Covid-19 and FDI screening mechanisms in India

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Rabindra Jhunjhunwala
Khaitan & Co, Mumbai
rabindra.jhunjhunwala@khaitanco.com                   

Varun Narayan
Khaitan & Co, Mumbai
varun.narayan@khaitanco.com            

On 17 April 2020, the Indian Government announced a significant change to its foreign direct investment (FDI) policy pursuant to Press Note No 3 (2020 Series). According to the Press Note, all investments by entities incorporated in a ‘country which shares [a] 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’ will now require prior approval of the Indian government. The countries which share a land border with India are Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal and Pakistan. Prior to the introduction of the Press Note, only FDI from entities based out of Pakistan or Bangladesh required prior government approval.

While the intention of the Indian government behind the introduction of the Press Note was to ‘curb the opportunistic takeovers/acquisitions of Indian companies due to the current pandemic’, the primary trigger seems to have been the rising geopolitical tensions between India and China at the Indo-China border. The introduction of the Press Note appears to be more of a retaliatory measure to put economic pressure on China to resolve the issues at the Indo-China border. In addition to the Press Note, the Indian Government has also banned the use and download of over 200 Chinese mobile applications^[1] and restricted Chinese involvement in public procurement, citing national security concerns.

More recently, on 16 December 2020, the Cabinet Committee on Security approved the National Security Directive on Telecommunications Sector (NSD), which mandates all telecom service providers (TSPs) to purchase telecom equipment only from ‘trusted sources’ in a move to create a secured national network. The government is expected to release a list of sources from whom procurement cannot be carried out, and many believe that the government will place restrictions on the use of Chinese telecom gear/equipment by private sectors TSPs.

Implications of the Press Note

According to the Press Note, the prior approval of the government will be required if there is any direct/indirect investment from entities situated in China or the other border nations. The Press Note, interestingly, does not provide any clarity on what is meant by ‘beneficial ownership’ and the method for computation of the same. It is noteworthy that other Indian legislation, such as the Companies Act 2013 and anti-money laundering laws, prescribe minimum thresholds (10 per cent/25 per cent) for computation of ‘beneficial ownership’. The lack of clarity on de-minimis thresholds in the Press Note has led to a draconian situation where minority/non-controlling stake purchases, and even Indian legs of global deals (involving minimal Chinese stakes), may potentially require prior approval from the government. It is very interesting to note that the press release restricting public procurement from China provides clarity on what constitutes beneficial ownership.^[2]

Since the introduction of the Press Note, more than 150 applications^[3] involving investments from Chinese entities have been pending for approval with the government and no approvals or clarifications have been issued. The Press Note has dealt a major blow to startups by depriving them of funds from cash-rich Chinese/Hong Kong-based investors.

As it stands currently, all investments (whether direct or indirect) from entities which have Chinese/Taiwanese/Hong Kong/Macau (or other border nation) beneficial ownership, irrespective of the percentage or quantum of investment, will require prior government approval. Further, all applications filed pursuant to the Press Notes are required to undergo a mandatory (and stringent) security clearance by the Ministry of Home Affairs.

Conclusion

The FDI screening mechanisms implemented, or proposed to be implemented, in other parts of the world like Australia, Canada, the European Union, Japan and the United Kingdom are envisaged to be used only for screening foreign investments in certain specified sensitive or critical sectors on grounds of national security. Such investments (in certain circumstances) are also required to meet certain additional objective thresholds. The US has been screening FDI in sectors such as biotechnology and critical technologies on grounds of national security for some time through the Committee on Foreign Investment in the United States (CFIUS) mechanism. The screening mechanisms implemented in the EU, Japan, the UK and so on were brought in to curb opportunistic takeovers of companies operating in critical sectors which were left vulnerable as a result of the Covid-19 pandemic.

In contrast, the Indian Government has gone a step further by imposing a blanket restriction on investments from Chinese entities (and other border nations) across all sectors, not just those historically deemed ‘sensitive’ in India (eg, telecoms, banking, insurance and pharmaceuticals). However, the Press Note is more nationalist in nature rather than a CFIUS-equivalent protectionist regime.

In our view, the Press Note is a retaliatory measure to put economic pressure on China and is likely to fall away or be withdrawn as soon as the border tensions between India and China are resolved. If recent news reports are to be believed,^[4] the Indian Government is apparently proposing to set up an inter-ministerial panel to consider and expedite approvals in cases where acquirers have minor investments from entities situated in China, Hong Kong and entities from other border countries.

Further, on 8 December 2020, the central government notified changes to the foreign investment rules clarifying that a multilateral bank (eg. the Asian Development Bank) or fund (eg. the IMF) of which India is a member will not be treated as an entity of any particular country, nor will any country be treated as the beneficial owner of the investments of such bank or fund in India.

It is interesting to note that the relaxation comes off the back of the Asian Development Bank (of which China is a member) recently sanctioning loans totalling over $1.3bn^[5] to India for undertaking certain critical infrastructure projects. While the relaxation will only benefit a limited set of investments, this is a positive development which seems to indicate a thawing in the government’s rigid stance vis-à-vis Chinese investments.

If news reports are to be believed, the central government has now created an inter-ministerial committee to consider all applications from neighbouring countries which have been filed for approval after implementation of the Press Note. The central government has already cleared investment proposals from two Japanese companies – Citizen Watches and Nippon Paint Holdings, and a third by Hong Kong based non-resident Indians in Netplay Sports Private Limited. However, the central government is yet to clear or approve any investment proposal from Chinese entities.