[Shivani Shenoy and Yashwardhan Rajawat are students at Symbiosis Law School, Pune.]
On 17 April 2020, the Department for Promotion of Industry and Internal Trade (DPIIT) under the Ministry of Commerce and Industry published Press Note No. 3 (Press Note), by virtue of which, the DPIIT revised the Foreign Direct Investment Policy (FDI Policy) on investment via the automatic route by entities residing in countries sharing land borders with India.
Former position
Prior to the release of the Press Note, all non-resident entities could invest in India under the automatic route, by simply informing the Reserve Bank of India after having made the investment under the Consolidated FDI Policy 2017. However, such investments were to be made other than in sectors/activities related to lottery business, gambling and betting, chit funds, Nidhi company, real estate business and manufacture of cigars. The citizens of, and entities incorporated in Bangladesh and Pakistan were and continue to only be permitted to invest after prior government approval. Additionally, investments by citizens/entities in Pakistan in defence, space, and atomic energy were and continue to be prohibited in addition to the prohibitions common to other countries.
Revised position
The Press Note amends para 3.1.1 of the FDI Policy by virtue of which, if:
entities belong to; or
persons are citizens of; or
beneficial owners of investments are situated in countries sharing a land border with India, they may invest in India only after prior approval of the government and in permitted sectors.
Additionally, where ownership of an existing or future FDI in an entity in India is to be transferred, directly or indirectly, such transfer will also require prior approval of the government if it results in beneficial ownership in the hands of persons/entities who share land borders with India.
International perspective
This Press Note affects all of India’s neighbouring countries with the exception of Sri Lanka and Maldives since they share water-borders with India. India has received FDI worth $8.97 million from Myanmar, $3.25 million from Nepal, $2.44 from Afghanistan, $2,342.03 million from China and $4,224 million from Hong Kong between April 2000 and December 2019 according to the DPIIT Factsheet on FDI. Hence, these changes are likely to affect Chinese entities more substantially than other countries sharing land borders with India. However, China only ranks in the 18th position among countries that have invested in India, measured in terms of the amount of FDI made between 2000 and 2019. However, DPIIT has not imposed restrictions on FDI through the automatic route for entities of any countries that don't share a land border with India. China has alleged that this discriminates against it and violates the principle of non-discrimination and free trade espoused by the World Trade Organization. There is however, a difference of opinion on whether India would be able to invoke the ‘security exception’ clause under Article XIV bis of GATS since it has reasoned ‘protection from hostile takeovers’ as the reason for imposition of additional barriers.
The Press Note cites “curbing opportunistic takeovers/acquisitions of Indian Companies due to the COVID-19 pandemic” as the intent behind the revision of the position. This change in the FDI Policy is close on the heels of other countries affected by COVID-19 such as Italy, Germany, Spain, Australia etc. also tightening their FDI norms on growing concerns of predatory behaviour by Chinese entities. In India, this comes at the backdrop of China’s central bank, People’s Bank of China raising its stake in HDFC Ltd. from 0.8% to 1.01% by purchasing around 1.75 crore shares. These shares were bought between January and March 2020 when the stock market had slid by about 25% caused by a sharp decline in the value of listed companies. The Saudi Arabian Monetary Authority had also purchased a 0.7% stake in HDFC Ltd. on behalf of their sovereign wealth fund. But, on account of its shareholding being lesser than a 1% trigger that requires regulatory notification, it was not an event of as much concern.
Nevertheless, the Press Note does not affect Foreign Portfolio Investors (FPI) with investment of less than 10% in companies listed on the stock market. The Securities Exchange Board of India (SEBI) has sought information from custodians and is monitoring portfolio investments specifically from 13 Asian countries including China and Hong Kong. But in the absence of a regulation by SEBI, Chinese investors can continue to buy stocks of listed companies upto 10% of their stake.
Impact on businesses
The Press Note has created artificial classification between entities a) funded/expecting to be funded by investors in China or other land border sharing countries and b) those funded/expecting to be funded by investors from other countries. The former are likely to suffer gross financial losses and the latter such as Reliance Jio which is slated to receive $5.7 billion of investment from Facebook, Vodafone Idea Ltd., expecting relief packages from Foreign Parent Vodafone Group Plc, Container Corporation of India Ltd. inviting participation of foreign PE firms to buy 30% of its shares continue to engage foreign investors or operate unaffected.
Indian start-ups are likely to face challenges in obtaining and continuing funding considering as many as 18 Indian start-ups and unicorns such as TikTok, PayTm, etc. are funded by Chinese investors.
Several Indian entities are witnessing a record fall in revenues due to nation-wide lockdown imposed from 25 March 2020 on account of the COVID-19 pandemic. This is likely to cause accumulation of stressed assets with an eventual threat of bankruptcy. Hence, the requirement of investments by a white knight or by a foreign parent would be vital to the survival of the company. A stressed entity looking for buyers for its shares will be relegated to a weaker bargaining position due to decreased number of participating investors.
Interpretational concerns
Ambiguity exists regarding the inclusion of Special Autonomous Regions such as Hong Kong and Macau within the purview of the Press Note as being part of China or otherwise. While government officials have affirmed the inclusion of the former on the ground that Chinese investments are generally routed through Hong Kong, both regions have in the past been explicitly included and treated as being separate from China for the purpose of FDI. An official clarification on both continues to be anticipated.
The date until which such revision remains in application has not been indicated and hence, it is assumed that it will remain in force until such time as the DPIIT releases further press notes/notifications.
The Press Note makes no distinction between the form of investment- greenfield/brownfield or type of investor- Financial Investors/Venture Capital Investors etc. but rather takes all forms of investment by all entities/persons from all countries sharing land borders with India under its sweep.
Attributing a nationality to Venture Capital Funds and tracing beneficial ownership of investor entities and on the basis of nationality of promoters, directors etc. will prove to be especially challenging.
The terms ‘beneficial ownership’ or ‘beneficial owner’ have not been defined and ambiguity exists whether to interpret them in accordance with the different definitions under Section 89(10), The Companies Act 2013 or Direction 3(iv), RBI Master Circular- Know Your Customer Direction 2016.
Conclusion
These changes are likely to have polarised effects on businesses and each must hence evaluate the impact of these changes on their specific business. Transferor companies must perform due-diligences to ensure that transferee companies do not attract provisions specified under the Press Note. In the event that provisions are attracted, they must brace themselves for the delay in investments due to government approval. While it is possible that the FDI Policy panders to a popular anti-China sentiment simmering worldwide due to the spread of the COVID-19 virus worldwide, it is feared that it may invite retaliation from Chinese quarters. In the meanwhile, it is recommended that the government install an FDI policy that maintains uniformity in investments from investors in all countries in the interest of protecting the health of businesses and economy at large to prevent a trade war between India and China in the middle of a pandemic, which seems to already be brewing.