December 06, 2024
Opportunities and Challenges for Global Investors in India’s M&A Landscape
India, with its burgeoning economy and vast market
potential, has long been an attractive destination
for foreign investors. The country’s diverse
sectors, ranging from technology and pharmaceuticals
to infrastructure and consumer goods, offer lucrative
opportunities for mergers and acquisitions. Recent
years have seen India implementing transformative
reforms aimed at creating a more business-friendly
environment, further solidifying its appeal as a
global investment hub.
With the global markets entering a recession,
investors are increasingly hesitant to part with
their capital. In such a scenario, it becomes essential
for countries to position themselves as investor-friendly
destinations. A key step toward achieving this is
easing procedural and regulatory guidelines for
doing business.
With this objective in mind, India reduced 39,000
compliances and decriminalized more than 3,400 legal
provisions1. It currently ranks 63rd
on Ease of Doing Business Index2. India
instituted structural economic reforms in recent
years that will improve the business environment,
including for U.S. exporters and investors. These
reforms include liberalizing foreign investment
restrictions, modernizing bankruptcy and labor laws,
ending retroactive taxation, and replacing a patchwork
of state border taxes with a national Goods and
Services Tax3.
While these reforms mark significant progress,
India’s potential to become a global investment
leader is boundless. Continued focus on reducing
compliance burdens and further simplifying regulatory
frameworks will enhance its attractiveness to foreign
investors. This article will outline some of the
key opportunities and challenges for foreign investors
when investing in India, particularly from a merger
and acquisition (“M&A”)
perspective.
1. Dematerialization
of shares of a private company
On October 27, 2023, the Ministry of Corporate
Affairs (“MCA”) released
a notification amending Company (Prospectus and
Allotment of Securities) Rules, 2014 (“PAS
Rules”)4. It mandated
compulsory dematerialization of securities of private
companies, except small companies, by September
30, 2024. Additionally, private companies which
are wholly owned subsidiaries of foreign companies
do not fall within the ambit of small companies
and this provision is applicable to them as well.
This reform is designed to enhance the safety, transparency,
and efficiency of share transfer processes, reflecting
India’s commitment to modernizing its corporate
framework.
For foreign investors, this change brings the
benefit of streamlined and secure share transactions,
reducing the risks associated with physical shareholding.
The dematerialization requirement aligns India with
global best practices, fostering greater confidence
among long-term investors and positioning the country
as a transparent and robust investment destination.
While for short-term, investors may initially
find the compliance process, such as obtaining a
Permanent Account Number (“PAN”),
fulfilling Know Your Customer (“KYC”)
norms, disclosing shareholding structure and ultimate
beneficial owner and paying additional fees for
opening the demat accounts, to be more involved,
these measures ultimately contribute to a more predictable
and secure business environment. Prior to this notification,
these investors had an option of purchasing shares
physically without registering/ disclosing the transactions.
These reforms may present an adjustment period
for investors considering these additional compliances
are cost and time intensive and potentially delay
the finalization of M&A transactions, but they
also signal India’s commitment to a more structured
and reliable investment ecosystem.
2. Downstream
Investments by FOCCs
Downstream investment by Foreign-Owned or Controlled
Companies (FOCCs) presents a significant
opportunity for foreign investors to deepen their
participation in the Indian market. This investment
route, governed by Rule 23 of the Foreign Exchange
Management (Non-Debt Instruments) Rules, 2019 (NDI
Rules), establishes a structured regulatory
framework. However, as India continues to position
itself as a global investment hub, there is an opportunity
to further streamline and clarify certain aspects
to enhance the ease of doing business.
A key area for refinement is the applicability
of pricing and reporting norms for FOCC-driven transactions.
Current rules occasionally lead to differing interpretations
by Authorised Dealer (AD) banks,
particularly regarding fair market value (FMV)
thresholds and norms depending on whether the counterparties
are residents or non-residents. This variability
underscores the need for consistent guidelines that
would simplify compliance and boost investor confidence.
Additionally, broadening the scope of downstream
investment regulations to include instruments such
as optionally convertible preference shares (OCPSs)
and debentures (OCDs) could ensure
greater uniformity and close potential regulatory
gaps.
The regulatory landscape becomes more complex
with share swap transactions. Although Rule 6 permits
non-cash consideration under the automatic route,
conservative interpretations by AD Banks now often
push FOCC transactions into the approval route,
citing concerns around funding sources specified
in Rule 23(4). Additionally, mixed consideration
transactions (part cash, part securities), remain
an area where clearer guidelines could reduce procedural
ambiguities.
Further challenges arise from limitations on
deferred payment arrangements and non-cash consideration
in downstream investments, which place FOCCs at
a disadvantage compared to direct foreign investors.
Addressing these issues requires targeted amendments
to the NDI Rules. By harmonizing these regulatory
elements, India can attract more foreign investment
while maintaining robust oversight. We have discussed the issues pertaining to downstream investment in detail
here.
