The IRDAI recently released exposure draft regulations titled the IRDAI (Other Forms of Capital) Regulations 2015 (Draft Regulations). These Draft Regulations follow the amendments to §6A of the Insurance Act 1938 through the Insurance Laws (Amendment) Act 2015 which was enacted earlier this year.
Prior to these amendments, Indian insurance companies were permitted to issue only equity shares of a single face value and equal voting rights. The amendments to this provision provided that the capital of an Indian insurance company can consist of equity shares of a single face value and "such other forms of capital" as may be specified by the regulations. This amendment to §6A of the Insurance Act 1938 and the Draft Regulations are of particular relevance when read along with the increase in the permissible foreign investment limit in to 49% (with up to 26% foreign investment being under the automatic route and foreign investment in excess of 26% and upto the permissible limit of 49% being under the approval route). With the increase in foreign investment limits, existing and potential investors and particularly foreign investors have been looking to infuse investments in Indian insurance companies and have been eagerly awaiting for some clarity from the IRDAI in relation to the permitted "other forms of capital". However, it must be noted that §6A of the Insurance Act 1938 also provides that "the voting rights of shareholders are restricted to equity shares". Hence, shareholders holding "other forms of capital" cannot be provided any voting rights by way of any regulations framed by the IRDAI as regulations cannot over-ride any provisions of the Insurance Act 1938.
The Draft Regulations have thus provided some much-awaited clarity on the IRDAI's stance in relation to the "other forms of capital", by specifying the instruments which will be considered "other form of capital" and setting out the rules governing the issuance and rights associated with such instruments. "Other form of capital" has been defined in the Draft Regulations to mean preference share capital and subordinated debts issued by an Indian insurance company with the prior written approval of the IRDAI, in the manner as specified in the Draft Regulations. The instruments issued by the Indian insurance company are required to be fully paid, unsecured and have a redemption period of not less than 15 years to qualify as "other form of capital".
It is interesting to note that an Indian insurance company proposing to raise "other form of capital" is required to file certain documents with the IRDAI including, the terms and conditions on which the preference shares or debentures are proposed to be issued and the rationale for issuing "other forms of capital" in lieu of raising funds through issue of equity share capital in order to obtain the prior approval of the IRDAI. In addition, investment in such instruments by foreign investors including Foreign Institutional Investors or Foreign Portfolio Investors is required to be in compliance with the foreign exchange management regulations or other applicable regulations issued by the Securities and Exchange Board of India.
For entities operating outside the insurance sector, foreign investment has long been permitted by way of equity shares and other instruments which includes fully, compulsorily and mandatorily convertible preference shares and fully, compulsorily and mandatorily convertible debentures, subject of course to the specific terms and conditions applicable to the foreign investment in the concerned sector. This position is also captured in the latest Consolidated FDI Policy issued by the Department of Industrial Policy and Promotion on 12th May 2015. Extension of this benefit to the insurance sector by the Amendment Act and the clarity sought to be provided on the same by the Draft Regulations is a move welcomed by the industry.
In other sectors, foreign investors have in the past been extremely innovative while determining the terms and conditions of the convertible instruments issued to them by the Indian company as long as they are compliant with the applicable foreign exchange management regulations and the regulations and directives issued by the Reserve Bank of India (RBI). One of the most significant rules prescribed by the RBI which foreign investors and Indian companies are required to comply with, is that there should be no assured or minimum return of investment (often termed as the "Internal Rate of Return") guaranteed to the foreign investor in any manner, including, by virtue of the terms of conversion of the convertible preference shares or debentures.
Needless to say, the above mentioned directive of the RBI will be applicable to the "other form of capital" proposed to be issued by Indian insurance companies as well. In addition, as the terms and conditions on which the preference shares or debentures are proposed to be issued by the Indian insurance company are required to be approved by the IRDAI, it remains to be seen whether the IRDAI will be amenable to innovative structuring of the terms of "other form of capital".
The Draft Regulations also go on to state that Indian insurance companies are not permitted to issue instruments with "put options". An Indian insurance company is permitted to issue the instruments with a "call option". However, such "call option" may be exercised after the instrument has run for a period of at least five years. In order to exercise the "call option" the Indian Insurance company will need to obtain the prior approval of the IRDAI.
The requirement to obtain the prior approval of the IRDAI at various stages is likely to increase the regulatory hurdles and may be a time consuming process. An Indian insurance company proposing to issue "other form of capital" to its shareholders will need to take these factors into consideration.
The Draft Regulations further provide that the total quantum of the instruments taken together is not permitted to exceed 25% of the equity share capital of an Indian insurance company. Further, there is a progressive decrease in the proportion in which the instruments are included as part of the capital (for the purposes of calculation of "Available Solvency Margins") for the final five years prior to maturity of such instruments.
The Draft Regulations are definitely a progressive step in terms of proposing a framework for Indian insurance companies to issue "other forms of capital". However, the Draft Regulations contain certain inherent restrictions and limitations so, if implemented in their present form, they may go against the spirit of some the recent amendments to the Insurance Act which were aimed at encouraging and facilitating increased investments in the Indian insurance sector.
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