The Ministry of Finance has on April 22, 2020 and April 27, 2020 published the Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020 (“Amendment Rules”) and the Foreign Exchange Management (Non-debt Instruments) (Second Amendment) Rules, 2020 (“Second Amendment Rules”) respectively to amend the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”).

Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020

The Amendment Rules have come into force due to the current Covid – 19 pandemic and is to curb the opportunistic takeover/acquisition of Indian companies.

Prior to the amendment of the NDI Rules, foreign investment was permitted under automatic route for countries such as China, Hong Kong, etc., unless the sectoral policy prescribed for approval. However, with the Amendment Rules, an entity of a country, or beneficial owner of an investment from a country, which shared its land border with India, shall invest in an Indian company only with the prior approval of the government. The Amendment Rules also require the approval of the government where foreign investment in form of transfer of ownership of any existing or future foreign direct investment results in the beneficial ownership or investment from a country, which shared its land border with India.

The countries falling within the ambit of these Amendment Rules are Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal and Pakistan. It is unclear whether Hong Kong and Taiwan would be seen to be covered within the ambit of the Amendment Rules.

Beneficial Ownership Deconstructed:

The NDI Amendment Rules do not define the term beneficial ownership. Therefore, the concerned parties would have to rely on the Companies (Significant Beneficial Owners) Rules 2018 and/or the Prevention of Money- Laundering (Maintenance of Records) Rules, 2005 (“PMLA Rules”) to apply the threshold for being a beneficial owner. However, both the Rules define the term differently as the threshold under the Companies Act for significant beneficial ownership is a person who holds indirectly, or together with direct holdings, at least 10% of the shares or voting rights of the share; or has the right to receive or participate in at least 10% of the total distributable dividend, or any other distribution, in a financial year; or who exercises significant influence or controlin any manner other than through direct holding alone whereas under PMLA Rules, in case of a company, it is ownership of or entitlement to at least 25% of shares or capital or profits of the company or who has the right to appoint majority of the directors or control management or policy decisions; in case of partnership firm, incorporated associations or body of individuals, it is 15% of the capital or its profits, and in case of a trust, it is at least 15% of interest in the trust.

The government should clarify the meaning of beneficial ownership at the earliest. In the absence of a clarification, it is implied that any foreign investment, whether direct or indirect, from such countries will require approval of the government.

It is also not clear whether the Amendment Rules would apply to rights issue, bonus issue, and whether even rights issue and bonus issue would require government approval.

Foreign Portfolio Investment (“FPI”):

A question that arises is whether FPI, that is, an investment which is less than 10% of the equity capital of a listed company would be impacted by the Amendment Rules. Presently, it appears that the Amendment Rules do not apply to FPI investment.

Foreign Exchange Management (Non-debt Instruments) (Second Amendment) Rules, 2020

Renunciation of Rights

Section 62 of the Companies Act, 2013 states that at the time of a rights issue, an existing shareholder has the right to renounce the shares offered to him or any of them in favour of any other person.

The Central Government has omitted the explanation of Rule 7 and introduced Rule 7A which states that in the event a person resident in India renounces their right to equity shares to a person resident outside India, then the pricing guidelines specified under the NDI Rules are to be abided by the issuing company.

The explanation to the NDI Rules provided that a person resident outside India was permitted to invest in equity instruments (other than share warrants) issued by an Indian company as a rights issue that were renounced by the person to whom such equity instruments were offered to. However, there was no pricing guidelines that were provided for the same. Thus, before the Second Amendment Rules, the following was to be complied with:

• in case of a listed Indian company, the rights issue to persons resident outside India shall be at a price determined by the company; and
• in case of an unlisted Indian company, the rights issue to persons resident outside India shall not be at a price less than the price offered to persons resident in India;

This led to many entities taking advantage of the lacuna and many foreign investors acquired equity instruments issued by an Indian entity for a cheaper price. This is commonly known as a designed rights issue.

