Regulatory Roadblocks in SPAC Listings in India

By Sourav Paul, Student at National University of Juridical Sciences

Introduction

Over the past few years, there has been a revival of Special Purpose Acquisition Companies [“SPAC”] in the international capital markets paradigm. As per SPAC Insider data, since 2009, out of 755 such Initial Public Offerings [“IPO”] by SPACs, 248 happened in 2020 and 281 in 2021 to date. The gross proceeds raised by SPACs in 2020 amounted to over $83 billion, whereas in 2021, it amounted to $91.65 billion as of now. In 2020, around $80 billion was raised in the US by 247 SPACs representing almost 50% of the raised capital of about $174 billion.  This resurgence of SPACs can be attributed to the pandemic-induced slowdown and extensive celebrity involvement. Some critics argue that the SPAC bubble is about to burst soon.

SPACs are referred to as ‘blank cheque entities’ in common parlance because they raise capital from an IPO to acquire a firm operating in a particular sector, often termed as ‘target’ company. This entity does not have any active line of business or operation as it is formed only to raise capital through an IPO. Therefore, SPACs are essentially ‘shell companies’. Generally, SPACs are established by experienced sponsors or managers with nominal invested capital of about 20% in the SPAC. Once the money is raised through IPO by using their expertise, it is kept in an escrow account, which may be accessed while making the acquisition. The approval of the shareholders in SPAC is sought post-identification of the target company, and those who disagree with the proposed acquisition are given an option to redeem their share in the SPAC. The final step is the acquisition of the target company, which is commonly termed as De-SPAC transaction or Reverse Merger. The average time taken for this whole transaction is generally 12-24 months. The operating company acquired by a listed SPAC gets indirectly listed, and valued and thereafter the promoters of the operating entity may plan a partial or total exit.

The SPAC route is generally adopted by startups and tech companies primarily because it is a faster and cheaper way of raising capital from the public and saves the entity from intense marketing. They also provide permanent capital, allowing shareholders to focus on long-term value creation rather than the short-term goals often needed to meet the return hurdle. The shareholders of the target companies do not face the burden of additional unexpected liabilities post-closure of the deal, considering SPACs have not conducted any material business and have a clean balance sheet. Raising money through a SPAC is easier than doing through an IPO, because the SPAC has already raised money through an IPO. Therefore, the company in question has to negotiate with a single entity, and not with multiple individual investors. Additionally, the incentives of underwriters and target company are more aligned in the SPAC process compared to a traditional IPO. This is because the amount that a company would pay an investment bank to underwrite an IPO is instead paid to the sponsors of SPAC in the form of equity. Since the underwriters of a SPAC are actually sponsors, they share the same long term incentives as the company. Furthermore, an offshore listing enables greater access to funds with a simultaneous increase in the entity’s brand value. The sponsors of SPAC generally place their reputation on line when they are confident about a target company, which often results in a fair and favorable valuation of the company.

The merger of ReNew Power Private, a renewable energy producer, and RMG Acquisition Corp II, a US-based blank-cheque company marks the resurgence of the SPAC debate in India. The online grocery platform, Grofers is also in an advanced stage of exploring a SPAC deal. According to some news reports, even Flipkart is considering US listing with the SPAC as an option. However, it is imperative to note that the concept of SPAC is not new to India, and there have been Indian companies like Citius Power, Yatra, Videocon DTH, etc., who have sought listing on Foreign Stock Exchanges through SPAC route. However, no foreign company has availed the SPAC route for listing on Indian stock exchanges, primarily due to the existing regulatory hurdles and the restrictive approach adopted by SEBI. In this article, the author highlights these roadblocks in the Indian regulatory regime and recommends specific changes to enable SPAC listing on Indian stock exchanges.

Analysing the Current Regulatory Regime in India

Companies Act, 2013

It is imperative to note that a SPAC is essentially a shell company with no active business operation. Its primary objective is to raise capital for the target company. Since 2016, post-demonetization, the government has been active in taking down shell companies. In March 2018, The Parliamentary Committee on Finance, headed by M.V. Moily, suggested the government define ‘shell companies’ within the Companies Act, 2013. As of September 2020, the Ministry of Corporate Affairs has struck off more than 3.8 lakh companies from the Register of Companies in the past three years. The Gauhati High Court, in the case of Assam Company India Ltd. v. Union of India, expounded on the concept of shell companies and recognized that there exists no definition of the same in Indian law. The court discussed the expression ‘shell companies’ in popular parlance and the negative connotation associated with the term. The court cautioned the SFIO by stating that a company cannot be declared as a shell company without giving them a reasonable opportunity of hearing, as this is a fundamental principle of natural justice. Hence, SPACs need to be protected against government’s action against shell companies.

