On April 17, 2020, India’s Department for Promotion of Industry and Internal Trade issued a press note amending the foreign direct investment (FDI) rules applicable to investments from countries having a land border with India. Following this, the Ministry of Finance issued a notification in the official gazette on April 22, 2020 (Notification) to amend the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (FDI Rules).
Impact of the Notification
As per the Notification, prior approval of the Indian government will now be required for FDI into India (direct or indirect) by an entity of a country which shares a land border with India, i.e., China, Pakistan, Bangladesh, Nepal, Bhutan, Myanmar and Afghanistan.
FDI covers any investment in or transfer of equity instruments of an unlisted company or in 10% or more of the post-issue, paid-up equity capital on a fully diluted basis of a listed company. Equity instruments include: (i) equity shares, (ii) compulsorily convertible preference shares and debentures, (iii) partly paid shares, and (iv) share warrants.
Wholly Owned Subsidiaries (WOS): A number of Chinese construction companies, telecommunication equipment companies and Internet companies have set up WOS’ in India either directly from China or through Hong Kong holding companies. Examples include Baidu, Tik Tok, Oppo, Haier and many others. All such WOS’ will now have to obtain prior government approval if they want to issue further equity capital to their parents.
Indian WOS’ established through Hong Kong intermediary companies by American or European companies: All such WOS’ will now have to obtain prior government approval if they want to issue further equity capital to their parents.
Global or multi-jurisdictional transactions: Such deals will require prior government approval if they result in an indirect investment in or transfer of an Indian company’s equity instruments or if the beneficial ownership of the Indian company goes to a Chinese investor.
PE/VC Investors: Chinese investors like Alibaba, Tencent and others will be heavily impacted. (i) Rights issuances; (ii) share buybacks; (iii) exits of existing investors from an Indian company which result in an increment in a Chinese investor’s stake will now require prior approval of the Indian government, although there may be no fresh inflow of FDI. PE/VC investors may not be able to effectively exercise call options, rights of first offer, anti-dilution or ratchet provisions.
What is not impacted?
At present, the Notification does not affect the following.
Foreign Portfolio Investments (FPI), i.e., investment below 10% of the post-issue paid-up equity capital on a fully diluted basis of a listed company or below 10% of the paid-up value of equity instruments of a listed Indian company are not covered by the Notification. Recent news reports suggest that the Securities and Exchange Board of India, which regulates FPI, has requested custodians to provide extensive information on FPI from funds emanating from and controlled by, thirteen (13) Asian countries, with a focus on China and Hong Kong. Therefore, a curb on FPI from China/Hong Kong may be in the works.
External commercial borrowings from a lender based in China or Hong Kong or import- export transactions should not be affected.
Establishment of liaison, branch or project offices in India by an entity based in China should not be affected.
Investments in LLPs: Technically, foreign investment in an LLP is not covered under the definition of “FDI” and is referred as “foreign investment” under the FDI Rules. Given this, it is likely that investors from China could potentially invest in an LLP without requiring prior approval of the Indian government. However, this may not be in line with the spirit of the Notification.
Scope of beneficial ownership
The Notification or the existing foreign investment law does not define the term “beneficial owner.” Given this, in the absence of an express definition, investors may have to rely on the definition of “beneficial interest” under the Companies Act, 2013, which does not have any objective thresholds and covers the holder of any right or entitlement attached to a share, under contract or other arrangements.
Our comments
With this amendment, investors will have to investigate their ultimate beneficial ownership, which will be a mammoth fact-finding exercise for listed investors and collective investment vehicles like PE funds. Moreover, in respect of global transactions, it remains to be seen if (and how) the Indian government will be able to monitor such transactions, as a majority these transactions do not have to be reported to Indian regulators. In addition, a huge responsibility will be cast upon authorized dealer banks in India to ensure that FDI inflows do not trigger the Notification. In our view, the know-your-customer processes may get extended.
Overall, we think that the Indian government may have jumped the gun in issuing the Notification, as many pertinent issues remain unaddressed. Given the lack of clarity on various issues and uncertainty on getting an approval from the Indian government, investors may be well choose to invest in other ASEAN countries, where the processes and timelines may be more efficient.