The Great Wall of “FDI”

[By Unnati Sinha]

The author is a student at the Narsee Monjee Institute of Management Studies (NMIMS).


The Consolidated Foreign Direct Investment Policy (Hereinafter as “FDI Policy”) underwent a significant revision as of April 18, 2020, according to Press Note 3 of 2020 (Hereinafter as “PN 3”) published by the Department for Promotion of Industry and Internal Trade (Hereinafter as “DPIIT”). In the past year, there has been a lot of investor interest in the controversial topic of the release of Press Note 3 of 2020. In light of the recent outbreak of the Covid-19 and escalating geopolitical tensions with China, the Indian government has announced that any investment or purchase by a company headquartered in a nation that shares a land border with India, or if the “beneficial owner” of the investment is located in a country that shares a land border with India, would require prior clearance. Even though the wording used was generic in nature and did not specifically mention any particular jurisdiction, the Press Note’s purpose and “target” seemed to be obvious. It was believed to be in response to the People’s Bank of China gradually increasing its stake in HDFC, India’s biggest non-banking mortgage provider, to over 1% via on-market acquisitions. The Press Note also served as the first in a line of actions taken against Chinese investments and investors, which was followed by the banning of several Chinese apps because they were involved in activities “prejudicial to the sovereignty and integrity of India, defence of India, security of the state and public order.”

The publication of the Press Note has immense impact on blocking Chinese investment, its primary goal.Some of the most important investments, in addition to Chinese investors, include investors from Hong Kong and Taiwan, who also seemed to get trapped. It was also unclear how the phrase “beneficial owner” should be construed, which further causes more ambiguities. Consequently, authorized dealer banks in India—who serve as the custodians for foreign investment inflows and outflows—adopted their own viewpoints or variations of present rules, which were not ideal for their needs.

In the light of the changes in the FDI policy and Press Note 3, the article discusses how India has created a barrier for Chinese investments in India.

The “Beneficial Owner” controversy

The current uncertainty over the definition of “beneficial ownership” under PN 3 has sparked discussion on the requirements for determining a beneficial owner. Regarding the threshold amounts of investment needed to determine whether an application for FDI needs government approval, multiple opinions seem to prevail at the moment. According to the first viewpoint, a beneficial owner is individual or any entity that owns at least 10% of a company’s stock. This opinion is based on the requirements of the Companies (Significant Beneficial Owners) Rules 2018 when combined with the Companies Act of 2013. The concept of “significant beneficial owner” has been adopted from those provisions.

The requirements included in India’s anti-money laundering framework serve as the foundation for the opposing perspective on beneficial ownership. This opinion is based on a provision in the Prevention of Money Laundering (Maintenance of Records) Rules 2005, which defines a “beneficial owner” as a person with either a controlling ownership interest—more than 25% ownership of the entity—or the ability to exercise control over the entity’s management or policy decisions.

It may be contended that because Foreign Exchange Management (Hereinafter as “FEM”) rules do not specify a threshold for defining beneficial ownership, a nominal or minor beneficial ownership held by an individual who resides in or is a citizen of a country that borders India could possibly lead to the entire body of funds being prohibited from investment in India under the automatic route. While the government has made it clear that in the realm of public procurement, beneficial ownership is to be understood in accordance with the Prevention of Money Laundering Act, 2002 (Hereinafter as “PMLA”), clarification regarding Press Note 3 is still expected.

It is expected that the majority of the pooled investment vehicles have stakeholders, such as limited partners, managers, or donors located in China, notably in Hong Kong, given the commercial prominence of China in general and of locations like Hong Kong in particular. China has recently played a significant role in India’s private equity industry by supporting a number of famous businesses and unicorns.

The China ingredient

Evidently, the goal of the policy is to avoid a bigger Chinese presence in important Indian industries. There has been at least 26 billion dollars’ worth of Chinese investment in India.

When HDFC notified stock markets that the People’s Bank of China had grown its investment in HDFC from 0.8% to 1.01% in mid-April, the warning bells went off in India. As it aggressively sought information on foreign portfolio investments from Asian nations, the Securities and Exchange Board of India (Hereinafter as “SEBI”) subsequently shifted its attention to the quantity of Chinese investments in Indian enterprises. These specifics involve whether Chinese investors control the funds and if investors from these nations have any kind of controlling stake.

Chinese state-owned enterprises have large reserves and deep coffers, which raise fears that they may purchase crucial companies whose values have degraded in their own countries. The COVID-19 pandemic has paralyzed the economies of most of the countries, yet the Chinese economy has demonstrated resiliency. Even before the crisis, governments were becoming concerned about global supply networks’ over-reliance on China. The COVID-19 pandemic has raised concerns about the over-reliance on China for global supply networks, including India’s. India and some other nations bought Chinese rapid test kits due to a shortage. However, these kits proved to be unstable. India reportedly canceled the purchase of these kits.