Pursuant to Section 248, the Registrar has the liberty to strike off a name from Registrar of Companies if it “fails to commence business within one year of its incorporation.” Even the directors or promoters may be penalized for non-compliance. As stated previously, the whole SPAC transaction takes 12-24 months as the sponsors need to identify the best target to maximize shareholders’ wealth. Therefore, in order to save SPACs from a coercive crackdown on shell companies, an exemption clause must be carved out to protect SPACs.  

In light of the above discussion, the author argues that a definition of SPAC would be highly beneficial. The Indian regulators should take inspiration from other jurisdictions to come up with a comprehensive definition of SPAC. For instance, according to Article 6(4)14 of the Enforcement Decree of FSCMA, a SPAC is defined as “a corporation, the sole business objective of which is to merge the corporation with another corporation and issue the stock certificates through a public offering.”[i] It also lists certain requirements for SPAC listing in KOSPI and KOSDAQ market.

SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 and Other Stock Exchange Regulations

Pursuant to Section 6(1) of SEBI ICDR Regulations, 2018 (last amended on January 8, 2021), the eligibility requirements of an IPO are as follows:

• Net tangible assets of at least three crore rupees for the preceding three years.
• Average operating profit of at least fifteen crore rupees during the preceding three years.
• Net worth of at least one crore rupees in each of the preceding three years.

 The SPACs would not meet these conditions as they do not have any operational profits or non-monetary tangible assets. Moreover, it is improbable that a SPAC would wait for three years before getting listed, even if the founders infuse monetary assets.

However, a SPAC entity may list itself under alternate eligibility norms specified under Regulation 6(2). In order to comply with Regulation 32 (2), read with Regulation 6(2), the SPAC needs to ensure that 75% of the net offer must be allocated to qualified institutional buyers. Prima facie , this condition might seem impractical, but it will ensure higher certainty of funds in the volatile Indian market.

It is imperative to note that SPACs need to comply with the listing requirements, disclosures, corporate governance standards prescribed under the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015. Listing on NSE requires a track record of at least three years of either the entity seeking listing i.e. the SPAC entity or promoter or promoting company incorporated in or outside India i.e. the sponsors of SPAC entity.

However, the author argues that a separate SPAC-related regulation will ease the listing process. It will also encourage SPAC listing and reduce price distortion. Indian regulators can take inspiration from NASDAQ, which in 2018 rolled out separate listing requirements for SPACs. Similarly, Hong Kong Exchange allows reverse mergers on a case-by-case basis.

Additionally, SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (last amended on August 14, 2017) is applicable only if the target company is listed, and hence imposes a limitation on the extent of control that can be acquired. It will also increase the transaction time period. Therefore, an amendment to the Takeover code incorporating exemptions for SPACs will solve this problem.

Applicability of FEMA provisions  

The merger of the target company and a SPAC is essentially a cross-border merger. Hence, it is highly likely that it will attract various RBI regulations and Foreign Exchange Management (Cross Border Merger) Regulations, 2018, which provides that in case of an inbound merger, the resultant company may issue or transfer security to persons’ resident outside India in accordance with RBI Guidelines and other sectoral caps. In SPAC transactions, the shareholders of the Indian target receive shares of the combined entity either as a consideration or as a share swap. These transactions operate with the presumption of RBI approval provided the fair market value of the shares is within limits prescribed under Liberalized Remittance Scheme and the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004. These transactions might also need prior approval of NCLT.

However, one cannot determine the maximum foreign shareholding in a SPAC, primarily because they do not have a specific business object which generates confusion about the sector in which this entity lies. Furthermore, the RBI Guidelines mandate intensive reporting requirements for cross-border mergers, leading to further compliance, ultimately elongating the timeline required for SPAC listing.

The Way Forward

The International Financial Services Centres Authority [“IFSCA”] was established on April 27, 2020, under the International Financial Services Centres Authority Act, 2019 with its headquarter in GIFT City, Gujrat. Recently, IFCSA rolled out a consultation paper that provides for SPAC listing in IFSCA. It seeks to regulate the listing of securities of foreign or Indian companies on the stock exchange in IFSCs. This consultation paper is a welcome step; however, it is important to note that IFSCAs in India is still at a nascent stage and not an established platform for raising funds. The exposure of IFSC and the access of capital it provides cannot be compared with the one provided by BSE and NSE.

Furthermore, on March 11, 2021, SEBI has formed a Group of Experts under its Primary Market Advisory Committee to examine the feasibility of introducing SPACs like structures in India “while at the same time building adequate checks and balances in regulatory framework to take care of the associated risks.”

Therefore, Indian policymakers and market regulators must acknowledge the limitations of the current regulatory regime and undertake reforms to make SPAC listing in India easier.  

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[i] Kab Lae Kim, The Characteristics of SPAC Investments in Korea, 2 KCMI Capital Market PERSPECTIVE 9, 10 (2010).