In a significant change to the Foreign Direct Investment Policy 2017 (“FDI Policy”), the Department for Promotion of Industry and Internal Trade has issued Press Note No. 3 (2020 Series) dated April 17, 2020 (“Press Note 3”), wherein it has imposed certain restrictions for receiving FDI from neighbouring countries. According to the Press Note 3, any entity of a country which shares its land borders with India (i.e. China, Nepal, Bhutan, Bangladesh, Myanmar, Pakistan and Afghanistan) (“Specified Country”) or where the beneficial owner of any investment in India is based in such country or is citizen of such a country, will now require prior approval from the Government for its direct investment in India. Additionally, any transfer of ownership (whether existing or future) of an entity in India resulting in the beneficial ownership being situated in a Specified Country will also require prior Government approval. Changes proposed vide Press Note 3 will have statutory effect upon amendment of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”).

Prior to the issuance of Press Note 3, citizens of/entities incorporated in Pakistan and Bangladesh required Government approval for investing in India. The most notable addition to the change under Press Note 3 will be China. The recent increase of stake by People’s Bank of China in HDFC from 0.8% to 1.01% through open market purchases appears to be the trigger for the above reaction by the Government. Indian Government is keen to curb any opportunistic takeovers/acquisitions of Indian companies who may be suffering from poor valuation due to the current COVID 19 pandemic.

We provide hereinbelow some of the possible scenarios which may arise going forward due to Press Note 3:

➢ Additional Investments and Transfer

• Existing investments of an entity based in a Specified Country including China will not be affected. However, going forward any investment proposed to be made by an entity based in a Specified Country will now require prior Government approval irrespective of the sectors proposed to be invested i.e., even the automatic route sectors such as services sector, education, township construction and development etc. will be out of reach for an automatic investment by an entity/individual based in a Specified Country and would need Government approval. Pakistan will continue to be not allowed to invest in sectors such as defence, space, atomic energy, and sectors/activities prohibited for foreign investment. Furthermore, any transfer of ownership (whether existing or future) of an entity in India resulting in the beneficial ownership being situated in a Specified Country will also require prior Government approval. In nutshell, both direct first-time investments and/or
transfers/acquisitions of ownerships will be impacted.

• As per the FDI Policy, additional foreign investment up to cumulative amount of INR 5000 crore into the same entity within an approved foreign equity percentage/or into a wholly owned subsidiary does not require fresh
government approval. However, in terms of Press Note 3, any additional funding by an entity based in a Specified Country will now require prior Government approval.

➢ Beneficial Ownership

• In case of any transfer of ownership of an entity in India resulting in the ‘beneficial ownership’ being situated in a Specified Country, will also require prior Government approval. The scope of the term ‘beneficial ownership’ has not been defined under Press Note 3.

• The concept of beneficial ownership is covered under the Companies Act, 2013 (“CA 2013”) read with the Companies (Significant Beneficial Owners) Rules, 2018 (“SBO Rules”). The SBO Rules were issued for the
purpose of identification of individuals who directly or indirectly hold beneficial interest or right to exercise significant influence or control in an Indian company as per the conditions specified under CA 2013 and SBO
Rules. It is expected that the scope of the term ‘beneficial ownership’ referred in Press Note 3 will be clarified by the Government in the notification for amendment of the NDI Rules.

➢ Indirect Foreign Investment/Downstream Investment
• Press Note 3 will have an impact on downstream investments by Indian entities having investments from the Specified Country. ‘Downstream investment’ has been defined under the NDI Rules to mean “investment
made by an Indian entity which has total foreign investment in it, or an Investment Vehicle in the capital instruments or the capital, as the case may be, of another Indian entity”. An Indian entity is considered to have ‘indirect foreign investment’ if the downstream investment is received by such Indian entity from another Indian entity which has received foreign investment and the Indian entity making the downstream investment is (i) not owned by resident Indian citizens; or (ii) owned and controlled by persons resident outside India. An Indian entity which has received the indirect foreign investment is required to comply with the entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable to foreign investment.

• Going forward, in the event an Indian entity, which has received foreign investment from an entity based in a Specified Country, proposes to make downstream investment in another Indian entity, which is treated as
‘indirect foreign investment’ in the second-level Indian entity, then investment proposed to be made by the first-level Indian entity will require Government approval, irrespective of the fact that the second-level Indian entity, in which the downstream investment is to be made, operates in 100% automatic route sectors.

➢ Possible Impact on Foreign Investment through Foreign Portfolio Investment route – Overseas funds flow in India both through FDI and the Foreign Portfolio Investors (“FPIs”) routes with substantial inflows into capital markets. The FPI can invest less than ten per cent (10%) of the total paid-up equity capital of a company on a fully diluted basis or less than ten per cent (10%) of the paid-up value of each series of debentures or preference shares or share warrants issued by an Indian company. As per reports, the Securities and Exchange Board of India (“SEBI”) is currently scrutinizing the FPIs coming from China and Hong Kong considering that there are 16 Chinese FPIs registered in India. It is possible that SEBI may issue certain notifications in tandem with Press Note 3 to augment its control over the FPI coming from the Specified Countries. While many FPIs use jurisdictions such as Singapore and Mauritius to pool in resources before investing in India, it appears that the ultimate beneficial ownership details of these FPIs would be carefully assessed going forward.

Conclusion
Amongst the Specified Countries, China has the highest foreign direct investment with approximately INR 14,900 crores invested during the period beginning April 2000 to December 2019. It is evident that the focus of Press Note 3 is aimed at controlling and mapping investments from Chinese entities in India and minimising the opportunistic acquisition of Indian businesses from China during the current COVID 19 pandemic.