by Pratik Datta, Radhika Pandey and Sumant Prashant.
Foreign investment into India has always been heavily regulated, requiring approvals from various government ministries. Post-liberalisation, a need was felt to create a single window for foreign investors applying for such approvals. As a result, the Foreign Investment Promotion Board (FIPB) was established in August 1991. Initially it was placed within the Prime Minister's Office (PMO) since its credibility needed to be projected speedily. Then it shifted to Department of Industrial Policy and Promotion (DIPP) and finally to Department of Economic Affairs (DEA) in Ministry of Finance. Here it functioned as an inter-ministerial body making recommendations to the Finance Minister for grant of approval for foreign investments as per the regulations under the Foreign Exchange Management Act, 1999.
Although FIPB was a single window for the foreign investors, at the back-end it was an agglomeration of various Ministries whose views were necessary. It comprised Secretaries from Department of Economic Affairs (DEA), DIPP, Department of Commerce (DoC) Ministry of External Affairs (MEA), Ministry of Overseas Indian Affairs (MOIA), Department of Revenue (DoR) and Ministry of Small, Medium and Micro Enterprises. Depending on the sector to which the investment proposal pertained, the concerned Ministry would also be asked to give comments. At times, views of RBI would also be sought. Naturally, this inter-ministerial coordination process took time and frequently delayed the approval process. Consequently, FIPB ended up being seen as another bureaucratic body delaying approvals. This fuelled the demand for a better substitute.
In a recent spate of reforms, the Cabinet finally decided to scrap FIPB. Now, foreign investment in any of the eleven notified sectors would require approval from the concerned Administrative Ministry. Last week the DIPP issued a Standard Operating Procedure (SoP) for processing FDI proposals under this new regime. The most promising feature of this SoP is the 8-10 weeks time-frame within which investment applications are required to be cleared by the government ministries. But will this reform ensure timely disposal of foreign investment approvals? To answer this, it would be useful to understand the legal institutional framework within which foreign investment approvals are processed in some advanced jurisdictions.
In Australia, the decision to approve a foreign investment proposal is with the Treasurer under the Foreign Acquisitions and Takeovers Act, 1975. When making such decision, the Treasurer is advised by the Foreign Investment Review Board (FIRB), which examines foreign investment proposals and advises on the national interest implications. Section 77 of the 1975 Act requires the Treasurer to make his decision within 30 days, which can be extended by 90 days. The Treasurer has to give reasons for rejecting substantial commercial proposals, which are published in Treasurer's press release.
In Canada, the decision to approve a foreign investment proposal is with the Minister under the Investment Canada Act, 1985. While taking the decision, the Minister is advised by the Director of Investments. A foreign investor is required to notify the Director before making an investment or within 30 days of making the investment. The investment proposal is subject to review only if the Director sends a notice for review to the foreign investor within 21 days. The Minister has 45 days to determine whether or not to allow the investment. The Minister can unilaterally extend the 45 day period by an additional 30 days by sending a notice to the investor prior to the expiration of the initial 45 day period. Further extensions are permitted if both the investor and the Minister agree. If no approval or notice of extension is received within the designated time, the investment is deemed approved. If a foreign investor's application is rejected, the law requires the rejection order to provide reasons for such rejection. Moreover, another opportunity is given to the applicant to reapply. If the applicant is unable to make its case stronger in the second attempt, the application is finally rejected.
Evidently, in these jurisdictions the primary law imposes time-limits on the Minister approving foreign investment proposals. The primary law is also clear on the precise purpose of the government approval. For instance, national security is a major concern while approving foreign investment proposals. Moreover, the primary law also lays down clear processes to handle rejection of investment applications, making the Minister more accountable. For instance, in the US, even the President, who has the final authority to reject an investment proposal, issues a presidential order providing justification for rejection. This institutional accountability hardwired within the legislative framework enables these jurisdictions to better handle foreign investment applications.
In contrast, the Indian primary law - the Foreign Exchange Management Act, 1999 (FEMA) - does not create any institutional accountability. It does not prescribe any time-limits for the Finance Minister to dispose of foreign investment applications. Neither is FEMA clear on the purpose of government approval itself. Further, the law does not require the government to give any reasons for rejecting an investment application. These are fundamental problems in the current Indian legal institutional framework around FDI approvals.
DIPP's new SoP does not resolve any of these fundamental issues. The timelines it imposes on the Ministries for various actions are not even binding. This is because the SoP is not a legal instrument. It is merely a pdf document uploaded as a public notice on the DIPP website. That does not make it a law binding on the different Ministries in the government. At most, it is an aspirational document laying out the good intentions of the government. But if a Ministry violates it, there are no consequences or sanctions. The SoP does not in anyway change the internal incentive structure of the bureaucracy to ensure that they comply with the timelines. Therefore, the SoP fails to solve the root cause of delay at FIPB - lack of time-bound inter-ministerial coordination needed for timely grant of approvals.
