FDI Policy: Control, Caps, Confusion!

India’s FDI policy is one of fits and starts! If you want more detail get this - when Indian airline companies were doing relatively better and could have benefited from foreign airline investments at high valuations, the government played Swadeshi. Now when airline companies are struggling and valuations far lower, the door has been opened to foreign airlines subject to a comma! In pharma, a trend of foreign acquisitions of Indian companies spooked the government into screening and blocking what should have been automatic investments in brownfield pharma. Whereas the same concerns regarding competition can be tackled by CCI, the regulator whose job it is to do so! 100% FDI in single brand retail and 51% FDI in multi-brand retail come with several conditions. They may be justified on grounds of protection for the unorganized sector or boosting domestic sourcing but they are so confusing that despite a few rounds of clarifications, doubts still remain! ‘Control’ was defined in Press Note 2 of 2009 but is still a bone of contention. And by the way, speaking of the 2009 FDI policy changes, they were acknowledged by RBI only last month via a FEMA notification.

NO FOREIGN AIRLINES!
Nov 2004
"We first need to give a level playing field to our carriers and at a later stage we can allow foreign airlines to pick up stake in domestic airlines"
Praful Patel
Aviation Minister YES FOREIGN AIRLINES!
Sep 2012
Foreign airlines are also, henceforth, allowed to invest, in the capital of Indian companies, operating scheduled and non-scheduled air transport services, up to the limit of 49% of their paid-up capital. YES FOREIGN PHARMA!
Upto Oct 2011
Greenfield          100%                    Automatic
Brownfield        100%                    Automatic NO FOREIGN PHARMA!
Oct 2011
Greenfield          100%                    Automatic
Brownfield        100%                    Government NO FOREIGN PHARMA!
July 2013
“FDI in the pharma sector has neither proved to be an additionality in terms of creation of production facilities nor has it strengthened the R&D in the country. All these facts make a compelling case for revisiting the FDI policy on brownfield pharma.” - Anand Sharma, Commerce Minister ‘CONTROL’ DEFINIED
2009 Press Note
A company is considered as “Controlled” by resident Indian citizens, if the resident Indian citizens and Indian companies,  which are owned and controlled by resident Indian citizens, have the power to appoint a majority of its directors in that company  I could go on but my guests are awaiting their chance to speak and so let me hand over the floor to Bharat Vasani, Chief General Counsel, Tata Group; Cyril Shroff, Managing Partner, Amarchand Mangaldas and Haigreve Khaitan, Partner, Khaitan.
 
Let's start with Tuesday’s announcements - in which telecom was the biggest beneficiary, defence is dependent on government discretion and the rest saw a shift from FIPB approval to automatic, which is good but really, 5 years to do that? TUESDAY’S NEWS!
Telecom: FDI limit raised from 74% to 100%
Defence: FDI limit maintained at 26%
                Cabinet discretion to raise limit if state-of-the-art technology on offer TUESDAY’S NEWS!
49% FDI limit maintained; No FIPB approval required
- Petroleum, Natural Gas, Refining
- Commodity Exchanges
- Power Exchanges
- Stock Exchanges
- Depositories
 
Vasani: The government has its own compulsions as we all know. My sense is that they have chosen to adopt this executive policymaking for prescribing FDI policy for the country, but they are stuck on insurance and pension where they still have a legislation to control that. The problem is that, as we saw from the media reports, that the administrative ministries dealing with specific sectors are still not willing to open up the sector, particularly defence, and many other sectors. In fact media and broadcasting virtually this time there is no change at all. So, I suppose they are working with so many compulsions that this is the maximum that they could do under the circumstances.
 
Doshi: They may not be willing to open up, let’s say in defence, I get that- there are concerns there. But in industries where you have opened- for instance pharmaceuticals-you have gone back in time. Several months ago, you were hoping to provide clarity or move the process to the CCI that hasn't happened and now you have several deals either stuck or waiting for clarification. FDI POLICY: PHARMA REWIND
Upto Oct 2011
Greenfield          100%                    Automatic
Brownfield        100%                    Automatic Oct 2011
Greenfield          100%                    Automatic
Brownfield        100%                    Government
 
Shroff: Absolutely and that was going to be my initial comment as well that I am almost missing pre-991 because there you could at least go and get an approval and be clear. So, de facto we have just gone back and slid back to almost like a licence raj and while we have paid a lot of lip service to welcoming foreign investment and we are attracting it, the reality of everything put together including the ambiguities in the FDI policy and all the other cognate legislations that work together- as a nation we have sent every possible negative message out to the world in terms of we say we want foreign investment but we are going to do everything possible for you not to come, we are going to create as many hurdles as possible for you. I think that is how I am feeling or rather my clients are feeling when they talk to us. There is enormous frustration in terms of India's attitude to FDI.
 