3. KYC Requirement:
pre-requisite for making investments in India
India has robust policies in place to prevent
financial institutions from being used for money
laundering and financing terrorist activities. The
Prevention of Money-Laundering Act, 2002 and the
Prevention of Money-Laundering (Maintenance of Records)
Rules, 2005, form the legal framework on Anti-Money
Laundering (AML) and Countering
Financing of Terrorism (CFT). In
pursuance of these statutes, KYC framework has been
established. KYC norms require the investor to submit
identity, residence proof and any other document
as required to the registered entity, as applicable,
before investing. This makes the financial framework
of the country more trustworthy and less risky.
It limits frauds while increasing lending.
While these norms contribute significantly to
the integrity of India’s financial system,
there is room to make the processes more seamless
for foreign investors. Streamlining KYC approvals
and enhancing coordination among regulatory bodies
could reduce redundancies and make compliance more
efficient. Foreign national investing in India may
not always be comfortable with divulging personal
information to a foreign nation, especially when
they are already compliant with anti-money laundering
policies of their own nations. They may want to
avoid this time and cost intensive activity of KYC
approval from several different regulatory bodies.
However, in our opinion, this is an important
requirement that India cannot do away with for several
security reasons. These statutes mentioned above
which give rise to the KYC framework, are derived
from Global Financial Action Task Force (“FATF”)
norms and rules. It sets standards and promotes
effective implementation of legal, regulatory and
operational measures for combating money laundering,
terrorist financing and other related threats to
the integrity of the international financial system.
India, being a member of FATF, has to uphold measures
to protect the integrity of international financial
system.
4. Disclosure of Significant
Beneficial Owners (“SBO”) of the investing
company
India’s commitment to a transparent and
accountable corporate ecosystem is reflected in
the provisions of Section 90 of Companies Act, 2013
(“CA 2013”) read along
with Companies (Significant Beneficial Owners) Rules,
2018 (“SBO Rules”).
These provisions deal with identification of SBOs
in a company along with the register that has to
be maintained and returns that has to be filed with
the Registrar of Companies (“RoC”).5
This framework not only safeguards the
integrity of India’s corporate environment
but also aligns with global best practices, providing
reassurance to international investors about the
country’s commitment to combating opaque ownership
and fostering good governance.
The SBO framework employs a twin-test approach
of objective and subjective analysis. The objective
test, evaluates the shareholding of the individual
in question and whether they indirectly (or together
with direct holdings) holds not less than 10% of
the shares.6 The subjective test examines
whether the individual in question has the right
to exercise, or actually exercises significant influence
or control in any manner, other than through direct
holdings.7
While the RoC has taken a proactive approach
in implementing these provisions, there have been
instances, such as the LinkedIn Order8,
which we have discussed in detail
here, where interpretations of the subjective
test extended beyond established norms. As foreign
investment into Indian entities continues to grow,
aligning the implementation of these rules with
investor expectations presents an opportunity to
refine processes. By initiating open dialogue with
stakeholders and ensuring consistent application
of SBO norms, India can further enhance its position
as a premier destination for global investment.
5. Requirement of physical
signatures
India’s commitment to improving its ease
of doing business is evident from its recent reforms
and initiatives. However, embracing further digitization
and paperless procedures presents an exciting opportunity
to make investment processes even more seamless
for global investors.
Currently, the need for physical signatures coupled
with notarization, apostille, or embassy attestation
for incorporation and numerous filings can be time-intensive
and add to investment costs for foreign investors9.
The investment schedule may be further delayed if
foreign investors are required to travel to India
in person or designate a local agent to finish these
requirements.
By implementing digital technologies and paperless
procedures, many other nations, such as Singapore,
have simplified their investment processes10.
Singapore frequently permits online document submission,
remote verification, and electronic signatures,
greatly cutting down on the time and expense involved
in investment approvals11. These
nations may become more appealing to global investors
looking for hassle-free and effective business practices
due to their ease of doing business.
India, with its strong focus on innovation and
technology, is well-positioned to adopt similar
measures. By further simplifying these processes,
the country can enhance its competitive edge and
solidify its reputation as a global investment hub.
Such advancements would not only make India more
attractive to foreign investors but also reflect
its readiness to lead in a rapidly digitizing world.
6. Requirement
of obtaining multiple valuation reports
Given that the regulatory environment in India
is changing, it is critical to stay abreast of the
valuation requirements when undergoing a M&A
transaction in India. In certain transactions it
may be required to engage an appropriate valuation
professional (i.e., Registered Valuer, Category
I Merchant Banker registered with the SEBI, or Chartered
Accountant who is member of the ICAI, as applicable)
to satisfy the specific regulations in India. While
this requirement adds a layer of diligence, it also
ensures that transactions align with international
best practices, protecting both investors and stakeholders.
This is primarily due to the overlapping regulatory
requirements under the Foreign Exchange Management
Act (FEMA), the Income Tax Act,
and the Companies Act.