Any reform to the Indian FDI approval regime must start with a complete rethinking and redesigning of the primary law - FEMA - from first principles. What is the market failure in the field of capital controls? Why is government approval even necessary? How can the government be made accountable to ensure that approval decisions are made in time-bound manner without prejudicing the main purpose of such approval?
The Financial Sector Legislative Reforms Commission (FSLRC) answered these fundamental quesions based on a holistic review of international best practices. It recommended that the objective of capital controls should be to address national security concerns. In addition the report envisaged controls of temporary nature to address crisis situation. All these aspects are codified in the chapter on capital controls in the Indian Financial Code (IFC), the draft law prepared by the FSLRC. Even as we debate the objectives of capital controls, the law on capital controls must be unambiguous in laying down an effective procedure for processing FDI proposals. As an example, Clause 243 of the IFC provides for a 90 days time-bound process to be followed by the Central Government while approving or rejecting FDI proposals. Chapter 9 of the FSLRC Handbook released by the Ministry of Finance further elaborates this approval process.
The shortcomings of FIPB were merely symptoms of a deeper problem in the primary law, FEMA. This underlying problem can be resolved only by replacing FEMA with a coherent new primary law. The new law should require government approval only for foreign investment in sectors that are strategic from the viewpoint of national security considerations or to address emergency situations such as war, or balance of payments crisis. The law should also focus on accountability of the government. It should provide clear time-bound legal processes and require the government to give reasoned orders while rejecting an investment proposal. Only such fundamental legislative reforms can help create a better substitute to FIPB.
Pratik Datta, Radhika Pandey and Sumant Prashant are researchers at the National Institute of Public Finance and Policy, New Delhi.
The Insolvency and Bankruptcy Code, 2016 (IBC) provides for the speedy resolution of insolvency. The process described in IBC hinges on the assumption that information will be easily accessible to the parties involved. It is for this purpose that IBC provides for the establishment of Information Utilities (IUs). As envisaged in IBC, as well as the Bankruptcy Law Reform Committee Report, IUs are repositories of information regarding debt and default, and are required to be able to produce this information quickly. This information can then be used for many purposes. For instance, the Courts can use it to decide whether to send a debtor company into a resolution process. But for this information to be widely used, it is essential that Judges, Insolvency Professionals, and other parties must be able to trust this information implicitly.
The timelines specified by IBC are quite strict. They can be met only if IUs stand ready to provide all requisite information quickly. IBC provides little guidance on how IUs are to function, leaving the details to subordinate regulation. A Working Group on IUs was set up by the Ministry of Corporate Affairs to draft the regulations governing IUs. The Working Group's suggestions (Draft Regulations) were put up for public comments. Subsequently, an Advisory Committee discussed the public comments, and the final regulations (IU Regulations) were notified on 31st March, 2017.
However, the regulations have some fundamental problems which are likely to impede the efficient and transparent functioning of IUs. In this article, we highlight some of these problems.
IBC defines "core services" to be a set of services every IU has to provide. This includes accepting information, authenticating and verifying it, storing it, and providing access to it. There are several issues with how the current regulations treat the provision of core services:
An information utility shall provide a registered user a functionality to enable its authorised representatives to carry on the activities in sub-regulation (1) on its behalf.This can be very dangerous, because of the possibility of misuse. For instance, can a bank be a registered representative of its borrower? Imagine a situation where an individual takes a loan from a lender, and one of the signatures among the many he signs in the paperwork authorises the lender to be his representative for filing information with an IU. The lender can now declare, on behalf of the borrower, that the borrower has defaulted. This is a clear conflict of interest.
This provision lends itself to misuse by the borrower, too. A borrower may borrow money and confirm this debt in an IU, but he could later claim that some authorised representative committed fraud.
If the functionality of enabling authorised representatives is desired, appropriate safeguards need to be added to the IU Regulations.
Registering users: According to section 214(e) of IBC, IUs are supposed to get the financial information authenticated before storing. But 18(1) of the IU Regulations suggests registration only for submitting and accessing information. Does this mean that unregistered parties can authenticate information? If yes, it can lead to the danger that IU records will have little sanctity in court.
The Draft Regulations expect that the user (or software deployed by him) would be able to query multiple IUs inexpensively and in parallel, as happens every day in online air-ticket booking. This is a simple and straightforward architecture that avoids the problems above.
The IU Regulations do not contain these requirements. Without them, it is difficult to detect if the IU loses data or manipulates it in connivance with parties to the debt. The information in the IU loses its sanctity, so that judges can no longer trust it.
An information utility shall accept information submitted by a user in Form C of the Schedule.
Items 37, 50 and 56 of Form C lay down the documents to be attached as proof. This suggests that an IU has to accept documentary proof of the financial information being submitted.
