With the effects of the pandemic on cross border investments slowly fading away, there has been a noticeable resurgence in such investments. It is rather sagacious to ensure compliance with countries’ ever-changing international investments regulations for such investments. This article discusses the changes in the investment regulations with reference to the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) in the U.S. that made changes to the regulations Pertaining to Certain Investments in the United States by Foreign Persons^[1],  and amendment to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules)^[2] in India that was brought about by much discussed Press Note 3.^[3]

Worldwide phenomenon

In the wake of the global pandemic, India had amended its Foreign Direct Investment (FDI) policy to curb opportunistic takeovers/acquisitions of Indian companies.^[4] The Indian Government revised the NDI Rules to provide that an entity of a country, which shares land border with India or where the beneficial owner of an investment into India  is situated in or is a citizen of any such country, can invest only after obtaining prior approval of the Indian Government.^[5] Further, any transfer of ownership of any existing or future FDI in an Indian entity resulting in the beneficial ownership of the Indian entity falling within the restriction will also require a prior Government approval. The Indian Government’s move is known to be in the aftermath of increase of shareholding of People’s Bank of China in Housing Development Finance Corporation (HDFC), a leading Indian bank in India which was concomitant with  the pandemic  and the intermittent  skirmishes with China along India’s border.

Whereas, in the U.S., FIRRMA was signed into a law in August, 2018, and made effective from February 13, 2020.^[6] Though FIRRMA was brought prior to the COVID-19 pandemic, it gains special significance now as stronger economies are looking to invest and acquire strategic stakes in U.S. businesses. FIRRMA brought drastic changes with respect to foreign investments. Primarily, it broadened the jurisdiction of the President and the Committee on Foreign Investment in the United States (CFIUS) to review and take action to address national security concerns which could result from certain non-controlling investments and real estate transactions involving foreign persons.^[7] As stated by the U.S. Government, FIRRMA was introduced to strengthen the Government’s ability to protect national security while preserving the longstanding open investment policy of the U.S.^[8]

The transformations in international investments regulations have been a worldwide phenomenon during the pandemic. For instance, the Australian Government announced temporary changes to the foreign investment review framework that are reportedly designed to protect Australia’s national interest to deal with economic implications arising from the spread of the coronavirus, ^[9]  for which the Australian Government will ensure appropriate oversight over all proposed foreign investment during this time.^[10]

Further, the European Commission issued guidance to the Member States of the European Union regarding foreign direct investment and free movement of capital from third countries, and the protection of Europe’s Strategic assets. The guidance is sector agnostic and is not subject to any thresholds. The guidance is also issued to review investments on the grounds of security or public order, ^[11]and to avoid that the current health crisis does not result in a sell-off of Europe’s business and industrial actors, including SMEs.^[12]The guidance had further noted that in reviewing a particular investment all relevant factors can be considered while it particularly mentioned critical infrastructure, technologies and  inputs which are essential for security or the maintenance of public order.^[13]   

The common thread noticed amongst all the above regulations is their connoted objective of protection of national interest.

India investment regulations

As per the amendment made by the Indian Government, any investment being made by any entity incorporated in Bangladesh, China (including Hong Kong and Macau), Pakistan, Nepal, Myanmar, Bhutan and Afghanistan (“Neighbouring Countries”)^[14] or where the beneficial owner of an investment into India is situated in or is a citizen of any of the aforementioned countries, shall require a prior approval of the Government (“Amendment”). Notably, the investments are not prohibited but they require government approval.

The restriction is applicable to all sectors if the investment falls within the purview of the above restriction, even in sectors which previously did not require any government approval.^[15] The main sector hit by the  Amendment is the technology sector as Chinese enterprises have been one of the leading investors in fund deficit tech start-ups. 18 out of India’s 30 unicorns are now Chinese-funded.^[16] This Amendment caused an upheaval in the investment industry as the Amendment has been subject to various interpretations without clarifications from the Government.

