DEA suggests 25% threshold for China FDI

The department of economic affairs (DEA) has recommended that the beneficial ownership threshold for foreign direct investment should be set at 25% to determine if they need to go through an approval process amid government efforts to restrict Chinese investments.

Tarun Bajaj, secretary DEA, said on Thursday that the department has recommended that beneficial ownership could be set as per its definition under foreign portfolio investor (FPI) norms and Prevention of Money Laundering Act (PMLA). This recommendation has been made to the department of promotion of industry and internal trade (DPIIT).

Under FPI norms, beneficial ownership is set at 25% of the total assets or on the basis of the fund manager. Under PMLA, the threshold is 25%.

“FDI restriction on China investment...is more about national security and integrity and all our interests are secondary to that. But we have given a suggestion on the definition of beneficial ownership as per the regulations under FPI on PMLA,” Bajaj told a capital markets summit organized by industry body Federation of Indian Chambers of Commerce and Industry (Ficci). On 22 April, the Centre issued a notice under the Foreign Exchange Management Act (Fema) saying investments originating from seven neighbouring countries, including China, must seek prior approval of the government. The wording of the notification would have rendered a Chinese investor holding even a single share in the investing entity to qualify as ‘beneficial owner’.

Many global private equity and venture capital funds tend to raise some amount of capital from Chinese institutional investors and HNIs. A lower threshold for beneficial ownership would mean such investors, even though not based in China or controlled by Chinese entities, would still need to pass through additional scrutiny.

If accepted, a threshold of 25% would ensure that the bulk of financial investors would not need prior approval and their investments in Indian companies and startups could go through the automatic route, within the sectoral FDI caps.

To be sure, investors and companies based out of China will in any case need to go through the government approval process.

According to Atul Pandey, partner, Khaitan and Co the DEA’s recommendation on determination of beneficial ownership as per the thresholds set under PMLA will result in a huge relief to funds and other investor firms.

“These firms are grappling with uncertainty, given that most major Private Equity (PE) funds have Chinese LPs and were potentially within the shadow of government approval, in the absence of a clear definition of beneficial ownership. This move will clear the air of uncertainty that has existed ever since April and I expect further clarity once the official notification is issued,” said Pandey.

This would come as a major relief for investors and companies who are currently assuming a definition under the Companies Act 2013 of 10% shareholding beneficial ownership for indirect investments. For direct Chinese investments bankers and lawyers are taking an extremely conservative approach and not assuming any thresholds.

“Clarity on the definition of beneficial ownership can greatly assist in containing varied interpretations which the industry might be taking currently since the advent of Press Note 3 and subsequent amendments. The higher the threshold, more the room for an investment. This is because of different threshholds that emanate from the Companies Act and Prevention of Money Laundering Act, for the explanation of beneficial owner,” said Dipti Lavya Swain, cross border M&A lawyer and partner, HSA Advocates

Since the notification was issued in April only a few investment deals have closed.

“While paperwork for approvals have been filed the deals are not yet closed. Deals are typically taking atleast three months for final clearances which earlier used to take about a month,” said an investment banker.