When news broke about Peoples Bank of China (PBOC) acquiring over 1% shareholding in one of India's largest housing finance company, the Housing Development Financial Corporation (HDFC), it caused a storm in the entire financial media and the business community. Alarm bells went off that Indian companies will become easy targets for acquisition by Chinese investors in the wake of sharp fall in the valuation of listed Indian companies because of COVID-19 pandemic. That the shareholding was picked when HDFC's price was down 40% from its peak further fuelled these concerns. While HDFC was quick to clarify that PBOC was already a shareholder holding 0.8% of its shareholding as of March, 2019 and had merely increased its shareholding to above 1%, a threshold that required notification, the issue continued to simmer because of its possible future implications.
PBOC's acquisition was not the only opportunistic trade taking advantage of the crashing stock prices. There were other similar trades. The Saudi Arabian Monetary Authority (SAMA) picked up a 0.7 percent stake in HDFC on behalf of Saudi sovereign wealth fund. SAMA's name isn't reflected in the names of major shareholders in HDFC's regulatory filing as the holding in the company is less than one percent. One can argue that crash is a good time for investors to go shopping and pick up bargains at a discount and that what PBOC or SAMA did was normal investment activity. Then why has PBOC's stake buy in HDFC caused such a furore?
There are a number of reasons. Firstly, a central bank buying an equity stake in a commercial entity is not common. The backdrop to this acquisition made the move even more unusual and caused greater panic. Chinese government's role in the spread of COVID-19 pandemic has come under a cloud with questions being raised whether the worldwide spread and the consequent tragedy could have been averted if China had acted more responsibly. Secondly, China's desire for financial hegemony and global dominance has been an open secret. China's current forex reserve of over $3.2 trillion, which equal India' s GDP for 2019, dwarf India's forex reserves of $476.475 billion thereby giving it enough firepower to acquire beaten down companies and businesses. Thirdly, recently, China has emerged as one of the fastest-growing sources of foreign direct investment (FDI) in India, especially in Indian start-ups (Alibaba and Tencent have invested in a large number of start-ups). This coupled with the fact that in China the dividing line between the state and the private sector is blurred has caused greater concern. According to a recent study by the Brookings Institution 1, India's biggest challenge is to be able to map Chinese investments in India due to lack of single point data and because of the ways and means in which FDI can be routed into India.
It seems that paying heed to such concerns, the Department for Promotion of Industry and Internal Trade, Ministry of Commerce & Industry, Government of India (DIPP), the Government agency responsible for FDI policy which regulates foreign investments into India, in a swift and largely welcomed move, has amended the FDI policy, with a view to protect Indian companies against opportunistic takeovers/acquisitions during the COVID – 19 pandemic. Although the move was in discussion for sometime within the Government, it appears that the COVID-19 pandemic and its impact on the Indian economy forced the Government's hand and prompted it to act. The amendment has come into effect from April 22, 2020.
Under the current FDI policy, a non-resident entity can invest in India except in prohibited sectors/activities under the automatic route, that is without requiring Government permission. However, a citizen of Bangladesh or Pakistan or an entity incorporated in Bangladesh or Pakistan can invest only under the Government route, i.e., after obtaining prior Government approval, except that a citizen or entity from Pakistan cannot invest in defence, space, atomic energy and prohibited sectors/activities. Per the amendment to the FDI policy, any entity or beneficial owner of an investment into India or a citizen, based in a country which shares land border with India can invest only under the Government route. Also, the transfer of ownership of any existing or future FDI in an Indian entity, directly or indirectly, resulting in the beneficial ownership falling within the above restriction will also require Government approval.
The intent behind this amendment appears to be to regulate both greenfield and brownfield investments from countries sharing a common border with India and to allow the Government to scrutinize such investments and approve them on a case-to-case basis. While, the amendment doesn't state it specifically, it appears to be aimed at regulating investments from China since of the seven countries that share land borders with India investments from Bangladesh and Pakistan were already regulated and investments from Bhutan, Nepal, Myanmar and Afghanistan are not significant to merit such a move.
The amendment is quite broad in its sweep and will apply to acquisition or transfer of even one share. What is unclear is whether the amendment will achieve its intent to regulate and slow the pace of Chinese investments into India. The amendment doesn't define beneficial ownership. The result could be that taking benefit of this lack of clarity, investments from China can and will continue to be routed from countries other than China. The amendment puts investment by a company or a citizen based in China or by a beneficial owner based in China under Government approval route. This restriction can be easily circumvented where the investment into an Indian company is by a company in a country other than China which is ultimately owned by a Chinese company or citizen. Unless beneficial ownership is defined to restrict ultimate ownership or control by Chinese companies and citizens the amendment may not achieve its desired outcome. It is also unclear whether the amendment would apply to investments from Hong Kong. So far, for the purpose of FDI into India, China and Hong Kong have been regarded as separate destinations even after Hong Kong became part of China.
The amendment also seems to be a prelude to perhaps a similar decision that is expected from the Government for investments by Foreign Portfolio Investors (FPI), entities that invest in companies listed on Indian stock exchanges. Although China doesn't figure in the top 10 jurisdictions for FPIs in India, in an unusual move, SEBI, the Indian stock exchanges regulator, has asked custodians to provide details of 'ultimate beneficial owners' of FPIs based in China and Hong Kong.
India's move is not isolated and follows similar developments in some other countries. In the last few weeks, Germany, France, Italy, and Spain have tightened their foreign investment laws to prevent hostile acquisitions. In the past, Chinese companies have escaped the kind of scrutiny in India that their investments have attracted in the West, despite several prominent investments and acquisitions. In America, the Committee on Foreign Investment in the United States (CFIUS) conducts reviews of foreign investment which may lead to control of an American entity 2. CFIUS's main focus is on investments involving Chinese state-owned or controlled investors and investments in industries like finance and technology.
While the change in the FDI policy has been largely received as a welcome move except perhaps by the start-up community who will have one source of funding shut off, it has also left open some questions. It is unclear how the government will monitor investments that are routed through various shell companies. Estimating the actual investment flows from China and Chinese companies could be difficult because many investments in Indian companies are routed through Hong Kong, Singapore or other third-party countries which don't share a border with India. Further, it is also not clear if this is a temporary arrangement or something that will stay on. The amendment will also impact transactions and investments that were at advanced stage of negotiations or waiting completion. It would be interesting to watch the approach the Government adopts in dealing with proposals submitted to it for approval post this amendment. Will it reject all proposals or adopt a nuanced approach to reject proposals that it perceives to be a threat to national security or India's strategic interest or involve investment in certain specific sectors. The Government would have done well to clarify the ambiguities and loopholes that the amendment leaves open for the new regime to be effective. May be there is a purpose behind not doing so.
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