This article is written by Aditya Kasiraman pursuing a Diploma in Mergers and Acquisitions, Institutional Finance and Investment Laws (PE and VC Transactions) from LawSikho.

Introduction

In particular, since 1991, India has sought to liberate its economy and has continued to open up many of its industrial and commercial sectors to foreign investment. In particular, the Indian government sought to attract foreign investors to the country by taking steps to promote free trade in India due to establishing long-term economic relations with India.

Foreign investment in India is governed primarily by the Foreign Exchange Management Act 1999 (FEMA) and its regulations, which include foreign exchange laws in India. To regulate foreign investment, the Reserve Bank of India (RBI) had published Foreign Exchange Management (Transfer or Issue of Security by a Resident Outside India) Regulations 2000 and subsequently Foreign Exchange Management (Transfer of Issue of Security by a Resident Person without India) Regulations 2017 (TISPRO 2017) (as amended from time to time), under FEMA were published on November 7, 2017. In addition, in 2010, the Department for Promotion of Industry and Internal Trade (DPIIT) (formerly known as the Department of Industrial Policy and Promotion) has developed a policy framework that includes industry requirements and other criteria to be followed by foreign investors who invest in Indian companies (FDI Policy).

On October 15, 2019, the central government announced, among other things, certain amendments to FEMA, pursuant to which the central government, rather than the RBI, authorized to clear all authorized non-credit transactions made through the main account and the RBI empowered to specify all equipment of debts made through a large account. The central government, on 16 October 2019, also announced the following instruments that would be considered ‘non-debt’, among other things, namely: all investments in consolidated companies (public, private, accounted and unregistered); financial participation in limited credit sharing (LLPs); all investment instruments as adopted in the FDI Policy as informed from time to time; investments in other investment units and real estate investment trusts and investment funds in infrastructure and investments in joint finance and exchange trading funds that invest more than 50 per cent equally.

Following these amendments to FEMA, the central government, on 17 October 2019, announced the Foreign Exchange Management (Non-debt Instruments) Rules 2019 (Rules 2019) and the RBI announced the Foreign Exchange Management (Debt Instruments) Regulations 2019 (Regulations 2019) and Foreign Exchange Management (Payment and Reporting of Non-Credit Assets) Regulations 2019, replacing TISPRO 2017 (as amended from time to time) and Foreign Exchange Management (Acquisition and Transfers of Immovable Assets in India) Regulations of 2018. Last year, the liberation movement continued, with the necessary changes to India’s foreign exchange laws in this regard, for example: the central government, in Press Note 4 dated 17 September 2020, increased the FDI rate to 74 per cent from 49 per cent with an automatic route in the defence sector.

In addition, Regulations 2019 contain industry requirements to be followed by foreign investors to invest in certain sectors in India and Indian companies receiving foreign investment in India. They also distinguish categories that fall under the approved route and those that fall under the automatic route. In addition, there are certain restricted sectors and industries where foreign investment is prohibited. Apart from those sectors and subject to foreign investment terms (working conditions) or government approval in certain sectors, for the most part, there are no conditions for foreign investment in other sectors in India.

In addition, the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations 2019 (FPI Regulations), read with Schedule II of the 2019 Regulations, allows foreign portfolio investors (FPIs) to invest in Indian company equity instruments and specify the form and method of investment in which such FPIs in Indian companies can be classified as a foreign investment or foreign direct investment (FDI). According to the rules of 2019, the total amount of each FPI is required to be less than 10 per cent of the total amount paid in full purification or less than 10 per cent of the total amount paid for each series of debts or stock options or share permits issued by an Indian company (limit individual); and the total investment of all FPIs consolidated in an Indian company (including any other direct or indirect investments) is required not to exceed 24 per cent of the paid-up equity share capital for each set of debentures or preference shares issued by an Indian company (combined limit). In addition, according to the FPI Regulations, if FPI investment exceeds the 10 per cent human limit, this investment will be eligible as FDI. In addition, the 2019 Regulations, read with the FPI Regulations, also allow FPIs to invest in any securities, shares, liabilities and guarantees of listed companies or companies whose securities can be listed on the stock exchange in India.

Therefore, foreign investment in India can be broadly classified as an investment in debt instruments and investment in non-credit instruments.

New foreign investment limits set by India

Like several other major economies, the Indian economy has been hit hard by closures and market disruptions caused by the COVID-19 epidemic. In these cases, the prices and stocks of Indian companies have seen a sharp decline. The Government of India (“Government”) has revised the Indian investment laws to address the “opportunistic seizure/acquisition” of Indian companies. This review is discussed below.