Doshi: It is not just big ticket decisions or the big ticket issues. It is even in simple things like the drafting for instance if you see the single brand or the multi brand policies- there has been so much back and forth on what does this really mean, the latest clarification seems to rule out franchising all together or the infamous comma in the aviation policy what impact is this having- do you think Tuesday's events moved the needle further at all for a country that desperately needs investment? FDI POLICY: AVIATION COMMA!
Sep 2012
Foreign airlines are also, henceforth, allowed to invest, in the capital of Indian companies, operating scheduled and non-scheduled air transport services, up to the limit of 49% of their paid-up capital.
 
Khaitan: Honestly once again a lost opportunity I would say. So much hope was built that over the last year, year and a half, there has been this maze of uncertainty and there is a lot of hope built that this will be an opportunity to do some clean up, clarify some of this, make it simple but what we saw was cosmetic changes.
 
Doshi: Especially the discretion part in defence which if you wanted to look at it positively you could say if I am bringing state of the art technology, I have the opportunity to even exceed 40 percent or 49 percent.
 
Khaitan: So, it’s much better to have 49 percent of 26 percent clearly rather than a discretionary 49 percent.
 
Shroff: How many people exercise their discretion because every regulator on the same issue is having multiple stance at the same topic.
 
Vasani: 1.1.2 of the government policy says- the government of India has put in place a policy framework on foreign direct investment which is transparent, predictable and easily comprehensible.
 
Doshi: You want to challenge all those three objectives?
 
Shroff: I would challenge all the three at this point of time.
 
Doshi: The one thing that didn’t happen on Tuesday again is that we were hoping there would be some clarification on the definition of ‘control’. Actually control has been defined in the FDI policy, it was defined in the 2009 Press Note 2 but since then there has been some confusion and that is yet not been dealt with. The minister keeps promising us that we will get an expanded definition of control – one that is probably similar to what the takeover code has or goes even beyond that. I am going to put this question to you Mr Shroff. How much trouble is this existing definition of control, which is not the actual definition of control, proving to be for investments? FDI POLICY: ‘CONTROL’
2009 Press Note
A company is considered as “Controlled” by resident Indian citizens, if the resident Indian citizens and Indian companies,  which are owned and controlled by resident Indian citizens, have the power to appoint a majority of its directors in that company TAKEOVER CODE: ‘CONTROL’
1997
“control” includes the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner:
 
Shroff: Firstly the concept of control is hard to define in any jurisdiction in the world. It’s been one of those grey areas but what we have done as a country and complicated life for ourselves enormously sending out the net negative message is that we really have multiple definitions of control. So, for the same transaction you will first run into a definition of control under the FDI policy which is narrower. Then if it is a public market transaction you run into the takeover code definition. Then there is the Competition Act which has a third definition. There is a definition under the IFRS regulation which is the fourth definition. You then have the takeover code definition on the face of it – the black letter law and then you have a case law which says a lot of different things as well. So, the takeover code definition would seem, on the face of it, to be more suggestive of positive control but then you have a slew of decisions like Subhkam and others which would suggest negative control as well as a possibility. Then the fifth part is inconsistent interpretations on the same issue. Even something like negative control on specific transactions I can point to you any number of transactions where they have been applied inconsistently. Even negative control has not meant the same thing on different transactions. So, it is as clear as mud. What that means from a transaction, particularly where large stakes are involved, is that you really don’t know.
 
Doshi: But you should have anticipated this; right? Because like you pointed out SEBI has raised this objections with Subhkam, more recently with the Kamat Hotels case – I am not asking for comment on those specific cases but those instances have abounded where SEBI has raised objections with a list of rights that could amount to control including affirmative or veto rights. So, this should have been anticipated?
 
Shroff: Lets step back to basics. Control can mean one of two things at very basic simple level – the right to say yes or the right to say no. The second related question would be say yes to what or say no to what. If you want to just boil it down to the simple logic you really don’t have any consistent method of how you are going to answer this yes/no question.
 
Doshi: But we have had these conversations on control before. It is subjective and all of you have accepted that there is always going to be more scrutiny of the shareholder agreement if it is subjective definition.
 
Shroff: But directionally that is not where it is headed.
 
