New FDI Norms – Curb on Opportunistics Takeovers in Times of Covid-19

Posted On - 5 May, 2020 • By - Souvik Ganguly

In a bid to prevent opportunistic takeovers of India companies in light of the unanticipated economic disruption and depression created by the Covid-19 pandemic, the Indian Government in a bold move has amended India’s foreign exchange policy. Consequently, all investments from India’s neighbouring countries will require prior government approval. This move echoes the growing worldwide sentiment to curb the unabated inorganic expansion of Chinese entities through acquisition of businesses which are already reeling under the stress of Covid-19 economic impact. Australia and Germany have also taken similar steps to tighten their foreign investment policies. India Government’s decision may have been precipitated by Bank of China’s further acquisition of shares in HDFC Bank, India’s largest private bank.

The Indian Government has introduced this change through an amendment (“Amendment”) to the Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020 in furtherance of Press Note No. 3 (2020 Series) of Department for Promotion of Industry and Internal Trade.

In India, foreign investment can be made under two routes, government approval route or automatic route. In recent years, India has liberalized its foreign exchange policy and foreign investments in most sectors can be made under automatic route that is without governmental approval. Pursuant to the Amendment, the following entities will require prior government approval for foreign investment irrespective of the sector in which investment is made:

1. Entities which are incorporated in a country which has a common land border with India (Pakistan, Bangladesh, China, Nepal, Myanmar, Bhutan and Afghanistan) (“Common Land Border Countries”).

2. Entities whose ‘beneficial owner’ is from a Common Land Border Country. The requirement of governmental approval is also applicable to individuals who are citizens of Common Land Border Countries.

Even transfer of ownership of foreign direct investment (existing or future) in an Indian entity which, directly or indirectly, results in transfer of ‘beneficial ownership’ to entities or citizen of Common Land Border Countries will require prior government approval.

As the Amendment is applicable to entities incorporated in China, the Indian Government will need to clarify if the Amendment also extends to Hong Kong or Macau which are special administrative regions in China but do not share any land border with India. Till date, since no such clarification has been issued by the Indian Government, we may reasonably presume that the Amendment is also applicable to Hong Kong and Macau. Apparently, HSBC which has operations in mainland China, is understood to have sought legal opinion on whether the Amendment covers Taiwan. The concern was whether Taiwan, which has a unique political status and no land border with China, will be considered at the same footing as China. Historically, India has treated Taiwan as a separate jurisdiction and even has a separate tax treaty with Taiwan (unlike Hong Kong and Macau). As per newspaper reports (Economic Times), we understand that government officials have unofficially clarified that investments from Taiwan will not be impacted by the Amendment.

While the intention behind the Amendment is appreciated, apparently there are some latent issues with the Amendment that need to be addressed immediately in equal measure. Firstly, the term ‘beneficial ownership’ has not been defined under the Amendment. Therefore, what constitutes ‘beneficial ownership’ especially in case of an indirect transfer of ‘beneficial ownership’ of Indian companies, remains a grey area in the absence of such definition. The Indian Companies Act, 2013 defines ‘significant beneficial owner’ as opposed to the ‘beneficial owner’. ‘Significant beneficial owner’ under the Indian companies law has been defined as individual, who acting alone or together, or through one or more persons or trust, possesses one or more rights or entitlements such as holding, directly or indirectly, 10 % shares or 10% voting rights or right to receive 10% or more dividend or such individual exercise significant influence or control, indirectly or directly in a company. Accordingly, further clarification the Government on the scope of ‘beneficial ownership’ will be appreciated to determine the scope of applicability of the Amendment to indirect transfer(s) of ‘beneficial ownership’.

An unintended consequence of the Amendment is that it does not exempt from government approval further investments by such foreign entities in existing Indian companies. Chinese companies have poured about USD 6 billion into Indian start-ups in the last two years. The majority of Indian unicorns are funded by Chinese investors, which are led by Aliababa and Tencent. Such a move by the Government of India, might become detrimental for growth stage start-ups which have already incurred Chinese investments and may be looking for further funding. As a result of the Amendment, Indian companies may need to consider expanding their horizon to foreign funding from other jurisdictions as United States and Japan.

To reiterate, government approval requirement is sector agnostic so long as the foreign investments are directly from entities located in Common Land Border Countries or the beneficial owner thereof is located in such country. The additional approval requirement Chinese investments will result in prolonged timelines as a result of increased scrutiny of such investment. In times, where governmental organisations are not functioning optimally due to social distancing norms, it can be assumed that the timelines for concluding any such transaction will be protracted. This ‘act first and think later’ strategy may not be ideal for the Indian Government as it may end up allocating its crucial resources to scrutinize applications from Chinese investors even in genuine greenfield investments.

In time, the Indian Government may consider relaxing the government approval requirement for greenfield investments for subsidiaries of Chinese entities. One may argue that any entry of Chinese entities in this market economy may potentially result in a significant diminution of local Indian entities. However, on the other hand greenfield investment in core areas of economy such as infrastructure, domestic manufacturing of core industrial products, pharmaceutical formulations, logistics, auto components, electronic components, etc. also has the potential to expand “Make in India”, create employment and generate revenue in India. As per newspaper reports (Economic Times), we understand that government officials have unofficially clarified that the government department will try to fast track governmental approvals for investments from China for non-core sectors.

The intention of the Amendment was to curb opportunistic takeovers. However, the question remains whether the Amendment may have overreached its objective leading to the proverbial ‘cure worse than the disease’ syndrome. Ideally, Indian Government should have considered a more streamlined approach of introducing the requirement of government approval for targeted sectors or select categories of investments. The Chinese Government has called out India’s Amendment as a violation of World Trade Organisation’s principles of free trade. However, it is also noteworthy that the Amendment in itself is not a direct and complete ban on Chinese investments into India and it only monitors such investments through a mandated government approval for such investments. Having said that, clarifications on the Amendment are critical as many Indian companies may have to look at other jurisdictions, that is other than China, for meeting funding requirements.

Authors: Souvik Ganguly

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