Uncertainty over new 'beneficial ownership' clause for Chinese FDI

While the government has mandated that all foreign direct investment (FDI) from China will need to have prior government approval, confusion reigns over how crucial indirect investments from the country will be affected.

The government's sudden move on Saturday to protect domestic firms from hostile takeovers by 'opportunistic foreign firms' as the coronavirus pandemic rages on, have used a curious legal condition for the first time. Globally, the powerful 'beneficial ownership' clause establishes who the ultimate owner of a company is, the extent to which cross ownership is allowed and sets rules on how companies should report on their ownership structures.

Now, the Department for Promotion of Industry and Internal Trade (DPIIT) has mandated that firms need to take the governments approval if citizens from neighboring countries have beneficial ownership of a company, before it can receive FDI from them. While India already has created legislation tackling the issue, the DPIIT is yet to clarify if those would guide the latest FDI rules. Meanwhile, investors, lawyers and experts continue to remain in the dark over it.

In the domestic arena, the government last year brought in the Companies (Significant Beneficial Owners) Amendment Rules, 2019 to deal with the issue. With effect from February 8, 2019, the rules aim to reduce opaque corporate structures by laying out a detailed set of requirements to strictly identify the ultimate individual owners of a firm.

"Beneficial ownership is tricky to define. The Companies Act defines a significant beneficial owner, but there might be a need to revise foreign investment laws in order to introduce another round of checks, e.g. stricter disclosure/ reporting norms for investments where the ultimate beneficial owner is situated in China," said Ambika Khanna, Senior Researcher, International Law Studies Programme at economic and foreign policy think tank Gateway House.

This is particularly important as Chinese companies often have opaque beneficial structures and have unbridled access to our market and other national information, she added.

"In China, company structures are such that you don’t know where private control ends and State control begins. So even in these tough times, State backed Chinese firms are willing to invest in foreign companies because they have an infinite (state backed) balance sheet," said Amit Bhandari, Fellow, Energy and Environment Studies Programme at Gateway House.

Different routes

Significant Chinese investment has flowed into Indian startups and the exact holding pattern of most such companies remain unknown to the government. According to Gateway House, Chinese tech investors have put an estimated $4 billion of greenfield investments in Indian start-ups and over the last few years, 18 of India’s 30 unicorns have become Chinese-funded.

But official data shows that historical investments from China remain a lowly $ 2.3 billion as of December, 2019 despite the government's push to seek more capital from the cash-rich neighbor. This is because the majority of investments from China are routed through the Singapore which has generous tax norms.

Senior government sources said the India is not considering putting in blanket measures for jurisdictions like Singapore or Hong Kong, from where most Chinese investments enter India, a key demand of the Swadeshi Jagran Manch. "Singapore is the second-largest source of FDI for India. So, while it is public knowledge that significant amount of round tripping currently takes place from other jurisdictions through the city, (Singapore), India's access to overall funds also have to be considered," an official said.

Segments of domestic industry have however cheered the move, arguing the current fall in market capitalisation of companies by 50-60 per cent, do not reflect their true valuation. "While we always stand for a liberal FDI regime, the move to curb any opportunistic takeover is pragmatic and fair, under the extra-ordinary circumstances arising out of coronavirus pandemic. The erosion in the market capitalisation is out of fear factor, spread all across the global investor community," said Deepak Sood, Secretary General of industry body Assocham.

India has brought in a nationwide lockdown impacting businesses but these businesses have been built over the years and possess lot of inherent strength, he added.

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