBI withdrew all the existing guidelines relating to valuation in case of acquisition/sale of shares through FDI, and further vide its circular stated that valuation for Equity Shares/CCD’s/CCPS of an unlisted Company could be made using any “internationally accepted pricing methodology for pricing of shares on an arms length basis” which would have to be certified by a Chartered Accountant or a Merchant Banker. Shares of listed companied were to be issued as per the ICDR Guidelines and transferred as per the prevailing market rate.
The reason for introducing “internationally accepted pricing methodology” was two fold:
- to let Companies and Investors determine by themselves the best method for valuation of shares, after taking into account industry practices.
- The underlying principle this move was to ensure that ensure that non-resident investors are not guaranteed any exit price at the time of making such investment.
It appears that the RBI wants to maintain a stance, that non-resident investors should not get a more favourable treatment than their Indian counterparts. In case they want to reduce the risk involved in an investment they can do so by opting for a debt exposure rather than an equity exposure.
There are however issues that have arisen with the RBI move in 2014, the primary ones being:
- Since the RBI has not defined what would constitute an “internationally accepted pricing methodology”, there remains a lacunae since there can be multiple prices that can be reached for the same security, using different methods.
- In the case of CCD’s/CCPS, in case the pricing methodology is previously not agreed upon by the parties, it might lead to a dispute between parties, at conversion stage.
Coming to the first concern: Although the RBI has not defined “internationally accepted pricing methodology” which in a way gives the Companies and the Investors a lot of freedom to choose from any methodology they deem fit, the Companies Act, 2013 (“CA, 2013”) does however, in its Draft Rules pertaining to Chapter XVII (Registered Valuers) provide ten different methods for valuation of shares which investors could be chose from, and yet there could be more internationally acceptable methods for investors to choose from.
It would be now upto the investors and the Company to reach a settlement as to which method would be suitable for them.
For the second issue: It is advisable that parties agree upon a valuation method previously in their Agreement, otherwise the same can become a bone of contention at a later date.
Another foreseeable problem with the RBI notification is its clash with the Draft Rules pertaining to Chapter XVII of the CA, 2013. The Draft Rules provide that valuation, if not done according to the methods already provided in the Rules, has to be done in terms of rules either notified by the RBI, SEBI or the Income Tax authorities or justification has to be provided for the same at a later date; the RBI on the other hand gives Investors and Companies a wide leeway by stating that any “internationally accepted pricing methodology” would be applicable.
Considering that these are Draft Rules, we would have to wait for an amendment to put things into right order.
Although there are apparent problems with the recent liberalization of Pricing Guidelines, it is none the less a welcome move, which would bolster India’s image as a global investment hub. The freedom that the RBI has given to the investor community as well as the Indian companies is commendable. There might be some discontent and initial hiccups due to the fact that returns cannot be guaranteed to foreign investors in this investment regime, however it is only fair that they bear the same risks as their Indian counterparts.
It is commendable that slowly and steadily the RBI is giving up day to day control over the mere technicalities involved in the Indian FDI regime, and instead assuming its position as a facilitator of economic growth.
Subhro Sengupta is a fifth year student at HNLU.
 Narendra Kumar Maheshwari v. Union Of India & Ors, 1989 AIR 2138.
A. C. Fernando, Business Ethics and Corporate Governance (2nd ed. 2012).
vide the Capital Issues (Control) Repeal Act, 1992.
A.P. (DIR Series) Circular No. 16 dated October 04, 2014.
Shares of Indian companies in the financial service sector (i.e. Banks, NBFCs and Insurance).
 A.P. Dir (Series ) Circular No. 49 dated May 04, 2010
Ashwath Damodaran, Disadvantages of DCF, An Introduction to the DCF Method, NYU. (Jan. 20, 2016) http://people.stern.nyu.edu/adamodar/pdfiles/eqnotes/approach.pdf
 A.P. (DIR Series) Circular No. 86 dated January 9, 2014.
 First Bi-Monthly Monetary Policy Statement, 2014-15 by Dr. Raghuram Rajan, Governor on April 01, 2014.
 A.P. (DIR Series) Circular No. 4 of July 15, 2014.
For more on the judicial stance on assured returns refer to IDBI Trusteeship Services Ltd. v. Hubtown Ltd.  131 SCL 365 (Bom).
Under Rule 17.6(iii): (a) Net asset value method (b) Market Price method (c) Yield method / Profit Earning Capacity Value (PECV) (d) Discounted Cash Flow Method (DCF) (e) Comparable Companies Multiples Methodology (CCM) (f) Comparable Transaction Multiples Method (CTM) (g) Price of Recent Investment method (PORI) (h) Sum of the parts valuation (SOTP) (i) Liquidation value (j) Weighted Average Method.