Social distancing the Dragon

The Department for Promotion of Industry & Internal Trade (DPIIT), Indian Ministry of Commerce and Industry has notified certain changes in foreign direct investment regulations vide Press Note No. 3 - 2020 Series (PN3 ) on April 17, 2020 for curbing opportunistic takeovers and/or acquisitions of Indian companies due to a raging emergency arising out of the COVID pandemic that has traumatized the world.

In view of the notification, (i) an entity of a country which shares land border with India; or (ii) an entity whose beneficial owner is situated in or is a citizen of any such country is mandated to obtain government approval for making an investment in India. PN3 further states any change in beneficial ownership resulting from a transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, will also require Government approval if the beneficial ownership is transferred to, (i) an entity of a country which shares land border with India; or (ii) an entity whose beneficial owner is situated in, or is a citizen of any such country.

Pursuant to the 22nd April 2020 notification under FEMA, PN3 has attained the status of a Law. The countries which share land borders with India are China, Bangladesh, Pakistan, Bhutan, Nepal, Myanmar, and Afghanistan. It is no secret that PN3 has cast its soft shadow on China more than others sharing the borders with India.

Rightly, PN3 has evoked unprecedented debate among the investing community ever since it was notified not so much for what it said, but what remained unsaid. PN3 has been badgered of being an enigma that’s riddle wrapped. It’s a different matter, if the cryptic nature of the PN3 arose from circumstances beyond the realms of ordinary commerce but catered to a pressing need of national interest. While its trite to mention that, national interest is far beyond fiscal mathematics, as citizens we have a duty to be aligned with it until business is as usual.

Be that as it may, global economy cannot afford to build walls in the twentieth century. The interdependency of nations today is far more intense than what it used to be. Consequently, there is a huge responsibility for all stake holders to work towards quickly diffusing the bottleneck by bridging the gap between national interest, economic security and needs of commerce. At the fountain head of many concerns regarding PN3, the lack of any direction as to its applicability in terms of thresholds has been the focal point of contention.

The PN3's stoic silence on the meaning of beneficial ownership that would trigger the approval process has caused a lot of anxiety. Cautiously, experts have even opined that pre-approval might be obligatory even where the beneficial ownership is de-minimis. While one could speculate that might not be intent of PN3, in times we are faced with, such intention cannot be ruled out. It’s no accident, that PN3 has been notified as is under FEMA with no amendments establishing clearly a point of harmony between the two institutions to lay bare the unequivocal regulatory intent.

The fact that, PN3 makes no distinction between minority investment and control transactions, the egalitarian issues that arise for targeting FDI only, lack of clarity on inter se affiliate transfers, treatment of warrant holders, rights of put and call option holders, confusion on preferential issue of capital, rights issue, bonus issue, status of a Chinese fund manager managing a non-Chinese pool of capital are few among many inaudible areas of PN3 that has been the epicenter of the ongoing debate. Also, doubts have been raised on whether investments from Hong Kong and Taiwan will be treated as investments from China and therefore subject to the requirements set out in PN3. The concerns of the investing community are well understood, and the air must be cleared soon.

Business compulsions aside, it’s also imperative not to consider PN3 as a press note simpliciter. Beneath the unspoken candor of PN3 lies hidden prolific foreign policy, national interest, economic security and an unwavering message of sovereignty. While earlier press notes have been harbingers of either some new initiatives or clarifications, PN3 contains an emergency regulation of national interest and containment. Citizens must be sensitive and understand that PN3 has a national interest mandate and not just notional. This is relevant considering Chinas expansionist and imperialistic imperatives. Frivolous as it might sound, the fact that the Chinese central banks recently forayed to acquire stakes in Indian companies at diluted values and the news that Industrial and Commercial Bank of China and China Investment Corporation are reportedly exploring investment opportunities in the Indian financial services sector are indications of bounty hunting to be watched in times of crises we are faced with.

At the same time, India is not some inconsequential territory on the globe. It can protect its sovereignty and integrity. Nations anyways have the unequivocal right of nationalization as the ultimate weapon to protect its economic interests. On the positive side, PN3 is not a blanket ban, but supervisory in nature to exercise diligence on opportunistic take overs during the pandemic. Obviously, PN3 could have been more audible and could have been specifically crafted to prevent takeovers and change of control rather being ambivalent about it. Circumstances are such, a timely legislation was probably the need over a perfectly speaking legislation. The law makers know it better.

Considering a 360-degree view of matters, it’s fair to state that PN3 is not an isolated and a hurried regulatory initiative by just the Indian regulators. As such, India need not play shy to put in place its own safeguards when nations have initiated such steps. Governments across the globe have taken steps to halt the designs of bounty hunters feasting on the spoils of the COVID pandemic.

The EU for example has issued guidelines to member states to strenuously enforce foreign investment screening mechanisms. Germany has adopted restrictive regulations against non-EU investors. It has also changed its scope of review from actual risk to public security to probable impairment tightening its inbound investment laws. Australia has adopted foreign investment laws to protect national interests. All Foreign investments are subject to Foreign Acquisition & takeover Act 1935. Approval requirement has been extended regardless value of investment, or nature of foreign investor involved. Statutory time frame for investment approvals have been extended from 30 days to 6 months. France has for instance enhanced information and filing requirements. French government has made it clear that, if need arises it would nationalize companies of strategic importance. Both United Kingdom and Switzerland have stated that they would adopt ad hoc foreign investment screening and filing rules if such need arises.

In the US, the Committee on Foreign Investments in the United States, (CFIUS) remain focused on national security. In addition, the recently enacted Risk Review and Modernization Act of 2018 has continued to move forward with implementing its increased jurisdiction under the foreign investment. In Italy, foreign investment regulations have been tightened and intends to grant the prime minister expanded veto powers to screen foreign investments. Italy for instance is contemplating to declare all companies listed on Milan stock exchange as strategic to control unwarranted takeovers. Spain has pursuant to a royal decree recently introduced a requirement for ex-ante authorization for Non-EU investors to acquire 10 percent or more of, or acquire management rights in or control of, Spanish companies engaged in sensitive sectors. Overall, international focus seems to avoid take overs of companies. That could be a good benchmark for us to follow here to.

Capital is scarce and there is no denying the fact that any fetters on inbound will do no good to the global economy that is already wilting. Clean and smart global capital must seamlessly flow like blood in the vein to keep the economy healthy. Automatic route is a key pillar of ease of doing business in India. If PN3 is just a social distancing, the Investing community hopes that PN3 in its current form is also momentary, subject to national interests and economic security. After all, occasional minor differences among India and China notwithstanding, China and India have a history of prolonged business partnership that has been significant. China has invested over and above 6.2 Billion USD in the last five years, has a total exposure of around 26 Billion USD and has seeded as many as 18 out of the 30 Indian Unicorns.

Until the government makes its final assessment of the situation, the industry will welcome some interim announcements on

(i) creating mechanism for fast track approvals in a time-bound manner

(ii) create a mechanism to clarify queries to avoid speculative interpretation of PN3

(iii) prescribe thresholds that trigger PN3 and (iv) make PN3 applicable to take over of control of strategic assets.

Nations cannot get nostalgic about cold war and crave for its return in whatever form that could cause irreparable damage to the fragile economy.

The author is P M Devaiah, Vice Chairman & Group General Counsel, Everstone Capital.

Views expressed are personal.