Under FEMA, the RBI mandates that foreign investments
must be made at a fair valuation. This often requires
a valuation report from a Category I Merchant Banker
or a Chartered Accountant as per internationally
accepted pricing methodologies. For tax purposes,
particularly in cases involving transfer pricing
or capital gains, the Income Tax Department may
require a valuation to ensure that transactions
are conducted at fair market value. The Companies
Act, 2013, also has provisions that may require
valuation reports, especially in cases of mergers,
acquisitions, or issuance of new shares. The valuation
must be conducted by a registered valuer to ensure
compliance with the statutory requirements.
Each regulatory framework may have its own criteria
for determining FMV or fair pricing, leading to
situations where valuations obtained for compliance
with one regulation may not meet the criteria of
another. While the need for multiple valuations
may initially appear complex, it underscores India’s
commitment to creating a transparent and equitable
investment landscape. With the right professional
guidance and a thorough understanding of the regulatory
framework, foreign investors can navigate these
requirements effectively.
7. Indian companies
to maintain daily back up of books of accounts
The amendments introduced by the MCA in August
2022 to Rule 3 of the Companies (Accounts) Rules,
2014, may pose some complexities for foreign investors.
However it reflects India’s commitment to
enhancing transparency and strengthening the integrity
of its financial ecosystem. These changes mandate
companies to ensure that books of accounts maintained
in electronic mode are always accessible in India,
require daily backups on servers physically located
within the country, and necessitate detailed disclosures
about service providers and data storage practices.
For multinational investors relying on global IT
infrastructure, these requirements may demand adjustments,
including reconfiguring systems and processes, securing
additional approvals, and potentially engaging third-party
service providers.
While these requirements underscore the importance
of data security and regulatory compliance, they
also present an opportunity for multinational companies
to integrate and localize their operations within
India’s rapidly growing market. For foreign
investors, this can lead to long-term benefits,
including improved data protection, better risk
management, and increased confidence from Indian
stakeholders. Adapting IT infrastructure and aligning
with local regulations may involve initial adjustments,
but these efforts will position businesses to better
leverage India’s expanding digital ecosystem
and benefit from the country’s progressive
corporate governance practices.
8. Consolidation of
MCA forms for Ease of Doing Business
Government of India is focusing on increasing
Ease of Doing Business and attracting foreign investors.
In pursuance to the same, MCA has taken several
commendable steps to simplify the investment process
in India, by taking initiatives such as the introduction
of the SPICe form12. However, further
consolidation of forms and streamlining of procedures
are essential to create a more investor-friendly
environment. Currently, the investment process involves
multiple forms and approvals from various authorities,
leading to significant time and cost burdens. By
consolidating these forms and simplifying the approval
process, the MCA can significantly reduce the administrative
hurdles faced by foreign investors.
A unified platform for all investment-related
filings can streamline the process and reduce the
compliance burden. By implementing these measures,
India can position itself as a more attractive destination
for foreign investment, fostering economic growth
and creating jobs.
CONCLUSION
India presents vast opportunities for foreign
investors, especially in the M&A space, with
its dynamic market and growing sectors. By strategically
understanding and steering the regulatory, cultural,
operational, and economic landscapes, foreign investors
can tap into India’s immense growth potential.
The country has made remarkable strides in streamlining
investment processes, creating an environment ripe
for business expansion. As India continues to implement
reforms and adapt to global economic conditions,
it is increasingly positioned as an attractive investment
destination, especially in a global market facing
recessionary pressures.
While some regulatory measures, such as the one
discussed above, present areas for improvement,
these steps are part of India’s commitment
to enhancing the security and integrity of its financial
systems. There is a strong opportunity to further
streamline processes which would simplify the investment
journey for global investors. By building on these
advancements, India can further strengthen its business
ecosystem, driving economic growth and promoting
a more investor-friendly environment.
Authors:
–
Maulin Salvi,
Janak Pandya and
Vaibhav Parikh
You can direct your queries or comments to the relevant member.
1https://www.makeinindia.com/eodb.
2https://invest-india-revamp-static-files.s3.ap-south-1.amazonaws.com/s3fs-public/2019-10/9781464814402.pdf
3https://www.state.gov/reports/2024-investment-climate-statements/india/
4Notification, Ministry of Corporate
Affairs, October 27, 2023, available at
https://egazette.gov.in/WriteReadData/2023/249772.pdf
5Discussed in detail at
https://nishithdesai.com/NewsDetails/15060.
6Rule 2(1)(h)(i) to Rule 2(1)(h)(iii)
of the SBO Rules.
7Rule 2(1)(h)(iv) of the SBO Rules.
8www.mca.gov.in/bin/dms/getdocument?mds=san%252BPg76sI9tkgd5lcHzZg%253D%253D&type=open.
9https://www.indiafilings.com/emudhra#:~:text=Overview%20of%20Class%203%20Digital,3%2Dyears.
10https://www.sqlview.com.sg/document-management-system-singapore/electronic-signature/understanding-electronic-signatures-and-its-use-in-singapore-part-2/#:~:text=The%20Singaporean%20government%20has%20special,least%20amount%20of%20red%20tape.
11https://sso.agc.gov.sg/act/eta2010.
12https://www.mca.gov.in/Ministry/pdf/SPICe+_help.pdf.
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