New FDI rules and proposals to shrink FPI investment from China : Is it justified? – By Rohitaashv Sinha

Introduction

With industry experts asking for clarification regarding the Government of India’s stand of investment from China, a period of speculation has taken over. As had been stated in our previous update (https://legiteye.com/revised-foreign-direct-investment-policy-to-prevent-hostile-take-over-by-rohitaashv-sinha/), The Department for Promotion of Industry and Internal Trade, the Ministry of Commerce and Industry, Government of India (DPIIT) vide Press Note No. 3 (2020 Series) dated April 17, 2020  amended para 3.1.1 of the current ‘Consolidated Foreign Direct Investment (FDI) Policy, 2017’ (FDI Policy) to curb opportunistic takeovers/acquisitions of Indian companies due to COVID-19 pandemic. The aforesaid was notified on April 22, 2020 (“Notification”). Similarly, with regard to Foreign Portfolio Investment (FPI) the DPIIT is seeking data and information from the Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI) around investments in Indian listed entities in order to determine whether Chinese investors directly or indirectly are taking advantage of the COVID-19 crisis. 

Why FPI is also important to DPIIT

FPI [1] license allows investors to freely invest in up to ten percent (10%) of the share capital of an Indian company without any approval. However, as per reports, SEBI has suggested that all new licenses or their renewals from countries sharing land borders (“Neighboring Countries”) with India are to be referred to it. SEBI is also investigating investments routed through Hong Kong. As a result, no China-domiciled FPI would be able to buy beyond ten per cent (10%) in a listed company without prior permission from the Indian authorities. 

The aforesaid proposed restriction and Notification has created an atmosphere of regulatory uncertainty with regard to investment from China. The Notification has also provided that any subsequent change (directly or indirectly) in the beneficial ownership of entities and/or citizens of the Neighbouring Countries would also require Government approval.

Beneficial owner

The concept of beneficial ownership was first brought to light in 1990, when the Financial Action Task Force (FATF) became the first international body to recommend international standards on beneficial ownership. It defines beneficial ownership to mean the “The natural person(s) who ultimately owns or controls a customer and/or the natural person on whose behalf a transaction is being conducted. It also includes those persons who exercise ultimate effective control over a legal person or arrangement.” Like in India, in other countries shareholders of a company need to report their details to government or regulatory authorities. 

The Notification further places an approval for all from neighboring countries as well as investments by any such entity that may have its “beneficial owner”, in a nation sharing land border in China. Although there is ambiguity with regard to investments with regard to “beneficial owner”, it appears (as reports suggest) that the government is going to stick with the standard interpretation of ‘Significant Beneficial Ownership” as provided under the Companies Act, 2013. The term beneficial owner can be interpreted as per the Companies (Significant Beneficial Owners) Rules, 2018 and the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 (“PMLA”). While the former defines it as 10 per cent (10%) ownership or voting rights, control or significant influence, the latter puts it at 25 per cent (25%) controlling ownership or profit share of the company or the person who holds the position of senior managing official.

The Beneficial Owner in an FPI can be determined in three (3) ways – first, whether the investor has put in twenty five per cent (25%) or more of the fund corpus; second, whether the investor ‘controls’ the board of directors of the asset management company of the fund; third, whether the investor has influence over the senior management persons of the FPI. An investor, who stays below the radar by owning less than twenty-five per cent (25%) and having no representation on the board, may still exercise control through senior managers. As portfolio investment, a single FPI can own up to nine point nine per cent (9.9%) equity of a listed stock. Beyond that, the entire holding is considered as FDI. With Chinese companies now required to take Government approval for any FDI, no Chinese FPI can buy beyond nine point nine per cent (9.9%) on the floor of the exchange without prior permission from Indian authorities. 

Controversy

Hong Kong, Macau and Taiwan – Indian Government alters position

The addition of China in the definition of Neighboring Countries prohibiting it to make an investment in India other than via Government approval was the change brought about by DPIIT. Special administrative regions such as Hong Kong, Macau and Taiwan do not share land borders with India, they are recognized as part of China and India, as a member of the World Trade Organization (WTO), does not recognize Taiwan as an independent country and accepts Chinese sovereignty over the region since China treats Taiwan as a breakaway province and not as an independent nation. However, with the politically changed scenario, the news from the Government suggests that they are now willing to alter their position and investments from the aforesaid three regions may flow through smoothly. India considers investments from Taiwan separately and the investments from Taiwan were never sent for security clearance from the Ministry of Finance. The statements given by senior government officials to various private media houses clarify that investments from Taiwan will be treated as they were previously and would be excluded from the latest changes in the FDI Policy. 

Protectionist outlook in line with other jurisdictions 

The altered view from the industry appears to be that of distress and caution where it is being felt that India is being increasingly protectionist. However, it is interesting to note that even major jurisdictions like the European Union (EU) and USA have already taken or are taking steps similar to India to protect homegrown industries and hostile takeover. On March 25, 2020 the European Commission issued certain measures that EU members could adopt regarding the FDI and free movement of capital from third countries for protection of Europe’s strategic assets (“Communication”). This Communication is in addition to the speculative scenario regarding screening guidelines issued by EU, i.e. Regulation on foreign direct investment screening, Regulation (EU) 2019/452. The suggestions amongst other points suggest a review of portfolio investments where it is ‘relevant to security or public order’. The aforesaid is a clear suggestion to any ownership which gives any kind of rights to shareholders from third world countries over and above their EU counterparts.  

Similarly, in the US, Representative Jim Banks has introduced the ‘Restricting Predatory Acquisition During COVID-19 Act’ in the US Congress. The aforesaid Bill amongst other aspects completely plans to restrict any Chinese investment in critical infrastructure in US in excess of 51%. Furthermore, another Bill, namely the ‘SOS ACT to Prevent Chinese-State Acquisition of Companies Affecting U.S. National Security’ was introduced by Representative Mark Green to possibly prevent strategic investment by Chinese state-owned companies is strategic US defence companies. 

Conclusion

Seeing the position taken by EU and USA, it would be unfair to treat India’s move regarding China as “ultra-precautionary”. It appears that the Government of India is also following or providing the same measure of caution as their western counterparts. If at all challenged before the World Trade Organisation (WTO), India’s stand would be that of applying a new approval route and in no manner challenging the existing openness to foreign investment from China. China may also argue in the WTO as to this being “discrimination” by India. However, India may take the exceptions of ‘non-discrimination’ of the General Agreement on Tariffs and Trade and may take umbrage of the aspect that China itself places several restrictions on foreign investment in its various sectors, like pharmaceuticals. Hence, such stance by it justified. 

Therefore, it would be interesting from a policy perspective what stand India takes with regard to “Chinese Investment”.    

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Mr. Rohitaashv Sinha, is an Associate Partner with Agarwal Jetley & Co. (AJC), a law firm based in New Delhi.  He has over 12 years of experience. His practice has been particularly focussed on corporate and commercial laws, foreign investment laws, mergers & acquisitions, joint ventures, labour and employment laws and regulatory issues. He is also actively involved in pro bono services on behalf of various NGOs. Mr. Sinha is an alumnus of ILS LAW COLLEGE, PUNE and received his BSLLB degree from Pune University in 2008. You can reach him at rohitaashv.sinha@agarwaljetley.com

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[1]  Issued under the Operational Guidelines For Foreign Portfolio Investors & Designated Depository Participants Under SEBI (Foreign Portfolio Investors) Regulations, 2019.

Disclaimer: The views or opinions expressed are solely of the author.