Foreign Exchange Regulation

[By Subhasish Pamegam] The author is a student of Gujarat National Law University, Gandhinagar.   Introduction The United States’ recent executive order (EO) regulating outbound foreign direct investments (OFDI) – also known as the Reverse Committee on Foreign Investment in the United States (CFIUS), marks a significant shift in the global landscape for outbound investment regulations. This regulatory mechanism is designed to scrutinize and potentially restrict outbound investments in critical infrastructure, particularly in “countries of concern”, to mitigate risks associated with technology transfers, the dissemination of critical know-how, and the allocation of resources that may enhance the military and intelligence capabilities of these nations. The advent of Reverse CFIUS  reflects growing geopolitical tensions and a heightened focus on national security considerations that are increasingly shaping international investment policies. In light of these developments, this article first, aims to provide a comprehensive analysis of the burgeoning trend of OFDI regulations, with a specific focus on the reverse CFIUS model of the US. Secondly, it will delve into the rationale underpinning these regulations and highlight the insufficiency of existing export control measures to capture national security risks in OFDI. Thirdly, by examining the framework, the article will explore the feasibility and implications of implementing similar outbound investment regulations in India. Finally, it will provide recommendations for crafting a balanced outbound investment regulatory framework that addresses national security concerns while fostering economic growth and international collaboration. Reverse CFIUS on Foreign Outbound Investment Screening The CFIUS is an independent, multi-agency governmental body responsible for reviewing foreign investments in U.S. companies and real estate to determine their potential impact on national security. The traditional CFIUS undertakes a review of inbound foreign direct investments in U.S. companies and real estate to assess potential risks to national security. Whereas the Reverse CFIUS aims to regulate OFDI by establishing a two-tier regulatory structure for its screening. Under this structure, investments in specific less sensitive sectors necessitate a notification to the Treasury Department, whereas investments in highly sensitive sectors are strictly prohibited. The objective is to prevent the inadvertent bolstering of technological and military advancement of “countries of concern” through seemingly benign economic activities such as mergers and acquisitions (M&A), joint ventures (JV), private equity (PE)/venture capital (VC), greenfield investments, and other forms of capital flows. Historically, CFIUS focused on regulating inbound FDI to safeguard national security. However, there was growing emphasis on scrutinizing OFDI to address heightened concerns about the inadvertent transfer of sensitive technologies. The concept of monitoring OFDI was initially introduced in early drafts of the Export Control Reform Act (ECRA) and Foreign Investment Risk Review Modernization Act (FIRRMA) in 2018, specifically for certain types of intellectual property. Although this idea was dismissed at the time because CFIUS traditionally focused solely on inbound investments, recent legislative developments indicate a potential shift. The initiative to screen OFDI emerged when a report by the China Select Committee on US Investments found that firms had invested a minimum of $3 billion in PRC critical technology companies,  offering expertise and other benefits to these companies, many of which support the Chinese military.  In response to these concerns, President Joe Biden issued an EO in August 2023 instructing the Department of the Treasury to create a program aimed at regulating OFDI involving the transfer of sensitive technologies in critical sectors such as semiconductors and microelectronics, quantum computing, 5G and AI in “countries of concern” which include nations like China, Russia, Iran, and North Korea. For instance, semiconductors are essential to all electronic devices and AI has vast implications for defence systems and cyber capabilities, making them vital to national security. Contextualizing Outbound Investment Regulations in India In India,  the Foreign Exchange Management (Overseas Investment) Rules 2022 (FEM Rules) which superseded the almost two decades old framework on OFDI in India under Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 and Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations 2015, imposed certain restrictions on OFDIs into foreign entities. The restrictions were three-fold: i) OFDIs in countries identified by the Financial Action Task Force (FATF) as “non-cooperative countries and territories” were restricted and ii) OFDIs by Indian residents in any jurisdiction periodically notified by the Reserve Bank of India (RBI) or identified by the Central Government under Rule 9(2) of the FEM Rules and iii) Foreign Exchange Management (Non-debt Instruments – Overseas Investment) Rules 2021 barred Indian residents from making overseas investments in foreign entities situated in countries or jurisdictions blacklisted by the Central Government. This included regions not compliant with the FATF or the International Organization of Securities Commissions. At present, the OFDI regulations in India are primarily driven by public policy, cross-border capital flow and exchange control considerations rather than national security concerns.  Neither the FEMA regulations nor the ODI Rules govern OFDI in the context of national security risks to prevent the leakage of advanced and sensitive technologies to countries of concern, which may threaten India’s national security. However, in an increasingly interconnected global economy, where geopolitical risks are dynamic, a comprehensive legislative framework addressing OFDI in countries of concern could provide clearer guidelines and greater flexibility to adapt to emerging threats. Therefore, before implementing a similar regulatory framework like the reverse CFIUS, India needs to collect data on several fronts: (i) the OFDIs made by Indian companies in critical technologies (ii) the potential security risks arising from these transactions; and (iii) the extent to which a national-level policy response at the national level might offer an effective and proportionate remedy to the identified issues. If policy intervention is deemed necessary to address the identified national security risks, India should establish a comprehensive legislative framework. The approaches to establishing an outbound investment regulation framework will be discussed comprehensively in the next section. Challenges in Implementing Outbound Investment Regulations in India Implementing outbound investment regulations in India for national security considerations also presents several challenges which need to be carefully analysed. Increased Operational Costs for Cross-Border Investments Implementation of outbound investment regulation in India