Recent issues in FDI Policy

For example, in
Bharti Airtel, SingTel of Singapore owns a 31% stake, of which only 15.8% is
direct and the balance is through its investment in Bharti Telecom which owns
45% of Bharti Airtel. As per the new norms, only 15.8% would be treated as
SingTel’s foreign ownership in Bharti Airtel, since Bharti Telecom is a company
owned and controlled by Indians and hence, its entire investment in Bharti
Airtel is treated as a domestic investment.

2.2.4 If the
investing Indian company’s ownership and control is not directly/indirectly by a
Resident Indian Citizen, the entire investment by such company would be
considered as indirect foreign investment. For example, A Ltd. which is owned
and controlled by an NRI, has invested 40% in B Ltd. The indirect foreign
investment in B Ltd. is 40%.

An exception has
been provided for in the case of downstream investments in a wholly-owned
subsidiary of operating-cum-investing/investing companies. In such a case,
the indirect foreign investment will be limited to the foreign investment in the
operating-cum-investing/investing company. Thus, A Ltd., which is an
operating-cum-investing company has 74% FDI and if it sets up a 100% subsidiary,
B Ltd., then B Ltd., will be treated as having 74% indirect foreign investment.

The
above-mentioned methodology for computation of foreign investment does not apply
to sectors which are governed specifically by a separate statute, such as the
insurance sector. The methodology specified therein would continue.

2.2.5 The Press Note also treats foreign investment as including all FDI, FII investment (as on 31st March), FCCB, NRI/ ADR/GDR investment/Convertible Preference Shares/Convertible Debentures, etc.

2.2.6 In the case of all sectors which require FIPB approval, any shareholders’ agreement which has an effect on appointment of directors, veto rights, affirmative votes, etc., would have to be filed with the FIPB at the time of seeking approval. It will consider all such clauses and would decide whether the investor has ownership and control due to them.

2.2.7 Issues:

The recent Press Note has thrown  up several issues:

(a)    It is necessary to note that an Indian company must be both owned and controlled by Indian citizens. If either condition is violated, then its investment would be treated as indirect foreign investment.

(b)    For determining the foreign ownership of an Indian company it should have more than 50% foreign ownership. What happens in a situation where the Indian and the foreign partner have an equal (50 : 50) stake? In several Indian JVs, the foreign partner desires one golden share (over 50%) to enable consolidation with his foreign company. If such a JV makes a down-stream investment in any company, then the entire investment would now be treated as in-direct foreign investment.

(c)    For determining the foreign control, it only needs to be seen whether the foreign entity has power to appoint majority of directors. It does not address the other ways in which control can be exercised, e.g., veto rights, affirmative votes, shareholders’ agreement. In sectors where the FDI is subject to Government approval, the Indian company will need to disclose to the FIPB the details of inierse shareholder agreements which have an effect on the appointment of the Board of Directors, differential voting rights and such other matters. But a similar treatment has not been extended to the indirect foreign investment. A majority of the private equity deals have a host of special investor rights, but may not necessarily have a majority of the Board seats.

(d)    What would happen if an Indian investing company with 49% FDI and which is owned and controlled by Indian citizens, invests 26% in an NBFC which already has 51% FDI? Under the new norms, 26% investment would be treated as domestic investment and hence, the NBFC would not have to comply with the minimum capitalisation norms applicable to an NBFC which has more than 75% FDI.

(e)    What if the Indian investing company, which has 49% FDI and which is owned and controlled by Indian citizens, invests in a sector for which FDI is prohibited, e.g., lottery business? Sectors such as retail trading, real estate, information, defence, avaiation, etc., are expected to benefit from this Press Note. We may soon have a case where several foreign retail players may try to invest in multi-brand retailing via the indirect foreign ownership method. As per press reports, the RBI has objected to this Press Note.

(f)    FII investment has been treated as foreign investment. However, to consider the same, one has to ascertain the limits as on 31st March. If one looks at the FII activity after 31st March, 2008 there are only withdrawals. Hence, even though the current position is drastically different from what it was on 31st March, 2008, yet one is required to consider the FITinvestment level as on 31st March, 2008. This provision would create a lot of problems. Further, clubbing ADR/GDR holding with foreign shareholding is also a vexed issue. The voting on ADR/GDR is by the custodian of the shares. How the custodian would vote is generally not specified. There are a few cases where it is specified in the pro-spectus. But generally, it is left open. Interestingly, Cl. 40A of the Listing Agreement, while computing the public shareholding in a listed company, excludes shares which are held by custodians and against which depository receipts are issued overseas. The logic being that the custodian would vote in unison with the promoter. If that be the case under the Listing Agreement, then the stand taken by the FIPB is diagonally opposite, i.e., the custodian would vote in unison with the foreign receipt owners.

(g)    Special investor rights are the norm in the case of private equity deals and hence, if PE deals are to be done in sectors requiring FIPB approval, then the Shareholders’ Agreement would have to be filed with the FIPB. Thus, if any courier company (where FIPB approval is required) wants to get PE funding, it would also have to get the Shareholders’ Agreement approved by the FIPB. Thus, the regulator would now exercise quasi-judicial functions. This amendment is truly amazing.

3.    Transfer of Ownership & Control of Indian Companies from Resident Indian Citizens to Non-Resident Entities (Press Note 3 of 2009) :

3.1 The DIPP has issued new guidelines in respect of transfers of shares in all sectors where the FIPB approval is required or sectors which have caps of FDI. These include sectors, such as defence, air transport, ground handling, asset reconstruction, private sector banking, broadcasting, commodity exchanges, credit information companies, insurance, print media, telecom and satellites.

