Press Note 3 of 2020: A First Anniversary Edition

A hot button issue which has been the subject of much investor interest over the last one year has been the introduction of Press Note 3 of 2020. Issued against the backdrop of the onset of the Covid-19 pandemic and the worsening geopolitical issues with China, the Press Note required that investments from and acquisitions by an entity based in a country which shares a land border with India, or where the “beneficial owner” of the investment is situated in a country which shares a land border with India, will be subject to prior Government approval. Whilst the language used was generic and did not refer to any particular jurisdiction as such, the intent behind the Press Note and the intended “target” was seemingly clear. It was understood to be a direct reaction to the People’s Bank of China steadily raising its stake in India’s largest non-banking mortgage provider HDFC to over 1% through on-market purchases. The Press Note was also the first in a series of steps against Chinese investments and Chinese investors which later led to the ban of several Chinese apps on account of these apps being engaged in activities which are “prejudicial to [the] sovereignty and integrity of India, defence of India, security of [the] state and public order”.

In addition to the intended effect of blocking Chinese investments, there were several (potentially unintended?) consequences that followed the issuance of the Press Note. Some of key one’s were that in addition to China, Hong Kong and Taiwan-based investors were also seemingly caught. How should the term “beneficial owner” which had been used in the Press Note be interpreted was also not clear and led to much confusion, ultimately resulting in authorised dealer banks in India – who act as the gatekeepers for foreign investment inflows and outflows – adopting their own interpretations or variations of the existing rules which were not entirely fit for purpose and which further varied across different banks. Given the far reach of Chinese investments internationally, even US institutional investors having raised monies from Chinese LPs have found it challenging to make investments in India given the potentially wide ambit of the term “beneficial owner”. In addition, the Press Note does not differentiate between: (a) controlling and non-controlling investments in the Indian target company, though the Press Note on the face of it was issued to curb “opportunistic takeovers / acquisitions”; (b) fresh investments and follow-on investments on a pro-rata basis in existing portfolio companies; and (c) direct investments into an India company and indirect investments into an offshore company which has an Indian subsidiary, all of which contributed further to the uncertainty. The Press Note also interestingly did not restrict on-market investments under the “foreign portfolio investment” regime which was understandably what triggered the requirement for the restriction in the first place.

Several press reports over the course of the past year have indicated that some or all of these issues would be addressed, but, alas(!), no formal clarification has been forthcoming from the Government. Some of the more recent reports suggested that discussions are ongoing in relation to setting a threshold for determining beneficial ownership (which could be 25%[1]) for the purposes of the Press Note and also that investments in “non-sensitive” sectors may be excluded from the ambit of the Press Note. However, no formal or final view has been expressed by the Government on these aspects so far.

The larger issue, over and above the lack of clarity around the scope of the Press Note, is that the Government has not been forthcoming in approving investment proposals that have been submitted for its approval under the Press Note. According to press reports, over 150 foreign direct investment proposals worth almost USD 2 billion have been submitted so far. It is understood that a mechanism has now been put in place in the form of an inter-ministerial committee for evaluating the various proposals and that significant progress is being made at the level of this committee. Some reports also indicated that the Government may be looking at finalising a three-pronged approach for dealing with proposals made under the Press Note in terms of which the following proposals may be considered more favourably for granting an approval: (a) proposals relating to investments in sectors critical for India or where local companies do not have adequate capacity; (b) proposals made by investors headquartered elsewhere but routing funds through Hong Kong; and (c) proposals for “small” investments by Chinese investors. Pursuant to a combination of these discussions, in February / March this year, a couple of approvals were reportedly granted to Hong Kong based investors – even if after a waiting period of over 6 months. There is also news about a handful other approvals having been granted, though (notwithstanding the tight media scrutiny around this issue) these have not found their way into the press. Notwithstanding these isolated cases of approvals having been granted, it is only fair to say there has not been any meaningful movement on this front. The lack of any significant breakthrough on the geopolitical front raises a further question mark on the fate of the pending proposals.

Whilst India is not an outlier in its attempts to regulate investments from China, the lack of clarity, even after a year, around the scope of the Press Note and the subsequent stonewalling of applications for approvals has significantly disrupted the venture capital industry, particularly for entities in the tech sector which has recently been the largest beneficiary of significant cheques drawn by Chinese investors.

Next steps

The recent approvals in terms of the Press Note that are being issued by the Government have instilled some confidence in investors to at least submit an application rather than continuing with the “wait and watch” approach that had been adopted by a number of them so far. At the same time, investors have been negotiating sensible time periods with target companies to give them a fair shot at obtaining an approval. The most ideal outcome from an overall deal certainty perspective would be for clarifications to be issued in connection with the following:

1. Clarifying the scope of what constitutes “beneficial ownership”: Whilst the Press Note has not defined the expression “beneficial ownership”, the expression is regularly being used in tender documents for public auction processes (which regulate participation by bidders from land bordering countries), and those effectively set the beneficial ownership threshold at 25%. Whilst it is understood that the Government has generally been using the same definition while evaluating proposals made under the Press Note too, it would be good if the stance could be formally clarified as a 25% threshold is also a well-recognised benchmark under the anti-money laundering regime, the Companies Act regime as well as the regime governing mandatory tender offers. Additionally, the applicability of the Press Note to a GP / LP structure and entities which are ultimately held by a listed entity (both of which are more nuanced than the usual corporate structure) has been a grey area so a focussed clarification around how the “beneficial ownership” definition would apply to those would also be welcome.
2. Exempting minority investments: Borrowing slightly from the foreign portfolio investment regime, it would be ideal if investments of up to 10% by a single investor group, and up to 24% by all investors from land bordering countries, in a single target company are exempted from the purview of the Press Note. A 10% or 24% shareholding does not confer any meaningful control rights on the investors so would fit well within the objective of the Press Note to curb “opportunistic takeovers / acquisitions”, but if not that then at least an exemption for investments of up to 10% by restricted investors in non-sensitive sectors can be considered.
3. Exempting follow-on investments on a pro-rata basis: Follow-on investments which do not lead to an increase in the shareholding percentage of the investor or to the acquisition of any additional rights should be permitted without any restrictions.
4. Clarifying the applicability to indirect investments: Whilst concerns around investments being made into a hold co of a largely Indian operation are understandable, given the broad wording that has been used in the Press Note, it equally applies to a structure where the primary business of the offshore hold co is located elsewhere and it just happens to have a subsidiary in India. For instance, a China SOE purchasing a German business which has one of its several subsidiaries in India gets caught. It is unlikely the intent was to capture transactions such as these but currently there is ambiguity on this front. One option could be for the Press Note to be made applicable to only such indirect investments which are India focused. For example, where the India business constitutes more than 50% of the business of the offshore hold co.

It was expected that once the State elections are complete, the Government would attend to the Press Note. But, with the ongoing second wave of Covid-19 in India, it is unlikely that things will be resolved in the near term, though one remains hopeful that once things are back to normal, the Government would clarify things and put to bed the uncertainty which has been looming large for more than a year now.

Endnotes

[1] In other words, this would mean that investing entities where the stake ultimately held by shareholders from countries sharing land borders with India is less than 25% would be exempt from the purview of the Press Note. We believe that such a specific numerical threshold is far better than an uncertain “control” test also being applied.

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This material is for general information only and is not intended to provide legal advice.
For further information, please contact:

Karam Daulet-Singh
Managing Partner
karam.dauletsingh@touchstonepartners.com

Gaurav Desai
Partner
gaurav.desai@touchstonepartners.com

Sameeksha Chowla
Senior Associate
sameeksha.chowla@touchstonepartners.com