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FOREIGN INVESTMENT IN INDIAThe Impact of Press Notes 2, 3 and 4 of 2009

August 26, 2009

By Shardul Shroff

Privileged & Confidential 2

Outline

Foreign Investment Policy: A Historical Overview

Foreign Investment: Facts and Figures

Legal Framework Governing Foreign Investment

Press Note 2 of 2009 – 13th Feb 2009




FOREIGN INVESTMENT POLICY A HISTORICAL OVERVIEW


A Historical Overview: Pre-2000

Pre-1991- “Careful regulation” of foreign capital and enterprise –

FERA- Hardly any foreign inflows, mostly reliance on foreign

debt 1991-92

- Balance of payments crisis led to IMF-induced liberalization

- Automatic route (Annexure III) – FI <= 51% permitted in various sectors

- Portfolio investment by FIIs allowed


A Historical Overview: Pre-2000

1996-97- FIPB set up - facilitation of expeditious approvals through

nodal agency- Automatic route expanded with increase in sectoral caps

1999- FEMA - Fundamental shift in philosophy and

liberalization


A Historical Overview: Post-2000

Sectoral classification- Prohibited List- Approval Route – with / without sectoral caps- Automatic Route - with / without sectoral caps (most

sectors)• Shift from ‘Positive List’ to ‘Negative List’

FDI sectoral caps exclusive of FII investment- Per recommendations of Expert Committees (2004 &

2005) Some Grey Areas

- “Opco Holdco” issue- FIPB approval for issue of warrants- FII v. FDI- FVCI regime


FOREIGN INVESTMENT:FACTS AND FIGURES


Foreign Investment: Facts and Figures

+Source: IMF Statistics 2008 *Source: DIPP Factsheet on FDI (May 2009)

Goldman Sachs BRIC Report 2007: “…if India can fulfill its growth potential, it can become a motor for the world economy.”- 2nd fastest growing economy in the world

4th largest economy in the world in terms of PPP+

Foreign Investment from August 1991 to May 2009 = USD 110 Billion*


Facts and Figures:FDI inflow (1970 – 2009)

0

20

40

60

80

100

120

'70-'80 '81-'90 '91-'00 '01-'09

FDI

(In

USD

Bn)

Source: RBI Bulletins


Facts and Figures:FDI Inflow - India v. China

0

10

20

30

40

50

60

70

80

90

100

'90-'91

'91-'92

'92-'93

'93-'94

'94-'95

'95-'96

'96-'97

'97-'98

'98-'99

'99-'00

'00-'01

'01-'02

'02-'03

'03-'04

'04-'05

'05-'06

'06-'07

'07-'08

India

China

(FD

I in

US

D B

n)

Source: RBI Bulletins, US-China Business Council Statistics


Facts and Figures:Inflows - FDI v. FII

0

5

10

15

20

25

30

35

'95-'96

'96-'97

'97-'98

'98-'99

'99-'00

'00-'01

'01-'02

'02-'03

'03-'04

'04-'05

'05-'06

'06-'07

'07-'08

FDI

FII

(In

USD

Bn)

Source: RBI Bulletins


Facts and Figures:Sectoral Distribution of FDI in 2008

Services

Computer Software andHardware Telecom

Construction

Housing and Real Estate

Automobiles

Power

Metallurgical Industries

Petroleum and NaturalGasChemicals

Source: DIPP Factsheet on FDI (May 2009)


LEGAL FRAMEWORK GOVERNING FOREIGN INVESTMENT


Legal Framework: Sources of Law

Multiple entry routes for foreign investment into India- FDI / FII / FVCI

FDI framework is governed by- FEMA 1999 - rules and regulations thereunder, primarily

FEMA 20- FDI Policy and Press Notes- Primarily regulated by FIPB and RBI- FDI in certain financial services activities regulated by

SEBI / RBI FII

- SEBI FII Regulations, 1995 & FEMA 20 FVCI

- SEBI FVCI Regulations, 1996 & FEMA 20 Sector specific regulators: IRDA, TRAI, DoT


