India’s capital markets are starting to mature: Rahul Guptan, Clifford Chance

India’s capital markets are starting to mature and one of the key reasons is the investment banking community wisening up, says Rahul Guptan, partner, Clifford Chance.

“They are applying some sort of self-discipline as to what companies they are taking to the market,” he says, indicating the reason behind some of the proposed IPOs getting shelved in the country.

Considered one of the pre-eminent lawyers on India’s capital markets, Guptan led the Clifford Chance team that advised on IRB InvIT Fund’s $785 million IPO, India’s first IPO of an infrastructure investment trust, and on the $184 million IPO of BSE, Asia’s oldest stock exchange.

He recently spoke with DEALSTREETASIA about the current IPO boom, concern around exits and investor sentiment about India. Edited excerpts:

We’ve seen a lot of IPOs over the last couple of years in India. Is it because a lot of quality companies are now tapping the market or is it the euphoria over the way the markets have performed? With some IPOs also being pulled back, has the market reached a maturity where it can gauge as to who are the ones that will sail through?

I think we are at the start of developing that maturity. The reason for this present huge take up in activity is two-fold. One is that there is this natural release of pressure. There were a lot of quality companies that have been wanting to tap capital markets, but they couldn’t because of a whole lot of factors — there was no deal activity taking place, there was a lot of focus on corporate and government corruption. That was just prior to the present government getting elected.

With the change of government and easing of foreign investment rules, there is now a release to the pressure. People who wanted to come to the market in the prior years but couldn’t due to market factors have now done so. There are quality companies for sure but India has always been a mixed market. For as many quality companies that there are, there is also an equal number that don’t deserve to be listed. The real change according to me is the way the investment banking community has been shaken up. The quality players are now well known and established. They are applying some sort of self-discipline as to what companies they are taking to the market. Their reputation has become so important that rather than do the deal and take the fee, they are now more focused on what are they taking to market.

There was a phase where investment bankers were like us lawyers. If someone was paying them fees to IPO, they would do it. They were not applying that filter as advisers, asking “Does this company need to be listed at all? This company should be looking at private equity or fund raising somewhere else. Do another 3-4 years, take your revenue to some level and with that have the maturity to go to market.” I think that filter has started being applied a lot more by the players.

IPOs are now being viewed as an exit option in India, which they weren’t earlier. Exits were always a huge problem for private equity in India, even in good times. Are we seeing a trend here?

In the last 12-18 months, practically every transaction we have worked on has involved a private equity exit in some form or the other. That’s just our practice I’m talking about. If you analyse the 100-odd IPOs in the last 24 months, I’m pretty certain most of them would have some sort of PE exit. In some ways, I would think that IPO is the best route for an exit. The only problem that has always existed and still exits is the timeline because you cannot execute an IPO in 30 days. It is a long drawn out process and takes 6-9 months to complete. You can do it faster if you’re lucky, but you have to be supremely ready as a company to do it on a fast track basis, and you have to have the buy-in from the regulator. That doesn’t take place. First of all, once companies start the IPO process, they start learning as to what is required to be a listed company. The diligence is very rigorous. There is diligence by the auditors, the investment banks and the lawyers. In some cases, it is almost a forensic audit of the company’s historical records.

A lot of private equity players that have invested in these companies are not aware of these issues. Once you go through that period of pain and file the document with SEBI, you are in the hands of market conditions. Therefore, the advice that we give private equity investors when they finish their deals is that you’re investing today, your IPO may happen 8 years from now, but start thinking of it from today. Start putting in place the procedures, the record keeping, the financial reporting. People mostly get some spreadsheet every quarter, which they look at for their financial reporting and see the company’s performance. (We tell them) Don’t do that, insist on quarterly audits, or quarterly limited reviews. Let the company get used to the process of being reviewed every quarter and preparing financial results. And then when you come into the IPO process, you can tell your bankers and advisers that we can produce numbers within 30 days from the end of the quarter.

Are exits still a cause for worry for private equity and venture capital players? Or is that fear receding now that some of the capital has been recycled?