The emergence of Foreign Direct Financial Regime

There are two routes where foreign investors can invest in India. One of them is the “automatic route”, where no government permit is required under India’s foreign exchange laws to invest as long as it is within the relevant sector boundaries. Another route is the “government route”, where approval is required under foreign exchange rules to the relevant industry regulator, prior to investment.

Over the past several years, the rules relating to direct investment (“FDI”) in India have been progressively relaxed. Companies and organizations in many sectors can be 100% foreign and investments in many sectors can be made “automatically”. Historically, investors from only two neighbouring countries of India; Pakistan and Bangladesh have been subject to strict investment laws (requiring all funding to be approved by the Government). Significantly, investors from the People’s Republic of China (“PRC”) have never been subjected to such rigorous research other than critical areas such as telecommunications, security and rail infrastructure. According to Government data for the period April 2000 and December 2019, the PRC has come up with more than 99% of all foreign direct investment made by foreign investors sharing countries with India. This does not include investment by PRC-based investors who are diverted to investment paths such as Mauritius and Singapore.

Given the traditional investment regime in India, widespread concern has emerged that investors from countries bordering India (especially the PRC) could acquire stakes in Indian companies at very low prices, in the current economic downturn, becoming an important player in the Indian economy.

Recent limits under India’s investment laws

To curb such ‘opportunistic’ investments, the Government has issued a notice amending the External Finance Management (Non-Debt Instruments) Act, 2019 (“Revised Rules”). According to the revised rules, any business that invests:

(i) included; or

(ii) managed for the benefit of a citizen or a resident,

(iii) a country that shares a border with India (“Influential Investor”), must obtain Government approval before making its investment. The Revised Law came into effect on April 22, 2020.

Under the Revised Rules, the following transactions will require prior approval by the Government (even if the sector is an “automatic route”):

Direct Acquisition: Any acquisition of a stake in an Indian business by an affected investor, or

Indirect Acquisition: Any transaction that will result in the Affected Investor becoming a profitable owner of an Indian business.

In the past, it must be approved by the government for any transfer of existing foreign investment, which may result in the investor concerned acquiring ownership of an Indian company.

These revised rules will affect the acquisition of multiple restrictions by the affiliate investor who is part of India, even if the transaction does not result in the transfer of shares of the Indian business. For example, the investor concerned will require prior approval by the government for any acquisition outside of India, if that acquisition leads to a change in the beneficial ownership of the Indian business.

Uncertainty regarding investment limits

The revised rules contain completely vague language. The following are some of the key issues that need to be addressed by the government:

(i) Will the previous government approval be required to be obtained from all transactions that have resulted in any profitable ownership of an Indian business held by the affected investor (excessive definition)? 

(ii) In doing so, can the State utilize the affected boundaries in terms of value or quantity of beneficial ownership?

(iii) The status of investors from special administrative districts of Hong Kong and Macau is unclear, as these regions are part of the PRC. Given that Hong Kong is an important investor in India (and calculated differently by the Government in terms of investment figures), will investors from Hong Kong be considered as those organizations from the PRC?

The revised rules currently apply to additional investments made by affected investors who already have an interest in Indian companies. For example, a PRC business with a fully owned company in India will need to seek approval before the Government to make further investments in its fully owned company. It is not clear why such a permit needs to be given that the PRC business already owns all the shares of a company wholly owned by India.

In addition, the length of time to process approval applications from the investors involved is unclear. This could lead to significant uncertainty over indirect purchases and cross-border transactions with India where India is only one part of the larger transaction.

The government is expected to provide more clarity on the Revised Rules in the next few weeks. This is necessary to ensure that Indian businesses continue to be able to access foreign investment sources quickly, both to curb the recent economic downturn and long-term growth.

The COVID-19 crisis promotes global strengthening of the Foreign Investment Program

Foreign investment in India is governed by the Foreign Exchange Management Act, 1999 and the laws and regulations made under it from time to time (“FEMA”) include the Foreign Exchange Regulations (Non-Debt Instruments) of 2019 (as amended from time to time), issued under FEMA (“NDI rules”). Accordingly, all Indians (including Indian companies) whether they want to receive foreign investment or have a foreign investment are required to comply with these rules and regulations including entry procedures, sectoral limits, investment restrictions and pricing guidelines, as applicable.

The Indian government recently revised its foreign investment regime with the aim of curbing the takeover and acquisition of Indian companies due to the current COVID-19 epidemic. On April 17, 2020, the Department of Commerce, Indian Government released Press Note 3 (2020 Series) (PN 3/20) to amend the Existing Foreign Investment Policy (“FDI Policy”). The corresponding amendments made to the NDI Rules (“NDI Amendment Rules”) in terms of PN 3/20 came into effect from 22 April 2020.