Legal Framework: Government Agencies

Ministry of Finance Minister: Mr. Pranab Mukerjee

Ministry of Commerce and Industry Minister: Mr. Anand Sharma

Government of India

FIPB Unit: approves FDI proposals, encourages FDI, reviews FDI policy and offers suggestions to the DIPP Director: Mr. Prabodh Saxena

DIPP: Promotes and formulates FDI policiesSecretary: Ajay Shankar Joint Secretary: Mr. Gopal Krishna

FIIA: facilitates implementation of FDI approvals, addresses concerns of investors

FIPC: attracts FDI into the country

Department of Economic AffairsJoint Secretary: Dr. Anup K. Pujari


Legal Framework: Routes

FDI FII FVCI

• No special registration

• Investment limits per sector specific rules

• Entry/Exit price regulated

• Entry on market not permitted

• Pre IPO-lock in

• Most commonly used entry route

• SEBI & RBI Registration

• Aggregate investment up to 24% or FDI sectoral caps (with shareholder approval)

• Maximum of 10% per FII or 5% per sub account per target

• Entry - direct or on market

• Exit on market• Pre IPO – lock in• Registration 4-6 weeks

• SEBI & RBI Registration• Recent RBI limitation to

10 sectors • Can invest whole corpus

in DVCF• Pricing flexibility• Takeover Code

exemption• No Pre-IPO lock in if

held for 6 months• Registration 6-8 weeks or

longer


Legal Framework: FDI Entry Norms

Automatic Route- No Cap or Conditions (Eg: Manufacturing)- No Cap but with Conditions or Soft Caps

• Eg: minimum capitalizations norms for NBFCs, Real Estate- With Cap (no express see through) (Eg. Scheduled Air

Transport Services)- With Cap (see through under specific statute / rules) (Eg:

Insurance) Approval Route

- No Cap (Eg: Tea, Courier)- With Cap (no express see through) (Eg: Single-brand

Retail)- With Cap (see through under specific rules) (Eg:

Broadcasting)


Legal Framework: FDI Entry Norms

Automatic cum Approval Route- Eg: Telecom automatic upto 49%, approval to go up to

74% Prohibited Sectors (Eg: Multi-brand Retail)


PRESS NOTE 2 OF 2009


Press Note 2: Holding Structure

Son

Father

Grandfather

Overseas

India

Direct

Indirect

The New Vocabulary


Press Note 2: Key Concepts

New norms for computation of foreign investment Direct foreign investment

- All investment directly by a non-resident entity Indirect foreign investment

- ‘Father’ owned and controlled by resident Indians - NO see through

- ‘Father’ owned or controlled by non-residents – FULL see through

» Case 1: Majority foreign shareholding and / or foreign control» Case 2: 50:50 ownership / joint control

• Exception WOS (100% subsidiaries)- Review of inter-se agreements

“Grandfathering” of existing investments


Press Note 2: Some Issues

Definition of ownership?- Beneficial ownership - 187 C declaration / pledged shares

- Convertible instruments*

- Widely held companies without promoters?

Effect / rationale for exclusion of public sector banks and financial institutions for I&B and Defense sector (numerator, denominator or both?)

* DIPP officials have indicated that convertible instrument would be counted only upon conversion


No. Rule of foreign investment in Son

FIPB approval Change

1. No sectoral cap NoYes (PN 4)

2. Sectoral cap (under automatic route)

No(filing may be required) Yes (PN 4) ?

3. With prior Government approval

Yes(if inter-se agreement) Yes

4. Banned (eg. Retail, non-compliant Real Estate)

??? Yes ???

