Chinese Investments In India Need Deft Handling
On April 18, 2020, the Government of India announced changes to the FDI policy followed by a notification on April 22, 2020, to amend the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, to “curb the opportunistic takeovers/acquisitions of Indian companies due to the current pandemic”.
Prior approval of the government would now be required for any foreign direct investment into India from any entity from a country sharing a border with India or if the beneficial interest of the direct investor lay with any such entity—in effect, expanding the list of countries whose investment in India was regulated (being Pakistan and Bangladesh) to include China.
In taking this step, India took a leaf out from the United States’ CFIUS regime and mimicked the recent spate of protectionist legislation introduced by other jurisdictions like the European Union, Australia, Germany, Spain, and Italy, all aimed at restricting Chinese investments. India’s legislative change is particularly far-reaching as it applies across all sectors and not just those historically deemed “sensitive”; and makes no distinction between majority or control investments and minority or passive investments from China.
China, increasingly peeved at being isolated internationally, has claimed discrimination and a breach of WTO rules by India. Notwithstanding the geopolitical machinations, the FEMA amendment is not free of ambiguity.
FDI Versus FPI/FVCI/AIF Investments
The amended Rule 6(a) of the Non-Debt Rules deals with FDI in an Indian company by a person resident outside India, as opposed to foreign portfolio investment or foreign venture capital investment, which are covered under other provisions of the Non-Debt Rules. Essentially, any form of FDI, whether by way of fresh investment by Chinese entities or transfer of shareholding by existing shareholders—including existing Chinese investors—to Chinese shareholders or to entities whose beneficial holding may be held by entities based in China, will now require government approval.
While the FEMA amendment does not impact previous investments, in its overarching impact, it seems that any future rounds of funding or acquisitions by Chinese investors in companies with existing Chinese investments will now require approval including for rights issues, bonus issues or increase or buying of new stake by existing Chinese investors.
Additionally, any investment in any units of an investment vehicle including alternate investment funds remains untouched by the FEMA Amendment.
An AIF could potentially make downstream investments in India so long as the investment manager of the AIF is an Indian owned and controlled entity to establish independent management and deployment of investments.
While it has been stated that prior government approval will be required for any FDI wherein the ultimate beneficiary is Chinese, the FEMA amendment is silent on how to determine ‘beneficial ownership’. While the definition of ‘beneficial interest’ as set out in Companies Act, 2013, or the definition of ‘beneficial owner’ under Prevention of Money-Laundering Act, 2002, may be illustrative, the government should provide clarity on this issue, considering that more often than not, FDI investors deploy multi-layered structures.
An immediate impact of the FEMA amendment will be felt by Chinese limited partners and general partners, who participate in various investment vehicles who invest in India.
The FEMA amendment would cover all funds that have Chinese LPs and at this moment, there is a need to clarify as to whether the government will relax the requirement for Chinese LPs that have no significant control or where there are broad-based funds / independent GPs or ‘fund of funds’ arrangements. At this point, all funds having Chinese LPs looking to invest in India would need to get approval.
Investments From Hong Kong
While the FEMA amendment does not clarify whether the new curbs will also cover the investments from Hong Kong, which is a special administrative region of China, the Indian government has traditionally distinguished between Hong Kong and China as two separate jurisdictions as is evidenced by the separate income tax treaties. Hong Kong was also specifically declared as a reciprocating territory under Section 44A of the Indian Code of Civil Procedure, 1908, while China was not, again indicating the distinction Indian government makes between the two jurisdictions.
While there are other supporting reasons to believe that Hong Kong is not impacted by the FEMA Amendment—including separate WTO memberships for China and Hong Kong—this may need to be amply clarified.
It is very likely however that investments from Hong Kong may be subject to additional scrutiny and in case the beneficial owner of investments from Hong Kong is determined to be Chinese, the curbs under the FEMA amendment will apply.
Disrupted Cross-Border M&A And Contractual Arrangements
Any global M&A transactions involved a Chinese buyer or investor with an Indian subsidiary involved will now be impacted by the FEMA amendment with the India leg subject to government approval. This may impact ongoing and future deals and may require structuring solutions to be determined upfront, to deal with this situation.
Under existing investment arrangements, since any further acquisition and investments by Chinese entities are now under the approval route, the exercise of any existing contractual rights such as put and call options which entitle entities in China (or whose beneficial interest are held by entities based in China) to buy more stake in Indian companies will also require prior approval of the government.
Given a cumulative Chinese investment of about $12 billion in India (including $4 billion in startups) and ever-increasing interest from Chinese investors, both strategic and financial, it is unlikely that the Chinese interest in India will wane any time soon. Given the government approval requirements, the volume of applications from Chinese investors may be substantial and subject to heavy scrutiny, which is bound to impact transaction timelines and predictability.
With many examples of heavy investments into Indian companies and more capital available to be deployed, Chinese investments require deft handling by the government and a starting point would be to allay bona fide concerns and provide clarity on the issues mentioned above.
Haigreve Khaitan is Partner, Khaitan & Co, and leads the firm’s corporate / M&A and private equity practices.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.