No hostile takeover of Indian firms: New FDI guidelines come into effect

The updated FEMA Rules came into effect from Thursday midnight

The latest changes to the Foreign Direct Investment (FDI) came into effect from Thursday midnight with all direct investment from China now requiring mandatory government approval.

The Department of Economic Affairs on Wednesday issued the updated the Foreign Exchange Management (Non-debt Instruments) (FEMA) Rules, 2019 which includes the latest FDI norms. The routine update to the FEMA rules mean that from now on, all incoming funds from China, as well as all nations with which India shares a land border - including Pakistan, Bangladesh, Bhutan, Nepal and Myanmar, will now face close inspection. Earlier, this was true for only Pakistan and Bangladesh.

The sudden move by the government has been attributed to the rising possibility of “opportunistic takeovers” of Indian firms by cash rich Chinese corporates, as the ongoing Covid-19 pandemic wreaks havoc on the domestic economy.

The pitch for curbing Chinese investments in India picked up pace recently after the People’s Bank of China (PBoC) increased its shareholding in Housing Development Finance Corporation (HDFC) amid a sharp correction in the stock of India’s largest mortgage lender.

While existing investments shall remain unaffected, any fresh infusion by Chinese firms in existing investments or any transfer of investments by existing investors to Chinese firms will be hit.

"Further, any transfer of investments, future FDI resulting in beneficial ownership falling with Chinese firms will also require prior approval, however, the mode of determination of ‘beneficial ownership’ is still uncertain. This will have repercussions for FDI by PE firms, banks and other sovereign funds based out of China or having Chinese partners and the sectors where Chinese players have a substantially presence or are looking to expand (eg- personal electronics, automobile, manufacturing etc) may also see some impact," said Atul Pandey, partner at law firm Khaitan & Co.

However, he added that the latest notification now makes it clear that the FEMA notification does not cover Foreign portfolio investment or Foreign Venture Capital Investment. "Investments in Indian Alternative Investment Fund (AIF) will also be permitted subject to such AIF being Indian owned and controlled,” said Pandey.