Vasani: To add to Cyril's point there is one more definition of control coming under the new Companies Bill which is fortunately in line with the takeover code. The objectives of the Companies Bill, the objectives of the takeover code which is to give an exit opportunity to minority shareholders in the event of any change of control, the objectives of the FDI policy to attract more FDI - they are totally different. I am not so sure whether it is advisable to take a takeover code definition and transplant it into an FDI policy. The objectives of the two legislations are completely different and if you are wanting to attract new FDI in the country which is the dire need at this stage of our current macro economic situation, I think we should adopt a definition which is precise, clear, and very definite in terms of ……(Interrupted)
 
Doshi: In that case it could only be a numerical threshold and nothing else? Vasani: Takeover code definition is very subjective and my biggest worry is if they take takeover code definition, every time a proposal goes to FIPB, the administrative ministry will have lot of discretion to say whether it results in change of control or it doesn’t result in change of control. It will be purely discretionary left to the administrative ministry and they call the shots in FIPB meeting.
 
Doshi: I am going to argue this. I thought that the Press Notes of 2009 already brought in a degree of subjectivity because while they defined ownership as more than 50 percent and they said control being the ability or the right to appoint majority directors, they also said in that, that in any sector activity where government approval is required for foreign investment and in cases where there are any inter-se agreements between amongst shareholders which have an effect on the appointment of the board of directors or on the exercise of voting rights or on creating voting rights disproportionate to shareholding or any incidental matter thereof such agreements will have to be informed to the approving authority. So, in 2009 as well they brought discretion into determining what exactly is control. It was subjective right then. Now all they are trying to do is take it away from a footnote and make it part of the definition itself as is the takeover code, what is the harm in that? The purpose is the same right? FDI POLICY: ‘OWNERSHIP’
2009 Press Note
A company is considered as 'Owned? by resident Indian citizens if more than 50% of the capital in it is beneficially owned by resident Indian citizens and/ or Indian companies, which are ultimately owned and controlled by resident Indian citizens. FDI POLICY: ‘CONTROL’
2009 Press Note
In any sector/activity, where Government approval is required for foreign investment and in cases where there are any inter-se agreements between/amongst share-holders which have an effect on the appointment of the Board of Directors or on the exercise of voting rights or of creating voting rights disproportionate to shareholding or any incidental matter thereof, such agreements will have to be informed to the approving authority. The approving authority will consider such inter-se agreements for determining ownership and control when considering the case for approval of foreign investment. Khaitan: To be honest whether you can take out all subjectivity from a definition of control may be challenging but the idea of having a consistent definition across different legislation where you are acquiring control or you have control is definitely required.
 
Doshi: So, you agree that it should be the same.
 
