Regulatory Framework for SPACs in India: Critique & Comparative Analysis

The author is Malika Gupta, a second year student at O.P. Jindal Global University

Introduction

The discussions over Special Purposes Acquisition Companies (“SPACs”) gained momentum in India when ReNewPower, one of the country’s largest energy sector companies, listed itself on NASDAQ via the SPAC route. With SPACs increasingly being seen as an alternative to Initial Public Offerings (“IPO”) in the West, it is exigent to deliberate upon their application in India. This paper identifies the regulatory hurdles for SPACs in the country and suggests amendments to better tackle the emerging issue. A comparative analysis with the United States (“US”) is also undertaken to that effect. At the outset, the concept of a SPAC is briefly discussed.

What is SPAC and how it is different from an IPO?

SPACs are companies which are formed to raise capital through an IPO, with the intention of using the proceeds for acquisition post its listing on the stock exchange. The acquisition occurs in the form of purchase of shares, swapping of shares or a merger. As such, SPACs are also known as blank cheque entities since they are formed without a specific target in mind. Once the target company is identified and the SPAC’s shareholders provide their assent, the SPAC and the target company merge into a public listed entity. Such a transaction is referred to as a De-SPAC transaction and is undertaken within a set time frame of 18-24 months. The key differences between the IPO and SPAC route are that firstly, in an IPO, the company looks to raise capital and with a SPAC, the capital pursues a target company. Secondly, SPACs are more flexible in structuring agreement terms and the lock-in periods are usually avoided, while IPOs have limited flexibility in setting terms as compared to SPACs and even the shares listed recently have lock-in periods. Thirdly, IPOs don’t have a fixed specified time-frame, whereas the duration fixed for a SPAC transaction is 18-24 months, failure of which necessitates refund of money to the investors.

Regulatory Hurdles for SPACs in India

In India, IFSCA (Issuance and Listing of Securities) Regulations 2021 (“IFSC Listing Regulations”) explicitly provide a framework for SPACs, but they are applicable only to International Financial Services Centres (“IFSCs”). GIFT City in Gujarat being the only IFSC, the aforesaid law does not apply to the country at large.

The Companies Act, 2013 (“CA 2013”) does not explicitly address the permissibility of a SPAC. However, Section 248(1) of the CA 2013 states that if a company fails to commence its business within a year of its incorporation, then the Registrar has the authority to remove its name from the register of companies. A period of 18-24 months is generally reserved for the acquisition of the target company by a SPAC and their only goal is to acquire or merge with an existing share. It could be contended that SPACs fall under the ambit of the aforesaid provision as a shell company and must have their name struck off from the register of companies. Consequently, unless Section 248 of the CA 2013 is amended, SPACs cannot operate in India.

The SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (“SEBI ICDR”) also poses significant hurdles for the operation of a SPAC. Regulation 6(1) of the SEBI ICDR provides the eligibility criteria for an IPO and states that the issuer must have in the preceding three years, first, net assets of at least three crore rupees; second, an average operating profit of at least fifteen crore rupees; and third, net worth of at least one crore rupees. Given that SPACs do not run any business operations until they merge with a private company post their listing, at the time of going public, they possess no operating profits. As such, SPACs cannot meet the criteria under the Regulation 6(1) of the SEBI ICDR.

Regulation 6(2) of the SEBI ICDR notes that companies which fail to meet the standard under Regulation 6(1), may make a public offer only if they abide by the book building process and have at least 75% of their net offer allotted to Qualified Institutional Buyers. Given the uncertainty of a lucrative future acquisition and the difficulty in attracting institutional buyers, Regulation 6(2) of the SEBI ICDR could be an extremely onerous threshold to meet for SPACs. Rather, an enabling provision along the lines of Regulation 6(1) of the SEBI ICDR may be inserted via an amendment, that permits the listing of SPACs in the country with less stringent eligibility criterion.

Comparative Analysis

The US provides a flexible regulatory framework for SPACs, which is evident from the 613 SPAC listings at the American stock exchanges in 2021 alone. A SPAC fits the definition of a shell company under Rule 405 of the Securities Act 1933 (“Securities Act”). As a consequence of the same, SPACs are characterised as ‘ineligible issuers’ within the meaning of the Securities Act. However, such a classification only adds certain restrictions and does not prohibit the SPACs from raising funds from an IPO. For instance, an ineligible user is subject to additional restrictions during the roadshow presentation. It is noteworthy that the US treats a shell company under Rule 405 and a blank cheque company under Rule 419 of the Securities Act differently. The latter puts certain restrictions on the trading of penny stocks until the business combination is complete, which SPACs claim an exemption from, by filing Form 8-K.

Consequently, unlike India, SPAC listings are permissible in the US. The Indian legislators can also take a cue from the manner in which the US deals with shell companies. Although the Securities Act in the US categorises a SPAC as a shell company, it nevertheless permits them to raise funds via an IPO, albeit with stricter restrictions. A provision to that effect can be inserted in the CA 2013 and SEBI ICDR in India, to facilitate the introduction of SPACs.

At this juncture, it is pertinent to analyse the IFSC Listing Regulations. While they have paved the way for the introduction of SPACs in the GIFT City, it is necessary to examine the same from a comparative standpoint. Firstly, under Regulation 75(1) of the aforesaid Regulations, the issue size of the SPAC must be at least USD 50 million. This is much smaller than the issue size in the UK, where the same must be at least 100 million Euros. A higher threshold could have ensured that only well-capitalised SPACs participate in the market, thereby reducing the risk for the investors. However, the current issue size is satisfactory as it permits greater participation by Indian SMEs and start-ups in the business combinations.

Secondly, as per Regulation 84 of the IFSC Listing Regulations, the shareholders are given the right to vote on the proposed business combination, whereas the sponsors are not given such a right.

Furthermore, as per Regulation 82(1), the entire proceeds of the IPO must be deposited in an interest-bearing escrow, controlled by an independent custodian. These approaches are similar to the methods adopted in the US and UK, where escrow accounts are utilised and no rights are granted to the sponsors to vote on the proposed business combination. In the UK, the approval of the majority of shareholders is taken for the approval of the business combination. However, the UK requires the opinion of an independent valuator and financial advisor to be informed to the non-founder shareholders, if the proposed business combination is entered with an interested party or a founding shareholder. This ensures that there is no prejudice or bias of the sponsors that could affect the interests of the investors. Such an approach may be adopted in India to safeguard the investors.

Conclusion

While IPO is the traditional method of raising funds through capital markets, SPACs offer an attractive alternative. To be at par with the US and the UK, India must implement an appropriate SPAC listing regime at the earliest. Suitable amendments to the CA 2013 and the SEBI ICDR, as discussed above, are necessary in that regard. Further, the SEBI Regulations that are specific to SPAC listing need to be accompanied with necessary changes made in the requisite RBI Guidelines, the Stamp Act 1899 and the Takeover Code. Currently, GIFT City in Gujarat is the only one IFSC in India. However, it is still in a developing phase and is not established completely to fulfil the objective of the fund, and the reach of the IFSC is not close to the BSE and NSE yet. Thus, a dedicated regulatory framework for SPACs should be brought for India at large.