Protecting home turf

In light of COVID-19 and the great economic stress on the global economy, major economies have realized the urgent need to protect home turf. There have been numerous instances worldwide in the last 4 months of opportunistic increase in shareholding by Chinese Companies in distressed companies and other companies where valuations are lower than normal.

Ministry of Commerce & Industry has correctly and timely issued Press Note 3 to curb opportunistic takeovers/acquisitions of Indian companies during COVID-19 pandemic. The Indian Government were possibly prompted to revisit the FDI regulations and restrictions in light of the recent increase in shareholding in HDFC Bank by People's Bank of China (PBoC). The erstwhile position was that foreign investment by citizens/entities of Pakistan and Bangladesh required prior Government clearance. As per Press Note 3, the restrictions have been extended to cover all countries sharing a land border with India. In the revised position, government approval would be required for any foreign investment from an entity of such country or where the beneficial owner is situated in such country or is a citizen of such a country. Further, the press note also now regulates the transfer of ownership of existing or future foreign investment in an Indian entity, directly or indirectly to an entity/citizen of a country sharing a land border with India as elaborated above. The restrictions would apply to all sectors and are not limited to sensitive sectors. Interestingly, the proposed changes also cover enterprises that are owned by the government of such neighbouring country and therefore, would include even sovereign funds. Existing investments would not be impacted by proposed changes in FDI regulations. At the moment this is no clarity on whether the restrictions would apply to Hong Kong which is a Special Administrative Region of the People's Republic of China.

Ministry of Commerce & Industry has emphasized on the concept of 'beneficial ownership' to ensure that funds are not indirectly routed through neutral jurisdictions such as Mauritius, Singapore etc. Therefore, if investments of Chinese origin are routed through another jurisdiction which has enforced similar FDI restrictions then dual approval would be required for an increase in Chinese shareholding in the foreign domiciled entity from the foreign regulator as well as Indian authorities.

Other countries too have been taking similar steps to protect local companies from hostile takeovers and opportunistic increase in shareholding. There have been a significant drop in share prices and an increase in interest from Chinese entities — privately owned and Government-owned. In Europe, the debate on the need for protection from Chinese acquisition was alive even before COVID-19. One of the significant takeovers that started the debate in Germany was the takeover of Robot manufacturer Kuka by the Midea Group from China in 2017 in a multi-billion dollar acquisition.

Germany has approved tighter norms for takeover bids from outside the European Union. Other EU members France, Italy, Spain and Switzerland are doing the same. It may be noted that recently the European Commission President Ursula Von Der Leyen stated that, "As in any crisis, when our industrial and corporate assets can be under stress, we need to protect our security and economic sovereignty." While China was not specifically named, it is clear that all countries are tightening their investment regulations with one eye on China. It may be noted that Chinese entities have a strong presence in the textiles, automotive and shipping sectors in Europe. Australia too would now be reviewing all takeover bids irrespective of the value whereas previously bids below A$ 1.1 Billion were not examined. The restrictions imposed would also have an impact on domestic companies and investors in such companies. Existing investors who were contemplating an exit by sale to Chinese buyers would have to factor in the additional scrutiny. Further, fundraising from existing Chinese shareholders at short notice would now not be possible since this would now require government approval which can typically take around 10 weeks. Therefore, start-ups which were relying on Chinese funding would have to consider alternative financing measures in the short term. Also, Indian companies that were already in talks with raising funds from Chinese investors or entities would have to wait until the investment is approved by Indian authorities. It is interesting to note that majority of Indian unicorns have Chinese funding.

The changes in FDI regulations would be applicable from the date of FEMA Notification issued by RBI in this regard. The changes introduced by the Government of India are timely and necessary to not only check the charge of the Chinese Brigade but also to protect the national interest.

(Shlok Chandra is an Advocate and Chandni Sood is a Chartered Accountant. Views expressed are strictly personal)