Khaitan: I would say that takeover code has a definition. If there are some instances which have come out, may be there needs to be a clarification as to negative control; if the intent is not meaning control- that needs to be clarified. Today the difference between positive control and negative control – negative control is being perceived as control. So, that is something which needs to be clarified. Doshi: Just before I move it to you, SEBI has told us- Mr Sinha said this in an interview- that they are looking at trying to give some guidance on the issue of veto and affirmative rights. It cannot be terribly prescriptive, you cannot draw up a list but they are looking to try and offer some clarification and we understand; that might happen very soon. Where do you stand on these differing definitions of control and whether they should stay different or they should be combined? Shroff: I tend to agree with Haigreve and not with Bharat on this. What Bharat is saying is that for different purposes, control could be different things but I think as the common sense matter because all of these factors would affect the same transaction. So control must mean the same thing regardless what the context is. However, if you have additional concerns on policy such as for aviation you might have a particular concern or for a pharma- you could introduce those additional requirements as a matter of sector regulation or as an additional conditionality but don’t play around with the English meaning of the word control. Vasani: You cannot have a universal definition because the objectives of all the legislations are very different. If you try to adopt a common definition- like if you take a takeover code definition- and transplant it into FDI policy, in my opinion it would be an immense impractical decision. Shroff: I sort of thought of it like a 2/2 metrics. If the vertical axis is a level of formality and the horizontal axis is a sort of level of control, I think you can put everything down into four boxes, which is negative or positive control de facto and negative and positive control de jure. So whether that de facto space you should regulate at all or not is where the challenge is. De jure namely whether it is 51 percent or 26 percent or 74 percent, you regulate that and that will go to your second issue of caps because that is a bright line test- it is mathematical, you know whether you are on this side or you are on that side. Doshi: It is still going to create trouble in those deals where special rights have been assigned to the incoming investor. That is exactly what you are referring to; right? The one deal in question that has been hogging the headlines is Jet-Etihad, we are not talking deal specific, you all are involved in several different deals. This is the problem that comes up several times. Khaitan: I would agree with Mr Shroff that yes, we need a consistent definition but I would also agree with you that the uncertainty or some subjectivity- you cannot do away with. You have some boundaries and to some extent clarify what Mr Sinha has said as to what negative control will not amount to positive control or what veto rights will not amount to positive control and that will all help. Vasani: Every foreign investor when he comes to India and when he is putting multimillion dollars in investment, he would like to have some protective rights to protect his investment. If he is a minority shareholder, he would like to have protective rights and if he is a strategic shareholder, he would like to have participative rights. If you say – my thing is that I would suggest in FDI policy the right to appoint majority of the board of directors or right to have more than 51 percent shareholding is a very good test, very objective; you want more FDI in the country, let us not leave it to any interpretative issues. Doshi: There are several rights that go beyond just appointing directors. Vasani: I would rather allow these transactions to go through rather than block in FDI. Today the way the situation is let us not create any further uncertainty and I think particularly FDI policy, the objective is very different. Doshi: Would you say that if you were wearing the government’s hat or the regulator’s hat; would you say the same thing? Vasani: I have been always of the view that okay; there maybe some cases of excesses but still it is better to have more FDI in the country today rather than create further uncertainty by changing the definition of control and our experience of interpreting it by different administrative ministries is not very encouraging. Doshi: Where and how would you fit the issue of caps into this because that was the other thing that we got the sense from the Arvind Mayaram Committee report that hopefully in this country, the many different levels we have of FDI limits, 26-49-51-74 percent and then all the way to 100 percent would converge to hopefully just two caps, which is 49 percent and 74 percent. That is a great move except that I would like to ask the question- are those the best two caps to have- 49 percent and 74 percent- or are you better served with 26 percent and 51 percent? The logic being that why would you spend all that money to go all the way up to 49 percent and be denied that 2 percent on being absolutely in control? MAYARAM COMMITTEE RECCO
Sector Categories 49%: Foreign Ownership & Control not allowed
74%: Indian participation/oversight necessary Vasani: The Companies Act definition of ‘control’ whether you have an ability to block an ordinary resolution which comes at 51 percent or even an ability to block a special resolution which comes at 26 percent, I see no logic in pegging somebody at 26 percent and not allowing the person to go up to 49 percent where he doesn’t get any higher control from a legal perspective. So question is why do you won’t let there be more FDI coming in the country by allowing a person who is currently capped at 26 percent? Doshi: So you agree at 49 percent and 74 percent? Vasani: There should only two caps- 49 percent and 74 percent and let us not go down to the sub-caps of different types because it doesn’t serve any purpose. Doshi: Even as we say this, the 26 percent cap for defense has been retained, we have got multibrand retail at 51 percent so I don’t think the clean up is going to happen at any time soon but principally speaking, do you think 49 percent and 74 percent is a better place to be in as opposed to 26 percent and 51 percent? Khaitan: I agree with Mr Vasani absolutely because these are the two right limits because you don’t get anything extra in terms of being 26 percent to 49 percent but look at the foreign investor, they are getting a better economic interest. Doshi: That is all you are getting and you are still being denied the 2 percent that gives you full control. Khaitan: We are talking about sensitive sectors where we don’t want to give control. We cannot give control to the foreigner. If you are talking about those sectors, at least from an economic interest perspective, they need to have enough of an economic interest and incentive to invest in the country. Doshi: Even for defence, you are saying it should be 49 percent and not 26 percent? Khaitan: How many defence players and clients who have told us that look 26 percent is not attractive enough but 49 percent might be attractive enough because you have virtually half the economic interest. Doshi: But it