[By Aditya Maheshwari and Dhruv Gupta]
The authors are students at the Gujarat National Law University.
Introduction
Both global and domestic markets witnessed continuous growth post-1991’s globalization policy. One of the outcomes of this policy was Foreign Direct Investment (“FDI”). It can be understood as financial transactions between a foreign and a domestic entity where the former has a significant say in the management of the latter.
Over the years, the Ministry of Corporate Affairs (“MCA”), along with the Reserve Bank of India (“RBI”), has liberalized the FDI Policy to provide an opportunity to foreign investors and Indian companies to boost access to investment opportunities. In the Consolidated Foreign Direct Investment Policy, 2017 (“Policy”), only investors from Bangladesh and Pakistan are required to take permission from the govt, while others were allowed to invest through an automatic route. However, due to the threat posed by opportunistic takeovers by investors from bordering countries, certain amendments were introduced by the MCA to strengthen national security against such investments.
This article intends to take the lid off the amendments that are being brought since the inception of Covid-19, the cause and effects of such amendments, and the loopholes in the present legal regime of the FDI Policy.
Press note No. 3 (2020) – a first step towards preventing opportunistic takeovers
The Department of Promotion of Industry and Internal Trade (“DPIIT”) vide Press Note No. 3 (2020 Series) (“PN3”) amended para 3.1.1 of the Policy. Consequently, the restriction to take the govt route for FDI by a citizen or an entity of Bangladesh and Pakistan had been replaced with “an entity of a country which shares a land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country.”
As PN3’s subject indicates, DPIIT’s sought to check opportunistic takeovers/acquisitions of Indian companies in light of the pandemic. The approach to making amendments is evident from the fact that China’s central bank has acquired a 1% stake in India’s largest mortgage lender i.e., Housing Development Finance Corporation Ltd (“HDFC”). This was the first-time efforts were made to strengthen national security by not allowing Chinese investors to go through the automatic route.
-
Consolidating the FDI Policy against Border Sharing Countries
After over two years of PN3, the MCA understood the FDI Policy 2020 to be insufficient in insulating Indian companies against opportunistic takeovers: it lacked protection regarding managerial aspects of the company. Thus, certain amendments have been made in 2022 to remedy the loophole and to insulate against managerial takeovers.
-
Amendment related to Investment
1. Transfer of shares
As of May 4, 2022, the Companies (Share Capital and Debentures) Rules, 2014 were amended. There is now a provision requiring transferees to furnish a statement regarding the application of the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 (“NDI Rules”) to transferred assets. Thus, if shares are being transferred to a citizen or legal entity of a country sharing a land border with India, said citizen or entity must first secure government approval in accordance with the NDI Rules. This approval must be submitted alongside Form SH-4, the appropriate form for transferring shares.
2. Private Placement
As of May 05, 2022, the Companies (Prospectus and Allotment of Securities) Rules, 2014 were amended. Now, in cases of private placement, if the proposed allottee is from a country sharing a land border with India, it has to attach government approval along with the private placement offer-cum-application letter- “PAS-4.” A declaration regarding the applicability of NDI rules is to be given by the proposed allottee in PAS-4.
-
Amendment related to Management
1. Appointment of Director in a company
The MCA has made it mandatory to obtain security clearance from the Ministry of Home Affairs (“MHA”) for nationals of a country sharing a land border with India before becoming a director of an Indian company. The director has to attach the approval along with the consent letter i.e., DIR-2. This amendment is brought vide Companies (Appointment and Qualification of Directors) Amendment Rules, 2022 effective from 01 June 2022.
2. Application for Director Identification Number (“DIN”)
Where a national of a country sharing a land border with India applies for DIN, he has to attach the security clearance along with the DIN application i.e.,
DIR-3. A declaration in this regard has been inserted in the e-Form DIR-3 vide Companies (Appointment and Qualification of Directors) Amendment Rules, 2022 effective from 01 June 2022.
