Foreign investment in India – a shift in regulatory powers
Back to Corporate and M&A Law Committee publications
Rishabh Bharadwaj
Khaitan & Co, Bengaluru
rishabh.bharadwaj@khaitanco.com
Neil Deshpande
Khaitan & Co, Bengaluru
Introduction
India’s journey from a closed and restricted economy to a preferred investment destination is an intriguing one. Though the economic reforms introduced in 1991 removed a slew of barriers for foreign investments, with measures like current account convertibility being adopted in August 1994, India still does not have a full capital account convertibility and has a regulated regime for foreign investments. Until recently, foreign investment in India was primarily regulated by India’s Central Bank – the Reserve Bank of India (RBI) – pursuant to the Foreign Exchange Management Act 1999 (FEMA) enacted by the Indian Parliament, read with (1) the Foreign Exchange Management (Transfer or Issue of any Security to a Person Resident Outside India) Regulations 2017 (TISPRO) framed by the RBI pursuant to its powers under FEMA, and (2) in case of foreign direct investments (FDI) (ie, foreign investment in equity instruments of an unlisted Indian Company or in ten per cent or more of the paid-up equity capital of a listed Indian company), the consolidated FDI policy issued by the Government of India (‘FDI Policy’).
However, on 15 October 2019, the Government of India notified the amendments to the FEMA that were passed by the Indian Parliament in 2015 (‘2015 Amendments’). Pursuant to the 2015 Amendments, (1) RBI’s power to specify and regulate (in consultation with the Government of India) all classes of permissible capital account transactions has now been limited only to the ones pertaining to ‘debt instruments’; and (2) the Government of India has been empowered to: (i) specify and regulate (in consultation with the RBI) the classes of permissible capital account transactions not involving ‘debt instruments’; and (ii) to determine which instruments will be specified as ‘debt instruments’ for purposes of the foregoing.
In furtherance of the 2015 Amendments, on 17 October 2019, (1) the Government of India issued the Foreign Exchange Management (Non-Debt) Rules 2019, as amended on 5 December 2019 (‘Non-Debt Rules’); and (2) the RBI issued the Foreign Exchange Management (Debt Instruments) Regulations 2019, in each case in supersession of the TISPRO regulations, thereby shifting the regulatory jurisdiction pertaining to equity foreign investment (ie, foreign investment involving non-debt instruments or securities) from the RBI to the Government of India.
For the purposes of this article, reference to ‘foreign investment’ means investment in non-debt securities or instruments. The exchange control regime for investment in or acquisition of immovable property in India, which forms part of the Non-Debt Rules, is also not discussed in this piece.
Key highlights of the recent changes relevant for equity investments
Distinction between debt and non-debt instruments
Non-debt instruments are all equity instruments (ie, compulsorily and fully convertible preference shares, compulsorily and fully convertible debentures, share-warrants (in some cases) and partly-paid-up shares) of entities incorporated in India (public, private, listed and unlisted), capital participation in limited liability partnerships, other instruments of investment permitted in the FDI Policy, investment in units of alternative investment funds, real estate investment trust and infrastructure investment trusts, investment in units of mutual funds and exchange traded funds investing more than 50 per cent in equity, the junior-most layer (equity tranche) of securitisation structures, instruments pertaining to acquisition or sale of or dealing in immovable property, contribution to trusts, depository receipts issued against equity instruments. Debt instruments are government bonds, corporate bonds, all tranches of securitisation structure which are not equity tranche, borrowings through loans and depository receipts whose underlying securities are debt securities. Any instrument that does not fall under either of the abovementioned categories will be deemed to be a ‘debt instrument’. While practically nothing much has changed on this front other than the shift in regulatory jurisdiction, it will be interesting to see the evolution of and changes to the scope of these instruments (and consequent regulation thereof) in the future.
Other investment instruments
Under the TISPRO regime, only equity shares, compulsorily and fully convertible preference shares, compulsorily and fully convertible debentures, share-warrants (in some cases) and partly-paid-up shares were permitted to be issued by an Indian company against receipt of foreign investment. This position continues even in the Non-Debt Rules. However, it is interesting to note that the term ‘hybrid securities’ has been mentioned in the Non-Debt Rules, which has been defined to mean hybrid instruments that can be issued by an Indian company or a trust to a person resident outside India, such as optionally or partially convertible preference shares or debentures and other such instruments as may be specified by the Government of India from time to time. While this definition of ‘hybrid securities’ has been inserted into the Non-Debt Rules, no specific provisions regulating issuance of such securities have been set out in the Non-Debt Rules. The Government of India may possibly permit such instruments in the future.
