India, one of the world’s largest economies, remains an attractive market for foreign direct investment (FDI). Since 1991, the Indian FDI legal and regulatory framework has seen continuous reforms. Foreign investors can invest in most sectors of the Indian economy without the Government of India’s (GOI) prior approval. The two channels are commonly referred to as the “automatic route” and the “approval route.” However it is important to note that certain sectors are entirely prohibited from accepting FDI, and certain sectors under the approval and the automatic routes are subject to FDI caps.
Press Note 3: Restricted Countries / Restricted Persons
On April 18, 2020, India amended its FDI policy through a new “press note” (Press Note 3) which announced the requirement of the GOI’s prior approval (i.e., the approval route) for any FDI inbound from countries that share a land border with India, irrespective of the sector. This has implications for Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal, and Pakistan (all bordering India, viz, the Restricted Countries).
The official remit of Press Note 3 is to curb “opportunistic takeovers/acquisitions” of Indian companies in the wake of COVID-19. However, the practical effect of Press Note 3 is much broader. Essentially, prior GOI approval for FDI into India is required if:
- the investor entity is from a Restricted Country, or the beneficial owner of the investor entity is based in, or is a citizen of, a Restricted Country;
- any direct or indirect changes in the beneficial ownership of any existing or future FDI would result in such beneficial ownership falling into the hands of persons referred to in (i) above. (for convenience, persons referred to in (i) and (ii) are being referred to as Restricted Persons).
Implications for FDI into India
Press Note 3 targets new or follow-on FDI, or changes to the existing FDI involving China, a circumstance of particular note as China has become one of the largest FDI providers in India.
Press Note 3 also covers those foreign investors whose beneficial owners are Restricted Persons or where interest in any Indian entity is directly or indirectly transferred to a Restricted Person.
The GOI is yet to provide guidance as to how (i) it will evaluate and approve the FDI proposals (ii) it will define and calculate the beneficial ownership under Press Note 3.
A key issue is that there is no de minimis/materiality threshold for the beneficial ownership or clarity of the meaning of the term “beneficial ownership.” As Chinese investors have invested in several international entities, including PE and VC funds, technically FDI into India from such international entities (including any minority stake) is also covered by Press Note 3 requiring prior GOI approval under the approval route.
Some banks processing FDI into India (referred to as “Authorised Dealers”) are taking different views on the de minimis / materiality threshold (ranging from 10% to 25%) for the beneficial ownership if the FDI into India is from international entities, i.e., Authorised Dealers applying Press Note 3 and requiring prior GOI approval if the Restricted Persons own more 10% / 25% in the international entity.
Press Note 3 is expected to have an adverse effect on new or follow-on FDI from China. It is important to note that Press Note 3 does not affect existing investments from China. However, Press Note 3 applies if any changes are made to existing Chinese FDI after April 18, 2020, i.e., the date of Press Note 3. Press Note 3 will also affect investors from non-Restricted Countries if such investors have direct or indirect beneficial owners situated in, or are citizens of, Restricted Countries.
While the recent steps taken by the GOI to welcome and increase FDI into India has increased investor confidence, Press Note 3 has unfortunately raised unintended issues given that casting this “wide net” results in “indirect beneficial owners” being caught as well. Further clarity from the GOI is expected in relation to the application and interpretation of Press Note 3, which will help clarify the position on FDI for market participants.