Direct investment laws in India existed before the NDI Amendment Rules, as long as a person who is a citizen of Bangladesh or Pakistan or an organization incorporated in Bangladesh or Pakistan cannot invest in an Indian company without the approval of the Government of India. In addition, any citizen of Pakistan or a business incorporated in Pakistan is not permitted to invest in defence, space, atomic power and in sectors or activities restricted by foreign investment. NDI Amendment Rules read with PN 3/20 extend the scope of these summaries below:

1. A business entity of a country that shares a land border with India or a profitable Indian investment owner who resides or is a citizen of any such country, will invest in an Indian business with the prior approval of the Government of India.
2. In the case of a transfer of ownership of any existing or future business investment in India, directly or indirectly, resulting in beneficial ownership falling below the upper limit, such subsequent change to profit ownership will require prior approval by the Government of India.

As a result, investments from countries such as China, Nepal, Myanmar, Bhutan and Afghanistan, in addition to Bangladesh and Pakistan (countries that share the border with India), may also now be subject to the approval of the Indian Government. In addition, the use of the term ‘direct or indirect’ in PN 3/20 and the NDI Amendment Regulations also suggests that the acquisition of an overseas business by an investor from any of the above countries, which, upon termination, would result in indirect acquisition/conversion of shares that have resulted in the acquisition of interest on an Indian company, will be subject to amendments and such transaction will require prior approval by the Government of India.

Accordingly, there are a few important things to consider, regarding investment in India from any of the above-mentioned countries, going forward, which are as follows:

1. The amendments appear to include a follow-up investment by investors from these border countries to Indian companies in which they have already invested.
2. The amendments also appear to apply to any investment that does not lead to a change in the share of foreign shares from the relevant country bordering the Indian company or where such investments are exercised with the right/obligation of existing shares.
3. Any investment in India through a fund funded and/or managed by investors living in that country will require the prior approval of the Government of India. Investments in India from countries controlled or claimed to be owned by China such as Hong Kong may be included in these amendments.
4. Given that the terms “profitable owner” and “beneficial ownership” used in PN 3/20 and NDI Amendment Rules are not specified in FDI Policy (or applied to it) or in NDI rules, the meaning of these terms should be determined in accordance with other similar rules and Indian Companies Act, 2013.
5. The acquisition of a foreign business by an investor from China, which, upon completion, will result in an indirect acquisition/change in the allocation of shares that will result in the acquisition of an interest in the Indian company, which will also be included in these amendments. The use of the term ‘direct or indirect’ in PN 3/20 and the NDI Amendment Rules applies directly to this situation. Therefore, such indirect acquisitions will also be included within the amendments.
6. That the acquisition of shares by an investor from the aforementioned countries in a listed company with shares in an Indian company will be affected by these amendments. This will depend on the facts of each case. An investor (in that listed company) without special rights may not be considered to be in a position to hold the ownership of an Indian company by that listed company. In the event that the investor himself controls the listed company or if he owns certain exclusive rights to the listed company (for example, special severance rights or such voting rights that give the investor a viable Indian company), then the amendments will apply to his investor, regardless of shareholder listed externally.

Although there are seven countries sharing world borders with India, the rapid collapse of these amendments impacts Indian investment from China. It will also have to be seen if these changes are temporary until the situation of COVID-19 is resolved or they continue to control the foreign exchange reserves in India from these border countries for a long time.

In drafting these amendments, the Government of India may not have realized that it would impede the flow of foreign investment in India beyond its stated purpose, namely, the ability to curb the acquisition of Indian companies due to the current COVID-19 epidemic. However, if you have been given a large draft of the amendments and the opportunity for these issues to be brought to the attention of the Government of India in their opinion, it is prudent not to include any decision on what the Government of India thinks pending clarification. The fact that the amendments do not explicitly take into account the intent and the purpose also does not support a minor interpretation, the Government of India and banks authorizing Indian traders involved in the foreign exchange transactions in India will be actively interpreting the NDI Amendment Rules.

Conclusion

In the case of India which is an open, transparent and prosperous democracy, it is important that developed countries with the same mindset as the US and some members of the European Union (EU), provide for the Government to support efforts to close gaps within the domestic system while building a standard that allows free flow of investment to India. The country has high prospects for growth and potential and is needed to help reverse the declining global economy affected by the COVID-19 epidemic. Therefore, a strong and easily accessible FDI regime will also transform India into a new manufacturing capital and provide an alternative to the world-shaking chains in which it should be based.

References

• https://www.lexology.com/library/detail.aspx?g=88f6b143-68a9-400d-95e3-992c740d699c
• https://www.gibsondunn.com/new-foreign-investment-restrictions-imposed-by-india/
• https://www.nortonrosefulbright.com/en/knowledge/publications/24313880/india
• https://www.mondaq.com/india/inward-foreign-investment/972652/the-fdi-regime-in-india

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