Background

Earlier this week, as a part of a broader set of key decisions, the Union Cabinet announced modification to India’s foreign investment regulatory framework on cross-border investments originating from countries sharing land borders with India (“LBC”). The changes announced are significant as they indicate a recalibration of the Government’s approach to certain categories of investments in India by LBC investors. The move is aimed at encouraging increased foreign capital flows in strategic industry sectors (with an emphasis on manufacturing capital goods, electronic capital goods, electronic components polysilicon and ingot-wafer (“Focus Sectors”)). They also clarify the applicability of the Government approval route to certain LBC investors, and the reducing regulatory approval timelines for such investments.

India’s foreign investment rules pertaining to LBCs were originally introduced in the midst of the COVID-19 pandemic to curb opportunistic takeovers of Indian companies by (1) foreign investors from LBCs, or (2) foreign investors which were beneficially owned by persons (a) situated in LBCs, or (b) who were citizens of LBCs (“LBC Investors”) pursuant to  the now well-known Press Note 3 of 2020 (“PN3”). Under the PN3, LBC Investors were mandated to obtain prior approval from the Indian government for investments in Indian companies through the FDI route.

One of the key challenges for deal-making that quickly became apparent to transacting parties at the time was that the terms “beneficially owned” or “beneficial ownership” remained undefined under PN3. In the absence of a definition or an explicit clarification by the Government, market practice evolved to interpret “beneficially owned” by referring to the thresholds under the Prevention of Money Laundering (Maintenance of Records) Rules, 2005 (prescribed as 10% of the shares, or capital or profits through an amendment in 2023 (from 25% prior to the amendment), and 10% of shares or voting rights (based on the definition of “Significant Beneficial Owner” under the Companies Act, 2013). M&A deal flow continued with parties assessing whether the beneficial ownership in LBC Investors reached or crossed such thresholds.

Other potential investments that crossed the prescribed thresholds were progressed through prior governmental approval route. However, the regulatory review process had no projected timeline for completion impairing transacting parties’ ability to visualize overall M&A timelines and also undermining deal certainty.

Changes and Impact

There are four key parameters that appear to have been addressed by the Union Cabinet’s decision. First, the Government aims to codify the 10% beneficial ownership threshold (“LBC BO Threshold”); secondly, foreign investors that have a non-controlling beneficial ownership from LBCs, can proceed to invest without prior government approval (assuming other sectoral or FDI-linked approvals are not triggered); thirdly, the Government proposes to cap the regulatory process timeline for approval applications to 60 days for LBC Investors investing in Indian owned and controlled entities engaged in businesses in the Focus Sectors; and finally, the Cabinet Secretary will be empowered to revise the list of such industry sectors.

The codification of the LBC BO Threshold is expected to provide more comfort to market participants and increase deal execution speed since cross-border transactions involving foreign investors not based in LBCs, but which have a nominal amount of beneficial ownership from LBCs (below the prescribed LBC BO Threshold), can now quickly assess the requirement for a Government approval, and proceed to either close transactions, or apply for such approval.  However, the press release pertaining to the Union Cabinet’s decision provides an additional compliance requirement, mandating that the Indian investee entity report such investments to the Department for Promotion of Industry and Internal Trade (“DPIIT”).

The Government’s decision to process investment proposals from LBC Entities in the Focus Sectors in a time-bound and expeditious manner signifies a measured approach to encourage global capital to flow to industries critical for India’s continued growth. Such investment proposals must now be processed and decided within 60 days. Simultaneously, the Cabinet Secretary-led mechanism has been empowered to revise the list of specified sectors from time to time, allowing additional sectors to be introduced under this framework or existing ones to be removed in response to evolving market requirements. This will bring greater deal certainty and allow these sectors to grow more confidently. Equally important to note is that this framework only extends to Indian companies where majority shareholding and control vests with resident Indian citizens and/or resident Indian entities owned and controlled by resident Indian citizens, thereby ring-fencing these sectors from opportunistic takeovers and acquisitions – the primary objective of the original PN 3.

In essence, the key changes to the positions that were announced in the Union Cabinet’s decision can be summarised in the table below.

Conclusion

The Government’s decision is a positive policy move to enhance clarity, improve ease of doing business for foreign investments, and encourage overseas equity capital in specified Indian sectors that need impetus. This measured approach is encouraging considering India’s aim to become a regional manufacturing hub, and for providing impetus to draw FDI into the country. Now attention turns to the anticipated amendment to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, text of which will perhaps clarify certain aspects, such as the timing and content of the reporting to the DPIIT.

[1] means a company owned by resident Indian citizens and controlled by resident Indian citizens as defined in Explanation (b) and (e) respectively to Rule 23(7) of the the Foreign Exchange Management (Non-debt Instruments) Rules, 2019

[2] means a company owned by persons resident outside India or controlled by persons resident outside India as defined in Explanation (c) and (f) respectively to Rule 23(7) of the the Foreign Exchange Management (Non-debt Instruments) Rules, 2019