[By Lavanya Chetwani & Shriyansh Singhal]
The authors are students of National Law University Odisha.
Introduction
The Ministry of Finance through its Department of Economic Affairs has introduced the Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024 (‘Amended Rules’), which signifies a major shift in the regulatory framework in India. The amendments have been issued to somewhat modify the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (‘Existing Rules’). The announcement in the Union Budget 2024-2025 has led to the introduction of these amended rules.
These changes will enhance India’s legal and regulatory landscape by bringing Indian regulations to align with international standards. A new provision on equity swaps, improved investment regulations, and alterations to some significant definitions are just a few of the important changes made to the rules.
This article examines how the new amendments enable an Indian company to issue or transfer its shares in return for shares from a foreign corporation, facilitating cross-border share exchanges. Altogether, these changes are expected to improve the flow of cross-border M&A deals, help in attracting foreign investments, and allow Indian companies to increase their global footprint effectively.
Interpreting the Amendments
(i) Revised Definitions
The amended rules added a new clause, Rule 2(da), which defines ‘control’. According to this provision, the meaning of control is the same as defined in the Companies Act 2013. Section 2(27) defines control as having the power to appoint the majority of directors and exercise control or influence the policy decisions of the company, either directly or indirectly, through shareholding, management rights, voting agreements, or any other means.
Rule 2(da) when applicable to an LLP, defines control as the ability to appoint most of the directors who have the final say in the company’s decisions.
Rule 2(an) of the amended rules has also defined ‘startup company’ as a private company incorporated under the Companies Act 2013 and is identified as a ‘startup’ to make it parallel with the definition given by the Ministry of Commerce and Industry and the Department for Promotion of Industry and Internal Trade.
The objective of bringing the changes is to make the definitions in line with other laws like the Companies Act 2013 and other rules and regulations which several statutory bodies & ministries release from time to time. This ensures consistency in legal frameworks and helps in streamlining regulatory compliance for easier interpretation.
(ii)Refined Rules for improved clarity
The amendments have also brought some clarity over the treatment of downstream investments. The earlier guidelines provided for sectoral caps, prior government approvals and reporting requirements. According to the amended Rule 23(7)(i) explanation, an investment made by an Indian entity that is owned or controlled by non-resident Indians (NRIs), on a non-repatriation basis, would not be taken into account when determining indirect foreign investment (‘IFI’).
Pursuant to this amendment, the investments by entities owned and controlled by OCI(s) will now be treated at par with entities controlled by NRI(s) and will not be considered for the calculation of IFI. It is expected to encourage more OCIs to invest in India through entities owned and controlled by them.
Further, Rule 9(1) Proviso (i) has been amended and it states that for transfer of equity instruments, prior government approval is necessary in all cases where such approval is applicable. Prior to this amendment, approval was necessary if the target company was engaged in a sector that required government approval. Additionally, the amendments have lifted the 49% cap on aggregate foreign portfolio investments, now allowing investments up to the sectoral or statutory cap without needing government approval, provided that such investments do not result in a change of ownership or control of the entity.
A change in the principal rules in Schedule I now permits an Indian company to offer equity instruments to a person residing outside of India in place of a swap of equity capital of a foreign company in compliance to the rules stipulated under the Foreign Exchange Management (Overseas Investment) Rules, 2022 and RBI regulations. These amendments aim to facilitate easier transfer or swap of equity instruments between entities. All these amendments are directed towards making cross-border swaps easier, expecting that this will lead to more foreign investment in India and will make Indian practices more in line with international practices.
(iii) Addition of rules in relation to equity instruments and equity capital
The introduction of Rule 9A allows the transfer of equity instruments between an Indian resident and a foreign resident through a swap of equity instruments or equity capital. Complying with the rules set by the Central Government and the Reserve Bank of India (‘RBI’) regulations is sine qua non. Strict adherence to the Overseas Investment Rules is required for the swap of equity capital of a foreign company, and Government approval is required in all cases where it is applicable.
Earlier the act did not provide for authorizing swap of equity instruments of an Indian entity with that of a foreign entity. Therefore, by allowing this, the rule encourages more dynamic and flexible investment strategies.
Additions have also been made to Schedule I, where White Label ATM Operations (‘WLAO’) is added to the table of permitted sectors for Foreign Investments. WLA is a term used for ATMs operated by Non-Banking Finance Companies (‘NBFCs’), allowing customers from multiple banks to make various transactions. The cap for foreign investment in this sector is put at 100% and the entry route is Automatic, meaning no government pre-approval is required.
Investors in this sector must meet several requirements. They must have a minimum net worth of hundred crore rupees and comply with minimum capitalization norms if they are involved in other financial services. Additionally, any foreign direct investment in WLAO must adhere to specific criteria and guidelines established by the RBI under the Payment and Settlement Systems Act of 2007.
Decoding the amendments: benefits and drawbacks
The amendments will result in the expansion of Indian companies at the global level through mergers, acquisitions, and other strategic initiatives. The new definition of ‘control’ aims to standardize it and align it with other laws. However, because of its broad scope, it might also lead to complexity and potential legal disputes, especially in entities with layered ownership. The clarity over downstream investments aligns the treatment made by NRIs at par with domestic treatment. The requirement for government approval in certain cases adds a layer of oversight, likely aimed at protecting national interests and ensuring that sensitive sectors or strategic assets are not transferred without proper scrutiny. However, it is anticipated that this change of requirement of government approval might not have much impact because according to Rule 6 of the Non-Debt Instrument (‘NDI’) Rules and Para 3..1.1 of Press Note 3 of 2020, any transfer of equity instruments of an Indian company to an entity or individual from a country sharing a land border with India, or where the beneficial owner is from such a country, requires prior government approval. Thus, even after the aforementioned amendment, the requirement of government approval still exists.
Exploring potential implications and outcomes
The amended rules will have multiple effects on the M&A regime in India by bringing many alternatives for cross-border M&A deals. This will enable the parties to better structure the sale, particularly in earn-out agreements where the acquirer is varying the consideration based on the company’s performance or the state of the market. This move by the government will lead to increased foreign investments in Indian companies as they can now engage in mergers and acquisitions, which can lead to their presence at the global level. Even Reserve flip transactions are now much simpler to execute as swaps can be structured through secondary transactions for both residents and non-residents. The amendments also bring the NDI rules in line with the Overseas Investment rules, thus ensuring parity among various rules. All things considered, it is anticipated that these changes would increase competition and bring the Indian M&A practices in line with international norms.
Conclusion
These amendments represent a significant advancement in India’s regulatory framework being a pivotal development towards aligning with international standards. The changes brought forward in the Amended Rules are steps taken further in facilitating overseas investments and to promote ease of doing business by simplifying rules. The major changes cover updated definitions of ‘control’ and ‘startup,’ certain rules for downstream investments, and the introduction of equity swaps for cross-border deals. The cross-border share swap amendments will specifically benefit Indian start-ups aiming for global expansion. Even though the broader definitions and additional government approval requirements could introduce complexity and potential challenges in sectors of strategic importance, it also invigorates regulatory overwatch, fostering an investment-friendly environment. This will stimulate more transactions and further help Indian entities in marking their global presence as well as ensuring the protection of key national interests simultaneously.