New FDI rules raise eyebrows

NEW DELHI: The new foreign direct investment (FDI) norms, announced by the UPA government, has opened a can of worms. They allow foreign Get set for long-term investment Investing in volatile markets Tax-saving investment avenues investment to enter restricted sensitive sectors through a circuitous route, and to beat sectoral caps in areas like telecom, aviation and the media, said experts. Unless, of course, the detailed guidelines, yet to be issued by the government, address some of these concerns. The cornerstone of the new FDI norms is the notion of control by resident Indians. If a company A, in which foreigners have a stake, is controlled by resident Indians, the new norms hold that any investment by A in other companies would have no element of foreign investment. Till now, the norm was that foreigners would be deemed to have a stake indirectly in the companies in which Company A has invested, proportionate to the foreign holding in Company A. According to the revised norms, there is no concept of any indirect holding — if the investing company is controlled by resident Indians, its foreign investors are deemed to have no stake in other corporate entities in which this company invests. (In the case of a 100% subsidiary of a majority foreign-owned company, foreign investors are deemed to have the same stakeholding as in the parent company). Also Read  → Govt plans VCFs to pay the requisite taxes  → FDI takes cautious steps forward  → Sops elude finance cos with NPAs  → New investment norms throw FDI gates open According to investment bankers, even the existing sectoral foreign investment caps are insufficient to restrict foreign control. Even with a minority stake, foreign investors are able to exercise effective control through a variety of shareholder agreement clauses, preferential shares, 'economic interest', etc. The revised FDI norms undermine the caps even further, making it easier for foreign investors to own — directly and indirectly — a larger share of the company they want to run, and to control it. "The government is playing a trick," said Mukesh Butani, partner, BMR&Co, "trying to demonstrate that we have FDI restrictions in sensitive sectors". But, he went on to add that given the current economic reality, we want to allow this leeway. "(There is a) paradigm shift in the way FDI concept will be understood, that is, now FDI will be linked to 'control' and 'legal ownership', completely divorced from 'economic ownership'", said Akash Gupta, executive director, PwC. The corporate reality is that ownership and control are not related to formal stakes held, said another merchant banker, who did not wish to be named. Control can be maintained through other forms of funding like preferential shares — convertible or not; which is why RBI took into account preferential shares while regulating FDI inflows into real estate companies. Then there are those who hold equity on behalf of foreigners — both high net worth individuals and companies — whose only concern is that they are adequately remunerated for such warehousing of shares. Shareholder agreements can vest in the minority foreign shareholder executive authority, super minority provisions to vote against a resolution even with a minority shareholding, right to demand consultation before decisions are made, right of first refusal, etc. Sectoral FDI caps in telecom, insurance and media have given birth to creative holding structures. Lenders have better rights than equity shareholders. In these days, commercial loans to companies are attracting management rights. As a result, it is possible to manage companies with lender nominees on company boards — in the garb of protecting lenders interests. As regards the provision that government/foreign investment promotion board permission is required for transfer of ownership from residents to non-residents is concerned, this is meaningless on two counts. In the first place, ownership is not necessary for a foreign entity to control an Indian company, as explained above. Then again, enforceability of the provision is suspect. In public listed companies, Sebi, the stock exchanges and RBI get access to data on shareholding much before the government. Whether the guidelines, yet to be issued, will empower these agencies to send out intelligent questions to ensure that FDI caps are not being breached through either of the creative routes mentioned above — preferential equity and warehousing — remain to be seen. In fact, this was one of the key contentious issue that had been flagged by various sections within the government like finance, information and broadcasting and corporate affairs ministries, which were opposed to the move initiated by the Department of Industrial Policy and Promotion (DIPP). It may be recalled that the foreign investment promotion board (FIPB), after approving Vodafone's acquisition of Hutchison Essar, had recommended a review of the FDI norms to plug policy loopholes to prevent companies from flouting sectoral caps. Incidentally, a presentation was made on the Vodafone issue before the group of ministers looking into the guidelines, to highlight how the new norms would legitimise the then use of policy loopholes. Sections within the government were of the view that instead of encouraging back-door entry of FDI, sectoral caps should be removed. Since, the new guidelines are meant for sensitive sectors, a non-transparent route for induction of FDI will pose further challenge to the government in keeping a watch on creative corporate structures. Abani Roy, RSP Rajya Sabha member, had also written a letter to Prime Minister Manmohan Singh asking the UPA government to frame guidelines in such a manner that the 26% Indian shareholding in the telecom sector was protected, according to reports. He had said loopholes must not be left for foreign companies to exploit.