As noted the Amendment covers investments that have its beneficial owner either situated in, or is a citizen, of the Neighbouring Countries. The definition of beneficial owner in Indian laws is posing one of the biggest conundrums to the investment community. The NDI rules or the Amendment does not define beneficial owner. Moreover, the Indian regulations which interpret beneficial owner have different thresholds. A significant beneficial owner of a company under the (Indian) Companies Act is defined as an individual who acting alone or together holds directly or indirectly at least 10% of shares or voting rights or has the right to exercise significant influence or control. Whereas under the Prevention of Money-laundering (Maintenance of Records) Ru les, 2005 (PMLA), the beneficial ownership of a company is considered as ownership of or entitlement of at least 25% of the shares or capital or profits of the company (at least 15% in case of partnership, unincorporated associations) ^[17] or a person who exercise control through other means including the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements.^[18] In fact, in October an Indian official reportedly clarified to media  that FDI from an entity with even a small fraction of Chinese holding will require government approval.^[19] However, now regulators are  settling towards a 10% threshold for determining the presence of beneficial ownership. This could create inconvenience even for U.S. companies that have any Chinese investments and are looking to invest in India. 

The Amendment only revised Rule 6(a) of the of the NDI rules which indicates that Foreign Portfolio Investment or Foreign Venture Capital Investment are not subject to the restriction.^[20] However, the amendment has a very wide scope. Any transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership emanating from Neighboring Countries will also be covered within the restriction. It covers primary as well as secondary investments. Even the existing investments are not grandfathered, i.e., any fresh infusion in an existing investment will also be subject to the restriction. It has an extra-territorial impact and government is expected to examine transactions on a look-through basis. Some of the transactions covered under the Amendment include transfer of shares of an Indian company amongst non-residents changing the shareholding pattern of such Indian company.

The Amendment has greatly impacted timelines for investment into the country. It is predicted that a approval under the Amendment may take anywhere between 3 (three) months and a year.^[21] In the event of flouting the above restriction which is riddled with uncertainties, the investee companies will have to bear serious consequences. The government is adjudicating several investment applications received pursuant to the Amendment, and it was reported in April, 2021 that the Amendment caused the authorities to restrict and scrutinize   over 150 (one hundred and fifty) proposals of investment from China which were together worth more than USD 2 Billion^[22]   Indian businesses which have already received investments where the beneficial owner of this investment falls within the said restriction could in good faith seek post facto approval from the Indian Government. If the Government gives a post facto approval, then the already committed non-compliance would have to be compounded from the Reserve Bank of India. Compounding entails the process of voluntarily admitting the contravention, pleading guilty and seeking redressal.^[23] However, if the Government rejects the application, then the foreign investment may have to be divested within a time period that the Government may stipulate. 

The Amendment also magnanimously increases the due diligence efforts of the investee companies in India, as now while receiving investments they will have ensure that the beneficial ownership of the investor entity does not fall within the restriction of the Amendment. The Indian investee companies could be rightly predicted to be shifting towards devising alternative investment strategies.  

U.S. investment regulations

 Jurisdiction of  CFIUS hinges  on national security,^[24]  and  FIRRMA seeks to address growing national security concerns over foreign exploitation of certain investment structures that were earlier outside of the CFIUS jurisdiction and hence broadens the jurisdiction of CFIUS.^[25] Prior to FIRRMA, CFIUS’s jurisdiction extended to transactions that could result in foreign control of any U.S. business referred as covered control transactions.^[26]  FIRRMA now grants jurisdiction to CFIUS over two new aspects: first: certain non-controlling investments in U.S. entities carrying on only specified activities^[27] in particular sectors of critical technology, critical infrastructure, or sensitive personal data of US citizens   (TID U.S. businesses) ^[28]  and second: specific real estate transactions.