Fundamentally that concern will never move away. If you’re a private equity investor, the moment you write the cheque, you are worried about your exit in any country, not just India. A big example is Uber, where the investors are having a tough time with the CEO. It can happen to an Uber in America, it can happen to a company XY in India. The exit problem will always be there and you will always be worried about it. How much you have to worry about external factors has somewhat changed in India.

Before you talk about external factors, you have to analyse private equity investment in India in two phases. Initially and for the longest period of time till 2010 or so, a lot of private equity was offshore based funds coming into India with no local presence. So, you were looking at a dollar IRR. A lot of that has changed. There is a lot more onshore money available. They may have LPs which have offshore funds, but that dollar return is not hanging over their head like a big problem, so that has changed fundamentally. Second, the regulatory clarity on a number of issues has come through. There are still litigations that are going on but from a regulator’s point of view, a lot of that has been settled. You know what answers you want when you are speaking to your lawyers or financial advisors as to how to structure this deal and what’s the tax treatment going to be like. More or less, the doubts that were there in the early 2000s and the 1990s are now being settled.

If you look at the last 24 months, as much as the capital market exits have taken place, private exits have also taken place. You had sales to other third party foreign investors, other domestic funds and back to promoters. You’ve had a combination of exits that has taken place in the last 18-24 months.

As far as investor concerns go, how has that changed over a period of time? What are the most common questions and concerns of investors now relating to India?

I put clients into two buckets. One is a highly sophisticated client that has eyes and ears on the ground. Even if they don’t have an office in India, they have seen markets develop abroad and their questions are very specific to what they want to do in India. There is, surprisingly, still a category that does not know India that well. They are aware that it’s a market that they should be in. They are examining the market and trying to understand how to structure investments but a lot of the times they buy into the misconceptions about India being a tough market to get in, and red tape and enforcement issues. For those clients, it’s a big educational process.

But the questions more or less come down to the same things — the big concern is corporate and public corruption, because in other parts of the world anti-corruption and anti-bribery issues have become much cause for concern, compliance is a huge risk and India doesn’t do very well on the global corruption index. So, there’s a lot of questions around how endemic is corruption really and how do we protect ourselves. Regulation and compliance, that’s a big concern.

Second is how do we structure our investment, what is our exit option, how certain is the tax, do we need any regulatory approvals, will our agreements be enforceable, where do we go for dispute resolution, should we do it in India or should we do it abroad?

For foreign investors, there are new sectors that are coming up and have huge potential, with the way we are urbanising and growth of e-commerce. Do you see a lot of investor interest in these spaces?

I think that’s a macro-economic story. As long as you believe in the larger India macro-economic story, where India is going to be a growing economy and growing at the rate at which it is growing currently, investment is required in practically every sector. The government has, through its Make in India and other initiatives, tried to roll out a red carpet for people’s interest to remain in India. In sectors like logistics or agri food processing, there is really no regulatory impediment to setting up businesses. I see no reason why local Indian business houses are not using that as an opportunity just given the impact potential in India. There was an article which I read recently, which said that some ridiculous number like 20-30 per cent of India’s food production is lost in transit from farm to city, and if enough of that is saved, you could feed at least a 100 million people. When you read statistics like that, yes you need the power plants but you also need somebody to transport that produce from point A to point B in a safe healthy manner, that not so much is lost.

How do your clients view GST? Are they happy? Relieved? 

Very happy. The only sort of comment that we’ve heard from everybody is that there are too many slabs and these should be rationalised. I think it’s tough from the government’s perspective because you have so many interest groups and they have to meet the requirements of their constituents somehow. So, one effort is to keep it stable and the other is to meet the requirements they are getting as feedback. I think it’s a tough job. Possibly over time, if the slabs are reduced or brought down to a couple of slabs, I think that would be viewed as a very positive measure. Currently, just the fact that they have been able to get it off the ground and running is huge.

So many people have said this to us that in Indian income tax, you have so many categories, you have education cess and other sub-categories in addition to income tax. That’s the only sort of cautionary word that they hope that GST doesn’t go down that route that there is GST and then some GST+X, then that will just do back to the indirect tax regime. As long as it just stays as GST it’s fine and as long as the slabs are rationalised, it will all be good. If you read the commentary everywhere, it is that India has finally become one market, which it should have been to begin with. And if we are one market then the purchasing power of a billion and a half people is captured much better than what it is today.

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