Thus, the Central Government has endeavored to plug this loophole through the Second Amendment Rules. Therefore, post the enforcement of the Second Amendment Rules, the issue price of the shares subscribed by a person resident outside India pursuant to the renunciation would be as follows:

• in case of an unlisted company, the price should not be less than fair value computed as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India (“SEBI”) or a practicing Cost Accountant; and
• in case of a listed company, the pricing shall not be less than price arrived as per applicable SEBI guidelines. If renunciation of shares is treated as rights issue then the pricing can be done as rights issue pricing guidelines. However, if shares issued pursuant to renunciation were to be treated as separate from rights issue, then the price should be determined in such a situation as there are no relevant SEBI guidelines dealing with pricing of shares issued pursuant to preferential issue. Considering that as per presently applicable SEBI regulations there is no differentiation on pricing of shares issued pursuant to renunciation, it appears that the former approach is better and if that is the case, it may be concluded that there is no impact of this amendment to subscription of renunciation of rights shares by the shareholders in a listed company.

If the renunciation is in favour of Non-resident Indian (“NRI”) or an Overseas Citizen of India (“OCI”) and the shares proposed to be acquired on non-repatriation route, then in such a situation the NRI or OCI may acquire the shares at the rights issue price as pricing restrictions are not applicable to investment on non-repatriation basis.

If the renunciation shares are to be acquired by foreign venture capital investor (“FVCI”), then in our view pricing guidelines would not apply as pricing guidelines are not applicable to shares issued to FVCI.

The Second Amendment Rules are silent about a situation where a non-resident renounces the rights shares in favour of another non-resident and hence it is open to interpretation as to whether pricing guidelines as per the Second Amendment Rules will have to be complied with in such a situation.

Another interesting question that arises is where a non-resident renounces the rights shares in favour of a Foreign Owned and Controlled Company Incorporated in India (“FOCC”) or whether FOCC renounces the rights shares in favour of another FOCC, will such FOCC (renunciation) also have to comply with pricing guidelines as per the Second Amendment Rules for subscription to shares to be acquired pursuant to renunciation.

Liberalization of foreign investment in insurance intermediaries

The Central Government has increased the cap for FDI in insurance intermediaries from 49% to 100%. Insurance intermediaries would be insurance brokers, insurance consultants, corporate agents, third party administrators among others. This amendment comes as a relief to many, as persons not resident in India may now invest 100% in insurance intermediaries, provided they would be verified by the Insurance Regulatory and Development Authority of India (“IRDAI”). It is noted that the sectoral cap for insurance companies still remains at 49%.

Foreign investors wanting to hold majority shareholding in an insurance intermediary shall comply with the following conditions, as per the Second Amendment Rules:

• be incorporated as a limited liability company under the provisions of the Indian Companies Act, 2013;
• at least one from among the Chairman of the Board of Directors or the Chief Executive Officer or Principal Officer or Managing Director of the insurance intermediary shall be a resident Indian citizen;
• shall take prior permission of the IRDAI for repatriating dividend;
• shall bring in the latest technological, managerial and other skills;
• shall not make payments to the foreign group or promoter or subsidiary or interconnected or associate entities beyond what is necessary or permitted by the Authority;
• shall make disclosures in the formats to be specified by the IRDAI of all payments made to its group or promoter or subsidiary or interconnected or associate entities; and
• composition of the Board of Directors and key management persons shall be as specified by the concerned regulators.

It has been further clarified that where an entity like a bank, whose primary business is outside the insurance area, is allowed by IRDAI to function as an insurance intermediary, the foreign equity investment caps applicable in that sector shall continue to apply, subject to the condition that the revenues of such entities from the primary (noninsurance related) business must remain above 50% of their total revenues in any financial year.

Amendment to Single Brand Retail Trading (“SBRT”)

The amendment made under SBRT is clarificatory in nature. It states that the sourcing norms shall not be applicable up to three years from the commencement of business. Commencement of business earlier only included opening of the first store, but post the amendment it also includes first store or an online retail store, whichever would be earlier.

Divestment by FPI

On breach of investment limit by FPI, FPI has an option to divest or reclassify their investment as FDI. Now the divestment or reclassification is subject to additional conditions, if any, specified by SEBI and the Reserve Bank of India (“RBI”) in this regard. No conditions have been specified so far. However, given the amendment SEBI/RBI may specify further conditions.

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