Apart from the nature of the target U.S. business, the scope of non-controlling investments or covered investments under FIRRMA is also based on the nature of the investment. The  nature of the investments in  covered investment must afford a foreign person one or more of (i) access to any material nonpublic technical information in possession of the TID U.S. business; (ii) membership or observer rights on, or the right to nominate an individual to a position on, the board of directors or equivalent governing body of the TID U.S. business; or (iii) any involvement, other than through voting of shares, in substantive decision-making of the TID U.S. business regarding certain specified use of sensitive personal data, critical technologies and critical infrastructure.^[29]

Notably one of the main thrusts of FIRRMA is technology and data industry, and has majorly impacted U.S. tech start-ups.^[30] FIRRMA led to a drop of 88% of China’s foreign direct investment into the U.S.^[31] FIRRMA did not mention any specific nation as a security threat, however reportedly it is intended to curtail China’s investments in the U.S. advanced technological sector and valuable assets, the control of which will give China an advantage over the US in terms of national security.^[32]  

Like, the amended NDI Rules, FIRRMA too has a wide and uncertain scope by significant discretion afforded to CFIUS and certain ambiguous definitions.  For instance, a finding of control is important to bring certain types of transactions within the ambit of covered control transactions subject tothe scrutiny of CFIUS. Though Provisions Pertaining to Certain Investments in the United States by Foreign Persons   have a definition of control,^[33]  the definition and its reach under  regulation is very ambiguous and wide, such as, the definition  covers  the power (direct or indirect), through the ownership of a dominant minority of the total outstanding voting interest in an entity or any contractual arrangements or formal or informal arrangements to act in concert or other means to decide or determine important matters affecting an entity.^[34] Thus, certain interests that confer a significant ability to influence important matters related to U.S. business may confer the required control.

The scope of CFIUS review also hinges on the definition and interpretation attributed to a foreign person. Notably, foreign person does not only cover a non-U.S. national or entity, but also any domestic entity over which control can be exercised by a non-U.S. national or entity,^[35] for instance:  U.S. based funds with foreign GPs or LPs. This can lead to a situation where even U.S. domestic investment funds are subjected to CFIUS review. FIRRMA does not even define U.S. business. Some experts say that it is in the CFIUS’s bid to have the discretion, and allow it the flexibility about the broadness of the interpretation and hence its jurisdiction.^[36] The outcome of the above definitions in FIRRMA affords an extraterritorial application to FIRRMA.  For instance, if a non-U.S. company is investing outside the U.S, and the investee company has significant business in the U.S, CFIUS analysis will be required as the investee company might be considered a U.S. business by CFIUS.

Another major change brought by FIRRMA is “mandatory” filings^[37] wherein for the specified enumerated transactions mandatory filings or declarations are required before the closing of the investment and no discretion is allowed to the business. The consequence of violation of the said provision is severe. While the penalty in case of some omissions in instances where voluntary filings are allowed, the penalty cannot exceed more than USD 250,000 but a failure to comply with mandatory filing  requirements may result in a penalty up to the value of transaction.^[38]

Given the uncertainties and the consequences of violation, investment community around the world has grown wary of FIRRMA compliances. Not making the declarations to CFIUS or not assessing the deal for FIRRMA compliances     subjects the investments made to CFIUS intervention, including CFIUS intervening after an investment has already been made, which can result in unwinding of a transaction or accepting conditions imposed by CFIUS such as divestiture of the entire investment. Besides, divestiture of the entire investments, if CFIUS determines a threat to national security, depending on severity of the risk, CFIUS may impose mitigation measures to allay the threat, such as, divestiture of assets or operations, forfeiture of sensitive contracts, appointment of special compliance personnel, or appointment of proxy boards consisting of U.S. citizens.

Timelines have also changed for getting approval from CFIUS and hence for closing a deal. Few strategies that investors and U.S. businesses have been adopting is undertaking the investments in two stages or limiting the rights granted to the foreign investors, or circumscribing the U.S. business activities receiving the investment to non-critical technologies.

Comparative analysis

Thus, the Indian Government’s amendment to the NDI Rules and the U.S. FIRRMA regulations share the commonality of being riddled with uncertainties and conundrums that are yet to be clarified by respective Governments and to be seen in implementation.   Moreover, both the regulations have extra territorial effects and cover indirect investments as well.  However, they differ in few aspects as noted below.

