Foreign funding is important to bridge the huge fund gap of investment in infrastructure in India, which in turn will spur economic growth. According to a recent report, the inflow of foreign direct investment (“FDI”) was US $ 28 billion in 2013, an increase of 17% over the previous year. The services sector attracted the highest FDI inflows in FY14 with US$ 2.25 billion, followed by the construction & development and telecommunication industries, but this is still a drop in the ocean.
Based on the recommendations of the Foreign Investment Promotion Board (“FIPB”) in its meeting held on 4th July, 2014, the Indian Government has approved 14 proposals of FDI, several in the pharmaceutical sector, amounting to Rs. 1528.38 crores. The Cabinet has recently announced increase in the sectoral caps in defense and is doing its utmost to increase the cap on insurance to 49%. This year, the government has announced a slew of policy reforms besides introducing certain new and amended definitions.
Control and group company
The concept of the term ‘control’ has been broadened. Earlier, the parameter for determining “control” was “the power to appoint a majority of directors in a company. The definition of “control” is now inclusive and “includes the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreement” bringing it closer, if not exactly in line with, the Companies Act, 2013 and the Takeover Code.
The phrase ‘Group company’ has been newly added to the extant FDI policy of India (“FDI Policy”) and means “two or more enterprises which, directly or indirectly, are in a position to (i) exercise twenty-six percent or more of voting rights in other enterprises; or (ii) appoint more than fifty percent of members of board of directors in the other enterprise”.
Revision in sectoral caps
Several sectoral caps in important sectors under the FDI Policy have been revisited and some of them currently stand as in the following paragraphs.
FDI up to 100% is permitted in Pharma but through automatic route only in cases of greenfield investment or a new venture and through the government approval route in cases of brownfield or existing companies. The government has decided not to permit ‘non-compete clauses’ in the agreements to be entered into by foreign investors with Indian entities, except in special circumstances with the prior approval of the FIPB. Additionally, the FDI Policy stipulates submission of a certificate by the prospective investor and the prospective investee (a brownfield entity) to the FIPB, providing a complete list of all agreements entered into between such investor and investee.
FDI up to 49% has been permitted in the defence sector under the government approval route with control and ownership in Indian hands. Approvals even beyond 49% will be permitted on a case to case basis, wherever it is likely to result in access to modern and ‘state-of-art’ technology in the country. Foreign investment limit is composite and includes FDI, foreign institutional investors (“FII”), foreign portfolio investors (“FPI”), non-resident Indians, Qualified Foreign Investors and Foreign Venture Capital Investors. Portfolio investment is under the automatic route and total of all such non strategic foreign investment is capped at 24% cumulatively.
FDI in this crucial sector has been enchanced up to 100% with 49% under the automatic route beyond which prior approval of the government will be required, subject to observance of licensing and security conditions by licensee as well as investors as notified by the Department of Telecommunications from time to time, except “Other Service Providers”, which are allowed 100% FDI on the automatic route.
Single brand product retail trading
FDI up to 100% under the government route was permitted earlier in this sector. The cap has been revised and now FDI up to 49% is permitted under the automatic route beyond which prior approval of the government will be required.
Multi-brand retail trading
The government has announced its in principle opposition to foreign investment in multi-brand retail trading but has not vetoed the earlier policy of the previous government in this sector.
Backend infrastructure - The earlier condition requiring at least 50% of total FDI brought in to be invested in 'backend infrastructure' of the company receiving FDI within three years of receiving the first tranche of FDI has been modified and now at least 50% of total FDI brought in the first tranche of US $ 100 million is to be invested in 'back-end infrastructure' within three years. Subsequent investment in backend infrastructure would be made by the multi-brand retail trading retailer on a need basis depending upon its business requirements.
Mandatory sourcing - The other significant change in this sector addresses the issue of minimum mandatory sourcing requirement. Under the erstwhile regime, companies with FDI in this sector were required to source at least 30% of the value of procurement of the manufactured or processed products from ‘small industries’ that have a total investment of not more than USD 1 million in plant and machinery. The aforesaid requirement has been revised with respect to the limit of total investment by ‘small industries’ in plant and machinery, which has now been increased to a maximum of USD 2 million.
This is the most recently opened sector under the FDI Policy and in terms of the revised FDI Policy, 100% FDI in the automatic route has been permitted in several segments of railway infrastructure including high speed train projects, dedicated freight lines, railway electrification, signaling systems and passenger terminals. FDI in these activities open to private sector participation including FDI is subject to sectoral guidelines of Ministry of Railways and proposals involving FDI beyond 49% in sensitive areas from security point of view, will be brought by the Ministry of Railways before the Cabinet Committee on Security (CCS) for consideration on a case to case basis.
The earlier onerous condition of compulsory divestment by the foreign investor of 26 per cent equity of the company in favour of the Indian partner or Indian public within a period of 5 years has been dispensed with.
FDI in the test marketing industry was permitted up to 100% under the government route. Recently, FDI in this sector has been brought under the automatic route and the very sectoral cap in the FDI Policy has been done away with.
Unlisted companies to raise capital and partly paid equity shares and warrants
Some of the other major reforms brought about in the FDI Policy include unlisted companies being allowed to raise capital abroad through depository receipts or convertible bonds without the requirements of the prior or subsequent listing in India, subject to certain conditions and timelines and partly paid equity shares and warrants issued by an Indian company in accordance with the provision of the Companies Act, 2013 and the SEBI guidelines, as applicable, being eligible instruments for the purposes of FDI and FPI by FIIs or Registered Foreign Portfolio Investors, subject to compliance with FDI and FPI schemes.
The Reserve Bank of India has also issued new pricing guidelines applicable on Indian companies for providing greater freedom and flexibility to the parties concerned under the FDI framework, wherein the fair value in respect of both transfer and issue of shares and exit from investment will be worked out as per guidelines different from those applicable under the earlier regime.
In case of listed companies, the issue and transfer of shares including compulsorily convertible preference shares and compulsorily convertible debentures shall be as per the SEBI guidelines and the pricing guidelines for FDI instruments with optionality clauses shall continue to be in accordance with the existing regime wherein the non-resident investor shall be eligible to exit at the market price prevailing on the recognised stock exchanges, subject to lock-in period as stipulated, without any assured return.
In case of unlisted companies, the issue and transfer of shares including compulsorily convertible preference shares and compulsorily convertible debentures with or without optionality clauses shall be at a price worked out as per any internationally accepted pricing methodology on arm’s length basis. Accordingly, the guiding principle will be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment or entering to an agreement and shall exit at a fair price computed as above at the time of exit subject to lock-in period requirement as applicable in terms of the existing conditions on the subject.
[The author is a Principal Associate, Corporate Practice, Lakshmikumaran & Sridharan, New Delhi]