E-commerce entities to mandatorily be Indian entities
Under the TISPRO regime, an e-commerce entity (ie, an entity that carries out and engages in buying and selling of goods and services including digital products over digital and electronic networks) included: (1) companies incorporated in India; (2) companies incorporated outside India having (directly or through an agent, physically or through electronic mode) a place of business in India and which conduct any business activity in India; and (3) any office, branch or agency, owned or controlled by a person who is not resident in India. However, under the Non-Debt Rules, only companies incorporated in India are referred to as ‘e-commerce entities’. References to other entities have been removed from this definition in the Non-Debt Rules. This effectively clarifies that the Indian exchange control regulations (ie, FEMA and the Non-Debt Rules) will cover Indian companies only.
Sectorial caps
The Non-Debt Rules have brought into force the changes in sectorial caps introduced by Press Note 4 (2019 Series) issued by the Government of India on 28 August 2019. These changes include: (1) an increase in the FDI permitted in Indian companies (without governmental approval) engaged in retail trading of single-brand products from 49 per cent up to 100 per cent; (2) the introduction of a new sub-category of business of ‘uploading/streaming of news and current affairs through digital media’ under the FDI permitted sector of ‘Broadcasting Content Services’ in which up to 26 per cent investment is now permitted with governmental approval; (3) permitting 100 per cent FDI (without governmental approval) for Indian entities engaged in sale of coal, coal mining activities and associated processing infrastructure including coal washery, crushing, coal handling and separation (magnetic and non-magnetic); and (4) inclusion of contract manufacturing through a legally tenable contract, whether on principal to principal or principal to agent basis, under the FDI-permitted sector of ‘manufacturing activities’, in which 100 per cent FDI was already permitted (without governmental approval).
Foreign investment in single-brand retail
The Non-Debt Rules have also brought into force the specific relaxations for foreign investment in single-brand retail trading introduced by Press Note 4 (2019 Series) such as: (1) inclusion of all procurements made from India by the entity engaged in retail trading of single brand products (‘SBRT Entity’) towards meeting the local sourcing requirements mandated for such SBRT Entities (ie, that 30 per cent of value of goods are to be procured from India) whether the goods procured are sold in India or exported; (2) the SBRT Entities being allowed to set-off the value of goods sourced from India for global operations for that single brand (in India Rupee (INR) terms) in a particular financial year either: (i) directly by the SBRT Entity itself or through any Indian or foreign group company of the SBRT Entity (an entity in which the SBRT Entity can directly or indirectly exercise 26 per cent or more of such entity’s voting rights or appoint more than half of the board of directors); or (ii) indirectly by the SBRT Entity or its group companies, through a third party under a legally tenable agreement, against the mandatory local sourcing requirement; and (3) permitting an SBRT Entity to undertake retail trading through e-commerce prior to opening up a brick and mortar store subject to such a brick and mortar store being opened by the SBRT Entity within two years from the date of starting retail online (under the TISPRO regime, only SBRT Entities operating through brick and mortar stores were permitted to undertake retail trading through e-commerce).
Foreign portfolio investors
Investment in ten per cent or less of the paid-up equity capital of a listed Indian company is treated as foreign portfolio investment. A host of changes with respect to investment by foreign portfolio investors (FPIs) registered with the Securities and Exchange Board of India (SEBI) have been introduced by the Non-Debt Rules including: (1) additional categories of alternative investment funds and offshore funds in which FPIs can invest; (2) benchmarking aggregate limits on investments by FPIs to the relevant sectorial foreign investment caps applicable to the Indian investee entity (to be effective from 1 April 2020); (3) specific permission for FPIs to invest (up to 24 per cent in aggregate) in sectors in which FDI is generally prohibited; and (4) a one-time permission for Indian companies to reduce (for a specified time period) or a general permission to increase (not exceeding sectorial limits of foreign investment) the limits of their share capital that can be held by FPIs. In case FPI investment thresholds are exceeded, such FPI entity would have five trading days to divest the excess holding, failing which, the investment would be re-categorised as FDI. Prior to the Non-Debt Rules, under the TISPRO regime, an aggregate limit of 24 per cent for all FPI investments and a ten per cent limit for an FPI or its investor group was prescribed. If the ten per cent limit was breached, the investment by such FPI was treated as FDI.
Foreign venture capital investors
Foreign venture capital investors registered with SEBI have been permitted to invest in equity, equity-linked instruments or debt instruments of Indian start-ups (ie, the entities that are registered with the Government of India and recognised as ‘start-ups’) regardless of the sector in which the start-up is engaged.
Concluding remarks
These changes to the FEMA and the consequent shift of regulatory jurisdiction regarding foreign investments is a welcome change as: (1) it will help to avoid conflicts with the FDI Policy, which in the past had arisen under the TISPRO regime (since the authorities responsible for (i) formulating the FDI Policy and (ii) framing and implementing TISPRO were different); and (2) consequently, any changes or modifications to this new regime will be made faster.
Back to Corporate and M&A Law Committee publications