While the Indian Amendment covers investments originating from only its Neighboring Countries, the US FIRRMA regulations are applicable to foreign persons of all foreign countries except certain specific exempted class of investors referred to as Excepted Investors^[39] and Excepted Foreign States^[40], currently identified by U.S. as Australia, Canada and the United Kingdom. FIRRMA  provides no criteria for the choosing of particular countries to be featured in the excepted foreign states list, however, it has laid down two prong test to be able to qualify as Excepted Foreign States ^[41] , viz: (i) a country must be first determined to be eligible by CFIUS; which is totally discretionary as the term is undefined in the regulations; and (ii) CFIUS should determine that the eligible country should have a robust process to analyze foreign investments for national security risks and to facilitate coordination with the U.S. on matters relating to investment security.^[42] Such excepted investors are only exempt from mandatory CFIUS filings and FIRRMA’s expanded jurisdiction, but CFIUS still retains jurisdiction over investments that could result in control of a U.S. business from excepted jurisdictions. It is also uncertain what factors CFIUS considers to determine if the country has the aforementioned robust process. 

Another contrast between India and the U.S. regulations is that CFIUS review is majorly a voluntary process under which parties to a proposed transaction may file a voluntary notice to the committee for it’s review to safe harbour their investments.^[43] However, in the absence of a voluntary notice,  CFIUS also has the authority to initiate reviews of a transaction if the committee concludes that the transaction may be a covered transaction and may raise national security considerations.^[44]  Additionally, FIRRMA has mandated filings in two scenarios^[45] that are most likely to raise national security concerns  (i) a covered transaction resulting in the acquisition of a substantial interest in a TID U.S. business by a foreign person in which the national or subnational government of single foreign state (except exempted foreign states) have a substantial interest; and (ii) a covered investment that could result in foreign control of a TID U.S. business engaged in specified activities of producing, designing, testing, manufacturing, fabricating, or developing in critical technologies. However, under the Indian amendment, all investments emanating from Neighbouring Countries as discussed above will necessarily require the government approval and hence the filing.

Another major difference, that is even worth emulating by the Indian investment authorities is with respect to timelines of processing application under the regulations. For instance, under FIRRMA maximum days for initial review is a 30-day period, followed by a 45-day period for investigation, if needed, and followed by a 15-day period for President’s review. 

The Indian amendment though introduced during the pandemic with a stated economic objective can be seen as a national security regulation, similar to   CFIUS regulations, in its incipient stage given it has identified specific countries with an undertone of national security.   

Extant state and the way forward

Given these changes, the investment community around the world has grown wary and are being conservative with their investments. While these regulations have increased diligence activities of investee companies to ensure compliances with the regulations, the businesses are also devising strategies to surpass these hurdles, such as alternative investment strategies, multi-tranche investments, investing in non-TID U.S. businesses for the U.S. etc.  Meanwhile, a CFIUS and NDI Rules risk analysis should be undertaken for any foreign investment into a U.S. business and an India business, respectively to safe harbor against a post-closing compelled review given that both the regulations have no limitation period for a culminated deal after which the respective authorities cannot intervene.  Another practical advice for parties could be: investees may seek appropriate representations and warranties from the investors whereas investors may seek a waiver of indemnification by the investees.

A significant point to note is that investment regulations around the world and the rules thereunder are evolving rapidly, and hence will their scope, whereas, fund structures or agreements last for a longer time and hence the businesses could follow a principles -based approach for investments that underlines and aligns with the intent of legislature behind investment regulations rather than the current rules, to preempt any future authorities intervention.

With the economies coming back to their feet, the investment community around the world is looking for newer avenues of raising investments post the pandemic in a new normal. Nations and businesses are going to vie amongst each other to attract investments to boost their sluggish economy.  With the noted decrease in FDI given the stringent investment regulations, nations around the world have now to find a way to balance the national interests and the need of their economy.