A prospective Indian-CFIUS?

National security issues are now more prevalent than ever, affecting practically every aspect of life. For any foreign investment, some jurisdictions have a particular screening mechanism that examines the transaction from the perspective of national security. One such interagency organization that examines foreign investments in the US to see if they pose a danger to US national security is the Committee on Foreign Investments in the United States (Hereinafter as “CFIUS”). Along with the Attorney General, it is made up of representatives from the Departments of Homeland Security, Defense, Energy, Commerce, Labor, National Intelligence Trade, and Science & Technology. The evaluation encompasses “any merger, acquisition, or takeover which might lead to foreign control of any person participating in interstate commerce in the United States” to determine the deal’s impact on national security. If it does, the President may stop, ban, or allow the transaction under specified conditions. The lengthy CFIUS review process might be automatically extended. CFIUS is highly secretive. The decisions are not public, so companies have little space to defend or oppose them.

The CFIUS’s notable actions involve requiring Beijing Kunlun Tech to divest its stake in Grindr and reviewing ByteDance Technology’s $1 billion purchase of, a popular US social media app. Even in the US, concerns have been expressed concerning TikTok’s acquisition of user data and Chinese censorship of information pertaining to Tiananmen Square or Tibet (among other topics). According to reports, the CFIUS and TikTok are discussing possible steps to try to allay these worries. Similar to this, Kunlun’s Grindr transaction was rejected because to worries about the personal information, especially user geolocation data, contained on the app.

A regulation for a framework to screen foreign investments on the basis of security or public order was adopted by the European Union in March 2019. This regulation states that such investments include “investments related to critical infrastructure, critical technologies, or critical inputs which are essential for security or public order.

Perhaps it is opportune for India to consider similar systems as well. Currently, each Ministry examines and authorizes foreign investments in its own area. India would find it advantageous to explore creating an inter-ministerial committee to evaluate investments in the context of national security. Likewise, obtaining clearances is time consuming. The formation of such a committee will strengthen and allow for a unified, comprehensive approach to national security. Such a method could be required sooner rather than later, given the rush of investment in India’s booming IT industry.

Concluding Remarks

Previously, the government singled out Hong Kong and Macau (distinct from China) when it banned Chinese investors from buying property in India without RBI approval for similar constraints since they are Special Administrative Regions (Hereinafter “SARs”). However, the Press Note of April 17 only applied these limitations to China, meaning that all Chinese SARs would have to be viewed equally.

The Press Note and the Foreign Exchange Management Act (Hereinafter “FEMA”) letter are inherently speculative. Thus, Chinese investments (like those by Alibaba and Tencent in e-commerce firms) would not need post-facto official permission. Given that most Indian companies require capital, the government would need to clarify if a rights issue in which Chinese investors acquire pro rata shares without increasing their ownership would also need prior approval. Since government approval might take months, even legitimate fund-raising by Indian enterprises could be harmed by such demands.

Despite the government’s attempts to present it as self-defense, in line with global trends, the move amounts to a deliberate economic attack on India’s foreign investment inflows. It also risks Chinese reprisal against Indian companies with holdings there. In a pandemic period, it’s hard to question the government’s motives or aims. Since China’s central bank only boosted its participation in HDFC Ltd. from 0.8% to 1.01%, we feel the government’s decision is based on facts rather than trepidations. As the country prepares for the consequences of this bold action, a thorough FEMA statement and SEBI explanation must follow the decision.

China has invested $4 billion in Indian startups since 2014. Chinese companies invest substantially in renewable energy, automotive, real estate, electronics, textiles, e-commerce, and start-ups. They also have government contracts for telecom equipment, electric automobiles, power equipment, infrastructure, construction materials, etc. Thus, PN 3 of 2020 is expected to have major consequences.

Evidently, with PN 3 of 2020, the government has implemented a one-size-fits-all strategy under which all upcoming Chinese investments will henceforth be assessed on a case-by-case basis. It is anticipated that the government would provide the following explanations and relaxations since the fund-raising efforts now being made by numerous Indian enterprises may also be negatively affected, a) exclusion of non-sensitive industries and industries with the ability to create jobs from the scope of PN 3 of 2020. b) Preclusion of businesses that are already 100% owned subsidiaries of Chinese enterprises or otherwise controlled by them. There is no mention of a “predatory” takeover. c) Because a hostile acquisition of private corporations is impossible, companies that have already completed their transactions are excluded. d) The exclusion of investments made by entities with pooled interests in which Chinese companies do not have a dominant interest. e) For funds managed by licensed third-party fund managers that are not headquartered in China, there may be room for flexibility (even if they have certain Chinese beneficiaries).


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