Analysis – Impact and the shortcomings in the present FDI regime
-
The impact and reasons behind the Amendments made by the MCA
While the amendment made by the MCA was done considering national security and the prevention of opportunistic takeovers by the investors or entities of bordering countries, FDI inflow is bound to be impacted negatively.
Data indicates that FDI for 2021 fell 30% in comparison to 2020. One of the reasons for this fall is the restriction being imposed by the government on the use of the automatic route by bordering countries. It must be noted that this reduction in value must not be misunderstood as arising from Covid-19. During the same period, China, the country most affected by Covid-19, had a growth rate of 21%. In the coming months, with the present restrictions becoming more rigorous, FDI in India is only going to decrease. Moreover, imposing stringent restrictions on China and Hong Kong, the largest investors in the region, won’t benefit the Indian economy in the long run.
It must be highlighted that the amendment through PN3 was insufficient to prevent opportunistic takeovers. To circumvent the PN3-imposed restrictions, the affected investors created a US or Cayman-based entity, using it to route the investment without any restriction. The same is suggested by the data released by the MCA where 490 foreign nationals are registered as active directors as of Feb 2022. Thus, to prevent managerial control over Indian companies, the amendment vide Notification dated June 01, 2022, in regard to security clearance was added.
-
Loopholes in the present FDI Policy
The Consolidated FDI Policy after the above-discussed amendments has various loopholes which defeat their very object: national security and prevention of opportunistic takeovers of Indian companies. The following loopholes are observed in regard to the current FDI legal regime-
1. The scope of FDI Policy
The NDI Rules only cover investments made under an Indian company. Thus, any investment through other business structures such as a partnership and a limited liability partnership (“LLP”) has been excluded from its ambit. Consequently, due to the limited scope of the FDI Policy, foreign investors have a chance to circumvent the present restrictions to effect opportunistic takeovers.
2. Lack of a homogeneous legislation
The United Kingdom enacted the National Security and Investment Act, 2021 (“NSIA”), a homogeneous, standalone legislation to counter the rising national security threat posed by foreign investments during a pandemic. It was in response to international pressure, especially the United States. As such, it draws extensively from the Committee on Foreign Investment in the United States (“CFIUS”). The NSIA imposes both criminal and civil sanctions in cases of non-compliance, and covers 17 designated “sensitive sectors.”
However, the Indian legislature has failed to enact any such comprehensive law.
3. Absence of standard procedure
CFIUS provides a standard procedure through a “Three Threats framework” included within the investment guidelines. This provides a decision tree for the authorities to decide the plausibility of national security threats. In comparison, the Indian regime lacks any such standard procedure/criteria to evaluate any national security threat.
Conclusion
Steps taken by countries all over the world, especially in the last 5 years, reflect a global trend for increased intervention and scrutiny in matters concerning national security. Volatile geopolitical scenarios have forced countries to come up with measures to regulate incoming FDI vis-à-vis national security considerations. This is particularly relevant during the Covid-19 pandemic, which affected the supply of essential goods and services.
India, with PN3 and 2022 Amendments, has also jumped on the bandwagon. Arguably, its approach has not been comprehensive, choosing instead to implement an assortment of half-baked measures. The NSIA is an exhaustive legislation, even prescribing penalties against partnerships. Both NSIA and CFIUS, which have been in existence for some time, could’ve been referred to as a guide by the MCA and the DPIIT to enact comprehensive measures.
As highlighted under part IV, the restrictions imposed adversely impact India’s FDI while failing to fulfill their very objective. Further, government approval for FDI is not particularly efficient: as approval is now granted on a case-by-case basis, some approval applications are taking over 12 months, which is thrice the industry expectations of around 4 months.
India lacks a dedicated, comprehensive, and homogenous statute that covers entities apart from companies and can help understand ‘national security’. The above discussion emphasizes on the need for a dedicated statute for national security screening of inward FDI to remedy the various loopholes present in the existing regime.