Recent amendments to FDI policy – a boon or a bane

Source: By Vivek K Chandy: Mint

Much has been reported about press note 3 of 2020 issued by the Department for Promotion of Industry and Internal Trade on April 17, over the last couple of days.

Pursuant to the press note, an entity situated in a country which shares land border with India, or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, is inter alia permitted to invest in Indian entities only under the government approval route. Further, any transfer of ownership of any existing or future foreign direct investment (FDI) in an entity in India (indirectly or indirectly) resulting in the beneficial ownership falling within the purview of the above restrictions, would require the government’s approval. The above restrictions came into effect from April 22 (i.e. the date of notification of the amendments to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“Rules")).

The press note appears to have been issued in the wake of the covid-19 pandemic and the effect it has had on entities operating in various sectors, making them relatively tempting targets for acquisition. The restrictions contemplated would cut across all sectors and would be applicable to entities operating in sectors which are otherwise permitted to receive FDI under the automatic route (such as attractive sectors like e-commerce, services and logistics).

While the intention of the government seems to be clear from the language in the press note and the timing of its issuance, there appears to be certain ambiguities arising from the press note and the amendments to the Rules. The usage of the term “FDI" in the press Note and the relevant amendments to Rule 6(a) of the Rules, seem to suggest that the restrictions are on investments that are structured as FDI (defined under the Rules to mean investment through equity instruments by a person resident outside India in an unlisted Indian company; or in 10% or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company) and not investments by an FPI registered with SEBI (which is permitted to invest in listed or to be listed Indian companies’ securities, in the manner set out in Schedule II of the Rules) or investments under the FVCI route (which is an investment in the securities of Indian companies operating in certain specific sectors, in the manner set out in Schedule VII of the Rules).

It is also unclear if “foreign investments" (defined under the Rules to mean any investment made by a person resident outside India on a repatriable basis in equity instruments of an Indian company or to the capital of a LLP) in LLPs, not being FDI, would also be subject to these restrictions. This ambiguity is further amplified by the subject line of the press note, which reads “curbing opportunistic takeovers/acquisitions of Indian companies", without making any reference to LLPs, and the amendments to Rule 6(a) of the Rules, which only pertain to investments in equity instruments of an Indian company under Schedule I of the Rules.

Further, the requirement of seeking government approval may also pose operational difficulties for many entities. For instance, the approval requirement seems to be applicable in all cases of further investments irrespective of the threshold, whether or not such investments are in the form of rights issue (where all or almost all existing shareholders also participate) or preferential allotments, causing some amount of hardship for entities to raise further capital, especially where entities already have existing investments from investors situated in countries like China.

The amendments to the Rules also do not attempt to clarify the applicability of the approval requirements where there is no change in the shareholding percentage of the investor pursuant to a follow-on investment. Another aspect which is important, is the usage of the terms “directly or indirectly" in the context of transfer/ divestment of beneficial ownership of existing FDI, to entities in/ citizens of a country which shares land border with India. This may require global acquisitions of entities in other jurisdictions which have subsidiaries/ investee companies in India, by a person in one of India’s neighbouring countries, to be subject to the approval requirements, thereby impacting timelines for closing.

It may be apposite to note that there are presently no such commensurate restrictions under the ECB regulations, and therefore, an eligible borrower could avail ECB from a recognised lender (including a foreign equity holder in one of India’s neighbouring countries which are FATF compliant) for any immediate funding requirements subject to the all-in cost ceiling, limits of ECB, etc. Having said this, it should be borne in mind that any conversion of the ECB or any part thereof, into shares of the Indian company, would be subject to the restrictions and approval requirements under the FDI policy and the Rules.

The government/RBI should provide necessary clarifications on these issues and ambiguities at the earliest. With there being no sunset clause presently contemplated on the applicability of these restrictions, only time will tell if the amendments to the Rules, are a boon to the economy and a step in the right direction, or otherwise.