3.2 In all such sectors, Govemment/FIPB approval would be required in the following cases:
(a)    If an Indian  company  is being  established  with foreign investment  and is owned  or controlled by a non-resident entity,  or   

(b)    The ownership or control of an existing Indian company, owned or controlled directly or indirectly by resident Indian citizens, is being transferred to a non-resident entity as a consequence of transfer of shares to NREs through amalgamation, merger, acquisition, etc.

3.3 The guidelines  will not apply  to sectors where there are no foreign investment caps, i.e., 100% foreign investment is permitted under the automatic route.

3.4 Issues:

(a)    Press Note 4 of 2006 had earlier put all transfers of shares from residents to non-residents on the automatic route, including in financial services sectors, or cases where the Takeover Regulations were attracted. It is intriguing that after a period of 3 years, the Government has decided to take a step backwards and put transfers in certain sectors on the approval route. When on the one hand, the RBI is taking measures for liberalisation of the FEMA, the FIPB on the other hand has taken us back to the approval raj.

(b)    The FIPB’s approval  would  be required  even

in cases of Court-approved mergers, demergers, etc. This has increased the number of authorities whose permission would be required for a merger. Thus, if a listed company in the telecom field decides to merge with another listed company which has more than 50% foreign investment, then consider the number of approvals it would require – the High Court, BSE/NSE (under Cl. 24 of the Listing Agreement) and now the FIPB.

The FIPB’s approval would be required even for cases of acquisition of shares. This would even delay the process for takeover of listed companies. A takeover, in a sector requiring FIPB approval for FDI, which attracts the SEBI Takeover Regulations, requires the clearance of SEBI, prior approval of the RBI and now also the approval of FIPB. Thus, this step is going to increase the time it takes for corporate re-structuring.

4.    Downstream Investments in Indian Companies (Press Note 4 of 2009) :

4.1 The last of the Press Notes aimed at simplifying the Rules is Press Note 4. This deals with down-stream investments by Indian companies. Down-stream investment, which refers to indirect foreign investment by one Indian company in another, was hitherto governed by Press Note 9 of 1999. This dealt with any downstream investmentby aforeignowned Indian holding company. FDI in such cases required prior FIPB approval. Recently, FIPB had taken an interesting stance that downstream investment on an automatic route was permitted only for pure investment companies and not by operating-cum-investment companies, those which have their own operations in economic activities and desired to invest in another Indian company. FIPB’s view was that this tantamounted to a change in status from operating to operating-cum-investment company and hence, required prior FIPB approval. Several renowned corp orates such as JSW Energy Ltd., Aditya Birla Nuvo Ltd., etc. were pulled up for getting FDI and making downstream investments without FIPB approval. FIPB allowed restrospective clearance subject to compounding of penalties with the RBI under FEMA. In some cases, the foreign investment was as low as 1% and yet FIPB treated it as a violation of Press Note 9 of 1999. Thus, this was one area where there was a lot of ambiguity.

4.2 Operating Companies :

The new norms state that foreign investments in operating companies would fall under the automatic approval route wherein the investing companies would have to comply with the relevant sectoral conditions on entry route, conditionalities and caps with regard to the sectors in which such companies are operating.

4.3 Operating-cum-Investing    Companies:

Foreign Investments in operating-cum-investing companies would fall under the Automatic Route as explained above. Further, the Operating-cum-investing company which is making the downstream investment into the Indian Company would have to comply with the relevant sectoral caps and conditionalities which are applicable to the investee company. Thus, if Hindustan Unilever Ltd., which is a foreign-owned company, desires to invest in a retail trading company, then it would become an operating-cum-investment company and its downstream investment would need to comply with the conditions applicable to FDI in retail trading.

4.4 Investing  Companies :

Foreign investments in purely Investing Companies would require FIPB approval, regardless of the extent of foreign investment. Further, as and when such Investing Companies make downstream investments in Indian companies, they would have to comply with the relevant sectoral caps and conditionalities. However, such downstream investments cannot be made for the purposes of trading of the underlying securities. The FIPB approval would be required regardless of the amount of foreign investment in such an investing company.

4.5 Shell Company :

Foreign investments into companies which are currently neither carrying on any operations nor do have any investment activities, would require FIPB approval regardless of the extent of the foreign investment. Further if and when such shell companies commence any operating/investing activity, the relevant conditionalities as explained above would have to be complied with.

4.6 Additional Conditions :

In case of Operating-cum-Investing Companies and Investing Companies, certain additional conditions have to be complied with, such as giving an intimation to FIPB regarding the downstream investment within 30 days of such investment, compliance with the Pricing Guidelines as prescribed by SEBI, etc. Further, in order to make the downstream investment, the funds must be brought in from abroad only and not borrowed domestically.

5. Conclusion:

5.1 Although Government has a noble intention of simplifying the FDI policy, it may have unwittingly opened up a few more pandora’s boxes. It has plugged a few leaks by creating new leaks. The days to come are likely to throw up new issues in respect of these Press Notes and in some of the cases, the remedy may be more serious than the ailment. One hopes that the FIPB addresses these issues and comes out with a clearer and unambiguous policy. One is reminded of the US author, Kerry Thornley’s words:

“What we imagine as Order is merely the prevailing form of Chaos !”