FDI Policy Amendment to curb Acquisitions of Indian Companies due to COVID-19

On April 18, 2020, the Central Government amended the Consolidated FDI Policy 2017 (“FDI Policy”), with the stated view of curbing “opportunistic takeovers/acquisitions of Indian companies” due to COVID-19. Press Note 3 of 2020 (“PN 3”) issued by DPIIT amends paragraph 3.1.1 of the FDI Policy, to introduce the following two new restrictions (while leaving prior restrictions intact):

1. An entity  of 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, can invest only under the Government route. 

2.Govt approval would also be  required where subsequent changes  in  beneficial  ownership  (by  way  of  direct  or  indirect transfers) of any existing or future FDI would  result in such beneficial  ownership  falling  within  the  purview  of  the  first restriction.

The largest impact will be to investments from China, although this development will also impact investments from Pakistan, Bangladesh, Myanmar, Bhutan,  Afghanistan and Nepal.

The change called for prior approval of the government for FDI by any entity based in any country sharing a border with India, or if the beneficial interest lies with any such entity.

Prior to PN 3 of 2020, FDI from entities based out of Pakistan or Bangladesh were subject to government approval.

This new rule is expected to have a large impact on the fundraising  efforts  of  start-ups  and  other  companies,  in  a  time where sources of funding have already diminished.

What will be the situation of where there is already Chinese investment are in?

Companies that already have Chinese investors under their Companies will find follow-on  rounds  difficult  to  undertake  if  those  investors  do  not waive their rights to play pro-rata. This policy change will also impact exits for financial investors,  as  potential  transferees  may need  to  be  tested  for  compliance  with  the  beneficial  ownership, citizenship and location restrictions.  Similar  challenges may  be faced by holders of rights of pre-emption in Indian companies against other  shareholders.  The  exercise  of  such  rights,  and  the  effect  of  PN 3 on the same, are likely to either result in delays while approvals are sought, or disputes where the implications of PN 3 on existing rights of pre-emption or capitalisation will come into scrutiny.

Further, This  policy change may also  impact foreign entities, who have subsidiaries,  group companies  or investee companies  in India,  and who  are  seeking  to  raise  funds  in  their  own  offshore  jurisdictions, or whose shareholders are looking  to sell their  stakes, or who are looking to further capitalise their Indian interests.

One idea to the policy easing some compliances can be to give a sort of blanket approval. The FDI Policy may permit  companies  to  seek  approvals  once,  and  attempt  to  use  those approvals  for  additional  foreign  investment  up  to  a  cumulative amount  of  Rs.  50,000,000,000  (Fifty  Billion /Five Thousands Crore Rupees)  into  the  same entity  within an  approved  foreign  equity  percentage/or  into  a wholly owned subsidiary. This means that tranched investments may  not  require  separate  approvals  for  each  tranche,  subject  of course to the terms of such approvals. Companies undertaking or planning capital events based upon existing approvals may need to re-evaluate the same, as similar dispensations already available under  the  FDI  Policy  for  approvals  already  granted  may  need  to  be revisited in light of the revised policy.

Another important point to note is that the PN-3 notification uses,  but does  not  define,  the  terms  “beneficial  owner”  and  “beneficial ownership”.  These  terms  could  be potentially be interpreted by reference to similar  terms under either the Companies  Act, 2013, or the Reserve Bank of India’s  Master Direction - Know Your Customer  Directions,  2016.

However, given that these terms  are defined  very  differently  under  these  two  pieces  of  legislation,  it would be important to see if clarity emerges within the construct of exchange control laws. The use of the  terms “direct or indirect” will also  create a  degree  of  uncertainty as  to  how  to  determine  the ambit of  the  restrictions.  The  amendments  will  come  into  force  with  effect from  the  date  of  the  FEMA  notification  operationalising  this  policy change, so still needs clarity over the same.

Do it also covers Foreign Portfolio Investment (FPI)?

It appears that  portfolio investments by  FPIs are outside the  ambit of the proposed  changes.  There is some  concern  in some  quarters that PN 3 could also be read as applying to portfolio investments by FPIs,  although a plain reading would  not support this.  Portfolio investments by  FPIs are otherwise regulated  by  SEBI, and recent press  reports  suggest that SEBI  has  recently asked  custodians  for details of investments coming from or via China into Indian stock markets. Therefore, it is not unlikely that  SEBI might independently consider  similar  measures  as  well.  Any overly conservative readings or additional severe measures would have a meaningful impact on  Indian  stock markets, since  a number of  public market funds that invest into India are based out of Hong Kong.

Whether such  changes would result in claims  under the applicable bilateral investment treaties, would also need further evaluation