This is a clear problem. The design of IBC intended IUs to be an electronic repository of financial information, and not a document management system. That is why the requirement of authentication and verification of information submitted to an IU was envisaged. While it may be possible for IUs to accept documents in electronic form, even this process creates two challenges. First, storing documents will add to the cost of the IU infrastructure, which will then be passed on to users. This may make storing credit contracts in an IU expensive and may disincentivise users from doing so. This in turn will pose fundamental viability challenges for the IU business model. Second, if an IU stores financial information as well as documents, its not clear whether both will need to be matched, and if so on whom the responsibility of doing so will fall upon.
The Working Group Report thinks this through properly: an obligation is placed on each IU to inform all IUs about default, and also on each IU to inform all creditors of a defaulting debtor.
Marking records as erroneous: Regulation 25(2) suggests that a user can unilaterally mark any information as erroneous. This is very dangerous. A process needs to be specified for correcting errors, and it should involve confirmation by the counterparties, just like any other information that gets to the IU.
An information utility shall not outsource the provision of core services to a third part service provider.
This clause is problematic, as it can create operating inflexibility for IUs. It is unclear how broad this clause is. For example: does this mean that the IU platform cannot be outsourced, or does this outsourcing ban apply to data center and related services, technology maintenance contracts, technology support personnel, physical security including guards, etc?
Technically, it can be read as an IU having to create every component of its core services delivery entirely on its own. This will increase the time taken for an IU to be set up, as well as add to the costs of service delivery by an IU.
Due to this problem, the Working Group Report suggested that outsourcing of core services could be possible, subject to approval by the IBBI. Alternately, instead of a blanket ban on outsourcing, the IBBI may consider a two stage outsourcing structure. First, a narrow list of services, such as authentication and verification, may be classified as those that cannot be outsourced. For the remaining, an outsourcing model similar to the one that the RBI follows for its regulated entities may be followed. Under this model, two elements are taken into consideration by the regulator when allowing outsourcing: (1) that the standards of service for the user remain the same, whether the components of service delivery are in-house or outsourced; (2) the primary liability, even in case of outsourced services, lies with the regulated entity.
The Draft Regulations provided the information stored in an IU should conform to requirements laid down in section 65B of the Indian Evidence Act, 1872 (Evidence Act). This section of the Evidence Act lays down the standards for storage and maintenance of electronic records so that they are admissible as evidence.
As per Regulation 20(2)(ii), on receipt of information by an IU, the submitter of information will be provided with terms and conditions of authentication and verification of information. It is not clear why the terms and conditions should be provided once the information has been submitted. The user should be aware of these terms before the information is submitted to an IU.
Regulation 21(1) states that on receipt of information about a default the IU shall expeditiously start the process of authentication and verification. This raises following questions:
Regulation 23(2)(b) and (c) states that an IU shall enable the user to view the status of authentication and verification. It is not clear why the status of authentication is required after information has been submitted. IBC mandates that information should be stored only after authentication, so an IU should never store any unauthenticated information in the first place.
The Draft Regulations addressed the above issues by obligating an IU to do the following:
Since the information submitted to an IU is highly confidential and commercially sensitive, it is essential that there should be some accountability for the access of information by the IBBI. The Draft Regulations provided that in order to access information stored in an IU, the IBBI must pass a written order.
The Draft Regulations put the onus of making sure information is transferred from one IU to another on IBBI and the IU. This ensures smooth transfer of information since they will be better equipped with resources to perform this task.
Entry Barriers: Regulation 3 of the IU Regulations requires that IUs have a net worth of at least Rs 50 crores, and prevents foreign control of IUs. Regulation 8 prevents any single shareholder from holding more than 10 percent of the equity share capital of an IU. Together, these have a chilling effect on the entry of firms into this industry.
Annual fees: Regulation 6(2)(e) provides that an IU must pay a fee of fifty lakh rupees to the Board annually. This is a large sum of money, especially given that the business model is unproven. This will discourage entry, limit competition, and increase the fees charged to the users.
In-principle vs regular registration: Regulation 7 is unclear on the difference between a regular approval and an in-principle approval. It is also unclear as to why an applicant would choose one form of application over the other. In the Draft Regulations, the idea was that in-principle registrations would be granted faster than regular registration.
An IU shall provide services without discrimination in any manner.
An explanation follows that mentions specific kinds of discrimination. It is not clear whether the explanation is indicative or if it is exhaustive. If exhaustive, there is no need for the broad prohibition of all discrimination above. This creates confusion for potential IUs.
Regulation 32(2)(a) provides that the fee charged for providing services shall be a reasonable reflection of the service provided. This is a very broad statement in the absence of any test of what a "reasonable reflection" is.