is still virtually half. Vasani: But we still prefer 49 percent. Khaitan: Another aspect I would like to bring out. We are talking about this whole issue of control and there is this concept about Indian owned and controlled companies allowed to do any investments. The threshold there is 49 percent- you cannot have an Indian owned and controlled threshold at 49 percent and have a sector threshold at 26 percent because the two just don’t make sense. So you can invest in an Indian owned and controlled company at 49 percent which can then invest in a regulated sector where the cap is 26 percent but you cannot invest directly more than 26 percent. So it makes no logical sense apart from the economic side, even from a regulatory framework, to have one threshold at 49 percent at that top as a holding company but bottom leave it at 26 percent. Shroff: I am in total disagreement and I will tell you why. Let us not take the last point which Haigreve made on this 49 percent through this indirect route - the Indian owned and controlled company - despite the technical reality of what Haigreve said, the fact is that that it is not in fact being applied that way. How many multi-brand transactions – just to take that example – have come in through this 49 percent road? So can you take the view in restricted sectors and get a blessing on it and without the fear of somebody coming and arresting you of having an Indian owned and controlled company, which is 51 percent and blatantly invest down in a restricted or a prohibited sector. So the ground reality of this is completely different. I am a 26 percent and 51 percent man. You either restrict them to 26 percent or 51 percent and I think there is a lot of logic to that because one represents negative control and other represents a positive control or 100. Step back to why there are caps at all? There are two reasons. One is you don’t want money flowing into that sector, for instance real estate, you might have a fear about real estate bubble being created - so you create restrictions around that or in a particular sector like agricultural land, you don’t want the money flowing into that sector at all. However you want to control the level of influence and level of influence should be measured just by two tests, the right to say no or the right to say yes which is 26 percent and 51 percent. Doshi: That is the basis for my argument for 26 percent and 51 percent. Vasani: But foreigners want higher economic interest and if you can give them 49 percent without higher control, they are happy to come. But the actual deal experience is they prefer 49 percent rather than be at 26 percent. Shroff: They would love 51 percent. Doshi: It is a punt on whether this will go to 51 percent or not. Shroff: There is always the fudge at the last 2 percent; there is all sort of stuff that happens there. Doshi: Thank you for saying that because that is the honest truth. All those who come in at 49 percent find other side letter routes, if I may use that, to have 51 percent. Shroff: Not everybody does but…(Interrupted) Doshi: Many of them right. I don’t want to generalize. Vasani: I want to make an important point on multi-brand retail. Lot of talk has happened on why people are not coming. Multi-brand retail, the single-most important factor that foreigners are not coming after the Press Note came out is the fact that it is a concurrent subject and all the States which are owned by opposition parties have said, no and it is impossible to develop a business model where you have some States where you can do the business, some States you can only have a wholesale cash and carry part but you cannot have a front-end retailing. Doshi: Actually the clarifications have made that even worse now because they said you cannot have wholesale cash and carry in the same company as retail; so you have got to break up all those elements and have different companies. Vasani: The trading being in the concurrent list - can I tell you something that even government of India is so worried at that time when the Constitution was framed. Foreign Direct Investment (FDI) doesn’t even feature in the list one, list two or the list three of the Constitution. There is no entry, so it comes under a residual category entry number 97. So tomorrow if State wants to legislate on foreign direct investment as far as retail trading is concerned, I will not be surprised. Doshi: In case of the multi-brand, central government has kept those concerns in mind. Vasani: Absolutely and in fact tomorrow the State can say I want a multi-brand retail, I want only 10 percent foreign shareholding-  they can do that as well because there is no specific entry in either of the list because they were worried about economic imperialism at that time; the East India company will come back. Khaitan: What we need is clarity. Just on this Indian owned and controlled, when we debate control and when we debate 49 percent, all we need is clarity. Can you have an Indian owned and controlled company doing any investments even in prohibited sectors, say yes or say no. Doshi: I have listed out what I thought were some of the big ticket concerns or challenges facing our ability to attract more foreign investment, would you like to add to the list? Vasani: I think the conditionality is attached to each of the FDI cap. Those are concerns which the administrative ministry needs to relook at. There is a classic case. Last year they came out with this Press Note raising all the caps in the media and broadcasting sector, cable companies, DTH companies can go from 26 percent to straight 74 percent but the cross media ownership cap was not changed. So not a single transaction has happened. Doshi: It is not just about everybody within government speaking the same language, it is also giving all the other sort of regulators connected to this speaking the same language. Classic instances RBI notifying four years after the press notes were out, now notifying press note 2, 3 and 4 through FEMA notifications. So you have got to wonder why it would take anybody four years and in those four years what damage that may have done to certain kinds of transactions? Shroff: I do not think it is that hard for somebody to tie up all these agencies together and just simplify the whole thing. This whole foreign investment framework which includes all these laws has become grotesque. Doshi: There is very little discussion that goes on before you suddenly see changes in a Press Note - that is one aspect and again with everything else in FDI policy, it is very opaque, you don’t know why  deals are being blocked, there is so much discretion and there is no way to appeal. Vasani: Technically you can challenge it in a writ jurisdiction in the High Court but courts generally don’t interfere in economic policy matters. Khaitan: I wish there was forum by which these regulators call for parties interested and say- look this is a sectoral issue we are facing, how do we address it. Doshi: If your deal is stuck because the ministries involved have raised objections, that you don’t think are valid or are not in keeping with their state of policy, where do you go, what do you do? Shroff: What I would do as the government if I were to invite foreign investment in large amount and which will make an impact on the country and I will answer that same question by saying ‘simplify, simplify, simplify’, that is all that you need to do.