China's central bank faces uncertainty over HDFC Bank's bonus issue due to Chinese investment norms

The People's Bank of China (PBC), China's central bank, faces an unusual predicament regarding its stake in HDFC Bank, as India's largest private lender gears up for its first-ever bonus share issuance.

According to legal experts, PBC could find its entitlements caught in regulatory uncertainty over Press Note 3, a circular issued by the Indian government in 2020, primarily seen as an attempt to curb Chinese investments in India.

The board of HDFC Bank will on July 19 take up the bonus issue proposal along with the results for the June quarter.

The ambiguity arises because Press Note 3 mandates prior government security clearance for any fresh allotment of shares to Chinese entities. While a bonus issue does not involve new capital inflow or a change in shareholding percentage, legal experts say the sheer increase in the number of shares held by PBC could technically trigger the regulation.

"The shareholding structure and percentage in capital structure, before and after the bonus issuance, remain unchanged. However, if one were to go by the literal interpretation of Press Note 3, then it appears to be a violation. However, in substance, there is no additional issuance of shares, resulting in a change in inter-se shareholding percentage. This issue requires clarification from the government," said Amit Singhania, partner, Areete Law Offices.

As of March 31, official filings by HDFC Bank show that  PBC holds 3.4 crore shares, valued at approximately $800 million and representing about a 0.5 percent stake in the lender. This follows a period in 2020 when the PBC's stake in the erstwhile HDFC (now merged with HDFC Bank) briefly crossed the 1 percent threshold, sparking concerns in Indian financial markets about potential Chinese influence over strategic domestic companies.

Time for clarity

Market participants in the past have highlighted the ambiguous wording of Press Note 3, as it lacks clear guidance on corporate actions such as bonus issues or stock splits.

"While bonus issuances are typically regarded as non-cash corporate actions, the ambiguity under Press Note 3 creates a regulatory grey area in cases involving entities from countries sharing land borders with India," said Ankita Singh, founder of Sarvaank Associates. “In the absence of a specific exemption, such issuances may still invite regulatory scrutiny, particularly when the beneficiary is a state-owned or state-controlled entity, such as the PBC.”

The PBC is registered as a Foreign Portfolio Investor (FPI) with India's market regulator, holding investments in about a dozen Indian companies, though its stake in all these remains below 1 percent.

Technically, PN3 only covers Foreign Direct Investments(FDI) and not FPI investments. However, since the bonus shares are being issued by the company and not being purchased by FPI from the open market, it may fall under the purview of PN3, legal experts said.

"While a bonus issue does not involve any fresh inflow of foreign capital, it nonetheless results in an increase in the number of shares held by a foreign investor," said Tushar Kumar, an Advocate at the Supreme Court of India. "Given the sensitivities around strategic sectors and the evolving regulatory landscape under Press Note 3, even passive corporate actions like bonus issuances may trigger the need for government scrutiny when it involves entities from countries sharing land borders with India like China. In the absence of express exemptions, compliance risk cannot be ruled out."

Emails sent to PBC and HDFC Bank seeking comment remained unanswered at the time of publishing this article.

Anupriya Saxena, partner at corporate consultancy firm JMJA & Associates, said, "While bonus shares don’t alter ownership percentages, they do increase the absolute number of shares held, potentially strengthening a foreign entity’s influence over time. In sensitive sectors like banking, this could be perceived as a backdoor increase in foreign entitlements."

Industry observers and legal professionals have urged the government to provide a much-needed clarification on the applicability of Press Note 3 restrictions on corporate actions like bonus issuances.

They point to a recent precedent when the government issued a similar clarification on Press Note 2, which governs FDI in so-called prohibited sectors. The clarification said corporate actions like bonus issuances do not constitute fresh investment, clearing the path for the Indian tobacco companies to proceed with bonus issues and stock splits.

"The lack of a clear carve-out in the policy framework puts both the company and the investor in a bind, forcing them to navigate between commercial entitlements and geopolitical sensitivities," said Raheel Patel, partner at Gandhi Law Associates.