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The Government of India has taken several measures in order to sustain the declining economy lately, due to the COVID-19 pandemic. On this note, the Department for Promotion of Industry and Internal Trade (DPIIT) reviewed the current FDI Policy to prevent opportunistic takeovers of Indian companies, during the pandemic. The Press Note 3 (2020 Series), issued by the authority on April 17th amended paragraph 3.1.1 of the Consolidated FDI Policy of 2017, and imposed restrictions on entities that share land borders with India, or where the beneficial owner of any investment in India is based in such country or is citizen of such a country. Such entities will now require prior approval from the Government authorities for direct FDI after the FEMA Notification was issued on April 22nd 2020. Further, the amendment also provides for prior government approval for the existing or future transfer of ownership of an Indian entity that results in beneficial ownership in these neighboring countries. Through this pre-emptive move, the government seems to scrutinize the predatory conduct and increasing capital flow by companies or investors from neighboring nations, especially China, which has been eyeing struggling Indian companies. The government’s reaction to amend the policy was preceded by People’s Bank of China’s (PBC) move to increase its stake to 1% in HDFC Bank.
Automatic and Government Route in FDI:
To better understand the implications of the amendment, it is crucial to know the ways through which foreign direct investments are made in India. Foreign country entities can invest under the FDI Policy through two routes. The Automatic Route allows foreign countries to invest in India without prior approval of the government or authorities, in any sector, as specified by the FDI Policy of 2017. The Government Route requires prior approval of government authorities like the Department of Economic Affairs, Ministry of Finance and Foreign Investment Facilitation Portal (FIFP). The Press Note mentions that countries that share land borders with India can invest only under the Government route, therefore restricting the increasing investment activities by China. Prior to the amendment, the FDI Policy of 2017 already restricted Bangladesh and Pakistan to invest under the Government Route only.
The Press Note mentions “beneficial owner of an investment into India” or “transfer of ownership of an Indian entity that results in beneficial ownership”. However, neither does it define beneficial ownership, nor does it clarify the intent of the statement. The Ministry of Finance on 22nd April 2020, also issued notification amending the FEMA (Non-Debt Instruments) Rules, 2019, to give effect to the Press Note. Nevertheless, the position is still ambiguous as the Notification does not suggest any guidance on the interpretation either. The terms “beneficial owner” and “beneficial ownership” are defined under the Companies Act and the Prevention of Money Laundering Act (PMLA). Under the Companies Act, guidance of Section 89 and 90 can be taken. Section 89 read with Rule 9 of the Companies (Management and Administration) Amendment Rules 2018, determines a beneficial owner as “a person who holds or acquires beneficial Interest in the shares of a company.” Section 90 mentions ‘significant beneficial owner’ (SBO) as an individual acting alone or together with others, who holds beneficial interests, of not less than 25% or such other prescribed percentage, in the shares of the relevant Company; or holds the right to exercise, or the actual exercising of significant influence or control over the relevant Company. Beneficial interest is known as the right to receive benefits on the shares held by another party.
The Prevention of Money Laundering Act (PMLA) also defines a ‘beneficial owner’ as an “individual who ultimately owns or controls a client of a reporting entity or the person on whose behalf a transaction is being conducted and includes a person who exercises ultimate effective control over a juridical person.” Although there is no clarity as to what definition will be adopted, the definition under PMLA seems to be the choice as it will most efficiently fulfill the purpose of the changed FDI Policy. Assistance from SEBI’s “Operational Guidelines for Foreign Portfolio Investors, Designated Depository Participants and Eligible Foreign Investors” can also be taken to identify beneficial owners. A general understanding of the Press Note suggests that the inclusion of the term ‘beneficial ownership’ targets to block ultimate beneficiary or the indirect beneficiary, especially in cases of complex and opaque company structures like that of China. As there are no clarifications even after the issue of FEMA Notification, the exclusion of the term may also be a deliberate act of the government.
Why is there a need to regulate Chinese Investment in India?
It is no secret that China has been on the forefront of global financial dominance. The Press Note released by DPIIT does not specifically mention China, however, it is clear that the need to amend the policy was felt due to the increasing investment activities in not just India but all over the world by the neighboring country. It is also important to note here that India is not the only country to take such action against China. The Committee on Foreign Investment in the United States has been consistently working with its main focus on Chinese owned or controlled investments that lead to control of American entities. Countries like Australia, Germany and Czech Republic have taken similar steps by amending their regulations.
Funds from overseas are invested in India through Foreign Direct Investment as well as Foreign Portfolio Investment (FPI) route. FPI is defined under the FEMA (Non-Debt Instruments) Rules, 2019 as any investment made by a person resident outside India through equity instruments where such investment is less than ten percent of the post issue paid-up share capital on a fully diluted basis of a listed Indian company or less than ten percent of the paid-up value of each series of equity instrument of a listed Indian company. The Securities and Exchange Board of India (SEBI) regulates the multi-national financial institutions and Indian financial services that handle the funds and securities of FPIs that are registered with SEBI. At present, the amendment in the Non- Debt Instruments Rules only deals with FDI, however it is pertinent for India to keep a keen eye on indirect investments in the form of securities and assets flowing from China as well. Major Chinese investment arms like China Investment Corp (CIC) and State Administration of Foreign Exchange (SAFE) have been investing in India for years.
In a recent move, SEBI has also sought information related to all portfolio investments from China, Hong Kong and other Asian countries to oversee the indirect investments as it is observed that China has adopted multiple tax friendly routes like Singapore, Hong Kong and other such countries, that do not share a border with India. The Indian government has treated Hong Kong and China as separate jurisdictions, even though Hong Kong is now a special administrative region of China, which should be subjected to restrictive treatment as well. As per DPIIT, the capital flows from China between April 2000 and December 2019, stood at $2.3 billion, whereas $4.2 billion came from Hong Kong. Meanwhile Singapore brought in the second highest amount of inflows. Here, it is also pertinent to note that Indian sectors, particularly technology, manufacturing and start-up companies, have attracted big names like Alibaba, Tencent, Vivo and Oppo, in the last few years and will be noticeably affected if the government is stringent in approvals. Although government’s interest to safeguard domestic entities is essential at this crucial time, a balance is also required to ensure global economic stability specially in key employment generating industries like Internet and tech companies of India, that are highly dependent on Chinese funds.
People’s Bank of China’s increased shareholding in HDFC proved to be a wake-up call for the government in the wake of the pandemic. Indian listed companies that recently experienced a sharp fall in their valuation, are increasingly becoming an easy target for acquisition. The Press Note and the subsequent FEMA Notification give a fair idea of government’s concern over hostile takeovers by China. However, it is unclear whether the step taken is temporary or here to stay. Nevertheless, the amendment and SEBI’s expected move to restrict indirect investments will undoubtedly make direct and indirect deal approvals time consuming, and will increase disclosure of information for government authorities. Unchecked Chinese possession could lead to drastic effects on ownership of assets in the country, especially when Chinese investments have a good amount of stake in various unicorn Indian companies. Yet, ignorance of the large fund pool provided to many non-sensitive sectors could largely hurt Indian companies after the situation improves globally. Clarifications with regard to the adoption of amendment of FEMA (Non-Debt Instruments) Rules, 2019 are much needed in order to remove ambiguities in the Press Note issued by DPIIT.
(This post has been authored by Antara Deshpande, a IV year student of National Law University, Odisha)