Many of the issues mentioned above can create serious problems for the new (and as yet unborn) industry of IUs. High entry barriers will lead to a monopolistic industry with high prices and poor service. If courts are not convinced of the accuracy of the records stored in IUs, the parties will get stuck in lengthy litigation to establish even the basic facts about the debt. IUs established under these regulations might not serve their basic purpose — the creation of an information-rich environment which would bolster speedy resolution in the country.
Government of India, The Report of the Bankruptcy Law Reforms Committee, chaired by Dr T K Vishwanathan, 4 November 2015.
Government of India, The Insolvency and Bankruptcy Code, 2016
Ministry of Corporate Affairs, The Report Working Group on Information Utilities, chaired by K V R Murty, 11 January 2017.
Insolvency and Bankruptcy Board of India, Insolvency and Bankruptcy Board of India( Information Utilities) Regulations, 2017
Sumant Prashant, Prasanth Regy, Renuka Sane, and Shivangi Tyagi are researchers at the National Institute of Public Finance and Policy, New Delhi. Anjali Sharma is a researcher at Indira Gandhi Institute of Development Research, Mumbai.
The Banking Regulation (Amendment) Ordinance, 2017 recently empowered RBI to issue directions to banks for resolution of stressed assets. After this, RBI issued a Press Release dated June 13, 2017 explaining the process it is following to direct banks to refer certain accounts for resolution under the Insolvency and Bankruptcy Code, 2016 (IBC). Essar Steel has challenged this process before the Gujarat High Court.
A single judge of the Gujarat High Court admitted the challenge at a preliminary level since it found two legal issues in the RBI Press Release. The first stems from poor legal drafting of the press release, and the second issue stems from the retrospective criteria of classification of accounts.
One of the fundamental features of the Indian constitution is separation of the judicial wing of the State from the executive wing. The judiciary, i.e. courts and tribunals, is supposed to be independent from the executive (government and regulators). When NCLT was being set up, its constitutionality was challenged for violating this basic principle. After a decade-long court battle, and consequent modifications to NCLT's structure, the Supreme Court was finally satisfied with the independence of NCLT from the executive wing.
RBI's Press Release dated June 13, 2017 walked into this delicate situation. While identifying certain accounts for reference by banks under the Insolvency and Bankruptcy Code, 2016 (IBC), the RBI mentioned:
Such cases will be accorded priority by the National Company Law Tribunal (NCLT).
In this, RBI, which is part of the executive wing, is directing NCLT, which is part of the judicial wing, on how it should list and allocate cases before itself. This direction concerns a core judicial function. This is beyond the powers of RBI. The newly inserted section 35AB(1) of the Banking Regulation Act, 1949 empowers RBI to issue directions to banks only.
In addition, a press release is not a legal instrument, and it appears overbearing to put this direction into a press release.
Hence, the Gujarat High Court found this direction 'quite shocking'.
RBI constituted an Internal Advisory Committee (IAC) to advise it regarding which cases should be considered for reference for resolution under the IBC. The Press Release dated June 13, 2017 says that the classification criteria developed by the IAC is as follows:
In particular, the IAC recommended for IBC reference all accounts with fund and non-fund based outstanding amount greater than Rs 5000 crore, with 60% or more classified as non-performing by banks as of March 31, 2016.
Essar argued that after March 31, 2016, it has taken various measures to ameliorate its financial stress. It was submitted that RBI's Press Release dated June 13, 2017 did not take these developments into account since it chose March 31, 2016 as the cut-off. RBI did not explain the reason for this retrospective criteria of classification - why did RBI in June 2017 choose to classify accounts based on their non-performing status as on March 31, 2016? This lack of explanation in RBI's Press Release gave Essar the opportunity to argue that RBI is acting arbitrarily.
The order by the Gujarat HC clearly explains the legal concerns about RBI's Press Release. Their action is mild: they have listed the matter for July 7, 2017, so that RBI gets an opportunity to present its version before the court. Till then, if Essar's matter comes up before the NCLT, it is required to be adjourned.
Standard Chartered Bank, one of the respondents in the case, appealled against the order of the single judge before a division bench of the Gujarat High Court. Reportedly, this matter was heard and then adjourned to July 11, 2017.
RBI suffers from low capacity in legal drafting. In this case, however, it is unlikely to lead to a serious legal problem. RBI's lawyer should ideally request the court to permit it to expunge that one line from the RBI's Press Release. That should allay the court's concern about separation of powers.
The second issue is more serious. RBI's Press Release does not explain why the IAC chose to use the non-performing status of the accounts as on March 31, 2016 for classifying the accounts in June 2017. However, if RBI's lawyers can provide the court with a clear rationale for choosing that particular date, the court may dismiss Essar's challenge. If RBI's lawyers fail to do so, the matter could drag on, causing much uncertainty in the stressed asset resolution regime.
Pratik Datta is a researcher at the National Institute of Public Finance and Policy, New Delhi.