Press Note 2: Snapshot Indian Owned & Controlled

Indian “Father”


No. Rule of foreign investment in Son

FIPB approval Change

1. No sectoral cap No No 2. Sectoral cap (under

automatic route)No

(if within caps & no change of control)

Yes (full see-through)

3. With prior government approval

Yes(plus filing inter-se

agreement)

Yes (full see-through, no

prorating)

4. Banned (eg. Retail, non-compliant Real Estate)

Not permitted No

Press Note 2: SnapshotForeign Owned or Controlled

Foreign “Father”


Press Note 2: Illustrations

Son

Father

Indian Foreign

49%

Case I – Indian Owned & Controlled

74%

Foreign Investment = 0

51% withcontrol

Son

Father

Indian Foreign

Foreign Investment = 74%

74%

49%

Case II – Foreign Owned Father

51% (without control)



Son

Father

Indian Foreign


74%

49% (with control)

51%

Case IV – Foreign Controlled FatherCase III – Indian Foreign 50:50 JV

Son

Father

50%

Indian Foreign


74%

50%



Son

Father

Indian Foreign

51%

Case VI – WOS by a Foreign Father

100%


49% (with or without control)

Son

Father

Indian Foreign


74%

49%

Case V – Foreign Owned & Controlled

51% (with control)


Press Note 2: Illustrations: Insurance

Pre & Post PN 2 Pre & Post PN 2

Insurance JV

JV PartnerOther Foreign Co.

Indian Co.

Indian promoter

10%26%

74%

90%

• Foreign Investment = 26% (Automatic Route)• Other Foreign Co. investment ignored.• Based on FIPB ratified market practice

Insurance JV

JV Partner

Indian promoter

10%17%

83%

90%

• Foreign Investment = 17% + 10% of 83% = 25.3% (Automatic Route)

Indian Co.

Nothing’s Changed


Press Note 2: Illustrations: Defense

Son

Father

Indian Group Foreign

26% (without control)

51% (with control)

49%

51%

Foreign Investment = 26%(FIPB Approval)

After PN 2 Additional conditions for I&B and Defense

51% single Indian shareholder / group

Excludes public sector banks and public financial institutions

Binding agreement to exercise control collectively


Press Note 2: Illustrations: Telecom

Son

Father

Indian

Son

Father

Foreign

49% 49%

74%

Foreign Investment = 49% of 74% = 36.26%

Indian Foreign


74%

51% (with

control)

51%

Before After

Indian Father


Press Note 2: Illustrations: Telecom

Son

Father

Indian

Son

Father

Foreign

51%51%

74%

Foreign Investment = 51% of 74% = 37.74%

Indian Foreign


74%

49%49%

Before After

Foreign Father



Applies to Sectors where FDI upto 100% not permitted under automatic route

FIPB / Government approval required when: - Indian company established with foreign ownership or

control

- Ownership or control of Indian company acquired by non-resident

• Consequent upon Transfer of shares

Foreign investment includes all types



Sectors directly impacted - Scheduled air transport, ground handling service, banking

– private

- Insurance, telecom, non-scheduled air transport (to the extent foreign shareholders acquire control through shareholder arrangements)

Impact on open offers under the SEBI Takeover Regulations



“Guiding principle” is that foreign investment by foreign Father would be governed by same norms as applicable to direct foreign investment- You can only do indirectly what you can do directly

“Operating’ & ‘Investing” Companies defined “Operating cum Investing” company – amalgam of 2

- No threshold of operations or investment prescribed

Sectoral caps and other requirements apply both at the level of “foreign Father” and Son



Current FIPB issue in relation to prior approval for foreign investment in operating cum investing companies has ended prospectively, but no “grandfathering” – compounding issue seems to continue for existing structures (para 7 PN 2)

Foreign Investment irrespective of amount or extent in “Investing Companies” (Indian or foreign Father) requires prior FIPB approval- This requirement cannot be got around by using shell

companies for downstream investment on the basis that they will commence operations in future (paras 4.2.2, 4.2.3 & 5)

Post facto notification requirements prescribed (para 6)



SEBI / RBI pricing norms for issue and transfer apply to downstream investment in Son

Bar against leverage by foreign Father if it is an Investing Company – continuation of policy

Old Press Note 9 (1999) and para 11 of Press Note 3 (1997) is DELETED!!

VERDICT – GREAT NEWS!!

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foreign debt

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