Screening Chinese investments: What happens next?

Entities affected by India’s new policy may be able to take measures to obtain fast-tracked approvals

During the first quarter of 2020, the People’s Bank of China made several purchases of shares in HDFC, India’s largest mortgage provider. When its total shareholding exceeded 1%, the news was made public due to disclosure requirements of the stock exchange.

Amid the COVID-19 pandemic, when most listed stocks were trading at historic lows, this news caused a sensation among Indian policymakers and the public alike. A few days later, on 17 April, the Department for Promotion of Industry and Internal Trade (DPIIT), within India’s Ministry of Commerce, issued press note No. 3 (PN3) with a stated view of curbing “opportunistic takeovers/acquisitions of Indian companies”.

It made government approvals mandatory for investments from countries that share 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. Since similar approvals were already required for Pakistan and Bangladesh, and remaining neighbours of India like Afghanistan, Bhutan, Nepal and Myanmar are not significant foreign investors, it was clear that the move was primarily targeted at investors from China.

Further, any subsequent changes in beneficial ownership, either through direct transfer or otherwise, of any existing or future foreign direct investment (FDI) would result in such beneficial ownership falling within the purview of the above-mentioned restriction, and being put under the government approval route.

The consequential amendments to the Foreign Exchange Management (non-debt instruments) Rules, 2019, incorporating the changes introduced under PN3, were notified on 22 April 2020 (Foreign Exchange Management Act [FEMA] amendments).

The decision to subject Chinese investments to government approvals has triggered debate around the possible reasons behind such a decision, and its potential impact on different types of investments. Although there might be political and security aspects to this decision, the focus of this article will be on its legal implications: (1) who will be considered as “Chinese” investors?; and (2) what steps will Chinese investors need to undertake to obtain government approvals?

The new rule does not distinguish between greenfield and brownfield investments, or between types of investors, such as industry players, financial institutions, or venture capital funds. Hence, the “beneficial ownership” test employed under the Companies Act, 2013 assumes significance.

Under section 89(10), this definition includes interests held “directly or indirectly”, whether “through a contract, arrangement or otherwise”, as a “right or entitlement” of a person acting “alone or together with any other person” in relation to a share.

Further, section 90 of the act defines a significant beneficial owner as an individual who: (1) holds not less than 10% of shares, voting rights or dividends; or (2) exercises, or has the right to exercise, “control” or “significant influence” over a company. This means the mere presence of an investment holding structure with multiple layers will not be enough to avoid government approval.

In addition, Hong Kong, from where a bulk of Chinese investments currently flow, is likely to be considered as part of China for the purposes of the new rule. While the application of this rule is relatively simple for traditional industry players and business groups, it gets more complicated when applied to entities such as venture capital funds, which are often registered in tax havens, and have multiple investors from various nationalities. For instance, the presence of limited partners with a Chinese nationality in a fund could trigger the requirement of a government approval.

An investor who requires government approval for a proposed investment is required to complete and submit an online application at the website of the Foreign Investment Facilitation Portal. This is the same procedure that was established in May 2017, when the Indian government took a decision to abolish the Foreign Investment Promotion Board and the authority to grant government approvals for foreign investment under the Foreign Direct Investment Policy and the FEMA Regulations was entrusted to the concerned administrative ministries or department.

Santosh Pai is a partner at Link Legal India Law Services. He can be contacted on +91 9004 2652 35 or by email at santosh.pai@linklegal.in

Anuj Trivedi is a partner at Link Legal India Law Services. He can be contacted on +91 9971 9920 92 or by email at anuj.trivedi@linklegal.in

Link Legal India Law Services
Thapar House, Central Wing,
First Floor, 124 Janpath,
New Delhi-110 001, India
Tel: +91 11 4651 1000
Email:
santosh.pai@linklegal.in
anuj.trivedi@linklegal.in
cn.linklegal.in